Six Key Steps for Managing Nonprofit Corporate Governance Disputes

For most nonprofit organizations, it is a rare occurrence for internal corporate governance disputes to escalate to the point of litigation. However, court cases are sometimes unavoidable. A recent D.C. Court of Appeals decision addressed several important issues related to corporate governance challenges and illustrated some key steps nonprofits can take to better manage these disputes.

Summary of the Case

This case, OverDrive, Inc. v. The Open eBook Forum, 288 A.3d 305 (D.C. 2023), happened to be one with which I was directly connected. The organization (one of my clients) was a 501(c)(6) trade association whose Board of Directors and voting members voted to approve a transaction similar to a merger with a larger organization. The transaction was challenged in court by a dissenting member, leading to over six years of litigation. With the help of litigation attorney David G. Ross (now with Garris Horn LLP), the organization ultimately won a case-ending victory in the D.C. Court of Appeals, which affirmed the lower court’s summary judgment ruling declining to invalidate the transaction.

Specifically, OverDrive was the first case to address a provision of the D.C. Nonprofit Corporation Act, D.C. Code § 29-401.22(c), that limits the court’s power under certain circumstances to “hear and determine the validity of a corporation action” if the nonprofit corporation has “provided in its articles of incorporation or bylaws for a means of resolving a challenge to a corporate action.”  

The D.C. Court of Appeals held that so long as this mechanism is not illusory, a D.C. court’s power to review the validity of a corporate action pursuant to a case brought under D.C. Code § 29-401.22(a) is limited to enforcing the organization’s Articles of Incorporation and Bylaws. The court determined that the organization satisfied this standard based on a Bylaws provision establishing that a vote to rescind any Board action would be held upon the petition of a group of voting members at least equal in number to the number of Board members (14, in this case), a process that the dissenting here failed to use.

Additionally, the court held that this mechanism was not rendered illusory by the fact that the organization did not provide the dissenting member with the email addresses and names of the specific individuals designated by the other members to vote on their behalf (note, the D.C. Nonprofit Corporation Act generally entitles members only to the “names and addresses” of voting members. See D.C. Code §§ 29–405.20 and 29-413.02). Mr. Ross has written a helpful summary of the case with additional details that you can read here.

Lessons for Other Nonprofits

As a technical matter, the holding in the OverDrive case is limited to organizations that are incorporated in the District of Columbia, and there not many other jurisdictions that have this same language in their nonprofit corporation statutes (the State of Washington is one that does have similar language).

Further, this holding is not likely to apply in certain other contexts in which there may be challenges to corporate actions, such as “derivative lawsuits” brought in the name of the organization to address fiduciary breaches and similar issues, claims based on a member’s allegation of direct injury such as an improper termination of membership status, and petitions for enforcement of member rights such as the right to hold meetings and inspect documents.

Nonetheless, this case and the facts addressed therein illustrate some lessons that could have a far-reaching impact on nonprofit organizations in general, particularly those that are structured as membership organizations and/or are exploring potentially contentious transactions or decisions.

The following recommendations will help nonprofit organizations to manage internal disputes more effectively and mitigate the potential damage of these disputes if they escalate to the point of litigation:

1. Work towards building a culture that is open to dissenting views.

 An organization should strive to welcome feedback and differing opinions from Board members, management, staff, and (if applicable) voting members, actively and genuinely engaging with dissenting viewpoints before making a final decision. While not all disputes can be resolved through open discussion, in general disputes are less likely to escalate to litigation if the parties feel like they have been heard and treated fairly.

This first recommendation can be the most difficult to implement. Building this organizational culture takes time and persistence, but organizations that work toward this goal tend to be healthier, more sustainable, and better at managing risks over the long term.

2. Consider amending the Bylaws to add a process for hearing and addressing dissenting views.

The practical impact of the OverDrive case is that D.C. courts have limited power to invalidate an organization’s decisions if the organization has an internal process in its governing documents to hear and address dissenting views. This is consistent with the general reluctance of courts to “interfere with the management and internal affairs of a voluntary association,” Blodgett v. Univ. Club, 930 A.2d 210, 225 (D.C. 2007).

Accordingly, organizations whose Bylaws do not already have such an internal dispute resolution process should consider adding one. This will provide D.C. nonprofits with special protections under D.C. Code § 29-401.22(c), but having a process to hear and address dissenting views can benefit nonprofits generally regardless of jurisdiction. In addition to helping to establish a strong organizational culture, it can also strengthen the perception that dissenting views were treated fairly and that the final decisions were well-grounded and consistent with fiduciary duties.

