Two daughters of the late Paul Newman have filed a lawsuit against their father’s nonprofit organization, claiming that the Newman’s Own Foundation has “lost its way” since their father’s death and is not preserving and honoring his legacy, CNN Business recently reported. Filed in Connecticut by sisters Susan and Nell Newman, the suit alleges breach of fiduciary duty by the organization’s board and claims that the $400,000 in contributions each of Newman’s five daughters was set to control each year had been improperly cut in half starting in 2020.
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“This lawsuit arises from family members who are alleging that the funds of a nonprofit are not being distributed according to the wishes of the individual who established the foundation,” said Marvin Cigarroa, Broker, Professional Liability, Burns & Wilcox, San Diego, California. “That is a very common type of allegation that you would find with nonprofits.”
Such litigation could prompt coverage under a nonprofit organization’s Directors & Officers (D&O) Insurance, which protects the organization and its board members in their fiduciary duty, roles and responsibilities, and decisions they make on behalf of the foundation. “I think this lawsuit reflects the exposure that a lot of these nonprofits face,” Cigarroa said.
Nonprofit organizations may be especially vulnerable to lawsuits
Failure to follow through on the mission of a nonprofit organization is a “recurring theme” in litigation against them, Cigarroa said, and it is one of many reasons a nonprofit could be sued. Earlier this month, Black Lives Matter Grassroots filed a lawsuit against the Black Lives Matter Global Network Foundation, accusing one of its board members of siphoning $10 million of donations for his personal use, Business Insider reported. In 2021, the attorney general of Washington, D.C., announced a lawsuit against nonprofit Pavilion USA 2020, Inc. over improper use of charitable funds at the expense of the organization’s goals, and in 2015, the New York attorney general’s office sued the National Children’s Leukemia Foundation after it was discovered less than 1% of its funds raised directly assisted leukemia patients, Fox News reported.
Those who serve on nonprofit boards must ask themselves, “What is the mission of the organization and is the board following through on that mission and making decisions in accordance with it?” Cigarroa said. “The Newman’s Own lawsuit is a high-profile case that helps illustrate the exposure that nonprofits face.”
When a foundation is sued, D&O Insurance can immediately help with legal defense costs and could also cover eventual settlements or court judgments against the organization. While this coverage is vital for corporate entities and nonprofits alike, not-for-profit organizations could be especially vulnerable in a variety of ways.
“With nonprofits, there could be a narrower focus of what the intention of a nonprofit is and, more importantly, what their funds are supposed to be used for. That is where nonprofits can get tripped up,” he said. “They may have the duty they owe to their stakeholders of where those funds are going and if they are not being distributed to the right beneficiaries or in the correct way. This raises a heightened exposure as opposed to a for-profit company where they answer to shareholders, and you are allowed to change your strategy and invest the money as you wish.”
The financial footing of a nonprofit could also be less steady. Many nonprofit groups have struggled during the pandemic, with a 2021 report showing that more than one-third of nonprofits were in jeopardy of closing within two years due to pandemic-related financial harm, PBS reported. Earlier in the pandemic, some even pushed for legal immunity for nonprofits because they could be sued over their inability to executive their missions amid COVID-19 concerns, USA Today reported in August of 2020.
“A larger nonprofit like Newman’s Own Foundation is more likely to be in a fairly healthy financial position, but that is not the case with a lot of nonprofits,” Cigarroa said. “There are grassroots organizations that are going year by year and maybe they do not have that cash balance to be able to withstand this type of claim and keep the organization going.”
Without D&O Insurance, those out-of-pocket costs can add up quickly. “As soon as that claim is made, you must legally start defending it. That means getting lawyers on the case,” he said. “They may not have done anything wrong, and it may end up being dismissed or going in favor of the nonprofit but at the end of the day, you still must incur all the legal expenses. For a smaller nonprofit, that could be a big burden. That is not even getting into the potential of a settlement or adverse verdict. If they do not have insurance, that is a big concern.”
Board members’ personal assets at risk
The U.S. has around 1.8 million nonprofit organizations, with expenditures of $1.94 trillion, according to a 2021 report from the nonprofit Urban Institute. Canada has an estimated 170,000 registered charities and nonprofits, representing 8.7% of the country’s GDP, or $189 billion, according to Imagine Canada. When a nonprofit organization is sued, its board members are often individually named in the lawsuit and their personal assets could be at stake if the board is not covered by D&O Insurance.
“If you volunteer to serve on a board and they do not have the insurance and they do not have the funds to indemnify you for legal expenses and any settlement, you are potentially on the hook for your personal assets,” Cigarroa said. “You are trying to do a good thing and volunteer on a board, but now you could end up jeopardizing your personal assets. D&O Insurance is there not only to protect the mission and the financial position of the organization itself but also the personal assets of the directors and officers.”
In addition to a nonprofit founder’s family members, lawsuits against an organization can also come from its donors, governmental entities, volunteers, or former employees. “Volunteers with grassroots or local community organizations may not really be thinking about what can happen or where these lawsuits can come from,” he said. “Donors that donate to these nonprofits could bring a suit saying they made large donations, but the money is not being invested or used for the activities it should be used towards.”
Legal action could also be taken when a nonprofit receives funding from a governmental source or another organization. “Nonprofits a lot of times are getting contracts from government sources, and with these grants, there are responsibilities,” Cigarroa said. “These bodies that are giving these grants could come in and audit them and make sure they are spending that money appropriately. The oversight and accountability comes from a lot of different sources.”
Consider employment-related allegations, liability limits
Beyond the legal risks boards may face over financial oversight, nonprofits can also be sued for employment-related matters. Nonprofit organizations accounted for 10.2% of total U.S. private sector employment in 2016, according to the Bureau of Labor Statistics, and 12.8% of all jobs in Canada as of 2019, Statistics Canada reported. In August, nonprofit group Vote.org was sued by its founder for wrongful termination and other allegations, Time reported.
Employment-related lawsuits over alleged discrimination, harassment or other issues can trigger the Employment Practices Liability (EPL) Insurance portion of a D&O Insurance policy. While these two types of insurance are usually purchased separately by private companies, they are often combined for nonprofit D&O Insurance, Cigarroa said.
“That is a really big benefit for the not-for-profits,” he explained. “That can cover harassment and discrimination claims from not only employees but also customers and vendors bringing those types of claims against the nonprofit and the board.”
This can also include volunteers, which are often excluded on corporate D&O Insurance policies but can be covered on a nonprofit’s policy. “That is a key point that these nonprofits need to understand,” Cigarroa said.
From hiring decisions to how charitable funds are spent, documentation is a critical part of risk management for nonprofit organizations, he added. Nonprofit organizations should also find out whether their D&O Insurance includes defense costs inside or outside of their liability limits. If defense costs are included in their liability limits, this could “significantly reduce” the nonprofit’s ability to pay a final settlement, Cigarroa pointed out.
“Defense costs are usually included within the limit of liability. When determining how much to purchase, just keep in mind that your defense costs will erode your limit of liability,” he said. “For nonprofits, one of the advantages of insurance is not having to worry about how they are going to pay the defense costs. If you are a small nonprofit and you get a claim with no merit, if you do not have this program you are going to start tapping into your funds.”
Since nonprofits are often tied to specific regulations over how their funds are used, he said, that may not even be possible. “A lot of times, donors donate funds with a very specific purpose of what those funds are for. Defending a claim is not one of those uses,” Cigarroa said. “A lot of cash that a nonprofit may keep on hand is earmarked for specific purposes that may not be able to be used in defense of a claim.”
