Top Mistakes Nonprofits Make
Most non-profits govern by the generosity of volunteers, gathered from a cross-section of businesses that have a relevant interest in the cause of the not-for-profit organization. These can range from chambers of commerce, to club organizations, to home owners associations, to country clubs, to art
I. An Overview: Reasons to Incorporate the Not-for-Profit OrganizationA. It generates a *profit* from its activities
B. It wants to apply for public or private grant monies
C. It wants to solicit tax-deductible contributions
D. It wants protection from personal liability for the organization*s activities (concern for charitable time and expertise donated for the cause)
E. It wants individual liability protections for officers, directors, employees and volunteers, since advocacy can sometimes provoke differences of opinion as to causes making for litigation
II. Entity CreationA. Michigan Nonprofit Corporation Act. MCL 450.2101 et seq.
B. Section 501(c) (3) of the Internal Revenue Code of 1986 defines a tax exempt organization as:
*corporations , and any community chest, fund, or foundation, organized and operating exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition* or for the prevention of cruelty to children or animals**
It further provides that the organization is one that
**.no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting to influence legislation** and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office*
C. Selecting a Name * Search of the State of Michigan, Department Licensing & Regulatory Affairs (LARA) www.dleg.state.mi.us/bcs_corp/sr_corp.asp -limit ations on name use similar to any other Michigan corporation; a charitable entity may use the word *foundation* in its name, with limitations. MCL 450.2212
D. Articles of Incorporation *
Sample LARA Instructions and Form www.michigan.gov/documents/lara/BCS_CD_269_08-15_527658_7.pdf
Sample variations for different sorts of non-profit entities
a. Domestic non-profit www.michigan.gov/documents/lara/502_08-15_527692_7.pdf
E. By-Laws * Examples of variations for different sorts of non-profit entities:
Literacy education, volunteers and charitable solicitation
Chamber of commerce
F. The Difference between Articles and By-Laws * the Articles of Incorporation are the *constitution*, the Bylaws are the *statutes*, and the policies and rules of operation are the *administrative implementation*.
Content of articles of incorporation. MCL 450.2209
Adoption of bylaws. MCL 450.2261
G. Crafting the Mission
Mission is what distinguishes nonprofit entities from for profit: nonprofits have missions, instead of owners, members or shareholders, with the prime purpose to ensure the highest possible fulfillment of the mission.
There exists a non-distribution constraint * mission must be service to the public, not any individuals, private parties.
III. Governance, Oversight and MeetingsA. Bylaws control criteria of meetings, attendees at meetings, record of meetings and business to be conducted
B. Directors and officers * *Election,* volunteer service
C. Annual reporting and compliance
IV. Board Actions for Liability ProtectionsA. *Checks and balances*, oversight and team actions * Policy of professional accounting guidance, familiar with not-for-profit financial matters, template in place for year-end review and audit, filing of IRS Form 990 series and schedules.
B. Standard of care for directors and officers. MCL 450.2541. See samples of policies below.
C. Insurance Coverage(s) * typical corporate insurance coverage
D. Errors & Omissions coverage, directors & officers* liability coverage
E. Annual Audit needs -grant applications, requirements
V. Conflict of Interest PolicyA. Grant-Making Foundations
The law requires those who manage and govern not-for-profit entities to exercise due care in administering the charity*s affairs. This requirement is known as the duty of care. The law also prohibits fiduciaries from using their position to obtain personal gain for themselves or others at the charity*s expense. This requirement is known as the duty of loyalty. Paying careful attention to transactions where there may be a conflict of interest ensures that a fiduciary does not breach his or her duties of care and loyalty to the organization. It can also help instill public trust by demonstrating that fiduciaries are committed to managing an organization with the utmost integrity and good faith and in the best interest of the organization and its charitable mission. Conflicts of interest occur in our everyday lives when multiple loyalties pull us toward opposite courses of action. In the context of charities, a conflict of interest may occur when personal interests prevent an individual from making an impartial decision that is in the best interest of the charity. Applicable legal standards and prohibitions differ depending on:
- whether the charity involved is a public charity or a private foundation,
-whether the transaction is financial or non-financial in nature,
- whether state or federal law is most pertinent
- whether the charity is organized as a trust or a corporation.
Samples of policies include:
For purposes of this provision, the term "interest" shall include personal interest, interest as director, officer, member, stockholder, shareholder, partner, manager, trustee or beneficiary of any concern and having an immediate family member who holds such an interest in any concern. The term "concern" shall mean any corporation, association, trust, partnership, limited liability entity, firm, person or other entity other than the organization.
No director or officer of the organization shall be disqualified from holding any office in the organization by reason of any interest in any concern. A director or officer of the organization shall not be disqualified from dealing, either as vendor, purchaser or otherwise, or contracting or entering into any other transaction with the organization or with any entity of which the organization is an affiliate. No transaction of the organization shall be voidable by reason of the fact that any director or officer of the organization has an interest in the concern with which such transaction is entered into, provided:
1. The interest of such officer or director is fully disclosed to the board of directors.
2. Such transaction is duly approved by the board of directors not so interested or connected as being in the best interests of the organization.
3. Payments to the interested officer or director are reasonable and do not exceed fair market value.
4. No interested officer or director may vote or lobby on the matter or be counted in determining the existence of a quorum at the meeting at which such transaction may be authorized.
