Nonprofit Law Info Blog

Are Cooperative Associations Governed by the Nonprofit Corporation Statute?

According to Wikipedia, a utility cooperative has the following characteristics:

A utility cooperative is a type of cooperative that is tasked with the delivery of a public utility such as electricity, water or telecommunications to its members. Profits are either reinvested for infrastructure or distributed to members in the form of "patronage" or "capital credits", which are essentially dividends paid on a member's investment into the cooperative.^[1]. Each customer is a member and owner of the business with an equal say as every other member of the cooperative, unlike investor-owned utilities where the amount of say is governed by the number of shares held.

http://en.wikipedia.org/wiki/Utility_cooperative

Will a utility cooperative be governed by the non-profit corporation statute? Denton County Electric Cooperative, Inc. d/b/a CoServ Electric v. Nicole Hackett, 36 S.W .3d 765 (2012) sought to answer this question.

In that case, the Court addressed whether electric cooperatives must adhere to the Texas nonprofit corporation’s code. The facts were straightforward. A class-action lawsuit was filed against Denton Electric Cooperatives, Inc. (“Defendant”) alleging that Defendant failed to provide open meetings; open records; and fair voting for board elections.  The trial court certified the class to proceed with the lawsuit based upon Texas’s non-profit corporation’s code. Defendant argued that the class certification was improper because that code did not apply to electric cooperatives.

The Texas Electric Cooperative Corporation Act (“ECCA”) applies to electric cooperatives. Plaintiff argued that since the ECCA does not state whether it governs all aspects of running a member cooperative, the nonprofit corporation statute would govern. On appeal, the Court explained two reasons why that statute did not apply to electric cooperatives:

(1) cooperatives were not similar enough to corporations, and

(2) the fact that the legislature deliberately chose to incorporate only two specific provisions of the non-profit corporation’s code implied that the legislature did not intend for that code to apply to electric cooperatives. 

Therefore, the Court of Appeals ruled that class certification was improper because the Texas non-profit corporation code did not apply to cooperatives.

Is a Person who Indirectly Benefits from a Nonprofit Organization Considered a “Beneficiary” Under the New Jersey Charitable Immunity Act?

Who should be considered a beneficiary under the New Jersey Charitable Immunity Act?

In Larissa Sapia and Joseph Sapia v. Hunterdon County YMCA, L-10265-09 (N.J. Super. App. Div. August 10, 2012), Larissa Sapia (“Plaintiff”) went to the YMCA (“Defendant”) to examine its facilities with her parents. Plaintiff went with her parents only to act as a translator for them because they did not speak English.  While touring the facilities, Plaintiff slipped on a puddle of water located in front of a water fountain. The fountain was between the men’s and women’s locker room entrances.

Plaintiff sought damages against Defendant that were caused by the unsafe condition of Defendant’s premises. Defendant claimed its potential personal injury liability was limited by the New Jersey Charitable Immunity Act (“Act”) and moved for summary judgment. The court granted Defendant’s motion. Plaintiff filed a motion for reconsideration with the Superior Court of New Jersey, Appellate Division (“Court”). Plaintiff acknowledged Defendant’s status as a nonprofit tax exempt entity that was organized for charitable purposes. Therefore, the issue considered on appeal was confined to whether Plaintiff was a beneficiary of the charitable works. If it were, it could potentially receive immunity under the Act.

The Court explained that the Act shields charitable entities from liability for negligence in certain circumstances. The Court noted that the grant of immunity under the Act is not mandatory; it is not conditional. However, the Court also noted that the Act is liberally construed so as to afford immunity to nonprofit corporations organized for charitable, educational, or hospital purposes. 

In order for an entity to qualify for charitable immunity it must be:

1)      formed for non-profit purposes;

2)      organized exclusively for religious, charitable, or educational purposes; and

3)      promoted for objective and purposes at the time of the injury to the plaintiff who was then a beneficiary of the charitable works.

The Court elaborated upon who is considered a beneficiary of the charitable works under the Act. The Court explained that beneficiary status does not depend upon a showing that plaintiff personally receives a benefit from the works of the charity. Rather, the issue was whether the entity claiming immunity was engaged in the performance of the charitable objectives that was the purpose of its creation. 

