A review of key legal developments at the federal and state levels for nonprofit organizations

Takeaways

Federal government and private antitrust enforcement continues against nonprofits.

Nonprofits have litigated in other areas including employee benefits, governance and tax.

Nonprofits can enhance compliance by learning from the legal outcomes of others.

The Third Circuit found that the PTA did not establish a claim of attempted monopolization because, although Uber could eliminate competitors in the Philadelphia taxicab market, it was not anticompetitive. Conversely, vehicle-for-hire companies strengthened competition by offering lower prices, more available vehicles, and a high-tech alternative to hailing traditional taxicabs. Uber’s ability to operate at a lower cost represented economic efficiency, which would lead to enhanced competition, better products, and lower prices for consumers. Uber’s recruiting of traditional taxicab drivers was also not anticompetitive because recruits were able to drive for Uber and thus not remain idle as taxicab drives may. Finally, PTA did not establish antitrust injury because harm to individual businesses does not equate to harm to competition.

N. Am. Soccer League LLC v. United States Soccer Fed’n Inc., 883 F.3d 32 (2d Cir. 2018)

Defendant, the United States Soccer Federation (USSF), designated soccer leagues as Division I, II, or III according to its Professional League Standards (Standards). From 2011 to 2017, the North American Soccer League LLC (NASL) operated as a Division II league, but its application for Division II designation for the 2018 men’s professional soccer season was denied. In response, NASL filed an antitrust suit against USSF, claiming that USSF applied its Standards in an anticompetitive manner to prevent NASL from competing with Major League Soccer LLC in the Division I market. NASL moved for a preliminary injunction in the form of designation as a Division II league and permanent enjoinment of USSF from utilizing the Standards to separate leagues into divisions.

The Second Circuit affirmed the District Court’s denial of NASL’s motion for a preliminary injunction and the Court’s reasoning that the USSF Board’s promulgation of the Standards failed to demonstrate a conspiracy. The court reasoned that, instead of having an adverse effect on competition, the Standards could be found to have a net procompetitive effect or no competitive effect at all.

Ass’n of Am. Physicians & Surgeons v. Am. Bd. of Med. Specialties, No. 14-cv-02705, 2017 U.S. Dist. LEXIS 205845 (N.D. Ill. Dec. 13, 2017)

The American Board of Medical Specialties (ABMS) offered a physician recertification program called the Maintenance of Certification (MOC) program. Participation was not required for physicians to be licensed to practice. However, ABMS obtained the agreement of The Joint Commission – a private organization that accredited health care organizations and hospitals – to require hospitals to mandate recertification for physicians to renew their medical staff privileges. In response, the Association of American Physicians & Surgeons Inc. (AAPS) sued ABMS alleging restraint of trade in violation of Section 1 of the Sherman Act.

The District Court granted a motion to dismiss in favor of ABMS because AAPS failed to allege a per se restraint of trade or that ABMS had sufficient market power to cause a restraint of trade. As the MOC program was voluntary, physicians were still able to practice medicine without certification. AAPS did not allege that the MOC program was required by a significant portion of American hospitals or that ABMS had the ability to control and coerce hospitals to force physicians to participate. Further, AAPS did not allege any reduction in the output or increase in the cost of medical care; and limiting patients’ access to their own physicians was not the type of injury antitrust laws intend to protect.

09.28.17 – Federal Trade Commission Approves Final Order In the Matter of National Association of Animal Breeders Inc.

(In re Nat’l Ass’n of Animal Breeders, 2017 FTC LEXIS 115 (F.T.C. September 26, 2017))

The National Association of Animal Breeders (NAAB) signed a cooperative research and development agreement that gave NAAB exclusive access to new technology developed by the U.S. Department of Agriculture (USDA). The technology analyzed commercially relevant genetic traits – such as milk yield – and produced a dairy bull’s Genomic Predicted Transmitting Ability (GPTA), which indicated the bull’s commercial value.

