The Non-Profit Revitalization Act of 2013 Overhauls New York Nonprofit Corporation Law

Both houses of New York’s legislature this spring unanimously passed The Non-Profit Revitalization Act of 2013, (NY S.5845/A.8072) (the “Act”), a bill undertaking the first major overhaul of New York’s nonprofit laws in more than 40 years. If signed into law by New York’s governor, the Act will be effective on July 1, 2014. The Act aims to eliminate administrative red tape that is needlessly confusing and burdensome to nonprofits and that often prompts New York-based charities to incorporate in another state having favorable laws, such as Delaware.

The Act is based on recommendations from the Leadership Committee for Nonprofit Revitalization (the “Committee”), which was convened by New York’s attorney general in July 2011. The Committee consisted of 32 nonprofit leaders across New York, who were charged with recommending proposals that would reduce regulatory burdens on nonprofits, while strengthening governance and accountability. The Committee’s recommendations are reflected in the Act and two initiatives – New York on BOARD (“Building Oversight, Awareness, Resources and Depth”), a directo recruitment initiative to build stronger and more diverse boards for nonprofits, and Directors U, which provides low-cost training to board members on topics related to nonprofits and governance. The Act applies to nonprofits incorporated in New York. Some provisions also apply to nonprofits that are required to be registered to solicit charitable contributions in New York under New York Executive Law Section 172, even if they are not incorporated in New York. Proponents of the Act, including several New York bar associations, welcome the updates and have encouraged New York’s governor to sign the bill.

The Act has three general purposes: (1) to eliminate unnecessary administrative and procedural burdens, (2) to modernize the New York nonprofit law, and (3) to strengthen governance through compliance with certain best practices (general practices that many nonprofits already use and most should use). Several of these changes may create practical challenges for some nonprofits, which may need to make significant governance and oversight changes to comply with the new law. Highlights of the changes under the Act are summarized below.

Elimination of Letter Types. One of the most significant changes in the Act is the replacement of New York’s unique taxonomy of four types of nonprofit corporations (Types A, B, C and D) with two types of nonprofit corporations – charitable and non-charitable. Under existing New York law, a nonprofit’s purpose determines its Type. Type A nonprofits are membership organizations formed for a specific list of purposes including, but not limited to, civic, political, social, fraternal, and athletic, and for professional, trade or service associations. Type B nonprofits are formed for any one or more of the following purposes: charitable, educational, religious, scientific, literary, cultural, or for the prevention of cruelty to children or animals. Type C nonprofits are formed to achieve a public or quasi-public objective. Finally, Type D nonprofits are those formed under New York nonprofit law when their formation is authorized by another New York law, regardless of whether their purposes also fall within Types A, B or C. If a nonprofit is formed for both Types A and B purposes, it is classified as Type B. If any of the purposes for which a nonprofit is formed would be characterized as Type C, then it is classified as Type C even if other purposes of the nonprofit might be appropriately characterized as Types A or B.

The Act aims to eliminate widespread confusion about the Types and simplify the process of incorporation for nonprofits in New York. Under the Act, nonprofits formally known as Types B and C entities, as well as Type D entities formed for a charitable purpose, will be designated as “charitable” corporations. Type A and all other Type D entities will be designated as “non-charitable” corporations. This change was motivated by a desire to clarify the law and reduce needless startup costs and delays. For example, the Committee recommended that the Act remove the following barrier to incorporation. Many nonprofits, such as local community theaters, believing they are Type B nonprofits, find that their certificates of incorporation are rejected because they conduct business-like activities such as selling tickets. In some cases, such rejections cause the Internal Revenue Service to question the charitable nature of the nonprofit as well. The Act’s replacement of the Types with “charitable” and “non-charitable” corporations aims to eliminate that problem by making it easier for nonprofits to determine the correct classification, which in turn will reduce costs and avoid complications with applying for federal tax exemption.