The Court considered the following factors: 

• Plaintiff was educated regarding the nature of available services that Defendant offered and on Defendant’s proposed goals.
• Plaintiff’s presence was incidental to the accomplishment of her own objectives, which were related to the charity’s beneficence; ensuring her parents could receive the benefits of the facility tour.
• Defendant was advancing its charitable goals at the time Plaintiff was injured because it occurred while walking a guided tour of the facility where Defendant conducted its activities and functions.

Based upon these factors, the Court held that Plaintiff benefited from the charity’s works. Therefore, she was a beneficiary of Defendant. Thus, the Court affirmed Defendant’s motion to dismiss.

A lesson to be noted is that nonprofits may be immune from personal injury claims even if the person injured is on the premises for purposes that do not directly benefit them. 

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May a 501(c) Organization Utilize Its Funds For Issues Oriented Advocacy?

Most people are familiar with 501(c)(3) non-profit organizations.  These are entities that perform charitable work that is mostly (though not necessarily completely), devoid of political content.  Generally speaking, donations to such entities are fully deductible for tax purposes.

However, many people are unaware that there are a series of additional types of entities under section 501(c) of the Internal Revenue Code (“IRC”).  Those entities can engage in far more issues oriented political advocacy.  Generally speaking, donations to those entities are not necessarily deductible.  An example of such entities are 501(c)(4) organizations that are often specifically organized for the purpose of political advocacy.

One of the critical changes to this scheme has occurred as a result of Citizens United v. Federal Election Commission, 558 U.S. 50 (2010).   In that case, the Supreme Court held, among other items, that a 501(c)(4) entity could donate unlimited amounts for an issue oriented campaign. 

One of the more interesting questions is whether this will allow donors to shield themselves from being identified.  While the Federal Election Commission has approved that anonymity, recent court decisions have called that into question.  We expect that this will become an issue on appeal in the months and years to come.

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May a Texas Nonprofit Organization Use Charitable Donations for Personal Use?

In December 2011, Texas Attorney General Greg Abbott (“Abbott”) sued the Texas Highway Patrol Association (“THPA”), the Texas Highway Patrol Museum, THPA Services, Inc. and several senior THPA officials (collectively “THPA and Affiliates,” separately “Affiliates”).  The suit claimed that THPA and Affiliates defrauded charitable donors by illegally soliciting donations under the false pretense that the contributions would be used to benefit the families of slain state troopers.  Instead, state investigators found that few survivors actually received financial assistance from THPA and Affiliates, and the money went toward personal use such as meals, movie theater and amusement park tickets and unauthorized association credit card charges for travel for officials and their family and friends. 

THPA and Affiliates received up to $10,000.00 a day and they could not produce receipts for their expenditures that evidenced business related transactions.  While the organization had raised approximately $12,000,000.00 in donations within five (5) years, only a reported $63,500.00 was given to the families of fallen state police officers. 

Some THPA officials gave employees excessive compensation and used donations to pay for personal vehicles.  Although THPA officials told investigators that the cars were for business, the insurance policy listed the purpose of the vehicles as being for pleasure. 

The lawsuit also charged THPA and Affiliates with falsely claiming that they were a tax-exempt, charitable organization registered with the Internal Revenue Service (“IRS”).  THPA was a nonprofit business league, not a charity.

THPA and Affiliates also face civil penalties under the Texas Deceptive Trade Practices Act for falsely claiming that they are associated with the Texas Department of Public Safety (“DPS”) and its highway patrol division.  Neither the THPA nor its Affiliates are associated with the DPS.

The Travis County Probate Judge Guy Herman appointed a temporary receiver and froze THPA’s assets at $490,000.00.  The total amount of money improperly used was not acknowledged in the suit because Abbott plans to make that a part of the ongoing investigation.  The suit has not yet been adjudicated.

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May A Homeowners’ Association be Qualified as a 501(c)(4) Entity?

A homeowner’s association for a condominium complex may qualify for status under 501 (c)(4) of the Internal Revenue Code (IRC) under certain circumstances.

