OVERVIEW: Nonprofit Sector

  1. Important distinctions of 501(c)
  2. Tax-exempt vs. nonprofit: not the same thing even though often referred to as the same
  3. Nonprofit refers to state law corporate status
  4. All non profits subject to non-distribution constraints—can’t be a non-profit under state law without accepting this constraint
  5. Can be a non-profit without being exempt
  6. Tax-exempt refers to federal tax rules; also applies to state tax law
  7. Can be exempt without being a non-profit such as a charitable trust
  8. 501(c)(3) vs. other 501(c) organizations (sections of the IRS code)
  9. 501(c)(3): Charitable is a sub-category but we use it as an umbrella category
  10. Can take a charitable contribution only for 501(c)(3)
  11. Code:Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.
  12. Other 501(c)s
  13. Up to 25 501(c) and all tax exempt
  14. 501(c)(4): can lobby and intervene in campaigns so long as not primary activity, no deduction for donations
  15. Ex: Sierra Club
  16. 501(c)(4) can also have a 501(c)(3) organization if kept separate in accounting
  17. 501(c)(3)s: Public charities vs. private foundations
  18. Public charity typically receives income from many donors and operates charitable programs rather than making grants to other charities
  19. Private foundation typically receives income from own endowment and/or a few large donors, and makes grants to public charities
  20. Subject to different tax laws, and different deduction rules
  21. Overview of non-profit sector
  22. Overview of sectors
  23. 5% of GDP
  24. 49% of funds from fees, dues, and charges
  25. Ex: museum entry fees, hospital bills
  26. 29% of funds from gov
  27. 12% of funds from contributions
  28. 10% investment income and other
  29. Source of giving
  30. Individuals larges source of charitable giving
  31. Most gifts given to churches and other religious organizations
  32. Rationales for nonprofit sector
  33. Historical
  34. Such as the growth of voluntary organizations in the American colonies that predated government
  35. Market failure
  36. Inability of the market to handle public goods that can only be consumed collectively because of free rider problem
  37. Definition of public good
  38. A good or service such that
  39. Cost of providing it to many is not appreciably more than cost of providing it to one and
  40. Once the good has been provided to one, it is difficult to prevent others from enjoying it as well.
  41. Examples of a public good:
  42. Public radio
  43. National defense
  44. Public monuments
  45. Scientific research
  46. Clear air
  47. Safe neighborhoods
  48. Government failure
  49. In that government can act only if majority supports; moreover, government action can be cumbersome, unresponsive and bureaucratic. Some things are desired by a large minority
  50. Pluralism, freedom & Solidarity
  51. The nonprofit sector allows smaller groups to play an important role in expressing their values and in engaging in joint action.
  52. Hansmann’s Analysis—Very influential
  53. Financing
  54. Donative—grants or donations
  55. Commercial—fees for services (hospitals, universities)
  56. Control
  57. Mutual—by patrons
  58. Entrepreneurial—self-perpetuating
  59. Non-distribution constraint—profits not to go to equity owners
  60. “The advantage of a nonprofit producer is that the discipline of the market is supplemented by . . . the organization’s legal commitment to devote its entire earnings to the production of services; as a result of this institutional constraint, it is less imperative for the consumer either to shop around first or to enforce rigorously the contract he makes”
  61. CA Corp Code 5410
  62. No corporation shall make any distribution. This section shall not apply to the purchase of a membership in a limited-equity housing cooperative.