The Federal Trade Commission (FTC) charged NAAB with restraining competition for purchasing dairy bulls for use in artificial insemination. The FTC claimed that NAAB adopted a resolution that only NAAB members could obtain GPTAs and that any member who wanted to obtain a dairy bull’s GPTA had to have an ownership interest in the bull. The FTC argued that this resolution distorted the market because access to GPTA information ensured the price of a bull reflected its ability to produce more commercially efficient dairy cows.

In the final order, NAAB agreed to refrain from adopting rules that suppress competition by preventing access to technology or information. The order also stops the association from stifling price-related competition among its members and requires NAAB to implement an antitrust compliance program and meet compliance and reporting standards.

ERISA

01.05. 18 – U.S. Department of Labor Issues Proposed Rule “Definition of ‘Employer’ Under Section 3(5) of ERISA-Association Health Plans”

On October, 12, 2017, President Trump’s Executive Order 13813, “Promoting Healthcare Choice and Competition Across the United States” named association health plans (AHPs) as an area of improvement that the Administration will prioritize.

Subsequently, the U.S. Department of Labor proposed a regulation under Title I of the Employee Retirement Income Security Act (ERISA) that would amend section 3(5) of the Act. The regulation would make it easier for an association to be considered “the ‘employer’ sponsor of a single multiple employer ‘employee welfare benefit plan’ and ‘group health plan.’” Specifically, the regulation would create a more flexible “commonality of interest” test under the definition of “employer” to determine which groups or associations of employers could create AHPs. Associations of employers could meet the standard via “common geography” or “common industry.”

The goal of the rulemaking is “to expand access to affordable health coverage, especially among small employers and self-employed individuals, by removing undue restrictions on the establishment and maintenance of association health plans under ERISA.”

Governance

Ryan v. Henry, Nos. 1 CA-CV 16-0217, 1 CA-CV 16-0601, 2018 Ariz. App. Unpub. LEXIS 98 (Ct. App. Jan. 18, 2018)

Four individuals decided to start a medical marijuana business and drafted a joint venture agreement, which divided the business and the profits equally. For the first dispensary, they executed Articles of Incorporation for a nonprofit entity, Absolute Healthcare Inc. (Absolute), and later replaced the Articles with the assistance of counsel. The new Articles stated that two of the individuals, a couple, solely comprised the board of directors and that they would serve until the first annual meeting of the members or Board of Directors, or until successors were elected and qualified. The Articles stated that Absolute would have members but the group subsequently executed Bylaws stating that Absolute would not have members. Three of the members filed suit to contest the identity of the members of Absolute’s board of directors.

The Court found that under Arizona law, when Articles and Bylaws conflict, the Articles control, so Absolute had members and those members elected the directors.

A Pocono Country Place Prop. Owners Ass’n v. Kowalski, 2018 Pa. Commw. LEXIS 159 (Commw. Ct. May 7, 2018)

Appellants, A Pocono Country Place Property Owners Association Inc. and eight members of its board of directors, petitioned to remove the defendant from his position as a director of Property Owners Association and bar him from serving as a director in the future. The issue presented was whether a director’s boorish and insulting behavior toward other members of the board of directors constitutes sufficient grounds for judicial removal of a director under Section 5726(c) of the Nonprofit Corporation Law of 1988 (Nonprofit Corporation Law), 15 Pa. C.S. § 5726(c).

The defendant directed multiple insulting remarks at these Board members including emails that characterized specific female directors as “cunning and conniving,” “vindictive and spiteful,” and “incoherent”; telling a female director at a Board meeting that “maybe I’d let you cook for me” and more.

The Board suspended the defendant, and Plaintiffs filed a petition to remove him as a director and bar him from serving as a director under Section 5726(c) of the Nonprofit Corporation Law.

The trial court found that “proper cause” for court removal of a director under Section 5726(c) cannot be found without a showing that the director committed fraud, dishonesty, gross mismanagement, a violation of the Nonprofit Corporation Law or other illegal or ultra vires conduct. Because Kowalski’s boorish and unprofessional behavior did not constitute fraud, dishonesty, gross mismanagement, or illegal or ultra vires conduct, the court denied Plaintiffs’ petition to remove him as a director. The appellate court affirmed the trial court’s order.

