Non Profit Law

Galston – Fall 2011

Governing Law

  • State Law – each state has different nonprofit/corporate law requirements
  • Model Nonprofit Corporation Act (MNCA) – not adopted by any state
  • Model Nonprofit Act of 1952 – Adopted by 12 states
  • Revised Model Nonprofit Act of 1988 – 26 states loosely base laws on RMNA
  • Internal Revenue Code
  • Treasury Regulation (Official Interpretation of the IRC)
  • Revenue Ruling – IRS admin. ruling that applies Code to particular facts (nonbinding)
  • Gen.Counsel Memo – explains reasoning behind Rev. Rulings

What is the Non-Profit Sector?

  • Difference between federal tax-exempt and state non-profit (state law term)
  • Nonprofit—must file within state and assert a promise that the organization will exist for a certain purpose and with a certain form
  • Under state law, all you have to allege is any lawful activity and allege the non-distribution constraint
  • Tax-Exempt—any entity that is tax exempt is a non-profit
  • Not every entity that is a non-profit is tax exempt
  • Tax exemption must come from the feds
  • Lots to do to become federally tax exempt
  • Benefits
  • State: state income tax, sales tax, property tax, and qualifies for tort liability statutes in that jurisdiction
  • Federal Benefits: pension rules, federal income tax, FUTA taxes, postal rates are lower, relief from tort liability
  • Many states piggy back on feds in deciding on whether to give state exemption
  • Some states require federal income tax exemption to qualify for state income tax
  • Property Tax Exemption: many states look to local benefits to provide property tax exemption
  • Many use a formula (ie, 30% of services must be provided in state)
  • Fed. Tax Exempt:
  • 501(c)(3)—Charity
  • Public Charities—universities, hospitals, etc.
  • Private Foundations—very heavily regulated; Gates Foundation
  • Other 501(c)
  • 501(c)(4)—social welfare orgs; public purpose and look a lot like (c)(3)s but engage in political activities including lobbying; beneficiaries are not considered a charitable class
  • 501(c)(5)—unions and labor orgs
  • 501(c)(6)—trade ass’ns; chambers of commerce
  • Other 500s-
  • 527—political organizations
  • 528—homeowners ass’n
  • 529—tuition program
  • 530—educational savings account
  • What are the characteristics of a non-profit
  • (1) Voluntary organizations (not-government)
  • (2) Operate without distributing profits to stakeholders
  • Non-distribution constraint---whatever revenues are leftover do not go to stakeholders; no profit share, money is meant for the beneficiaries
  • (3) They exist without simple and clear lines of ownership and accountability
  • How much is too much to spend on fundraising?
  • IRS looks for relationship between source of money and the recipient
  • Dimensions of Non-Profit Sector
  • 2.1 percent of GDP; 1.5 million 501(c); $1.4 trillion for public charities (501(c)(3)’s
  • Charitable Assets (public charities)--$2.6 trillion; 7-9% of workforce
  • Health takes more than half of tax-exempt entities
  • Human Services: crime and legal related, food and employment, disaster preparedness, recreation
  • Public Societal Benefits: civil rights, social action and advocacy, volunteerism
  • 73-75% of contributions are made by individuals
  • The revenue from most non-profits come from fees (hospitals, tuition)
  • 67% comes from fees for services, not individuals donations
  • Purposes of the Non-Profit Sector: Justifying the Charities
  • (1) Cost—
  • Tax Expenditure:
  • Amount government loses by deductions$54 billion
  • (2) Public Services
  • when the government or business does not provide for certain services (immigration representation; religions)
  • (3) Advocacy
  • (4) Experimentation
  • (5) Diversity of Services
  • (6) Speedier Services

STATE LAW TREATMENT OF NONPROFITS

Chapter 2. Starting the Organization at the State Level

II.Considerations of Form When Setting up a Nonprofit Organization

“Research, Money, Personal Support are Key to Successful Charity Startups”

  • Many nonprofits fail early because of lack of these things

A.For-Profit or Nonprofit – Newman’s Own and Google are “for-profit” charities

B.Unincorporated Ass’n, Trust, Nonprofit Corporation

1.Unincorporated Ass’n: group of two or more people working together for a common purpose, who have not formalized the organization as a corporation or a trust

