On December 18, 2013 Governor Cuomo signed into law the Nonprofit Revitalization Act of 2013 (the “Revitalization Act”), Assembly Bill Number 8072; Chapter 549 of the Laws of 2013.1 Intended “to reduce unnecessary and outdated burdens on nonprofits and to enhance nonprofit governance and oversight,” the Revitalization Act amends the New York Not-for-Profit Corporation Law (“NPCL”) (as well as other New York laws governing not-for-profit and religious corporations and charitable trusts, including the Education Law, the Estates, Powers and Trusts Law, the Executive Law and the Religious Corporations Law) to simplify certain corporate transactions and processes, while at the same time making mandatory various “best practices” in corporate governance that are designed to minimize the likelihood of fraud and other potential abuses by charitable organizations. The majority of the provisions will go into effect July 1, 2014. In anticipation of the changes to be made by the Revitalization Act, the Boards of corporations organized under the NPCL and other charitable organizations operating in New York will need to revise and/or adopt new by-law provisions, conflict of interest and whistleblower policies and other procedures to comply with the new requirements.
Below is a summary of the significant provisions of the Revitalization Act and the law’s impact on corporations governed by the NPCL.
Governance and Board Oversight Requirements
Board oversight of audited financial statements (NPCL § 712-a)
The Revitalization Act will add a provision to the NPCL that will require the Boards of corporations that must file an independent certified public accountant’s audit report with the Attorney General under Section 172-b of the New York Executive Law (namely, charitable organizations registered or required to be registered pursuant to Section 172 of the Executive Law (“Registered Organizations”) with more than $500,000 in gross revenue and support2) to take a more active role in overseeing the audit process. Specifically, the Board or an audit committee made up entirely of independent Directors3 will be required, at a minimum, to select the independent auditor and review the results of the audit, including any management letters that accompany the audit.4
Additional Board oversight requirements will apply to Registered Organizations that have annual revenue in the prior fiscal year over $1,000,000 or that expect to have annual revenue in the current fiscal year over $1,000,000.5 Specifically, the Board (or committee of the Board) of such corporations subject to the NPCL will be required to (1) review the scope and planning of the audit with the auditors before the audit takes place; (2) review and discuss with the independent auditor any “risks and weaknesses in [the] internal controls;” (3) be informed of any disagreement between auditors and management; (4) assess the adequacy of the corporation’s accounting and financial reporting; (5) evaluate the “performance and independence of the independent auditor;” and (6) report to the Board regarding these procedures, if such procedures are undertaken by a committee of the Board.6 As amended, the NPCL will permit the Board or designated audit committee of a corporation that controls a “group of corporations” to perform the audit duties of one or more of the controlled corporations.7
Related-party transactions (NPCL § 715)
The Revitalization Act prescribes additional procedural requirements relating to, and Attorney General oversight of, interested-party transactions. Current law strongly favors the enforceability of Board-authorized transactions, only rendering such transactions voidable when (a) the voting Members or Directors had no knowledge of the Director’s or Officer’s interest in the transaction, or (b) the interested Officer or Director was necessary for the authorization of the contract or transaction.8 The Revitalization Act replaces the presumption in favor of the enforceability of interested party transactions with procedural requirements designed to require disclosure and more careful Board review of “related party transactions”.9 A “related party transaction” is defined for this purpose as a transaction “in which a related party has a financial interest and in which the corporation or any affiliate of the corporation is a participant.”10 “Related party” is defined, in turn, as any Director, Officer or “key employee”,11 or relative of such individual, or entity in which such individual has a 35% or greater ownership or beneficial interest or, in the case of a partnership or professional corporation, a direct or indirect ownership interest in excess of 5%.12 As amended, the NPCL will prohibit a corporation from entering into a “related party transaction” unless the interested Officer or Director discloses his or her interest in the transaction and the Board determines that the transaction is “fair, reasonable and in the corporation’s best interest at the time of such determination.”13 Additionally, the “related party” will be barred from participating in any deliberations or casting a vote with respect to the transaction.14 If the related party transaction involves a “charitable corporation” as defined below15, and an entity “in which a related party has a substantial financial interest,” the Board will be required to: (1) “consider alternative transactions,” prior to entering into the transaction; (2) approve such transaction by a majority of Directors or committee Members present at the meeting; and (3) contemporaneously record the justification for the transaction and the consideration of alternatives.16