Swank v. Valley Christian Sch., 188 Wash. 2d 663, 398 P.3d 1108 (2017)

Drew Swank, a student athlete at Valley Christian School (VCS), died from complications after contact with another player during a high school football game. Drew’s parents sued VCS (a nonprofit religious school) and Drew’s coach on behalf of his estate and individually.

In 2009, the Washington legislature passed the Lystedt law, RCW 28A.600.190. The purpose of the Lystedt law was to reduce the risk of further injury or death to youth athletes who suffer concussions in the state of Washington. The Lystedt law requires youth athletes to be removed from play immediately when they are suspected of sustaining a concussion or head injury and may not return until they are evaluated by and receive written clearance from a licensed health care provider. During the game, Drew complained of neck and head pain, but his coach put him back in play.  Drew was then hit by an opposing player, suffered head injuries, and died two days later. The Swanks brought common law negligence claims against the coach and the school for violating the Lystedt law.

Coach Puryear moved for summary judgment, arguing that under Rev. Code Wash. (ARCW) § 4.24.670 he is immune from liability for simple negligence because he was a volunteer of a nonprofit organization (the school VCS).  The trial court granted summary judgment on all counts against the Swanks, and an intermediate appellate court affirmed.

The Swanks appealed to the Washington State Supreme Court, which reversed the lower courts.  The state Supreme Court held that Coach Puryear met the definition of a “volunteer”, but he was only entitled to immunity if his conduct was simply negligent rather than grossly negligent. The Court found that the evidence created genuine issues of material fact regarding Coach Puryear’s degree of fault and should be relayed to a jury. As a result, the Court held that summary judgment on the claims against Coach Puryear was improper and reversed the lower court’s judgment, thus reinstating the Swank’s common law negligence claims against the coach and, by extension, VCS.

Jurisdiction

Data Research & Handling Inc. v. Vongphachanh, No. 1:16-CV-392, 2018 U.S. Dist. LEXIS 30935 (N.D. Ind. Feb. 27, 2018)

Data Research planned to launch an Employer-Assisted Housing Benefit Plan to provide financial assistance to individuals purchasing homes. The corporation alleged that the National Association of Realtors Inc. (NAR) spread the claim that Data Research was operating illegally, and asserted various claims against NAR, including libel, slander, tortious interference with contract, and tortious interference with a business relationship.

The Court granted NAR’s motion to dismiss for lack of personal jurisdiction. The Court agreed that despite NAR’s existing contacts in Indiana – including chartering associations, over 16,000 members, and selling education and other services to residents there – the law required more connection between NAR and the forum state in order for Data Research to sue it there.

Tax

Freedom Path Inc. v. IRS, Civil Action No. 3:14-CV-1537-D, 2017 U.S. Dist. LEXIS 104970, 120 A.F.T.R.2d (RIA) 5125 (N.D. Tex. July 7, 2017)

The Internal Revenue Service (IRS) denied Freedom Path’s application for recognition as a social welfare group under § 501(c)(4). Using the “facts and circumstances test” of Revenue Ruling 2004-6, the IRS determined that a significant amount of Freedom Path’s communications were political campaign interventions, so the organization was not considered as operating exclusively for the promotion of social welfare. In response, Freedom Path challenged the denial and claimed that the “facts and circumstances” test was unconstitutionally vague and/or overbroad.

The court concluded that the “facts and circumstances test” of Revenue Ruling 2004-6 was not unconstitutionally vague because the ruling was a civil regulation, and therefore subject to a more lenient vagueness standard than criminal law. In addition to a lack of controlling precedent supporting holding it void for vagueness, the use of a multifactor test did not make a tax rule vague per se. The ruling was also not subject to a heightened vagueness standard by virtue of being a restriction on speech.