FORMATION: Types of nonprofits and charitable purpose

  1. Legal structures
  2. Considerations for form of nonprofit
  3. The speed with which one needs to establish the organization
  4. Legal
  5. The capacity to own property and contract
  6. The capacity to sue and be sued
  7. Concerns with limited liability
  8. The sophistication and goals of the organizers
  9. Financial resources
  10. The type and scale of activities to be conducted
  11. The permanence of the organization and ease of dissolution
  12. Governance requirements
  13. Unincorporated Associations
  14. Definition: two or more persons organized for a common nonprofit purpose
  15. Ex: social clubs, athletic organizations, condo owners, religious organizations—also includes large unincorporated associations such as labor unions and political organizations
  16. Advantages:
  17. Ease of organization
  18. Informal/flexible
  19. No gov approval to form/dissolve
  20. Informality with which it can act
  21. Relatively few statutory formalities
  22. CA does have its own statute limiting members liability and allowing the association to hold real property
  23. Disadvantages:
  24. Lack of certainty in law regarding rights, duties and liabilities of members, directors, officers and agents
  25. Lack of case law/statutory rules
  26. Lack of standard of care for a director
  27. Lack of express operating authority, must rely on agency principles
  28. No separate legal existence apart from their members and individual members can be personally liable (CA limits liability)
  29. Can’t hold title to property (Except in CA)
  30. Charitable Trust
  31. Overview of structure
  32. Oldest type of tax exempt
  33. Fiduciary relationship to property—trustee has legal title subject to equitable duties per terms of a trust instrument
  34. Often used for private foundations
  35. Upon termination property has to go to charitable activities
  36. Difference from private trust
  37. Must benefit the community and not a private individual
  38. Enforced by the AG rather than the trust’s beneficiaries
  39. Can be of unlimited duration
  40. CA Specific
  41. A trust may be created for any purposes that is not illegal or against public policy
  42. A charitable trust is one that is created for religious, charitable, scientific, literary, education, or other purpose
  43. No more than 49% of directors can receive compensation
  44. Advantages
  45. Fewer required formalities than corporations to establish and operate/administer
  46. Can allow continuing control by grantor by naming trustees and successors and specifying purpose
  47. Can easily and quickly form
  48. Ease and swiftness to establish if time is of the essence for the receipt of assets
  49. Disadvantages
  50. High standard of care/liability of trustees
  51. May not be appropriate for an entity that intends to engage in operating activities or intends to have members or community involvement
  52. May be difficult to change if need be; likely need to go to court
  53. If an organization wants voting members this form can be awkward, particularly for family foundations
  54. Nonprofit Corporation
  55. Overview
  56. Predominant form
  57. There is statutory guidance and case law which provides certainty
  58. Governed by statute
  59. Governing instrument is articles of incorporation
  60. CA Structure
  61. Public benefit, mutual benefit, and religious allowed
  62. Permitted for any public or charitable purpose (Corp. C. 5111)
  63. Distributions prohibited (Corp C. 5410)
  64. AG oversight of property dedicated to charitable purposes
  65. Mutual benefit may be formed for any lawful purpose except exclusively charitable (Corp c. 7111)
  66. Formation
  67. Decide where (usually home state)
  68. Decide what type
  69. Prepare articles
  70. CA Corp. 5130 must include
  71. Name of corporation statement of purpose
  72. Name and address of agent for service of process
  73. File articles with Secretary of state
  74. Prepare bylaws (don’t simply use model)
  75. Hold organizational meeting to elect officers, directors, authorize next steps
  76. Get EIN, open bank account
  77. Prepare tax exemptions (state/federal)
  78. Types
  79. Overview
  80. To do good works, benefit society, improve the human conditions
  81. 501(c)(3) or (4)
  82. May have members, may have voting rights
  83. Members cannot have economic interest
  84. AG has oversight
  85. Religious corporations are also within 501(c)(3); less AG oversight
  86. Assets to another nonprofit upon dissolution
  87. Can sue/be sued, contract, hold property in its name
  88. Directors have more limited liability
  89. Indefinite existence and centralized management
  90. Public Benefit Corporation
  91. A organization serving a public/charitable purpose—to do good works, benefit society, and improve the human condition
  92. Members can have no ownership interest, assets held for public/charitable purpose and not to benefit members
  93. Membership can’t be sold/transferred
  94. Mutual Benefit Corporation
  95. Formed primarily to further common goals of members, whether economic or social—rather than public/religious purposes
  96. Ex: Trade associations, social clubs, fraternal associations
  97. Many have members and members often have more rights; may get distribution upon dissolution
  98. Hold themselves out as benefiting a group of individuals or entities, members have pooled their resources to do what they might have chosen separately
  99. Members have an economic interest and can sell their interest
  100. If you say nothing about members in your articles it means you have no members—important for drafting
  101. Purposes
  102. Lawful Purpose and Public Policy
  103. General Rule
  104. Generally any “proper” purpose so long as no personal pecuniary profit and nondistribution constraint
  105. Lawful purpose:
  106. Cannot be for an illegal purpose
  107. Public policy:
  108. Handled as an issue if tax exemption
  109. Commercial purpose
  110. People ex rel. Groman v. Sinai Temple: (based on different/no longer operational statutory scheme)
  111. AG filed a demand for Sinai to show authority for its action
  112. Nonprofit may engage in commercial, competitive, profit-making business as one of its activities
  113. The primary activity and benefit should not be too distant—ex: nonprofit gas station to benefit little league
  114. These activities can benefit its members (here as a discount) without amounting to a distribution
  115. CA Corp. 5140
  116. A public benefit corporation may carry on a business at profit and apply any profit that results form the business activity to any activity in which it may lawfully engage