If a Board of Directors does not adhere to such procedures, or if the transaction is “otherwise not reasonable or in the best interest of the corporation” when approved, the Revitalization Act will authorize the Attorney General to bring an action to “enjoin, void or rescind” the transaction.17 In such an action, the Attorney General will be able to seek restitution and the removal of implicated Officers or Directors, as well as (1) an accounting and repayment of any profits made from the interested transaction; (2) reimbursement for the value of the use of any property or assets involved in the transaction; and (3) the return or replacement of any property or assets lost through the transaction, including any lost income or appreciation.18 Significantly, if any party acts willfully or intentionally, the Attorney General will also be authorized to pursue double damages, calculated based on the value of any improperly obtained benefit.19
Conflict of interest policy (NPCL § 715-a)
The Revitalization Act will also require every corporation subject to the NPCL to adopt a conflict of interest policy that applies to all Directors, Officers and “key employees”.20 The conflict of interest policy must require that Directors, prior to initial election and annually thereafter, “sign and submit to the secretary of the corporation a written statement identifying . . . any entity of which such director is an officer, director, trustee, member, owner . . . or employee and with which the corporation has a relationship.”21 Additionally, Directors must disclose all transactions in which the Director might have an interest which conflicts with that of the corporation. Such disclosures must be provided to the chair of the audit committee, or if there is no audit committee, to the chair of the Board.22
Because entities that are exempt from Federal income tax are generally required to disclose whether they have a conflict of interest policy in filing Form 990 with the IRS, it is likely that most corporations subject to the NPCL have already adopted such polices, but these policies will need to be reviewed to determine their compliance with the new NPCL requirement.23
Whistleblower policy (NPCL § 715-b)
The Revitalization Act will also require corporations that are subject to the NPCL and have more than $1,000,000 in annual revenue and more than 20 employees to adopt a whistleblower policy “to protect from retaliation persons who report suspected improper conduct.”24 The policy must provide that any employee, Officer, Director or volunteer who in good faith reports a violation of any corporate policy or any illegal or fraudulent action that occurs within the organization, will not “suffer intimidation, harassment, discrimination or other retaliation,” including any adverse employment consequences.25 Each corporation to which the whistleblower policy applies must also ensure that the policy is distributed to all Officers, Directors, employees and volunteers who provide significant services to the organization.26
As with the conflict of interest policy requirement, it is likely that most tax-exempt organizations have already adopted whistleblower policies as a result of Form 990 reporting obligations. Again, however, these policies will need to be reviewed to determine their compliance with the new NPCL requirement.
Compensation determinations (NPCL § 515)
As amended by the Revitalization Act, the NPCL will prohibit any Member, Director or Officer from voting or participating in deliberations regarding compensation to be paid to them by a corporation that is subject to the NPCL.27
Employees precluded from service as Board Chairs (NPCL § 713)
Effective January 1, 2015, employees of a not-for-profit corporation will be prohibited from serving as the Chair of the Board of Directors “or hold[ing] any other title with similar responsibilities.”28 This provision raises the question whether a paid employee, such as a President or Chief Executive Officer, may serve on the Board and preside at Board meetings if there is no Chair of the Board of Directors.
Reducing Burdens on Not-for-Profits
Re-categorization of not-for-profit corporations (NPCL § 201)
The Revitalization Act will simplify the legal categorization of corporations formed under the NPCL. Under current law, each not-for-profit corporation must fit into one of four “types” based on corporate purpose, known as A, B, C or D corporations.29 After July 1, 2014, these “types” will be eliminated in favor of a simpler “charitable” or “non-charitable” distinction.30 Charitable corporations will be those formed for charitable purposes, defined in the Revitalization Act as those formed for “charitable, educational, religious, scientific, literary, cultural” purposes or “for the prevention of cruelty to children or animals.”31 Non-charitable corporations will be those formed under the NPCL “other than a charitable corporation,” including corporations formed for non-pecuniary purposes such as “civic, patriotic, political, social, fraternal, athletic, agricultural, horticultural, or animal husbandry [purposes], or for the purpose of operating a professional, commercial, industrial, trade or service association.”32 Where the corporation has both charitable and non-charitable purposes, it will be deemed a charitable corporation.33 As of July 1, 2014, all existing type A corporations will be deemed “non-charitable organizations,” all existing type B or C corporations will be deemed charitable, and all existing type D corporations will be deemed charitable only if the organization has a “charitable purpose” as defined above.34 Significantly, neither the definition of charitable corporations or non-charitable corporations expressly references health care purposes, an issue that will need to be addressed in forming new not-for-profit health care provider entities.
Simplification of purposes provisions of certificates of incorporation (NPCL § 402)
The Revitalization Act amends the NPCL to provide that, although the purpose or purposes of a corporation formed under the NPCL must be set forth in its certificate of incorporation, the certificate of incorporation need not state how such purposes will be achieved or the specific activities it might pursue.35 The purpose of this provision is to facilitate the filing of organizational documents and reduce the need for amendments to certificates of incorporation as corporate strategies and activities change.