Significant Corporate Events. The Act allows a charitable corporation seeking to sell, lease, exchange, or dispose of all or substantially all of its assets; merge or consolidate; or change its purpose to go through a one-step approval process (i.e., attorney general approval) instead of the more cumbersome two-step process under current law requiring court approval following attorney general review. This change endeavors to expedite the often lengthy approval process and reduce associated legal costs. Nonprofits would continue to have the right to seek court approval of a transaction at any time.

Real Estate Transactions. Existing New York nonprofit law requires a two-thirds vote of the entire board to approve non-substantial real estate transactions for nonprofits with fewer than 21 directors. The Act makes it easier to approve such transactions by permitting approval of such transactions upon the vote of a majority of the nonprofit’s directors. The two-thirds voting requirement is maintained for transactions involving property that constitutes all or substantially all of the nonprofit’s assets, unless the nonprofit has more than 20 directors, in which case only a majority vote is required. The intent of this change is to reduce administrative burdens associated with routine real estate transactions while preserving stricter requirements for more significant transactions.

Modernization of Board Procedures and Meetings. The Act modernizes board procedures to enable participation by directors who are unable to attend meetings in person. For example, under the Act, nonprofits may use electronic mail to transmit board and membership meeting notices and waivers of notice, and to enter into unanimous written consents. Board members will also be able to participate in meetings by video conference, Skype or other forms of video communication.

Required Financial Reporting and Audit Procedures. From July 1, 2014, to June 30, 2017, the Act outlines a sliding scale for financial reporting and audit requirements based upon gross revenue and support for every charitable organization registered or required to be registered to solicit charitable contributions in New York, as illustrated in the chart below.

* To reduce the burden on smaller nonprofits, the revenue and support levels increase on July 1, 2017, from $500,000 to $750,000 and again on July 1, 2021, from $750,000 to $1 million.

The Act also improves certain requirements related to the board’s handling of audit functions. The board or its designated audit committee must be composed of independent directors, who must oversee the accounting and financial reporting processes. Additionally, the audit committee of a nonprofit that has annual gross revenue and support in excess of $1 million will be required to review with the independent auditor the scope of the audit before its commencement and, upon its completion, discuss any material risks and weaknesses in internal controls identified by the auditor. The purpose of this provision is to ensure that boards are aware of, and respond to, issues and risks identified by auditors.

Mandatory Whistleblower Policy. The Act requires every nonprofit with 20 or more employees and annual revenue in excess of $1 million in the prior fiscal year to adopt a whistleblower policy. The whistleblower policy must protect directors, officers, employees and volunteers who report suspected improper conduct from retaliation. Among other things, the whistleblower policy must set forth a requirement that an employee, officer or director be designated to administer the policy and the procedures for reporting suspected violations, including procedures for preserving the confidentiality of reported information.

Mandatory Conflict of Interest Policy. The Act mandates every nonprofit to adopt a conflict of interest policy to ensure that its directors, officers and key employees act in the nonprofit’s best interest. This provision applies to all nonprofits incorporated in or transacting business in New York. The only exception to this rule is if a nonprofit has adopted a conflict of interest policy pursuant to any other law that is substantially similar to the provisions set forth in the Act. Among other things, the Act requires that the conflict of interest policy include the following: (1) a definition of what constitutes a conflict of interest; (2) procedures for disclosing a conflict of interest to the audit committee or board; (3) a prohibition against any attempt by the person with the conflict of interest to influence improperly the deliberation or voting on the matter giving rise to such conflict; and (4) a requirement that the existence and resolution of the conflict be documented in the nonprofit’s records, including the minutes of any meeting at which the conflict was discussed or voted upon.

Before the initial election of any director, and then every year of service thereafter, directors must complete, sign and submit a written disclosure of potential conflicts. Generally, the board or its designated audit committee must oversee the adoption, implementation of, and compliance with any conflict of interest policy.

Related-party Transactions. Like the current New York Not-for-Profit Corporation Law, the Act requires that related-party transactions be fair, reasonable and in the nonprofit’s best interest and that directors and officers who have a direct or indirect interest in a related-party transaction disclose such interest to the board. Yet the Act takes this requirement a step further by also requiring good faith disclosures by “key employees.” The Act defines a key employee as any person who is in a position to exercise substantial influence over the affairs of the nonprofit in accordance with the “disqualified person” provisions of the excess benefit transactions applicable to public charities and social welfare organizations under Internal Revenue Code section 4958.