  117. Commercial activities and property tax exemption
  118. Most issues arise in this area
  119. State property tax exemptions generally construed more narrowly than federal income tax exemptions
  120. Nonprofit hospitals and questions of charity care have been a “battle ground”
  121. CA has its own different categories and elaborate rules for property tax exemption
  122. Charitable purpose
  123. General
  124. Consider if the reason is “rational”—would a rational person in general believe public advantages accrue?
  125. Restatement Third of Trusts
  126. Relief of poverty
  127. Advancement of education
  128. Promotion of health
  129. Government or religious
  130. Other (benefit to the community)
  131. Preamble to statute of charitable uses
  132. Background
  133. First comprehensive list charitable purposes
  134. Regarded as starting point of modern law of charity
  135. Text
  136. Partial list: relief of aged, impotent and poor people, maintenance of sick and maimed soldiers and mariners, schools of learning, free schools and scholars in universities, repair of bridges, ports, havens, causeways, churches, seabanks, highways, education and preferment of orphans, relief or maintenance of houses of correction, help of young tradesmen and persons decayed, relief of prisoners and aid for poor inhabitants
  137. 501(c)(3)
  138. …religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition, or for prevention of cruelty to children or animals…
  139. Cases
  140. Commissioner v. Pemsel
  141. Recognizes trust for relief of
  142. Poverty
  143. Advancement of education
  144. Trusts for other purposes beneficial to the community
  145. Which can benefit the rich as well as the poor
  146. De Costa v. De Paz
  147. Judaism contrary to law of land, but b/c of religious purpose of trust, funds diverted to Anglican hospital—religious intent but impermissible
  148. In Re Shaw
  149. Court lays our 4 charitable purposes: religion, poverty, education, other purposes
  150. 2006 UK Charities Act
  151. Purposes
  152. Prevention of relief of poverty
  153. Advancement of education
  154. Advancement of religion
  155. Advancement of health or saving of lives
  156. Advancement of citizenship or community development
  157. Advancement of the arts, culture, heritage, or science
  158. Advancement of amateur sports
  159. Advancement of human rights, conflict resolution, or promotion or religious/racial harmony or equality and diversity
  160. Advancement of environmental protection or improvement
  161. Relief of those in need by reason of youth, age, ill health, disability, financial hardship or other disadvantage
  162. Advancement of animal welfare
  163. Promotion of the efficiency of the armed forces of the Crown, or the efficiency of the police, fire, and rescue services or the ambulance service
  164. Any other purposes recognized as charitable under existing law; as analogous or within the spirit or falling with the act or recognized as such after new Act comes into force
  165. Implementation
  166. Religious, educational, and poverty relief orgs no longer get presumption of public benefit
  167. All charitable orgs have to demonstrate
  168. Must have an identifiable benefit
  169. Benefit assessed in light of modern conditions
  170. Benefit must be to public at large or sufficient section thereof
  171. Any private benefit must be incidental
  172. Those who are less well off must not be entirely excluded from benefit

DISSOLUTION & CONVERSION: Ending or changing a charitable organization

  1. Dissolution
  2. Dissolution of a trust
  3. Private settlor has no rights
  4. Depends on trust’s terms
  5. Likely court would use cy pres upon dissolution if terms are not flexible
  6. Distribution of Remaining assets
  7. Public Benefit
  8. Assets that remain after liabilities must go to a C-3—same tax exemption
  9. Mutual benefit
  10. Assets (other than any dedicated to charity) that remain after liabilities satisfied may be distributed to members
  11. LA County Pioneer Society
  12. Purpose
  13. Nonprofit formed for social intercourse and friendship
  14. Collect and preserve data of early history
  15. Perpetuate memory of those who contributed to history
  16. Exist as social corporation
  17. Court holds the org is a public benefit and funds improperly distributed to members
  18. Today organizations formed have to specify their corporate category
  19. Involuntary/Voluntary Dissolution
  20. Voluntary
  21. CA Corp 6610/8610
  22. A corporation may elect voluntarily to dissolve
  23. By approval of a majority of all members OR
  24. By approval of the board and approval of the members
  25. Any corporation which comes within one of the following may elect by approval of the board to dissolve
  26. A corporation adjudicated bankrupt