2.LLC and Low-Profit Limited Liability Company (L3C): specific type of unincorporated ass’n that receives protection against the liability it would otherwise face as an unincorporated ass’n; L3C is a for-profit w/ a nonprofit soul—simpler to create than normal nonprofit

3.Trust: trust instrument that irrevocably dedicates specific property to the benefit of the community, rather than to the benefit of an individual

4.Nonprofit Corp.: entity that can sue and be sued, K, and hold property; governed by board of directors

C.Public Benefit or Mutual Benefit

1.Mutual Benefit: serves the interest of its members (clubs, unions)

2.Public Benefit: Serves the interests of others (may become 501(c)(3))

D.Membership of Non-Membership Organization

1.Non-Membership: governed by a board of directors

2.Membership: members elect directors, approve bylaws, and vote

on major decisions (like shareholders); (advocacy groups, churches,

mutual benefit orgs.)

E.Variations Among State Nonprofit Corporations Statutes

1.Focuses on NY, Cal, and Model Nonprofit Corporation Act (MNCA)

III.Legitimate Purposes of Nonprofit Corporations

  • Mostly based on facts and circumstances; no bright line rules of whether a nonprofit is allowed to incorporate

State v. Brown(Ohio 1957); illegality: if its illegal, it cannot be a proper nonprofit; practice of nudism organization application for nonprofit status denied because nudism was not lawful; therefore, could not form org. for unlawful purposes; state had police power to do so

Ass’n for the Preservation of Freedom of Choice v. Shapiro (NY 1961); public policy: exclusionary, supremacist group denied right to incorporate; denied not b/c it was unlawful but b/c it was against public policy;holding – justices and state may not arbitrarily decide which org’s get right to incorporate and those that do not; there is a right to such activity and to associate with each other; dissent—group has a right to meet and associate but not with the support of the state; NB: this is an unusual outcome – brings up debate whether public policy can be a factor; IRS rarely turns organizations down for being against public policy

  • What is the difference b/w public policy and the law?
  • Public policy can be the opinion of the sitting judge; defending the spirit of the law; but not necessarily the majority sentiment

In Re Sidney Gelb Chapter for Cancer Research (NY 1959); duplicative (rare): application for cancer research org denied b/c there were already too many cancer research orgs. in existence and took too much money that may not go directly to cancer research; dissipates resources

People Ex Rel. Groman v. Sinai Temple (Cal 1971):commerciality; religious org. operated a large Jewish cemetery that competed with private cemeteries and gave discounted plots to its members; court did not consider this to be a distribution of gains, profits or dividends; allowed to make money though; selling burial plots to pay off debt

  • Problem: cemeteries is a charitable purpose; Attorney General brought case b/c of private competitors and b/c cemetery was main purpose
  • Two Issues: (1) Constructive distribution of profits; (2)
  • (1) is not per se the payment of a dividend (no reasoned explanation)
  • Does the nonprofit have the power to engage in activities of this kind (corporate power)? According to statutes, yes as long as the profits go to the organization

In Re Shaw (England 1957); purposes: George Bernard Shaw left estate to an unidentified body for the purpose of promoting the reform of the English language; this is not considered charity and for the public utility (“other purposes beneficial to the community”) and is instead a task of general utility that can go to a public trust; therefore, British Museum and Royal Academy can invalidate will and collect immediately, not just after 21 years

New York Not-for-Profit Lawpresents a non-exclusive list of charitable organizations for legal non-business purposes; NY wants you to state the purposes of the nonprofit

  • Type A: not-for-profit corporation including civic, fraternal, social, etc. (mutual benefit groups); some may be 501(c)(4) orgs (lobbying, campaigning)
  • Type B: non-business corporation
  • Type C: lawful business purpose for a public or quasi public objective (micro-finance organizations; low cost housing
  • Type D: health care exchanges or other corporate law groups
  • Restricted to non-profit purposes; non-distribution restraint; reasonable compensation

California Corporations Code:

  • Public or charitable purposes, nondistribution, liability for received funds
  • Nonprofit Section: money come from donors and upon dissolution have to give money to A.G. or give their money to another public benefit organization);
  • Mutual benefit under 7000 (organization are allowed to distribute their assets to their members upon dissolution); or
  • Religious organization under 9000 regime (makes it hard for IRS to conduct an audit federally; main thing AG can go after is criminal actiity)

MNCA: Any lawful purpose; non-distribution constraint; reasonably comp.