There can be a wide variety of approaches to these provisions beyond the rescission procedures discussed in the OverDrive case. For example, the Bylaws could provide for an independent advisory committee whose opinion on certain important decisions or transactions can be sought upon petition by a minimum number Board members, officers, or voting members. Alternatively, the Bylaws could provide a more structured process for building consensus such as “fist to five voting,” to name one example. It is currently unclear what characteristics are needed to qualify as a “means of resolving a challenge to a corporate action” under the D.C. Nonprofit Corporation Act, but organizations should not hesitate to experiment and build a process that fits their unique culture and needs.

3. Know what documents and information to which dissenters are, and are not, entitled.

Access to documents and information is a hotly contested issue in most internal organizational disputes. The people on both sides of an issue usually want as much information as possible to understand the facts of the situation, vet the other side’s actions, and build their arguments.

However, not all requests for documents are made in good faith. There is a fine line between healthy transparency and bad faith attempts to stall the decision-making process. An organization cannot safely make these distinctions and set clear boundaries without being fully informed about which documents and information must be provided to dissenters under the applicable laws and which requests may be denied.

Planning Tip – Just as it is important to have policies and procedures for responding to document disclosure requests from the public, it can be equally important to have policies and procedures for responding to requests for documents from people inside the organization, such as Board and committee members, staff, and voting members. The appropriateness of document requests from those inside the organization will vary depending on their roles and reasons for wanting the information, so having clearly established policies and procedures can help to mitigate the appearance that the organization is acting arbitrarily and/or with improper motives in the event a request for information is denied.

For example, a key issue in the OverDrive case was whether the dissenting member should have received the email addresses and names of the individuals designated by the other member organizations to vote on their behalf. The organization in this case determined (and the court agreed) that this information went beyond the information to which the member was entitled under the law. Had this organization not scrupulously complied with all applicable disclosure requirements, its position in court would likely have been seriously undermined.

4. Carefully follow all governing document and statutory requirements related to meeting and voting procedures.

Similar to the document disclosure requirements, navigating meeting and voting procedures can be perilous. A single slip-up in this area has the potential to jeopardize months or years of hard work on a transaction or other decision. In the leadup to any vote on a contentious matter, it should be a priority to double and triple check the processes set forth in the organization’s policies and governing documents as well as the requirements of the applicable state nonprofit corporation law.

Make sure to pay special attention to quorum and minimum voting approval requirements, voting eligibility and how good standing status may be restored, the timing of meeting notices, requirements related to the provision of ballots and related information, the counting of votes, and how to document all of the above.

If necessary, build in time to amend the governing documents to address ambiguities that could impact the outcome before taking the final vote. Of course, this should be done transparently and in the interest of reaching a more fair and conclusive outcome rather than a thinly veiled attempt to bias the process.

5. Be aware of possible conflicts of interest and take steps to properly manage them.

There is no quicker way to taint an otherwise well-intentioned transaction than by improper management of conflicts of interests. Therefore, it is of the utmost importance to be on the lookout for potential conflicts of interests in any transaction, especially those that may be controversial within the organization. As always, the organization’s processes for conflict of interest disclosures and independent review of conflict of interest transactions must be carefully followed.

Proper management of conflicts of interest is important for both public perception and legal reasons. In the context of a corporate governance dispute, failure to properly manage a conflict of interest can create additional grounds for invalidating a transaction under applicable state law.

For example, one of the points of the transaction in the OverDrive case was that the organization’s Executive Director was to have a paid position with the recipient organization following execution of the deal, a common provision typically intended to help ensure these transactions are successful. Fortunately, this conflict of interest was fully disclosed to the organization’s Board and voting members and the Executive Director’s role in the approval process was properly limited so this was not a fact that the dissenting member could successfully use to block the deal.

6. Thoroughly document all Board and member meetings.

Board and member meetings take on a heightened significance in the midst of an actual or potential dispute. The meeting minutes are the most important records of what took place at these meetings and how decisions were made. Moreover, the meeting minutes are often required by law to be disclosed upon request to those within the organization such as directors and voting members, so these are often the first documents to be heavily scrutinized by dissenting parties. And having clear and thorough meeting minutes that are contemporaneously approved and certified by the appropriate officer will go a long way toward framing the narrative around the disputed issue(s).

For these reasons, it is crucial to follow best practices in drafting meeting minutes and make sure to be accurate and intentional about the information included in these documents. For example, in documenting the final approval of a transaction, recap the due diligence steps that the Board took that led to its final decision and document any steps taken to manage conflict of interest transactions, if applicable. At the same time, be careful not to include any inaccurate or false statements or opinions that may appear biased or one-sided in the minutes, as these are sure to be seized upon by those looking to undercut the approval process.

Conclusion

Whether your organization is currently working through an internal dispute or is preparing to hold meetings on a potentially contentious transaction or decision, it is important to be careful and thoughtful about how the organization responds to dissenting opinions. How an organization manages an internal dispute will directly impact its ability to mitigate the potential harm to the organization and defend a corporate governance lawsuit if the dispute continues to escalate.