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Nonprofit Organizations
University of North Carolina School of Law
Kelley, Thomas A.

Non-Profit Law Outline

Prof. Tom Kelley

Fall 2017

Non Profits Generally

Justifications for non-profit sector

Innovation
Public good
Filling gap between private sector and government
Micro-loans
Information Asymmetry

Can’t be sure product goes where it should or is adequate

For-profit -> not as trustworthy
Non-profit -> more trustworthy that money will go to service

Non profits have a nondistribution constraint

Why we have a tax-privileged nonprofit sector in the first place

Market failure
Contract failure
Information asymmetry
Social risk capital
Idea that people can try things in the nonprofit sector that aren’t part of the common wisdom
Incubate new ideas
Counter-majoritarian ideas

History of NPs

NP’s have changed but laws haven’t kept pace
Origins: God ordained disparity in wealth

Wealthy gave alms to poor, not about empowerment or strategy

Over time: Meaning of charity changed from alms to poor to social benefit and nondistribution constraint

Legal organizations also evolved

Legal Organization

In England: charity through trusts
In US: corporations not trusts because we didn’t want to be like England

Corporation = artificial person under US law

Type of Law used

Charity law in US uses a mix of trust and corporate law, but mostly corporate law

NP Proliferation of corporations

Forming a corporation was historically only for elites
20th Century: General Incorporation Statute

made it easy to form a corporation
lowered barriers
regulated by states (AG’s)

AG’s failed to regulate and now IRS is the regulator

Led to proliferation of NPs

Effects of rise NP corporation

Increase evaluation and measurement

Data; metrics; impact

Increase NP workers with degrees
Change in idea that charity isn’t giving alms but helping people take control of their lives

Increased professionalism and efficiency

Started to look more like for profit sector

Confusing for law

Blurred lines of FP and NP sectors

Often generate profit, just can’t distribute it to shareholders

“Non-distribution constraint”

FPs acting now like NPs
Law hasn’t kept pace
Efforts to create hybrid entities

Meaning of charity/charitable

Different in conversation than legal terms
Conversationally: focus on relieving the poor
Legally: fed and state laws use different definitions

501c3 generally

Having 501c3 status doesn’t mean you are exempt from all taxes

i.e. property tax, sales tax, state income tax

Choice of Form

Generally

Three main types

Corporation
Trust
Unincorporated Association

Want to choose the entity of NP that makes sense

Unincorporated Association

Gathering of 2 or more people united for a common purpose
Can’t hold property in corporation’s name
Personal liability of all partners

Can be sued and held joint and severally liable
Case law develops this and some state courts have provided some relief for this
Lots of potential liability here

Difficult to have bank account
Agency Principles apply
But can still get 501(c)(3) status

But will need proper documentation

Flexible and easy to create, don’t need governmental approval

If you want to kill it, you can just walk away

Can get 501(c)(3) fiscal sponsor

People can contribute money to existing 501(c)(3)
Contributors get tax deduction
Then 501((3) hands money down to smaller org
Can be intermediary step between unincorp assoc and corp

Law assumes you are an unincorporated association prior to converting to a corporation
Charitable Unincorporated Associations Act

NC adopted
Addresses some disadvantages of unincorporated association
Provides some limited liability coverage

BUT IT IS NEW SO NO ONE KNOWS IF LIABILITY COVERAGE WILL HOLD UP

Allows association to enter into a contract

Charitable Trusts

Advantages

Easier and less complex than incorporating
Trustee(s) make(s) decisions
Don’t need to get it approved or file it anywhere
Can own property, own a bank account, enter into contracts, etc.
Less expensive/easier to maintain than nonprofit corporation
No need for regular board meetings
Not subject to the rule against perpetuities
Purpose can be enforced in perpetuity, allows founder to maintain control

Disadvantages:

Hard to change purpose of organization or trustee
Trustee standard of care is harder to satisfy than a corporation

Easier to prove you didn’t do a job right or were negligent and can be personally liable because standard of care is higher

Banks like corporations better
Not a lot of case law for trusts/equity, so unpredictable
High fiduciary duty

Other trust characteristics

Settlor = person who gives money/puts assets into trust/creates trust
Need court approval to make any kind of significant change
Residuary legatees

If trusts fail, heirs (residuary legatees) in background get residual

Equity – roots in Court of Chancery in medieval England, was appeal to seek King’s justice, appeal directly to the King seeking fairness, guided by 12 Equitable Maxims

Equity suffers no wrong without a remedy
Equity looks at the intent rather than the form

ION: parent subsidiary corporation relationship

Make subsidiary as a member corp with parent corp as only member
Then parent gets to pick board

Disadvantages of members:

Factions waring/overthrow
Need to keep active rolls
Need to get qurom for votes

Extra provisions (#8 on form)

Statement of purpose is typically “to engage in lawful activities”
Statement of prohibited activities such as excessive lobbying, political campaign activity, and private inurement

Tax Exempt Status form

Magic IRS Language to get 501c3

Need dissolution language

If you dissolve your assets go to another NP charitable orrg
This is distribution constraint language

Most orgs check mopre than 1 purpose of corporation

complying with 501c3

charitable
religious
educational

gives most flexibility
better to state broadly and do more elaborate mission statement in bylaws

Prohibited acts

Nondistribution constraint
Don’t do anything illegal
No lobbying
No political action

Lawful Purposes of NP Corps

State Laws

In most states you can form for “any lawful” purpose
Can’t form a NP corp for an illegal purpose
Before: secretary of state would get paperwork for something it didn’t approve of (i.e. gay rights nonprofit) and could not allow them to incorporate
Now: Happens far less often than it used to
Most nonprofit statutes explicitly state that secretary of state’s role is purely ministerial

If paperwork is filled out correctly and purpose of corporation is legal, they do not have discretion to reject it

NC can reject on public policy grounds but it is rare

Commercial Purposes by NP Orgs

Commerciality doctrine- federal law when IRS thinks NP acts too commercial
At state level: comes up when we’re arguing about whether the nonprofit is or is not required to pay property taxes at a local level
Conundrum is that many have applied for 501(c)(3) status, and yet their local governments say that they don’t qualify under their definition of charity (more narrow like alms to poor)
Typically, local governments say that they’re too commercial