IV.Articles of Incorporation

General legal framework for nonprofit; generally includes name, purpose, whether or not it’s a membership org, and the registered agents; vary from state to state; difficult to change usu. by the board of directors unless a special provision applies

  • Look to federal laws for what is required of tax-exempt orgs. and put these into articles of incorporation

NY Incorporations Law: Include name, for public purpose; address; directors; duration; agents

Cal. Incorporations Law: directors; duration; name; declaration of public purpose; address;

MNCA Incorporations Law: MNCA doesn’t even require you to state your purposes (language says “may”); name, address; incorporated?; name of incorporator

Queen of Angels Hospital v. Younger (Cal. 1977): Queen of Angels hospital not allowed to rent out original hospital building in order to operate clinics throughout LA because this is not the purpose of the nonprofit according to its Articles of Incorporation; although its intent is good, this does not matter

  • While Queen of Angels can set up clinics, it cannot abandon the hospital
  • AG may have thought it was a charitable trust that AG must pursue; discourage hospitals specifically from entering into for-profit joint ventures—hospital mergers are big news

V.Bylaws

Internal rules that govern the nonprofit; provide details from the framework; rules for holding meetings, voting on issues, electing directors and officers, and other provisions

NY Bylaw Rqmts. – adopted by incorporators == relates to business fo corporation, conduct of affairs, powers of members, directors, or officers

Cal. Bylaw Rqmts. – similar to above; made by board setting meetings, votes, director/officer duties; reporting and due collecting, etc

American Center for Education v. Cavnar (Cal 1978): Amyx president of ACE; other Cavnar (VP) and Todt (VP) wanted to oust him; Amyx fled building at meeting to oust him; Cavnar and Todt met him at bank, told him he was going to be removed from his position; Amyx stayed and participated in discussion; Board meeting later approved this after giving notice to Amyx of meeting; according to bylaws, procedural requisites, quorum, and meetings were all valid

  • Counter intuitive that bank altercation is sufficient according to bylaws
  • Even in settings where it is okay to remove officers w/o cause, there are courts that will add a gloss that says “yes, but not for certain reasons” (b/c he is African-American)
  • Why does the court permit such informal actions? respecting freedom of K –bylaws may suggest that you can take these actions; also, prevents a standstill for the nonprofit

Chapter 3. The Board of Directors and Their Governance Role

I.Introduction

  • Directors and officers control and there are not shareholders like in for-profit corporations that are present; owe fiduciary duty to organization
  • Duties: make policy decisions, supervise senior staff, and ensure that the org. remains fiscally healthy, and that the org. stays focused on its mission
  • In reality, the officers actually run the directors; technically the model is top down but as a matter of practice it is less linear
  • As a matter of law, the board is liable as a matter of law
  • In general directors can act in two ways—through a majority meeting and also through written consent (need not be at a meeting); in almost all states there must be unanimous written consent – why? better to make decision at a meeting
  • Generally, directors cannot vote through proxy – shareholders can by the directors have a different mandate

II.General Concepts of Governance

Model Act:Became less liberal, less progressive by giving away some of the responsibility; caveat—model act in casebook is third version and not adopted in any state; revised act are the ones that have ben adopted by different states; sets duration; election and removal; compensation; meetings; voting; quorum; etc.

