Recent Changes in Delaware Law Governing Not-for-Profit Corporations

             Incorporating under Delaware law can be an attractive option for a not-for-profit organization because Delaware law often grants greater flexibility with respect to the governance and structuring of the organization.   For example, under Delaware law, a corporation (whether organized for profit or not) is only required to have one director, whereas the majority of states require a not-for-profit organization to have at least three directors, and Delaware law does not require a corporation to have officers.  

            Unlike many other jurisdictions, Delaware does not have a separate code governing not-for-profit corporations. Instead, not-for-profit corporations are governed by the same Delaware General Corporation Law (the “DGCL”) that applies to for profit corporations. Typically, although other entity options are available for forming a Delaware not-for-profit organization (such as a trust or a limited liability company), most Delaware not-for-profit entities choose to incorporate as a nonstock corporation (i.e., a corporation that is not authorized to issue capital stock and that has “members” and a “governing body” rather than “shareholders” and a “board of directors”). 

           In the past, the proper application of the DGCL to not-for-profits was not entirely clear, because most provisions of the DGCL use terms specific to stock corporations, such as the terms “shareholders” and “board of directors.” As part of a comprehensive revision of the DGCL to clarify its application to nonstock corporations generally, Section 114 was added to the DGCL in August 2010 to specifically “translate” the terms in the DGCL applicable to stock corporations into terms applicable to nonstock corporations (e.g., references to “shareholders” are now deemed to refer to the “members” of a nonstock corporation).  

The 2010 amendments also revised the DGCL to require nonstock corporations to have members. Previously, there was no such explicit statutory requirement and the Delaware Department of State’s Division of Corporations had taken the position that a nonstock corporation could choose to exist without members by providing in the bylaws that the corporation would not have members. However, the 2010 amendments also added a savings clause in Section 102(a)(4), which provides that neither a nonstock corporation’s existence nor any of its actions will be invalidated by virtue of its failure to have members and where the certificate of incorporation and bylaws are silent regarding the requirements for membership, the persons who are entitled to elect the governing body will be deemed to be the nonstock corporation’s members. 

 

The 2010 amendments distinguish between for profit and not-for-profit nonstock corporations, making it explicitly clear in Section 114(d)(3) that members of a not-for-profit nonstock corporation cannot take an equity interest in the corporation. Accordingly, there should be no concern that having members will necessarily cause a Delaware not-for-profit nonstock corporation to run afoul of the prohibition against private inurement  under federal tax law that applies to Section 501(c)(3) organizations (for more on the prohibition against private inurement, see our prior blog post).

 

Published In: Business Organization Updates, Nonprofits Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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