  27. A corporation which has disposed of all its assets and has not conduct any activity for a period of 5 years preceding the adoption of the resolution to dissolve
  28. A corporation with no members
  29. A corporation which is required to dissolve under provisions of its articels
  30. Check list for dissolution
  31. The BOD, members, or both adopt resolutions to elect to dissolve
  32. The corporation files a certificate of election to dissolve with the secretary of state
  33. The corporation notifies the AG, and requests a waiver of objectives to any proposed distribution of assets
  34. The corporation sends notice of the dissolution to members and creditors as necessary
  35. The corporation or its directors wind up operations, pay or provide for payment of liabilities, and distribute assets
  36. The corporation files a certificate of dissolution with the secretary of state
  37. If the corporation holds assets in charitable trust the corporation notifies the registrar of charitable trusts
  38. If the corporation is required to file international returns if files a final return
  39. Involuntary Dissolution
  40. Dissolution by Court Action: 6510/8510
  41. Parties who may file for dissolution
  42. ½ or more of directors in office
  43. A person(s) representing 33 1/3 of voting power excluding voting power held by those who participated in mismanagement, etc.
  44. Any member if ground is formation period has terminated and no extension
  45. Any other person expressly authorized in the articles
  46. The AG
  47. The head organization of the subordinate corporation
  48. Grounds for dissolution
  49. Corporation has abandoned its activity for more than one year
  50. The corporation has an even number of directors/equally divided who can’t agree on the management of affairs so the activities can no longer be conducted or there is a danger its property will be impaired or lost or its activities impaired and the members are so divided into factions they can’t elect a BOD consisting of an uneven number
  51. There is internal dissention and two or more factions of members in the corporation are so deadlocked that activities can not longer be conducted
  52. Members have failed to elect successor directors over 4 years or two consecutive meetings or written ballots
  53. Those in control have been guilty or knowingly participated in fraud, mismanagement or abuse of authority or org’s property being misapplied/wasted by its BOD
  54. Liquidation is necessary to prevent the org b/c org is failing and has continuously failed to carry out its purposes
  55. Formation period has terminated without extension
  56. Required to dissolve by terms of its articles
  57. AG is an indispensable party to an action for involuntary dissolution
  58. AG Dissolution: 6511/8511
  59. The AG may bring an action against any org in the name of the people upon AG’s own info or complaint of a private party, to procure a judgment dissolving the corporation and annulling, vacating, or forfeiting its corporate existence upon the following grounds
  60. Org has violated law regulating corporations or charitable organizations
  61. Org has fraudulently abused or usurped corporate privileges/powers
  62. Org has violated any law that calls for forfeiture of corporate existence
  63. Org has failed to pay taxes to franchise tax board for 5 years
  64. If the org may fix the problems by amending its articles, AG must give notice and opportunity to fix before filing suit for dissolution
  65. Court may order dissolution or partial relief
  66. Cy Pres
  67. Restatement 2d v. 3d
  68. Restatement 2d of Trusts
  69. If particular charitable purpose becomes
  70. Impossible
  71. Impracticable or
  72. Illegal
  73. Court will direct property to some charitable purpose which falls within the general charitable intention of the settlor
  74. Restatement 3d of Trusts
  75. If designated purpose becomes
  76. Unlawful
  77. Courts will reform the offending clause, but must ensure general charitable intent on part of testator outweighs impermissible provision
  78. Impossible
  79. Impracticable OR
  80. It is or becomes wasteful (new)
  81. Court will direct property to a charitable purpose that reasonably approximates the designated purpose (seems broader than 2d but not enough case law to know)
  82. General principles
  83. Overview
  84. Law favors charitable trusts and courts will use equitable powers to save a trust from failure or to reform it to accomplish general purposes
  85. Given to an org whose purpose is “as near as possible” to original purpose
  86. Three part test
  87. Elements
  88. Valid charitable trust exists
  89. Settlor’s specific charitable obligation frustrated
  90. Frustration must be great
  91. Settlor had a general charitable intent
  92. Evans v.