By John G. Fornaro
To err is human, so how does that relate to boards of equity, non-profit, private clubs. Well, mistakes that private club boards make are often considered ‘sacred cows’…the less said about them the better.
But it’s important to understand the legal implications and impact mistakes can have upon the successful operation of a private club. And the fact is when a board is clear about what it wants to do, and where it wants to go, the process becomes a lot easier.
So, if we accept the premise that private club boards do make ‘legal’ mistakes…what are they, and what can private clubs and their boards do about it.
Certainly, private club boards, committee and the club’s management make mistakes, but often what we call ’human errors’, mistakes that happen because we are human.
But it’s something quite different for boards to engage in ‘legal governance mistakes’, and for various reasons.
“The biggest governance mistake is to obfuscate the role of the paid management (GM and department heads) with volunteer leadership (the board and committees),” expressed Tarun Kapoor, a private club consultant with Kapoor and Kapoor Consultants.
“When volunteers, board members engage in operational matters they risk affecting the club’s liability. Every operational decision has both financial and legal implications. Volunteers should focus on establishing and enforcing guidelines to maximize efficiency and minimize liability.
“Human mistakes will prevail if the club’s governing documents fail to articulate roles and responsibilities as described,” he stressed.
If this is the case, what can be considered a ‘legal mistake?” Depending upon whom you speak with, ‘legal mistakes’ vary.
“Boards tend to make decisions sometimes on a ‘short-term and quick response basis’ without review as to long-term consequences on club operations and non-compliance with the club’s existing bylaws and membership agreements,” explained Randy Addison of Addison Law of Dallas, Texas.
“For example, a club experiences a loss of membership sales that a board attempts to fix with a “non-equity” or “modified equity” membership offering that lowers the value of club equity membership, and is not in compliance with existing bylaw requirements.
“Or, a board’s unilateral implementation of new programs, member rights, fees or assessments that are not in compliance with existing governing documents.
“Another issue,” Addison added, “is a board taking actions and not updating or amending the governing documents by the required actions, including a vote of the members, if necessary.”
This is certainly a point that resonates with others, including Michelle Tanzer, an attorney with GrayRobinson of Orlando, FL.
“Attempting to change governance documents or membership agreements without following the formal requirements of amendment,” in Tanzer’s opinion is a legal mistake.
“Recently, many clubs have attempted to revise categories of membership, create new categories, change redemption rights and make other changes to equity members’ rights by board action or simply by instituting new ‘policies.
“Doing so without following the procedural requirements frequently leads to disputes with members that could otherwise be avoided,” she added.
“Considering all the legal mistakes clubs can make, three come to mind as being completely avoidable, but possibly devastating,” offered Robyn Stowell, a partner in the Scottsdale, AZ-based law firm of Sherman & Howard.
“First, some clubs do not follow their documents or (for member-owned clubs) applicable state statutes. Secondly, they do not consult with the proper resources when making decisions, which is important for the board to be covered by the ‘business judgment rule’, which essentially protects directors when they make a wrong decision, but with the best available information.
“Third, they (board members) do not understand and live up to the directors’ fiduciary duties, which require among other things appropriate information and diligence in making decisions for the club,” Stowell opined.
“Directors are often surprised to know that they can be liable personally for their actions and/or for decisions that the board makes. For example, directors’ and officers’ liability generally covers directors when they are acting in their role as a director.
“Directors have been deemed to be acting outside the role of director when they violate their club governing documents, when they act individually rather than as a board, or when they are acting as an individual member,” Stowell stressed.
“When boards and/or directors violate their fiduciary duty or their club’s governing documents, resulting litigation can be expensive and embarrassing for the club,” she maintained.
It’s a requirement that board members understand their fiduciary duties and responsibilities, that they accept the responsibility to act with the duties of good faith, due care and loyalty, and it’s at a board member’s peril to not do so.
“Reviewing and knowing about contracts, in my opinion, is one mistake,” said Gordon Welch, a former club manager and now president of the Association of Private Club Directors. “Boards generally do not review contracts and sometimes do not even know they have one in place. I, for example, was hired at a club and had a contract with the previous GM and the board did not know it. The board fired him and he sued and won. Someone on the board should be aware of the contracts and maybe this should be a part of an annual review.”
“Secondly is the fiduciary responsibility of understanding the financials. Most boards are truly not aware. I read recently of a club going bankrupt and it was an oversight problem. The club is a real business and should be run as one.
“All are human errors, and they often happen when things are going well in the club and the board becomes lackadaisical,” he commented.
What are the implication of these ‘legal’ mistakes?
“We live in a litigious society and the number of clubs becoming the target of legal action is on the rise,” offered Tanzer. “Implications for a board, club’s management and members range from a mere inconvenience or nuisance, to complete ruination of the club.
