August 21, 2018
Author: Michael A. de Freitas, Esq.
Organization: William C. Moran & Associates, P.C.
A. CHOICE OF JURISDICTION.
1. Business corporation practice. In forming business corporations, it seems to be accepted good practice to consider incorporation in Delaware or other states as an alternative to New York. Among the reasons to consider another state is the liability of the ten largest shareholders for unpaid wages of employees of NY business corporations under Section 630 of the NY Business Corporation Law (“BCL”).
2. Not-for-profit corporation practice. Even though the BCL and the NY Not-for-Profit Corporation Law (“N-PCL”) were enacted contemporaneously and are structured in a very parallel fashion, the same practice does not seem to have become common in advising clients on the formation of not-for-profit corporations. Yet there are differences between the N-PCL and the laws of other states that lawyers should be aware of in counseling clients regarding formation of not-for-profit corporations.
3. N-PCL provisions not present in other corporate laws. To use Delaware as an example, the following provisions do NOT have a counterpart in the Delaware General Corporation Law:
a) “Types.” N-PCL Section 201(b):
(1) “Type A--A not-for-profit corporation of this type may be formed for any lawful non-business purpose or purposes including, but not limited to, any one or more of the following non-pecuniary purposes: civic, patriotic, political, social, fraternal, athletic, agricultural, horticultural, animal husbandry, and for a professional, commercial, industrial, trade or service association.
(2) “Type B--A not-for-profit corporation of this type may be formed for any one or more of the following non-business purposes: charitable, educational, religious, scientific, literary, cultural or for the prevention of cruelty to children or animals.
(3) “Type C--A not-for-profit corporation of this type may be formed for any lawful business purpose to achieve a lawful public or quasi-public objective.
(4) “Type D--A not-for-profit corporation of this type may be formed under this chapter when such formation is authorized by any other corporate law of this state for any business or nonbusiness, or pecuniary or non-pecuniary, purpose or purposes specified by such other law, whether such purpose or purposes are also within types A, B, C above or otherwise.”
(5) Effective July 2014, those “types” have been eliminated in favor of a simple distinction between “charitable” and “noncharitable” corporations. Type A’s will be treated as “noncharitable” and Types B and C as “charitable.” Type D’s will be charitable or non-charitable depending on their individual purposes.
Comment: Currently, Types B and C were largely treated the same, and Type D’s are comparatively rare, so the change may not seem dramatic. However, some of the legal issues with the current “types” were potentially difficult, if somewhat technical, and so the changes are perceived to be a significant improvement.
Comment: The classification affects transactional approvals. See below.
b) Agency consents. The requirement in N-PCL Section 404 of obtaining consents of state agencies or other third parties for particular language in “purpose” clauses.
c) Transaction consents. The various N-PCL requirements to obtain court approval of mergers (except foreign and domestic corp mergers), sales of substantially all the assets (but see below), amendment of corporate purpose clauses, and dissolution.
4. Other states’ provisions not present in N-PCL.
a) Director exculpation. Delaware General Corporation Law (“GCL”) permits the Certificate of Incorporation to contain a clause limiting director liability to the corporation. See Section 102(b)(7):
“A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director:
(i) For any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit. No such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective. All references in this paragraph to a director shall also be deemed to refer to such other person or persons, if any, who, pursuant to a provision of the certificate of incorporation in accordance with § 141(a) of this title, exercise or perform any of the powers or duties otherwise conferred or imposed upon the board of directors by this title.”
b) N-PCL provisions:
(1) The N-PCL has no counterpart to GCL Section 102(b)(7).
(2) But note Section 1318 provides that foreign corporation directors are subject to actions under Sections 719 (liability for certain actions) and 720 (liability for misconduct).
5. Other issues. Other issues to discuss when contemplating forming under other law:
a) IRS exemption timing. An application for exemption cannot be filed until the corporation exists, so the timing of obtaining prior consents under N-PCL Section 404 is an issue, especially with the lengthy processing times being reported for IRS exemption applications.
b) NY foreign-corporation requirements. Notable provisions:
(1) N-PCL Sections 201 and 404 apply to Applications for Authority (see N-PCL Section 1304), so those sections are not completely avoided by incorporating elsewhere.