Most importantly, it must operate for the benefit of the general public.  However, if there is a significant degree of private benefit served by the homeowner’s organization, it will not qualify.  An excellent discussion of this is contained in http://www.irs.gov/pub/irs-tege/eotopicr82.pdf.

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How Does a Nonprofit Corporation Commence Its Legal Existence in New York?

New York has a statute that anyone starting a nonprofit should read.  It is located at NY. NPC. Law Section 405.

The statute states, among other things, that a certificate of incorporation must be filed with the New York Department of State.  Thereafter, the non-profit corporation must hold an organizational meeting to elect directors, adopt by-laws and transact other business, such as authorizing a bank account to be opened; the execution of agreements; and appointing officers.  Under certain circumstances, there may also be a requirement to register with the office of the Attorney General, Charities Bureau.

It is important to note that in addition to all this, the corporation must also apply to the federal (as opposed to state) government for 501(c)(3) status.  This is done through a 1023 form supplied by the Internal Revenue Service (IRS).  See http://www.irs.gov/charities/article/0,,id=96109,00.html.  This is important to allow donors to deduct their donations.  

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The Requirement for Small Nonprofits to File IRS Form 990-N

It is important to keep in mind that there are filing requirements that apply to nonprofit corporations with revenue of not more than $50,000.00.  Such organizations are required to file a IRS Form 990-N e-postcard.  As the IRS previously stated:

The Pension Protection Act of 2006 made two important changes affecting tax-exempt organizations, effective the beginning of 2007. First, it mandated that all tax-exempt organizations, other than churches and church-related organizations, must file an annual return with the IRS. The Form 990-N was created for small tax-exempt organizations that had not previously had a filing requirement. Second, the law also required that any tax-exempt organization that fails to file for three consecutive years automatically loses its federal tax-exempt status. The IRS conducted an extensive outreach effort about this new legal requirement but, even so, many organizations have not filed returns on time.

If an organization loses its exemption, it will have to reapply with the IRS to regain its tax-exempt status. Any income received between the revocation date and renewed exemption may be taxable.

Internal Revenue Services Bulletin: 2011-25 (June 20, 2011), Transitional Relief Under Internal Revenue Code Section 6033(j)For Small Organizations.

It is critical that nonprofit entities with revenue under $50,000.00 comply with this requirement.   

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When Will a Nonprofit Corporation That Works with a For Profit Corporation Lose the Charitable Property Tax Exemption?

A nonprofit company should generally maintain a solid boundary between its activities and those of a related for profit company. A recent decision of the New Jersey Supreme Court highlighted why this is so important.

In that case, the Court held that nonprofit companies could lose their property tax exemptions if they commingle their affairs with affiliated entities that operate for profit. International Schools Services v. West Windsor Township, 207 N.J. 3 (N.J. 2011).

The plaintiff, International Schools Services, Inc. (ISS), was a nonprofit corporation that ensured that American children living overseas receive a quality education. In 1999, ISS created Independent Schools Group, Inc. (ISG), a for profit corporation that provided insurance and investment services to the educational community abroad. In 2002, ISS created ISS Financial and Insurance Network Inc. (ISSFIN), a for profit corporation that provided insurance services to ISS clients. The headquarters of both ISG and ISSFIN was located on ISS-owned property in West Windsor, New Jersey. Both ISG and ISSFIN paid below-market rates for their lease of the office space and ISS issued an unsecured loan to ISG. Additionally, ISS’ president was a member of the board of directors for both for profit entities.

West Windsor granted ISS a property tax exemption from 1990 through 2001 under New Jersey Statute 54:4-3.6. However, after reviewing the entity’s activities, the town revoked the exemption based on ISS’ close relationship with ISG and ISSFIN. The Tax Court rejected the plaintiff’s appeal and the Appellate Division partially agreed.

In 1984, the New Jersey Supreme Court set out three criteria for a nonprofit corporation to meet in order to secure a tax exemption for its real property:

1. It must be organized exclusively for the moral and mental improvement of men, women and children.
2. Its property must be actually and exclusively used for the tax-exempt purpose.
3. Its operation and use of its property must not be conducted for profit.