“Those familiar with the Spokane Club case know that a handful of disgruntled members’ discrimination law suit against the club ultimately resulted in a judgement against the club, hundreds of thousands of dollars in legal fees and costs, bankruptcy and then sale of the club facilities to a third party and the termination of the private club.
“While most governance documents provide for indemnification for board members, the indemnification is generally not without limits. For example, if an action or inaction was taken in bad faith by a board or a particular board member, the indemnification may not be available,” Tanzer explained.
“Costly litigation, public disputes between board Members, loss and potentially freezing membership sales due to public dispute, use of disputes by competing clubs, individual liability to board members,” are often the result, added Randy Addison.
So, to overcome these issues, “boards need to periodically review and revise the governing document, bylaws and membership agreements to reflect changes in the law, the club’s operations and the marketplace.
“The boards should participate in ‘club governance’ programs and presentations as governing a club is complex business, a ‘city’ with many new issues a corporate board does not have,” Addison explained.
Kapoor agrees. “Clubs must update their governing documents, and clearly articulate the roles of the board, the officers, the committees and management. They need to have checks and balances in place to minimize human mistakes. Board and volunteer orientations must focus on the do’s and don’ts.”
Yes, the board and volunteer orientations are a must in today’s private club world.
“Each board term should begin with a rigorous board orientation on legal issues given by someone who truly understands the legal issues specifically. Each director should start their term understanding their legal duties and responsibilities, what they can and must do (and NOT do), and the actions or inactions that could lead to personal liability,” explained attorney Stowell.
“It may sound overly simplistic, but the best way to overcome governance legal issues is to get proper advice from the outset from a legal professional well-versed in club law. So often clubs will rely on the legal experience of board members. While the legal experience of a board member may be very valuable, if the experience is not within the realm of club law, certain issues and risks may not be fully appreciated or vetted,” added Tanzer.
“Club operations and governance is an ever-changing business and the wrong actions taken by a board can be devastating to the club, its members and individual members on the board,” injected Addison. “Consult with someone with long term club experience.”
Publisher’s final thoughts
Many of the specific legal mistakes have been raised by these contributors well versed in the private club industry, but there are a few other specifics, I raise that can also have ugly implications.
Board oversight: It’s crucial that boards provide oversight to the happenings in a private club. Often tasks are delegated to board members, committees, staff or perhaps people hired for specific tasks. However, it’s a requirement of the board to make sure it provides sufficient oversight, meaning, the board must ensure that board policies and procedures are being followed.
This can include a review of financial statements and the implementation of various government policies, including, for example, conflict of interest, senior management compensation etc.
Preventing the club or the board members from lawsuits is the responsibility of the management and the past board members. Club management and previous board members must make sure the newly elected board members understand and commit to their duties…their roles and responsibilities.
A proper board orientation is extremely important. Not just to understand the financial landscape of the club, but also an understanding of what a non-profit private club is. New board members must understand the seriousness of their duties when they agree to serve on the board. While a volunteer brings in a depth of knowledge of how the organization work, they really may not understand what a board does.
I recommend the following. An initial meeting with each committee chair, general manager and past president, and a one-on-one with the general manager and past president is the start of the orientation. Each of these volunteers must be informed on the organization, history, mission and bylaws.
The next step is training, and I recommend a third-party day orientation or online non-profit club specific board training. Boardroom magazine’s ‘BoardRoom Institute’ is a great option.
This training should consist of an outline of the roles and responsibilities and an understanding of the duties of each committee chair, which of course varies with of the club’s committees. Also, an understanding of their fiduciary responsibly as a board members is a significant requirement. They should also understand the private club industry, their specific kind of club, and whether it is a for-profit operation or a 501(c) (7) non-profit equity club.
Providing oversight, ensuring the board establish policy while allowing the club’s management to handle the day-to-day operations (in other words, no micromanaging staff), and understanding and having an awareness of laws governing tax exempt clubs is vitally important for incoming board members.
We can borrow the Las Vegas line here: “What happens in the boardroom must stay in the boardroom.” When board members accept their position, they also accept the responsibility to act with good faith, due care and loyalty.
And with duty of loyalty board members accept the implied duty of confidentiality. Once a board settles an issue in the board room, it’s a fundamental requirement that the board presents a united front.
Airing of disagreements outside the boardroom or any confidential information about the members goes against the grain of the duty of loyalty.
Board members must hold each one accountable for their behavior, lives by the club’s code of ethics, avoid conflicts of interest, and seek to manage a club’s portfolio appropriately and to the benefit of the club’s members.
Board members are stewards of the club’s assets and the number one priority of the board must be to protect the club’s assets.
At least, that’s the way I see it! BR
John G. Fornaro, publisher
If you have comments on this article or suggestions for other topics, please contact John Fornaro at (949) 376-8889 or via email: email@example.com