(2) The Attorney General apparently takes the position that a foreign corporation must obtain court approval for transfer of real estate if it constitutes all or substantially all assets under Sections 510 and 511.
(3) Charities Bureau registration and reporting still apply (EPTL Section 8-1.4; Executive Law Art. 7-A).
B. BENEFIT CORPORATIONS.
1. Business Corporation Law Article 17.
a) “Benefit corporation.” A business corporation formed for general or specific public benefit. See Sections 1702, 1703, 1706.
b) Purposes. Every benefit corporation shall have a purpose of creating “general public benefit,” which may be in addition to other purposes, shall limit and control over other purposes. Section 1706(a). The corporation may also identify “specific public benefits” as purposes. Section 1706(b).
c) “General public benefit.” A material positive impact on society and the environment, taken as a whole, assessed against a third-party standard, from the business and operations of a benefit corporation. Section 1702(b).
d) Best interests. The creation of general and specific public benefits “is in the best interests of the benefit corporation.” Section 1702(c).
e) Annual benefit report. Section 1708.
(1) Given to shareholders and posted on corporation’s website, if any. The website version may omit compensation and financial and proprietary information.
(2) Contents shall include, among other things, an assessment of the performance of the benefit corporation, relative to its general public benefit purpose assessed against a “third-party standard.”
f) “Third party standard.” Section 1702(g). A recognized standard for defining, reporting and assessing general public benefit that is:
(1) developed by a person that is independent of the benefit corporation; and
(2) transparent because the following information about the standard is publicly available:
(a) the factors considered when measuring the performance of a business;
(b) the relative weightings of those factors; and
(c) the identity of the persons who developed and control changes to the standard and the process by which those changes are made.
g) Director duty. In taking action, directors and officers “shall consider” the general and specific public benefits, workforce, subsidiaries, suppliers, customers, environment, and corporations long and short term interests. Section 1707(a).
h) Beneficiaries. Directors and officers have no duty to beneficiaries of the general and specific benefit purposes unless otherwise stated in the Certificate of Incorporation or Bylaws. Section 1707(c).
2. Delaware General Corporation Law Subchapter XV.
a) Public benefit corporation. A for-profit corporation organized under and subject to the requirements of this chapter that is intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner. Section 362(a).
b) Purposes. Certificate of incorporation must state one or more specific public benefits to be promoted by the corporation. Id.
c) “Public benefit.” A positive effect (or reduction of negative effects) on one or more categories of persons, entities, communities or interests (other than stockholders in their capacities as stockholders) including, but not limited to, effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature. Section 362(b).
d) Biennial report. Section 366(c). Report shall include, among other things:
(1) The objectives the board of directors has established to promote such public benefit or public benefits and interests;
(2) The standards the board of directors has adopted to measure the corporation's progress in promoting such public benefit or public benefits and interests;
(3) Objective factual information based on those standards regarding the corporation's success in meeting the objectives for promoting such public benefit or public benefits and interests; and
(4) An assessment of the corporation's success in meeting the objectives and promoting such public benefit or public benefits and interests.
e) Third party standard. The Certificate of Incorporation may require the corporation to use a third party standard or obtain third party certification. Section 366(c).
f) Director duty. The board of directors shall manage or direct the business and affairs of the public benefit corporation in a manner that balances the pecuniary interests of the stockholders, the best interests of those materially affected by the corporation's conduct, and the specific public benefit or public benefits identified in its certificate of incorporation. Section 365(a).
g) Beneficiaries. No director duty to any person on account of any interest of such person in the public benefit or public benefits identified in the certificate of incorporation or on account of any interest materially affected by the corporation's conduct. Section 365(b).
3. Comments.
a) No tax exemption. The presence of shareholders and possible other business purposes alone would seem to preclude qualification for 501(c)(3) or 501(c)(4) status, though there have been cases of stock corporations obtaining exempt status in unique situations. See, e.g., University of Maryland Physicians, P.A. v. Commissioner, T.C. Memo 1981-23 (January 26, 1981) (medical school faculty clinical practice professional service corporation).
b) Utility for nonprofits. Some have suggested benefit corporations are potential source of funding for nonprofits as the benefit corporations seeks ways to achieve public benefit.
c) Shareholder value. The “best interests” and standard of conduct provisions seem intended to block a claim that maximizing shareholder value should prevail in corporate decisions.
