Nonprofits Face the Same Legal Pitfalls as Businesses — and Often with More at Stake
Many people think nonprofits operate in a different legal universe than businesses. After all, they don’t have shareholders, they rely on donations, and their mission is public service.
But under California law, a nonprofit corporation is still a corporation — and that means it carries many of the same legal and governance responsibilities as its for-profit counterpart.
Whether you’re a CEO, executive director, or volunteer board member, the obligations are real: maintaining bylaws, keeping accurate minutes, following proper voting procedures, and ensuring the organization acts within its stated charitable purposes. The failure to do so can expose board members to personal liability and even jeopardize the organization’s tax-exempt status.
As nonprofits grow, these risks often multiply. What begins as a clear charitable purpose — say, supporting local youth programs — can evolve over time into a range of community services, grants, or partnerships. Each new initiative may introduce new regulatory or tax implications. Expanding a mission without revisiting bylaws, board resolutions, or charitable purpose statements can unintentionally take an organization outside its approved scope, raising red flags with the Attorney General’s Office or the IRS.
Shared Foundations, Different Pressures
Both nonprofit and for-profit corporations must follow similar formalities — but nonprofits often face greater challenges doing so. Boards are usually composed of volunteers who wear multiple hats. Leadership changes more frequently. Resources are tight, and compliance can take a back seat to mission-driven work.
Having served on boards in higher education, healthcare, community development, and economic development, and as legal counsel to several nonprofits, I’ve seen firsthand how dedicated leaders pour their energy into serving others — sometimes at the expense of tending to their own governance. It’s not neglect; it’s passion. But passion without structure can lead to problems.
Like any corporation, a nonprofit must operate according to its bylaws and governance documents. That includes holding regular board meetings, keeping accurate and timely minutes, maintaining a current conflict-of-interest policy, documenting major votes and resolutions, and filing required reports — including the IRS Form 990.
When formalities are ignored — meetings not properly noticed, minutes not approved, decisions made informally without documentation — the organization’s corporate “shield” weakens. In serious cases, that can blur the legal line between the nonprofit and its directors or officers, opening the door to personal liability. It can also create confusion about authority and accountability, which regulators and auditors quickly notice.
Failure to observe these formalities can have serious consequences: loss of tax-exempt status, regulatory penalties, donor distrust, and even personal liability for directors if governance lapses are deemed a breach of fiduciary duty.
Understanding Fiduciary Duty — and Why It Matters
One of the most common gaps in nonprofit governance is a lack of clarity about fiduciary duties — what they are, and what they require of board members.
Serving on a nonprofit board is not just an act of community service; it creates a fiduciary relationship between the director and the organization. This means the board member is legally bound to act with care, loyalty, and obedience:
Duty of Care: making informed, thoughtful decisions and paying attention to the organization’s operations and finances.
Duty of Loyalty: putting the organization’s interests above personal or professional ones and avoiding conflicts of interest.
Duty of Obedience: ensuring the organization stays true to its mission, complies with its governing documents, and operates within the law.
The Duty of Loyalty, in particular, often trips up well-meaning directors. It prohibits conflicts of interest and self-dealing, requiring board members to:
Put the interests of the organization ahead of personal or financial gain
Disclose any relationships or benefits related to board decisions
Recuse themselves from votes where personal interests are involved
Common risk areas include hiring friends or relatives without proper process, approving contracts with businesses tied to board members, or steering grants toward personal affiliations. Even well-intentioned missteps can lead to investigations or the loss of tax-exempt status if they’re not handled transparently.
Real-World Scenarios
These issues aren’t hypothetical. I’ve seen boards approve contracts without disclosing conflicts, fail to keep minutes for months, or make major funding decisions without documentation. In one case, a foundation director approved a six-figure grant without a recorded vote and another where there was a vote but they had not established a quorum; in another, a nonprofit dissolved but failed to follow procedures for distributing assets, triggering a state inquiry.
These weren’t bad actors — they were passionate community leaders who simply didn’t realize that governance standards still apply, even in organizations driven by service.
Governance as Stewardship
Strong governance isn’t bureaucracy — it’s stewardship. Clear bylaws, transparent decision-making, and well-documented oversight protect not only the organization, but also the mission it serves.
The best-run nonprofits treat compliance not as red tape, but as a way to build public trust. When boards and executives commit to sound structure, donors feel more confident, regulators stay comfortable, and the organization can focus on what truly matters: making an impact.
The Takeaway
At the end of the day, both nonprofits and for-profits thrive when they operate with discipline, accountability, and integrity. The laws governing corporations are designed to promote exactly that — and nonprofits are no exception.
For those who lead, serve, or advise nonprofits, understanding that legal foundation isn’t just about avoiding risk — it’s about sustaining mission.
Interested in corporate best practices for for-profit businesses? Read our article on maintaining liability protection for LLCs and corporations.
By Jesse Molina, Managing Attorney at Valley Business & Tech Law, where he advises nonprofit and business leaders across California.