Under the Act, the board of a charitable organization must consider alternatives to any related-party transactions, approve the transaction upon the vote of at least a majority of the directors and document contemporaneously the basis of the board’s approval. The Act authorizes the attorney general to bring an action, in his or her discretion, to enjoin, void, or rescind any related-party transaction or proposed related-party transaction that is not reasonable or in the best interest of the nonprofit at the time the transaction was approved. Alternatively, the attorney general may seek restitution and removal of directors or officers.

Other Provisions. Other significant provisions of the Act include:

• Chair Requirements. To ensure independent board leadership and promote clear lines of accountability between management and the board, the Act expressly prohibits employees from serving as chair of the board or in an officer position with similar responsibilities, effective July 1, 2015.
• Executive Compensation. The Act continues to allow nonprofits to reasonably compensate their executives. However, no person whose compensation is being determined during a meeting may be present at or otherwise participate in any deliberation or vote on that person’s compensation.
• Privacy. The Act would still require nonprofits to produce a list of directors and officers upon demand from a member of the nonprofit or a law enforcement agency. The Act, however, eliminates the requirement to disclose the home address of directors and officers.
• Independent Director. The Act defines an “independent director” as a director who: has not been an employee of, or does not have a relative who was a key employee of, the nonprofit or an affiliate of the nonprofit in the past three years; has not received, or does not have a relative who has received, $10,000 or more in direct compensation from the nonprofit or an affiliate in the past three years (other than expense reimbursement or reasonable compensation as a director); and is not a current employee of, or does not have a substantial financial interest in, any entity that has made payments to, or received payments from, the nonprofit or an affiliate of the nonprofit for property or services in an amount that exceeds the lesser of $25,000 or 2 percent of such entity’s consolidated gross income in the past three years.
• has not been an employee of, or does not have a relative who was a key employee of, the nonprofit or an affiliate of the nonprofit in the past three years;
• has not received, or does not have a relative who has received, $10,000 or more in direct compensation from the nonprofit or an affiliate in the past three years (other than expense reimbursement or reasonable compensation as a director); and
• is not a current employee of, or does not have a substantial financial interest in, any entity that has made payments to, or received payments from, the nonprofit or an affiliate of the nonprofit for property or services in an amount that exceeds the lesser of $25,000 or 2 percent of such entity’s consolidated gross income in the past three years.
• Entire Board. The Act defines “entire board” as the total number of directors entitled to vote which the nonprofit would have if there were no vacancies. If the bylaws of the nonprofit provide that the board must consist of a fixed number of directors, then the “entire board” is that number of directors. If the bylaws of any nonprofit provide that the board may consist of a range between a minimum and maximum number of directors, then the “entire board” is the number of directors within such range who were elected as of the most recently held election of directors.
• Nonprofits With Educational Purposes. The Act changes the requirement under current law for certain organizations with an educational purpose as defined by New York Education Law ( i.e., colleges, universities or other entities providing post-secondary education; nursery, elementary, secondary or charter schools; libraries, archives, or museums or historical societies with collections; and public television and radio shows) to seek the approval of the New York commissioner of education before incorporating. The Act would require only nonprofits operating schools, libraries, museums or historical societies to obtain the consent of the commissioner. Colleges and universities would require the consent of their regents.

Conclusion. Current New York law and regulatory practices can place unnecessary and costly burdens on the nonprofit sector. The passage of the Act signals lawmakers’ commitment to reducing redundancies throughout the system that waste not only nonprofit resources but taxpayers’ dollars as well. The Act seeks to make New York more welcoming for nonprofits that incorporate or transact business in New York by setting forth clearer expectations of board duties in key areas and streamlining certain administrative and operating requirements. To be in compliance, however, many nonprofits will have to adopt additional policies and procedures and implement certain changes in governance. Any nonprofit that is incorporated in New York or operates or solicits in New York should follow the status of this bill and, if it becomes law, take steps to ensure compliance with applicable provisions of the new law.

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