C. CERTIFICATE OF INCORPORATION.
1. Generally. The Certificate of Incorporation is the document establishing the existence and purposes of a corporation. It lists the exclusive purposes which a not-for-profit corporation furthers. (NPCL Section 402). The existence of the corporation is created upon the filing of the Certificate of Incorporation in the Department of State.
2. Key clauses under state law:
a) Purposes. This is the most important provision. It must be carefully drafted not only to describe accurately the purposes of the organization but also to deal with other issues such as tax exemption and any requirements of governmental authorities governing the corporation’s activities.
b) Address for service of process. The certificate must supply an address to which the Secretary of State will send a copy of any legal claims served on the Secretary. A lawsuit may be commenced against a not-for-profit corporation by serving the complaint on the Secretary of State instead of directly on the corporation. Thus, it is important to keep this address up to date. Sometimes, this address is the corporation’s attorney; it may also be the corporation’s administrative office.
c) Internal governance (optional). The Certificate of Incorporation may include any other provision for regulation of its internal affairs or required by governmental authorities.
d) Other limitations. Limitations may be necessary for various activities or purposes that would trigger particular state government consents. The activities or purposes are listed in NPCL 404 (e.g., operating schools or hospitals).
3. Clauses regarding dissolution, lobbying and political activities.
Common limitations are those required by Section 501(c)(3) of the Internal Revenue Code.
4. Statement that formed exclusively for charitable purposes.
a) For many years, a standard clause required by the IRS for 501(c)(3) qualification was the following and was accepted by Dept of State:
Article [ ]: Notwithstanding any other provision of this
certificate, the Corporation is organized exclusively for charitable
purposes as specified in Section 501(c)(3), or any successor section
of the Internal Revenue Code of 1986, as amended, or any
successor statute (the “Code”), and shall not carry on any activities
not permitted to be carried on by a corporation exempt from
federal income tax under Section 501(c)(3), or any successor
section, of the Code, or by a corporation, contributions to which
are deductible under Section 170(c)(2), or any successor section, of
the Code.
b) Recently, Dept of State began rejecting certificates with that language, apparently on the ground that Dept of State believes such language states purposes that are too broad. In the author’s discussions with Dept of State, it appears that Dept of State counsel has discussed this issue with the Internal Revenue Service and arrived at the following new formulation:
Article [ ]: The purposes of the Corporation set forth in Article
[ ] are intended to be exclusively charitable purposes as
specified in Section 501(c)(3), or any successor section of the
Internal Revenue Code of 1986, as amended, or any successor
statute (the “Code”). The Corporation shall not carry on any
activities not permitted to be carried on by a corporation exempt
from federal income tax under Section 501(c)(3), or any successor
section, of the Code, or by a corporation, contributions to which
are deductible under Section 170(c)(2), or any successor section, of
the Code. This Article [ ] does not expand or alter the
Corporation’s purposes or powers set forth in Article [ ].
[italics added to show principal changes.]
c) There is no public written confirmation that the above language is satisfactory to the Internal Revenue Service.
D. BYLAWS.
1. Generally. At the most common level, they provide a clear set of procedures for the members and board of directors to exercise their functions.
That is, the By-laws set forth the procedures for calling and conducting meetings. In short, the By-laws, together with the procedural provisions of the NPCL, set the rules for the democratic functioning of the corporation.
2. Third parties. By-laws are also important to third parties. Copies of the By-laws may be requested by parties with whom a not-for-profit does business or makes filings, such as the IRS, financial institutions, or title insurance companies.
3. Notable elements:
a) Membership. In membership corporations, it is common to put all provisions concerning qualifications, rights, and obligations in the Bylaws. The alternative, as noted earlier, is to put the provisions in the Certificate of Incorporation.
b) Board. The number, terms of office, qualifications, rights, and obligations of board members should be in the By-laws.
c) Committees. Committees may, but need not, be described in the By-laws. Often, standing committees are described in the By-laws. Ad hoc committees, by their temporary nature, are usually established in board resolutions.
d) Officers. As with directors, the By-laws usually list the officers’ titles, duties and terms of office.
e) Indemnification. These provisions received much attention in the 1980’s. They are quite common now. As is discussed elsewhere in these materials, they are an important element in director and officer liability protection.
f) Staff. Some not-for-profits also describe the top staff position or positions, such as Executive Director. Staff rights and duties are not set forth in the NPCL, unlike the rights and duties of directors and officers. Also, since staff are frequently paid employees, these provisions would raise legal contract issues. Thus, any such provisions should be carefully drafted.
g) Amendment. It might be easy to overlook the importance of this provision. The amendment of the By-laws should be thought through before committing to a particular procedure. For instance, there may be good reasons to conclude that a super-majority of the entire membership should authorize amendments.
