Prof. Tom Kelly, Fall 2014
History and Emerging Trends
· Nonprofits include labor unions, fraternal lodges, social clubs, college fraternities, trade associations, libraries, museums, religious organizations, schools, colleges, and professional sports leagues.
· Difference between for-profit and nonprofit
o Nondistribution Constraint: A nonprofit can pay reasonable compensation to any person for labor or capital, but cannot distribute its profits to an individual who controls the organization. Such individuals include members, directors, and trustees. àno stock or other indicia of ownership that give owner a share in profits and control
o A non-profit’s net earnings must be retained and devoted to financing further production of the organization’s services.
o Most nonprofits are incorporated and the nondistribution constraint is imposed, either explicitly or implicitly, as a condition under which the organization receives its corporate charter.
· Attributes of the Nonprofit Sector
o Freedom from constraint and resulting pluralism: No need for a large constituency or reliance on a bureaucracy (as needed in government sector) and no need for profitable ideas (as in the business sector). As a result, a few people can back an idea.
§ Pluralism: (the more competing factions/ideas, the more creativity and innovation) the idea that a free nation should be hospitable to many sources of initiative, many kinds of institutions, many conflicting beliefs, and many competing economic unitsàleads to creativity
o Government bureaucracies are not designed to permit the emergence of new ideas and are less suited to winnowing out bad ideas. The business and the political sector are not open to controversial, unpopular, or strange ideas.
o The home of non-majoritarian impulses, movements, and values
o Nonprofits are in a position to serve as guardians of intellectual and artistic freedomàcommercial and governmental organizations are subject to levelling forces that threaten standards of excellence
o The sector preserves individual initiative and responsibility
o Nonprofits link individuals to communities
· The Underside of the Nonprofit Sector
o Examples: diversions of charitable assets; excessive trustee and executive compensation; failure to adhere to appropriate norms of fiduciary duty; creeping commercialism; abuses related to charitable contributions of noncash property; and the use of charities as tax shelter facilitators and even financers of terrorism
o Past areas of reform: transparency, governance, and defining “charity”
§ Good governance facilitates well-run charities and dissuades improper behavior
§ Transparency sheds light on an organization’s practices, which in turn should enhance ethical and effective operations and facilitate oversight.
Dimensions of the Nonprofit Sector
· The Numbers
o 1.9 million NPCs in the U.S. with 12.9 million paid employees representing 10% of the US economy plus 4.7 million additional volunteers
o Sources of Funding
§ Fees, dues, and charges for services provided
v 50% of total revenue
v Includes college tuition payments, charges for hospital care not covered by government health insurance, income from investments, and sales.
§ The Government
v Grants, contracts, reimbursements
v Reflects a widespread pattern of partnership between government and the nonprofit sector in carrying out public purposes, from the delivery of health care to the provision of education.
§ Private contributions
v Most private contributions go to churches
Charity, Philanthropy, and Nonprofit Organizations: A Historical Introduction
· Social Enterprise Organizations (“for benefit corporations”): for profit firms committed to philanthropic activity
o Driven by social purposes and profits
o Difference between SEOs and traditional charities: SE movement is based upon the belief that market forces offer a more flexible, efficient, and effective approach to promoting the public good than traditional NPCs, which are subject to a restrictive regulatory regime.
o Vermont Statute: The “L3C” is organized for a business purpose but: (1) significantly furthers the accomplishment of one or more charitable or educational purposes within the meaning of the IRC; (2) might not have been formed but for the L3C’s relationship to the accomplishment of charitable or educational purposes; and (3) no significant purpose of which is the production of income or the appreciation of property.
