CHANGES TO NONPROFIT CORPORATE LAW
Frank P. Rainer,
Sternstein, Rainer & Clarke, P.A.
One of the benefits of non-profit corporate law is that it has remained fairly stable over the years. It has not been as dynamic as for profit corporate law which has regularly seen changes over the years to accommodate changing market conditions and practices. This past legislative session, non-profit corporate law has been given a significant make over. There are significant changes dealing with membership interests and rights, director’s requirements, distributions and merger requirements.
Membership Interests: The statutory changes for membership interests are focused in the areas of transfer, resignation, termination, purchase, voting and derivative actions. There is now a prohibition on the transfer of membership interests unless done in accordance with the non-profit act. The amendments make a distinction between non-profits which are 501(c) qualified and a nontax exempt qualified non-profit; the later being newly defined as a “mutual benefit corporation.” Mutual benefit corporations can authorize the transfer of membership interests, but the provision must be contained in the Articles or bylaws; otherwise the transfer is prohibited.
Resignation from a membership interest does not relieve a member from any legal obligations owed to the corporation prior to such resignation. Termination or suspension of a member is now subject to the legal standards of “fair and reasonable” and “good faith.” There is also prior notice and the right to challenge up to one year the expulsion, suspension or termination of a member. Furthermore, there is now a right by members of non-profits to file derivative actions of the same nature and type as for profit corporation shareholders.
Repurchase of membership interests is prohibited. However, mutual benefit corporations may repurchase their own membership interests, as long as it does not result in the corporation becoming insolvent. There are tight balance sheet requirements for when funds from the corporation may be distributed to accomplish such purchase. While merger between non-profits are allowed with other entities, it is now required that the surviving corporation must be a non-profit.
With respect to voting of membership interests, procedures are in place now to contest the validity of any signature, or authority to vote or bid tabulation
There are also authorized procedures for remote participation and voting. In addition, there are provisions by which 5 percent of the voting membership interests can call special meetings.
Directors Requirements: Curiously, the legal age for a director of a 501(c)(3) has been lowered to 15; it is still 18 for any other non-profit. If there are to be staggered board terms that must contained in the articles or bylaws. The process for removal of a director or filing a vacancy has been tightly circumscribed as to who may vote to do so and as to the procedures. Most significantly, the conflict of interest provisions for directors have been substantially rewritten; and they are quite similar to the for profit corporation provisions.
Distributions: There have been some significant limitations imposed on making distributions to members or others from a non-profit corporation. There appears to be an absolute prohibition on any distributions from a 501(c)(3) non-profit. For a mutual benefit corporation, it is possible to make distributions. However, distributions may not be made to members, directors or officers, unless it is in furtherance of a repurchase of a membership interest. This limitation on distributions does not apply to compensation or repayment of debts.
The revisions to the non-profit corporate act are quite extensive. There are some significant limitations placed on the membership rights and distribution of funds from a non-profit. If your entity is a 501(c)(3) you will need to carefully review these changes. Many of your current business practices with such tax exempt qualified entities may need to be examined in light of these new statutory changes. On the other hand a non-tax exempt non-profit is subject to many of the same restrictions as a 501(c)(3), but with appropriate provisions in either the articles or bylaws the statutory treatment can be amended and in some instances opted out. It is suggested that you have a legal review done of your corporate organizational documents and contractual relationships to ensure that you are in compliance with these new requirements.
These revisions also have the potential of significantly constricting the use of non profits for the purpose of transferring assets and businesses among non profits. Certainly for tax exempt 501(c)(3) non-profits, the ability to engage in transfers through the vehicle of membership transfer is very tightly circumscribed if not outright eliminated.
Candidly, given the fact that non-profits are becoming a larger and more important part of the economy, this author is disappointed that the legislature has placed such restrictions. It is forecasted that the net result will be to stifle innovation in financing, asset deployment and service delivery. Nonprofits already are subject to significant corporate law and authorized expenditure disadvantages in comparison to the for profit economy. Efficiencies previously available for corporate restructuring and management of non-profits have now been tightly hampered, if not outright eliminated.