E. CORPORATE STRUCTURE.
1. Membership vs. non-membership.
a) A Type B not-for-profit corporation need not have members. (NPCL 601(a)). If a corporation does not have members, it is colloquially referred to as a non-membership corporation or as having a \"selfperpetuating\" board of directors.
b) If a corporation has members, there are strategies for structuring the members’ involvement in corporate business (other than fundraising strategies discussed elsewhere in these materials). The NPCL authorizes two basic strategies: voting/non-voting and classification.
(1) Voting rights may be granted or withheld or qualified as long as one or more classes of members, singly or in the aggregate, are entitled to full voting rights. (NPCL 612).
(2) Members can be divided into classes with different rights and obligations for the different classes. (NPCL 601). As an example of the differing rights of classes, the NPCL authorizes directors to be elected by specific classes, if so desired. (See NPCL 703(a)).
c) The NPCL specifies a number of transactions requiring a member vote (in a membership corporation) such as elections of directors and amendments of the Certificate of Incorporation.
d) The election of directors can be a confusing issue because of the creativity permitted for the selection of directors, as discussed below. NPCL 603 states that annual meetings of members must be held “for the election of directors,” yet NPCL 703 states that directors may be “elected or appointed at large,” among other options such as ex-officio status and election by special membership classes. With all this variety in the qualifications of directors, there is a potential for dispute or confusion about the administering the election and appointment process.
e) Notably, the NPCL does not give management authority to members.
2. Related corporations.
a) Membership is typically used to structure systems of related notfor- profit corporations, as in \"parent\" and \"subsidiary\" corporations. The subsidiaries may be title holding companies, foundations, or specialpurpose entities (even for-profit entities).
b) There are many issues to consider in forming related entities, such as:
(1) Financial issues (consolidation of financial statements; attribution for tax purposes; attribution for reimbursement purposes; and the provision of and accounting for shared assets and services)
(2) Liability issues (protecting valuable assets from frivolous claims; avoiding \"piercing of the corporate veil\")
(3) Cost issues (the cost of administering multiple corporations).
(4) Governance and control issues (overlapping boards; intercompany procedures; risk of a inadequately controlled affiliate \"drifting away\").
3. Membership as fundraising device.
a) Fees, dues and assessments. Perhaps the most common use of members as a source of income for a not-for-profit corporation is to charge initiation fees, dues or assessments to members. This is authorized by the statute.(NPCL 507).
b) Capital contributions. A not-for-profit corporation’s certificate of incorporation may require members to make specific capital contributions. This is authorized by NPCL 502. This requirement may also be imposed on just one class of members, or it may be imposed on all classes. The amount of the required contribution must be stated in the certificate of incorporation. It may consist of money, other property, or services. A capital contribution may not be satisfied by the value of future services. The judgment of the corporation’s board as to the value of property and services rendered is binding, in the absence of fraud. Capital contributions must be evidenced by a capital certificate. Capital certificates are not transferable except if the corporation is a Type A corporation. Capital certificates are not redeemable except as specifically authorized by the NPCL, such as upon the dissolution of the corporation, unless the certificate of incorporation provides for redemption. Redemption cannot be made if the corporation would thereby be made insolvent or unable to carry on its corporate purposes or if the fair value of its remaining assets would be insufficient to pay its liabilities. (See NPCL 515).
c) Subventions. Unlike fees, dues, assessments, and capital contributions, “subventions” can be given to a not-for-profit corporations by members or non-members. The most distinctive features of subventions are that (a) the corporation may effectively pay interest to the holder of a subvention, (b) members and non-members alike can give subventions, and (c) subventions are voluntary (unlike fees, dues, assessments, and capital contributions). Subventions are authorized by NPCL 504. A subvention may consist of money, other property, or services or benefit “actually received” by the corporation or “expended for its benefit.” The judgment of the corporation’s board as to the value of the consideration received is binding, in the absence of fraud. Subventions must be authorized by the certificate of incorporation and by resolution of the board of directors and evidenced by certificates.