Board authorization of real estate transactions (NPCL §§ 509, 510, 511)
The sale, lease, mortgage or purchase of real property by a corporation that is subject to the NPCL currently requires the vote of two-thirds of the entire Board, provided that if the Board has 21 or more members, a vote of the majority of the Board is sufficient.36 As amended by the Revitalization Act, the NPCL will allow a majority of the Board or a committee appointed by the Board to approve all real property transactions that do not involve all or substantially all of the corporation’s assets (“Non-Substantial Real Estate Transactions”).37 If a committee is empowered to approve Non-Substantial Real Estate Transactions, it must promptly report to the Board any action taken pursuant to its authority at or before the next scheduled Board meeting. The Revitalization Act retains the requirement that two-thirds of the Board approve all real estate transactions involving all or substantially all of the corporation’s assets, including the exception that allows for majority approval if the entire Board consists of 21 or more members. Approval of such transactions may not be delegated to a committee.38
Judicial approval of certain significant transactions to become optional (NPCL §§ 511-a, 804, 907-b, 1002)
Currently, the disposition of all or substantially all of a corporation’s assets, the merger or consolidation of a corporation, or the dissolution of a corporation, or a change in corporate purpose or power set forth in the certificate of incorporation of a type B or C corporation requires Supreme Court approval with notice to the Attorney General.39 The Revitalization Act will permit a corporation organized under the NPCL to petition the Attorney General, instead of the Supreme Court, for approval of a sale of all or substantially all of the assets of the corporation, changes in corporate purposes or powers, mergers, consolidations and dissolutions.40 The Revitalization Act does not alter the process by which a corporation petitions the Supreme Court or its right to do so. However, corporations subject to the NPCL will now have the option of by-passing court approval by petitioning the Attorney General instead.
Modernization of rules governing participation in meetings (NPCL §§ 605, 708)
The Revitalization Act will authorize notice of member meetings by facsimile or e-mail.41 Directors will be able to participate in Board meetings via video conference, and electronic participation will be automatically permitted without specific authorization in the corporation’s by-laws.42 In addition, unless restricted in a corporation’s certificate of incorporation or by-laws, corporate action by the Board or members will be permitted without a meeting by electronic written consent given by e-mail.43 Previously, such consent was required to be in writing.44
While the Revitalization Act will streamline certain corporate procedures and facilitate certain corporate transactions, it will also impose additional compliance obligations, particularly for the Boards of Directors of corporations that are subject to the NPCL. Under the Revitalization Act, Boards of Directors will be required to scrutinize “related party” transactions more closely or risk enforcement action by the Attorney General. For larger charities, the audit process will need to be overseen exclusively by independent Directors (or the entire Board), and procedures for compliance with the new statutory requirements will need to be documented. All corporations subject to the NPCL will also be required to adopt conflict of interest policies and, if the corporation has more than 20 employees and over $1,000,000 in revenue, implement whistleblower protections. As noted above, all corporations that are subject to the NPCL will need to review these new requirements and adopt revised (or new) policies and procedures to comply with the Revitalization Act by July 1, 2014.
1 According to Governor Cuomo’s approval memorandum, the Legislature has “agreed to remedy” “certain technical defects and barriers to implementation” contained in the law. The Governor did not specify which “technical defects” or “barriers to implementation” the Legislature has agreed to remedy or provide a timeline for the Legislature to take such action.
2 Increasing to $750,000 in 2017 and $1,000,000 in 2021.
3 N.Y. Not-for-Profit Corp. Law § 721-a(a). The term “independent director” is defined as a Director who (i) “is not, and has not been within the last three years, an employee of the corporation or an affiliate of the corporation,” and whose relatives have not and have not been within the last three years a key employee of the corporation; (ii) does not receive, has not received in the last three years, and has no relative that has received in the last three years, remuneration greater than $10,000 per year, excluding reimbursement for reasonable expenses or compensation for services of the Director as permitted by the NPCL; and (iii) is not an active employee or relative of a current Officer of an entity, and does not have a substantial financial interest in, nor have a relative who has a substantial financial interest in an entity, that has made or received payments to the corporation greater than the lesser of $25,000 or two percent of the entity’s consolidated gross revenue. N.Y. Not-for-Profit Corp. Law § 102(a)(21). Notably, “payment” does not include charitable donations. Id.