Paper Mill Playhouse v. Millburn Township, 95 N.J. 503, 506 (N.J. 1984).

The Legislature has since amended the second prong of the test, removing the requirement of exclusivity and instead permitting an exemption for property that is “actually used” in connection with tax-exempt functions. The Court considered this change and asked “whether the Legislature’s elimination of the exclusivity requirement allows a nonprofit entity to conduct for profit activities in a commingled fashion on its owned and occupied property.” International Schools Services at 6.

The Court determined that the Legislature did not intend for such a result, because doing so would allow a nonprofit entity “to claim a property tax exemption when it has become inseparably entangled with for profit entities” and thus “would allow indirect taxpayer subsidization of those entities.” Id. at 42. The Court upheld West Windsor’s denial of the tax exemption “because the commingling of effort and entanglement of activities and operations by ISS and its profit-making affiliates was significant and substantial, with the benefit in the form of direct and indirect subsidies flowing only one way – from ISS to the for profit entities.” Id. at 4.

This decision is important for nonprofit companies that have close corporate relations with for profit companies that might jeopardize their ability to receive tax exemptions. It suggests that allowing a nonprofit entity to get too close – financially or otherwise – with a for profit entity could leave the nonprofit without the tax exemptions they value so greatly. 

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Addressing a Conflict of Interest Confronting a Nonprofit Board of Trustees

There are a host of materials available for download on the topic of (a) what constitutes a conflict of interest for a member of the Board of Trustees of a nonprofit and (b) what penalties may arise as a result. However, the purpose of this post is to address (c) what procedure to put in place to vet it in the first instance.

It is obvious that an overt conflict of interest should be dealt with by simply prohibiting the activity. Yet, most conflicts of interest are not that overt. They are usually subtle, close calls; what lawyers refer to as mere potential conflicts of interest. In many  cases, assuming there is an appropriate written policy, these can be waived by a vote of the Board of Trustees after full disclosure and non-participation in the vote by the affected person(s).

However, that process can be particularly unwieldy for large Boards. For example, if there is a decision on a potential conflict of interest that is time sensitive, such as to allow or not allow a transaction to go forward between two Board members, the idea of placing it on the agenda for the next month’s meeting to be decided by two dozen people who are pressed for time is not the most efficient approach.

Instead, a better solution would be to create a standing committee of the Board that would review potential conflicts of interest. It would be empowered to consider the matter between normal meetings of the Board of Trustees. It would also be authorized to make decisions to (a) waive the conflict of interest; (b) take some provisional action until the matter can be heard by the entire Board; or (c) disapprove of the conflict and not allow it to continue. The standing committee would be required to keep minutes and report to the Board as a whole, which would also have the right to overrule the committee’s decision. In other words, the Board would remain ultimately responsible.

This is not a complete solution, and there are circumstances in which this approach simply would not work given the nature of the conflict and surrounding circumstances. However, it is an approach that is workable if applied in good faith and moderation.

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What Are the First Steps to Starting a Nonprofit Company?

There are many aspects to starting a nonprofit company. However, perhaps the most important question is what to do first. I would submit that having a great idea and knowing people who are interested in implementing it are not enough. The first thing that needs to be done is to prepare a formal business plan.

The business plan should be in writing and prepared in the standard format. There are software packages that guide one through this process. However, I would suggest that a good reference website or book on the topic is probably enough to give one a basic idea of how to prepare it. Indeed, the IRS application for 501(c)(3) status basically requires much (though not all) of the same information as a business plan.

A non-profit business plan includes the standard items one might expect: a list of proposed revenue sources (donations; grants; etc.); expenses; personnel; and so forth. However, it also requires a market analysis of the “competition.” In the case of a non-profit, the competition is competing for donations and grants. It is important that one see if others have already formed a charity that tends to the same needs. If so, is that charity going to be seeking contributions from the same donor base? These sorts of questions need to be answered at the outset.

In sum, although it might seem overly formalistic, it is a particularly good idea to have a business analysis of the proposed non-profit company set out in writing before proceeding. An extensive business plan is a particularly effective way of doing this.

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