4. Rights of Members.
a) Generally. Members’ rights are partly defined by the NPCL and partly by the corporation itself (through the certificate or incorporation or the by-laws).
b) Voting rights.
(1) The voting rights of members are set forth in Article 6 (Sections 601--623) of the NPCL. Particular matters which must be approved by members are set forth in other parts of the NPCL.
(2) At least one class of members must have full voting rights. In other words, if one class of members has such rights, other classes can be given limited or no voting rights. (NPCL 612).
(3) Members vote for the election of directors (NPCL 613(a)). Members must also authorize:
(a) the sale, lease, exchange or other disposition of all or substantially all the corporation’s assets. (NPCL 510). (b) amendments of the certificate of incorporation. (NPCL 802).
(c) merger or consolidation. (NPCL 803).
(d) voluntary dissolution. (NPCL 1002).
(4) Notably absent from the above list is the amendment of bylaws. Voting members are merely authorized to amend the bylaws. (NPCL 602(b)). The by-laws may require, of course, that only the members can amend them, but the statute does not so require.
(5) Members may give proxies to other persons to cast their votes for them at a members’ meeting. (NPCL 609).
c) Due Process Rights. There are New York court decisions supporting the existence of a due process right for members whose membership the corporation seeks to terminate. These cases often arise in the context of professional societies and similar organizations in which membership carries significant privileges.
d) Access to Records:
(1) Members are entitled to inspect the minutes of member meetings and the list of members. (NPCL 621).
(2) The right to inspect the member minutes and member list may be enforced in court under NPCL 621, but the statute is silent on whether the right to receive financial statements may be enforced in court. Whether the latter right may be enforced in court is probably immaterial because (a) annual financial statements must be in the minutes of member meetings (see the next paragraph) and (b) anyone can obtain a copy of the financial reports required to be filed with the New York State Charities Bureau and the Internal Revenue Service.
(3) The members are entitled to receive, at their annual meeting, an annual report from the board of directors. The report must include financial statements for the most recent full fiscal year and the number of members of the corporation as well as a statement as to the increase or decrease of members in the last fiscal year and the place where the names and addresses of the members may be found. This annual report must be entered in the minutes of the members’ annual meeting. (NPCL 519).
e) Liability protection. Members are also protected from personal liability under NPCL 517. No member can be held personally liable for the corporation’s debts, liabilities or obligations. A member can only be held liable to the corporation for unpaid fees, dues, assessments or other valid indebtedness.
f) Enforcement Action.
(1) Members can bring actions against the corporation’s directors and officers for breach of their duties owed to the corporation. To do so, 5% of any class of members must bring the action together. (NPCL 720).
(2) Members or holders of capital certificates may also bring an action on behalf of the corporation against anyone. The 5% requirement must be met in such an action. These plaintiffs must also show that they tried and failed to have the corporation itself bring the action. (NPCL 623).
F. DIRECTORS AND OFFICERS.
1. Duties.
a) Generally. The fundamental fiduciary duties of directors and officers are defined by state law and, specifically, by the statute or statutes under which the corporation is formed. The Not-for-Profit Corporation Law governs all nonprofits in New York, but some nonprofits are governed by other statutes as well. For example, religious organizations are governed in significant ways by the Religious Corporations Law. The duties discussed in this section are fundamental and general duties from which most specific procedural or enforcement rules (such as conflicts of interest, discussed later) follow.
b) Duty of care.
(1) Generally. A not-for-profit corporation is managed by its board of directors. (Not-for-Profit Corporation Law (“NPCL”) Section 701(a)).
(2) Standard. Directors and officers must discharge the duties of their positions in good faith and with that degree of diligence, care and skill which ordinarily prudent persons would exercise under similar circumstances in like positions. In making investment decisions, including delegating investment decisions to professionals, a board must consider the long and short term needs of the corporation, its present and anticipated financial requirements, expected returns, price level trends, and general economic conditions. (NPCL 717(a)).
c) “Duty of obedience.”
(1) Generally. Directors must be faithful to the purposes and goals of the organization. (Manhattan Eye, Ear & Throat Hosp. v. Spitzer, 186 Misc. 2d 126 at 152 (Sup Ct NY Co 1999).