Rationales for the Nonprofit Sector
· The Role of Nonprofit Enterprise: NPCs make their producers fiduciaries of their purchasers, giving purchasers greater assurance that the services they desire will be performed as they wish
· “Contract Failure”: NPCs serve well in situations in which, owing either to the nature of the service in question or to the circumstances under which it is produced and consumed, ordinary contract devices in themselves do not provide consumers with adequate means for policing the performance of producers. In a business corporation, the charter, and the statutory and case law in which it is embedded, serves primarily to protect the interests of the shareholders from invasion by those immediately in control of the corporation. In a NPC, the restrictions imposed on controlling individuals by the charter and the law are primarily for the benefit of the organization’s patrons.
o Third Party Payment: Individuals who receive NP services have no connection with individuals who pay for them. Because the patron has no contact to the intended recipient, the patron has no way of knowing whether the promised service was ever performed, much less performed well. Consequently, without the NPC nondistribution constraint, the owners of a firm would be incentivized to provide inadequate services and to divert money saved to themselves. However, because of the nondistribution constraint, those who control NPCs have less opportunity and incentive than for profit company managers to use donations in ways different from their ostensible purpose.
o Public Goods: a good or service such that: (1) the cost of providing the good to many persons is not appreciably more than the cost of providing it to one; and, (2) once the good has been provided to one person, it is difficult to prevent others from enjoying it as well. Ex.: noncommercial broadcasting, public monuments, scientific research. Notwithstanding the free rider issue, consumers of public goods likely would prefer to contribute to a NPC because the consumer will have no simple means of observing whether his contribution has increased the level of the service provided. Rather, the consumer must take the producer’s word that the contribution will be used to purchase more of the good, rather than to pad someone’s wallet.
o Complex Personal Services: Owing to the difficulty of making an accurate personal appraisal of the kind and quality of services people need and receive for things like nursing care, day care, education, and hospital care, people entrust a great deal of discretion to the suppliers of these services. The nondistribution constraint reduces a NPC’s incentive to abuse that discretion.
· Why do t
ciations and charitable trusts; legitimacy of the institution (people are comfortable w/doing business w/them)
o Disadvantages: getting started: more paperwork, hassle; more difficult to dissolve than an unincorporated association.
The Incorporation Process
Write mission statement
Write business plan
o Governance and structure; projections for growth; market analysis: is there a need?; where is the money going to come from?; who is the competition?; staffing
Come up w/a name and make sure nobody else is using the same or a similar name (on secretary of state website/google)
Get your paperwork straight: corporate record book
Pick state of incorporation
o Normally, where org. operates
o Or, pick a state that has advantageous laws (Delaware)
File w/Secretary of state
Draft corporate policies: bylaws; conflict of interest policy; whistle-blower protection policy; document retention and destruction policy
o Can find forms at Douglas forms or intermediary organization
File for employer ID number (EIN): open a bank account and apply for tax exemption
Have an organizational meeting: bring stakeholders together and the incorporator (paper work guy) will hand over power to board of directors. The board will then adopt various policies
Apply f/tax exemption
Member nonprofits vs. non-member nonprofits
· Members are like SHs: they periodically get together and decide who is on the board of directors and sometimes can approve fundamental changes.
· Memberships can be a pain in the ass, however, it may be beneficial to NPOs that are deeply rooted in a community.
· The procedures or internal rules governing the entity
· May contain any provision not inconsistent w/the corporate law of the jurisdiction
· Typically contain: notice requirements for special and annual meetings, definitions of members if a membership corporation, the date of the annual meeting, quorum requirements for conducting business, member tenure, election procedures, removal and filling vacancies of directors, the number an responsibilities of the officers, the fiscal year, committees of the board, indemnification provisions, whether informal action by the board is permitted, and procedures for amendment
· Special issues: actions authorized w/o a meeting must have unanimous written consent; voting via email, teleconferences
Purpose and Powers of Nonprofit Corporations
· Lawful Purpose and Public Policy: States generally permit incorporation for any “proper” purpose so long as the org is not operated for personal pecuniary profit and adheres to the non-distribution constraint
o State officials’ roles are generally ministerial and not discretionary
§ Public Policy: In the past, state officials could reject a NPC’s application if its purpose went against public policy. Now, the public policy doctrine is dormant.