Cal. Code: similar to the MNCA; ultimate responsibility is with the board

NY Laws:min. number, election; duration; removal; quorum to made decisions; meetings and notice; Board does not retain the liability

Herning v. Eason

Hearning wanted to remove Eason; Herning wanted to count proxy votes but Eason didn’t recognize the votes; a new law said voting by proxy was okay but this was not retroactive and org. was older than new law; court says it would be confusing to go back to the original intent and the bylaws did not expressly prohibit voting by proxy

  • Why is this not a substantive law change? Court says that if its substantive, then its prospective but here already had the right to vote

Tackney v. U.S. Naval Academy Alumni Ass’n

Alumni thought certain board members were violating the terms of the bylaws for term limits; dispute: was term limit 6 years or 9 years?; concern was that board was becoming too insular – number of board of directors is set; Courts will respect a reasonable and non-arbitrary interpretation of the bylaws in the absence of express language to the contrary

III.Fiduciary Duties of the Board of Directors (p100)

  • Fiduciaries are those that have a duty to someone or something other than themselves

A.Fiduciary Duties of Care, Loyalty, and Obedience

I.Duty of Care—duty to pay attention to the organization; not very strict--

usually requires just good faith which prevents a court from second

guessing the decision of the director on the merits – courts will look into the rigors of the decision making process (but not too intrusive)

  • Not rigorous

II.Duty of Loyalty—reminds board members to keep the interests of the

corporation paramount and avoid benefitting unfairly from their relationship with the corporation

III.Duty of Obedience—emphasizes the importance of the mission; this is not

accepted in all jurisdictions; can also be put under the duty of care

MNCA §8.30 – Standard of Care for Directors: good faith and due care; disclosure;

delegate authority; reliance on experts and other employees

§ 8.32: may not loan money to director

§ 8.60: Conflict of interest does not make K void; must be disclosed to board or those

who vote, Km ust be fair

§ 8.70: Business Opportunities – director can’t take advantage of business opportunities

Mad v. Lucy Webb Hayes National Training School for Deaconesses

Concerns the fiscal mgmt. Sibley Mem. Hop. in DC; Def. trustees enriched themselves through self-interest and breached fiduciaryduties of care and loyalty in mgmt. of Sibley’s funds; class action by patients; Corporate History: trustees were largely absent from running hospital for almost 20 years – run mainly by Orem and Ernst until their deaths

III.Breach of Duty of Care and Loyalty

A. The Trustees

1.Mismanagement: trustee held to high standard of care and

liable; director must have committed gross negl.

2.Nonmanagement: trustees vulnerable to this b/c of 20 year

lack of mgmt.

3.Self-dealing: may be held in breach of trust when using

bank accounts with which they are associated but most use

less stringent standard that requires only fairness and full disclosure; all trustees in breach of fid. duty accd. to DC Law even though they were of minor consequence

  • Requires care a reasonably prudent person would exercise in a similar situation;
  • Difference b/w prudent person standard and new good faith/reasonably belief that actions are in best interests of organization
  • (1) Good Faith
  • (2) Reasonably Believes in the best interest of the org.
  • [(3) Exercises the Care of a reasonably prudent person] – removed in new model code
  • removed a standard that might hold the directors to a higher level of diligence
  • Non-Profit Problem: there’s even less incentive to be hands-on because of the lack of compensation; in non-profit area there’s prestige in being director in the hopes that more money will be given but not for the purposes of directing the mission of the org.
  • Proposal: have an advisory and honorific board and then have a voting board

Committee to Save Adelphi v. Diamandopoulos

suit against former president and the board because of no oversight of Adelphi and wrongdoing

II.The President’s Compensation – must be reasonable and he must exercise due care; no self dealing; BJR not absolute; here he was overpaid and poor performance

D.Factors: Failure to Exercise Due Care: informed decision making; compensation v. performance; fair dealing

III.The Conflicts of Interest: must further goal of org. not personal interest

A.Adelphi’s Insurance Coverage: insurance obtained from head of ad

hoc committee on school’s insurance; failed to disclose though not in and of itself bad

C.The Board’s Failure to Protect Adelphi from Interested Trustee

Transactions

  • Court concluded that all directors must be removed

Manhattan Eye, Ear & Throat Hospital v. Spitzer;duty of obedience requires decisions of bd. to be faithful to purposes of org.

Board of hospital in Manhattan decided to sell hospital to set up free-standing clinic;