(2) Statutory basis. There is no NPCL provision stating that there is a “duty of obedience.” Such a duty, as articulated by courts, may be no more than a reiteration of the basic rules that the board must manage the corporation (NPCL 701), which itself is formed for a specific charitable mission set forth in its Certificate of Incorporation (NPCL 401). It follows from those two rules that the board’s duty is to manage the corporation in such a way that the corporation’s mission is fulfilled.
d) “Duty of loyalty.”
(1) Generally. The duty of loyalty is often loosely referred to as the duty of directors and officers to put the corporation’s interests above their personal interest.
(2) Statutory basis. As with the “duty of obedience,” there is also no NPCL provision imposing a “duty of loyalty,” but a variety of NPCL provisions limit and/or prohibit directors and officers from privately benefitting from the corporation, e.g., the provisions regulating conflicts of interest (NPCL 715).
2. Liabilities.
a) Selected state statutory provisions:
(1) A director may be liable to the corporation for voting for or concurring in: (1) impermissible distributions of corporate funds to corporate members, directors, or officers; (2) impermissible redemptions of corporate capital or subvention certificates or bonds; (3) impermissible payments to holders of subvention certificates or bondholders; or (4) distributions of corporate assets on liquidation without providing for known corporate liabilities. (NPCL 719(a)).
(2) A director may be liable for (1) neglect of, failure to perform, or violation of duties; and (2) the acquisition by the director, transfer to others, or loss or waste of corporate assets. A director may also be sued to (1) set aside an unlawful transfer of corporate assets if the transferee knew of the illegality or (2) prevent a proposed unlawful transfer. (NPCL 720(a)).
b) Selected federal statutory provisions: Directors or officers (unless honorary) may be held personally responsible by IRS for failure to withhold. (Internal Revenue Code 6672).
3. Liability Protection.
a) Generally. General principles of law limit personal liability of directors and officers to a very great extent.
b) Business Judgment Rule or Defense.
(1) The NPCL does not contain a “business judgment rule” or “business judgment defense.”
(2) Courts have developed the business judgment rule in cases challenging decisions by boards of directors of business corporations. This rule “bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes.” (Auerbach v. Bennett, 47 N.Y.2d 619 at 629 (1979)).
(3) Although this rule does not appear in the statute, it is consistent with the statutory standard of care (see above), which involves analysis of what the “ordinarily prudent person” would do. Such a standard logically permits that corollary that if action is taken consistently with that standard, the board has satisfied its fiduciary duty.
(4) The rule has also been cited in connection with not-for-profit corporations. (See., e.g., Levandusky v. One Fifth Ave. Apartment Corp., 75 N.Y.2d 530 (1990) (cooperative corporation),
Gillman v. Pebble Cove Home Owners Ass'n, 154 A.D.2d 508 (2d Dept., 1989) (homeowner’s association).)
(5) The practical effect of the rule that the substance of a board’s decision will not be reviewed by a court if the process of reaching the board’s decision was appropriate in light of the standard of care discussed above.
c) Immunity.
(1) State law: NPCL 720-a.
(2) Unpaid directors and officers (payment does not include expense reimbursement) of charitable organizations exempt under Internal Revenue Code Section 501(c)(3) are not liable to any person other than the organization based solely on his or her conduct in the execution of his or her office. (NPCL 720-a).
d) Exceptions to that immunity include:
(1) Gross negligence
(2) Intentional harm
(3) Lawsuits by the NY Attorney General
(4) Lawsuits by a trust beneficiary ( if the organization is a charitable trust).
(5) Certain statutory liabilities (See NPCL 719-720, discussed above).
e) Federal law: Volunteer Liability Protection Act. Parallel to above state statute, but also applies to all volunteers, not just volunteer directors and officers.
4. Indemnification.
a) Statutory protection. A corporation may indemnify directors and officers for liability to (1) third parties and (2) the corporation. The indemnification is for liability incurred in actions against them because they were or are directors or officers or served another entity in certain capacities at the request of the corporation. Depending on the type of lawsuit, indemnification may be made for expenses, settlement payments, fines, and judgments. (NPCL 722).
b) Other protection. More generous indemnification than that authorized in NPCL 722 may be made under a resolution of members, a resolution of directors, or a contract, but only if (1) the certificate of incorporation or by-laws permit such a method of indemnification and (2) the director or officer seeking indemnification did not act in bad faith or with active and deliberate dishonesty and did not gain a financial profit or other advantage to which he or she was not entitled. (NPCL 721).