The minutes of meetings at which su
VI. Director & Officers LiabilityA. Places of Vulnerability:
Breach of Duties * Self-Dealing
Liability Resulting from Board Actions
Actions as Officers
Contractual Liability * Personal Guaranties
Liability for Staff Activity * Failure of Oversight
Lack of Corporate Status * Lapse
Sarbanes-Oxley Act * analogous application to non-profits:
a. Need to memorialize and maintain records
b. Whistle-blowing enforcement
B. Protections to be afforded by the Organization
- Limit the liability of volunteer directors * money damages
- Assume liability to third parties for *good faith errors* * indemnity
- Acting in good faith and within the scope and authority conferred
C. Indemnity * including undertaking litigation defense and attorneys* fees and costs for same
D. Commercial Insurance * in place for protection of organization and directors and officers
E. Recommended Resource: Clark Hill *The Responsibilities of Service: A Guide for Directors of Nonprofit Organizations in Michigan* (2013) www.clarkhill.com/uploads/medium/resource/854/CH_Nonprofit_Guide_11.5.14.
VII. Drafting and Revising Nonprofit Bylaws: Common Mistakes and Best Practices. Member-Elected or Self-Perpetuating Board
Director is synonymous with *trustee*. MCL 450.2106(4) Member or shareholder is a person with interest or shares in the entity pursuant to the articles of incorporation and bylaws. MCL 450.2108(1), 450.2109(1) The articles of incorporation shall designate the purpose of the entity, the engagement of anticipated activities, and whether it has a stock or non-stock basis. MCL 450.2202
Every organization, in its formation, must determine how it wants to function. A member- based organization will function much like a for-profit corporation, with shareholders, if the members have voting rights to put the board into place and thereafter conduct elections for new or replacements to the board. There are multiple levels of governance: the member decision-making level and thereafter the board. The structure can be perceived as more democratic, much less *controlled*, but sometimes demonstrating a fickle character, affected by factions within the membership that can seek to take mission divergence in direction. For example, the Sierra Club was an entity that gave members the right to vote and, at the same time, entertained a faction that sought an anti-immigration agenda offensive to other factions within the Club. A board takeover attempt was averted, but not without serious internal struggles. In addition to the philosophical factions that can evolve, on an administrative level, recordkeeping can be duplicative and more burdensome with multi-levels. There can also be non-voting member organizations which are common with museums that sell membership to exhibitions, that carry no other rights or special privileges. The board of directors continues to operate and is self-perpetuating.
Since the Board of Directors is the center of ultimate authority for a non-profit, self-perpetuating boards are most popular for charities, which allow for board nominations and vacancy replacements simply by vote of the board, taking into mind the quorum rules. Self-perpetuating boards select their own members. Directors whose terms are expiring elect their successors, which may be themselves. Such governance allows for a more stable, streamlined administration. The downside is the potential for routine and *that is the way it has always been done*. It may allow directors to serve indefinitely. An overly friendly set of members of the board may avoid taking needed risks, for fear of hurting anyone*s feelings. Performance and reviews may be less than effective if problems are overlooked out of politeness. Moreover, in the long run, such may limit the organization*s ability to attract new board members, with new skills and ideas.
Many organizations, so established, avoid such entrenchment by limiting the number of terms each director may serve and by staggering the terms of the members of the board to afford routinized and continuous turnover.
One perception to avoid, however, is any perception that the non-profit charity is tightly controlled by any one related group, family or for-profit business. The balance test will be readily applied.
B. Process for Adopting and Updatin
VIII. Nonprofit Board Governance and Liability Oversights (Including Failure to Follow Gov. Docs)A. Failure to Operate in Accordance with Own Governing Documents or State Laws
The articles of incorporation should provide protections to the individual to be serving as directors, as volunteers, in order to eliminate or limit a director*s personal liability to the entity or members for money damages resulting from an action or failure to take an action, with the exception of
(a) financial benefit received to which the person is not entitled;
(b) intentional infliction of harm;
(c) involvement in any entity for unlawful purposes; and
(d) expenses resulting from defense against a derivative action.
Moreover, the articles should provide that the entity will indemnify for liability within the scope of an individual*s authority for reasonably believed acts or omissions, made in good faith, and not to the level of gross negligence or worse. See MCL 450.2545a; 450.2551 * 450.2665, inclusive
B. Not Advising Directors of Their Obligations
1. Duty of Care * duties must be discharged in good faith and with the same degree of diligence, care, and skill which an ordinarily prudent person would exercise under similar circumstances in a like position. The burden of establishing the validity rests upon the interested director. MCL 450.2541(1)(a) and (b)
- good faith
- exercise of care * attention, active interest, preparation, alertness and anticipation of expected problems
- with reliance upon experts both inside and outside the entity
- proper delegation
- to the extent of rational actions, taken in good faith, without conflicts of interest
- the *best judgment* or *business judgment* rule provides that a director who performs duties in good faith and in accordance with the appropriate standard of care will suffer no liability based upon alleged failure to discharge such person*s obligation, absent director fraud, self-dealing, or intentional misconduct
2. Duty of Loyalty * undivided allegiance to the entity; with directorship powers, director is precluded from using such power or information for personal gain. Interests of the entity put ahead of personal interests of the director. A personal benefit received by a director from an opportunity deprives the entity of the benefits of that opportunity, typically centered around conflicts of interest related to personal financial interests of a director. MCL 450.2541(1)(c), 450 2545a
a. Entity is precluded from providing loans or guarantees for an officer or director of entity unless (1) officer or director is a client of the entity; and (2) loan/guaranty is necessary for the entity*s charitable purposes.
b. However, a transaction is not void if either:
(1) it was fair or reasonable when it was authorized approved or ratified by entity; or
(2) the material facts of director relationship or interest were disclosed or known to the board and transaction approved by the board (exclusive of interested director); or
(3) the same material facts were known to and approved by the members of the entity.
c. Avoiding duty of loyalty violations:
1. Policy in place as to conflicts of interest, self-dealing transactions, seizing corporate opportunity; avoida