4 N.Y. Not-for-Profit Corp. Law § 712-a(a).
5 N.Y. Not-for-Profit Corp. Law § 712-a(b).
6 N.Y. Not-for-Profit Corp. Law § 712-a(b)(1)-(4).
7 N.Y. Not-for-Profit Corp. Law § 712-a(d). Notably, the term “group of corporations” is not defined.
8 N.Y. Not-for-Profit Corp. Law § 715.
9 N.Y. Not-for-Profit Corp. Law § 102(a)(24).
11 The term “key employee” is defined in NPCL § 102(a)(25), added by the Revitalization Act, by reference to the definition of “disqualified persons” in 26 U.S.C. § 4958(f)(1)(A) and 26 C.F.R. § 53.4958-3(c), (d) and (e). N.Y. Not-for-Profit Corp. Law § 102(a)(25). For the purposes of the referenced Internal Revenue Code and Treasury regulation, a “disqualified person” with respect to a given transaction is “any person who was . . . in a position to exercise substantial influence over the affairs of [an] applicable tax-exempt organization . . . at any time during the [five] year period ending on the date of [the] transaction,” including, but not limited to, “voting members of the governing body”, Chief Executive and Chief Operating Officers, Treasurers and Chief Financial Officers. 26 U.S.C. § 4958(f)(1)(A); 26 C.F.R. § 53.4958-3(c)-(e).
12 N.Y. Not-for-Profit Corp. Law § 102(a)(23).
13 N.Y. Not-for-Profit Corp. Law § 715(a).
14 N.Y. Not-for-Profit Corp. Law § 715(g).
15 N.Y. Not-for-Profit Corp. Law § 102(a)(3-a).
16 N.Y. Not-for-Profit Corp. Law § 715(b)(1)-(3).
17 N.Y. Not-for-Profit Corp. Law § 715(f).
18 Id. § 715(f)(1)-(3).
19 Id. § 715(f)(4).
20 N.Y. Not-for-Profit Corp. Law § 715-a(a).
21 N.Y. Not-for-Profit Corp. Law § 715-a(c).
23 The term “key employee” is defined differently for purposes of the NPCL and Internal Revenue Service (“IRS”) Form 990, “Return of Organization Exempt from Income Tax”, which must be filed by certain organizations exempt from Federal income tax under Sections 501(c) or (d) of the Internal Revenue Code. N.Y. Not-for-Profit Corp. Law § 102(a)(25). Accordingly, an organization’s conflict of interest policy should cover “key employees” as defined both by the NPCL (by reference to the Internal Revenue Code definition of “disqualified person”) and by the instructions to Form 990.
24 N.Y. Not-for-Profit Corp. Law § 715-b(a).
26 N.Y. Not-for-Profit Corp. Law § 715-b(b).
27 N.Y. Not-for-Profit Corp. Law § 515(b).
28 N.Y. Not-for-Profit Corp. Law § 713(f).
29 N.Y. Not-for-Profit Corp. Law § 201(b) (McKinney 2013). Under the law in effect through June 30, 2014, type A corporations are membership organizations formed for any lawful non-business purpose, such as civic associations, professional and trade groups; type B corporations are formed for any one or more enumerated non-business purposes including charitable, educational, religious, scientific, literary, or cultural purposes, or for the prevention of cruelty to children or animals; type C corporations are formed for any lawful business purpose to achieve a “lawful public or quasi-public objective; and type D corporations are formed when such “formation is authorized by any other corporate law . . . for any business or non-business, or pecuniary or non-pecuniary, purpose . . . specified by such other law, whether such purpose . . . [is] also within types A, B, C.” Id.
30 N.Y. Not-for-Profit Corp. Law § 201(a).
31 N.Y. Not-for-Profit Corp. Law § 102(a)(3-b).
32 N.Y. Not-for-Profit Corp. Law § 102(a)(9-a).
33 N.Y. Not-for-Profit Corp. Law § 201(b).
34 N.Y. Not-for-Profit Corp. Law § 201(b)-(d).
35 N.Y. Not-for-Profit Corp. Law § 402(a)(2).
36 N.Y. Not-for-Profit Corp. Law § 509 (McKinney 2013).
37 N.Y. Not-for-Profit Corp. Law § 509(a)-(b).
38 Id. § 509(a)-(c).
39 N.Y. Not-for-Profit Corp. Law §§ 511, 804(a)(ii), 907(a), 1002(d) (McKinney 2013).
40 N.Y. Not-for-Profit Corp. Law §§ 511-a, 804(a)(ii), 907-b, 1002(d)(1)-(3).
41 N.Y. Not-for-Profit Corp. Law § 605(a).
42 N.Y. Not-for-Profit Corp. Law § 708(b)-(c).
43 N.Y. Not-for-Profit Corp. Law §§ 614(a), 708(b).
44 N.Y. Not-for-Profit Corp. Law §§ 614(a), 708(b) (McKinney 2013).