G. NY NON-PROFIT REVITALIZATION ACT OF 2013.
1. Enactment. In 2013, the New York Legislature passed and the Governor signed the “Non-Profit Revitalization Act of 2013” (the “NPRA”). The NPRA makes the most significant changes to the Not-for-Profit Corporation Law (the “NPCL”) since it was originally enacted in 1969. Most of the NPRA changes take effect July 1, 2014; some take effect in subsequent years.
FREE Nonprofit Training from Lorman
Lorman has over 37 years of professional training experience.
Join us for a special white paper and level up your Nonprofit knowledge!
Fraud Considerations in Nonprofit Organizations
Presented by Carol Barnard CPA, CFE
2. Scope. The changes address governance practices as well as corporate and real estate transactions. The changes affect both new and existing not-for-profit corporations in one way or another. Some of the changes also affect charitable trusts due to parallel amendments to the Estates, Powers, & Trust Law. This material will discuss notable changes made to the NPCL by the NPRA.
3. Conflicts of Interest.
a) New rules, in sum.
(1) Every “related party transaction” must be determined by the board to be “fair, reasonable, and in the corporation’s best interest.”
(2) The scope has been broadened from directors and officers to “key employees.”
(3) The determination must be made by “independent directors.”
(4) Charitable organizations must also consider alternative transactions.
(5) All organizations must adopt written conflicts policy
(6) Attorney General has broad new powers.
b) New defined terms.
(1) “Related party transaction” means a “transaction, agreement or any other arrangement” by the organization (or an affiliate) in which a related party has a “financial interest.”
(2) “Related party” means (i) any director, officer or key employee of the Corporation or any affiliate of the Corporation;
(ii) any relative of any director, officer or key employee of the corporation or any affiliate of the corporation; or (iii) any entity in which any individual described in the preceding clauses (i) and (ii) has a thirty-five percent or greater ownership or beneficial interest or, in the case of a partnership or professional corporation, a direct or indirect ownership interest in excess of five percent.
(3) “Key employee” means a person with “substantial influence” under IRS “excess benefit” rules. See Treas. Reg. 53.4958-3(c), (d) and (e).
(4) “Relative” means spouse, domestic partner, ancestors, brothers and sisters (whether whole or half-blood), children (whether natural or adopted), grandchildren, great-grandchildren, and spouses of brothers, sisters, children, grandchildren, and greatgrandchildren.
(5) “Independent director” means a director who:
(a) is not, and has not been within the last three years, an employee of the corporation or an affiliate of the corporation, and does not have a relative who is, or has been within the last three years, a key employee of the corporation or an affiliate of the Corporation;
(b) has not received, and does not have a relative who has received, in any of the last three fiscal years, more than ten thousand dollars in direct compensation from the corporation or an affiliate of the corporation (other than reimbursement for expenses reasonably incurred as a director or reasonable compensation for service as a director as permitted by applicable law; and
(c) is not a current employee of or does not have a substantial financial interest in, and does not have a relative who is a current officer of or has a substantial financial interest in, any entity that has made payments to, or received payments from, the corporation or an affiliate of the corporation for property or services in an amount which, in any of the last three fiscal years, exceeds the lesser of twenty-five thousand dollars or two percent of such entity's consolidated gross revenues. The above definition of “independent director” is new to the NPCL. It does not have a counterpart in the IRS “excess benefit” regulations that many nonprofit organizations are familiar with. Thus, close attention is needed regarding existing compensation review policies and procedures, for example.
c) Whistleblower Policy.
(1) Every non-profit with 20 or more employees and revenues over $1,000,000 must have a written policy to protect directors, officers, employees or volunteers who “report suspected improper conduct” from “retaliation” by the organization.
(2) The policy must have procedures for reporting and for preserving the confidentiality of the reports. An employee, director, or officer must be designated to administer the whistleblower policy and report to the appropriate body, which must be the audit committee, another committee of independent directors, or the board.
d) Electronic Notices and Actions.
(1) Electronic mail will be permitted to be used for:
(a) Meeting notices and waivers of notice
(b) Written consents in lieu of meetings
(2) Electronic video screen communication will be permitted, in addition to telephone conferencing, for board meetings.
(3) The State Technology Law already permitted electronic documents and electronic signatures. It now appears that the NPCL has narrowed what that statute otherwise permitted.
e) Committees.
(1) For corporations required to file audit with Charities
Bureau under Article 7-A of the Executive law, new audit committee composed of independent directors (or the board acting through independent directors) is responsible to:
(a) Oversee accounting and financial processes.
(b) Retain or annually renew the retention of the outside certified public accountant.
(2) The long-time distinctions between “standing” and “special” committees have been eliminated in favor of just one type of board committee. In addition, the chair or president no longer has the authority to appoint special committees subject to board consent.
(3) There has been confusion over the years between the NPCL’s standing and special committee provisions. These changes should clarify committee structures. These changes do not, however, actually prohibit committees that are effectively permanent (“standing”) or committees that are effectively short term (“special”). So it may not be inappropriate to maintain such distinctions in practice. This is a good opportunity for organizations to revisit and clarify committee structures.
(4) The existing “committee of the corporation” has been retained, but it will not have “authority to bind the board.” It is not clear what the deprivation of “authority to bind the board” will mean for organizations, such as some health care providers, that are required to have committees that often have non-directors on them, such as incident-review committees that include staff.
f) Corporate “Types.”
(1) A variety of legal issues have been raised or affected over the years by the current system in which corporations are classified as Type A, B, C or D.
(2) Those “types” have been eliminated in favor of a simple distinction between “charitable” and “non-charitable” corporations. Type A’s will be treated as “non-charitable” and Types B and C as “charitable.” Type D’s will be charitable or non-charitable depending on their individual purposes. (The classification affects transactional approvals. See below.)
(3) Currently, Types B and C were largely treated the same, and Type D’s are comparatively rare, so the change may not seem dramatic. However, some of the legal issues with the current “types” were potentially difficult, if somewhat technical, and so the changes are perceived to be a significant improvement.
g) Corporate Transactions and Approvals.
(1) For not-for-profit corporations with charitable purposes, amendments of corporate purpose clauses, mergers, dissolutions, and sales of substantially all assets have all required certain approval by the court or the Attorney General as well as, in many cases, consents of various state agencies or other bodies, such as the State Education Department.
(2) Under the NPRA, in most cases, the corporation will now have the choice of seeking either court or Attorney General approval, but not both.
(3) It was widely perceived that in New York City, the courts were clogged and thus obtaining approval for such transactions was time-consuming. By contrast, it was perceived that, upstate, the courts were less busy and, moreover, could provide objective review of disagreements between nonprofits and the Attorney General.
h) Consents.
(1) Consents of state agencies or other bodies will be somewhat simplified. The consent of the State Education Department will no longer be required for corporations that could be chartered by the Board of Regents rather than incorporated as not-for-profit corporations.
(2) It had been widely reported that consents required weeks or months to obtain. The State Education Department is just one in a long list of state agencies and other bodies that might have to consent to various corporate transactions. However, it was also widely perceived that the State Education Department was the agency most often required to give consent, perhaps because of the prevalence of the term “education” in the purpose clauses of charitable organizations. Thus, the above change should simplify many corporate filings.
i) Real Estate Transactions.
(1) Current law requires a 2/3 vote of the entire board (counting vacancies) of any sale, lease, mortgage or other disposition of any real estate.
(2) Under the NPRA, a majority vote at a meeting (not counting vacancies) will be sufficient, unless the real estate is all or substantially all of the corporation’s assets.
(3) Comment: this should simplify votes on routine real estate transactions.
j) Major Pending Change For New Corporations.
(1) Senate Bill 6249 (January 2014) is pending. It would permit a not-for-profit corporation to be formed for generally stated charitable purposes.
(2) This would be a major improvement in current NY law. Under current NY Department of State practice, very specific purpose clauses are, in practical terms, required. This often has resulted in such narrow purpose clauses that frequent amendments are necessary as organizations naturally evolve. This new bill would, finally, recognize that charitable purposes are, fundamentally, not lists of activities but statements of general charitable missions or aims to be achieved by a variety of activities that necessarily change over time.