2017 PLR LEXIS 8207, PLR 201746028 (I.R.S. August 24, 2017)

The organization was formed as a nonprofit entity that would act as a membership-based trade association. Its members would be current and former owners and representatives of Independent Franchisees or Licensees of Brand. Its two classes of membership were voting members and non-voting members. The organization’s mission was to provide assistance to members by conducting educational workshops and by sponsoring trade shows. Its main source of support was vendor fees paid by trade show vendors. The organization sought IRC § 501(c)(6) status, but the IRS denied the application.

The IRS held that the organization did not meet the criteria in § 501(c)(6) because it was not organized and operated as a business league but in fact was organized to provide particular services to members. That being so, the organization did not satisfy the requirement that its operation be focused on improving business conditions in one or more lines of business. The organization thus was similar to the entities described in Rev. Rul. 58-294 and Rev. Rul. 67-77 because it was engaged in furthering the business interests of Brand’s Franchisees, which was a particular brand. This was illustrated by the fact their trade shows are only for vendors used by franchisees and potential vendors of franchisees, rather than the improvement of business conditions of one or more lines of business. Therefore, the IRS determined that the organization was only improving business conditions for Franchisees and exemption was properly denied.

2017 PLR LEXIS 8290, PLR 201750020 (I.R.S. September 19, 2017)

The organization was a membership entity that was formed for the purpose of advertising and promoting the products and services of Dealers who traded in Brand Vehicles. Only one class of Membership existed, and it was limited to persons, firms and entities actively engaged in retailing new Brand Vehicles. Representatives from member dealerships sat on the organization’s board. Members contributed funds on a monthly basis. Upon dissolution, assets were to be distributed to Members on a prorated basis.

The organization applied for IRC § 501(c)(6) exemption but the IRS denied the application. It held that the organization was not a business league per Treas. Reg. § 1.501(c) (6)-1 because its activities did not improve the business conditions of one or more lines of business. Moreover, that the organization’s advertising services furthered the business interests of Members, not the entire auto industry. Because the organization’s activities actually provided advertising on behalf of Members, the organization was providing specific services to Members and was not eligible for exemption.

2017 PLR LEXIS 8620, PLR 201820019 (I.R.S. July 19, 2017)

The organization sought IRC § 501(c)(6) exempt status for its provision of trained and qualified Officials to oversee amateur hockey games. Membership was voluntary and open to any person who met certification requirements. “Member rinks” were facilities that hosted Games. Rinks were charged fees based on the type of game, age level and skill level of players. The organization did not schedule games but simply provided Officials. The organization collected fees from rinks and redistributed it to participating Officials. The organization’s only source of income was dues and fees generated by its provision of scheduling services.

The IRS denied exemption. It held that the organization existed to afford employment services to its members and thus provided a private benefit to members. Not only did the organization not improve business conditions per Treas. Reg. § 1.501(c)(6)-1 but members of its board received a percentage of its revenue as compensation, which resulted in prohibited inurement. In that way, the IRS held that the organization was similar to the entity in Ind. Retail Hardware Asso. Inc. v. United States, 177 Ct. Cl. 288, 366 F.2d 998 (1966), which had failed to qualify for § 501(c)(6) exemption because providing services for members was a substantial activity and was not an exempt activity for which exemption was available.

2017 PLR LEXIS 8335, PLR 201751023 (I.R.S. September 27, 2017)

The organization sought IRC § 501(c)(6) exempt status as a membership organization providing programming for members and their guests, most of whom were small business owners or managers. Members also could pay an additional fee for the privilege of presenting business-related proposals to other members at such meetings.

The IRS denied exemption. The organization did not meet the criteria in § 501(c)(6) and Treas. Reg. § 1.501(c)(6)-1 because it was not formed to promote the common business interests of a particular industry or trade but in fact existed to create business opportunities for its members, and members had no common interest other than a mutual desire to increase sales. Similar to the organizations described in Rev. Rul. 67-77 and Rev. Rul. 73-411, its activities were not directed toward improvements in any particular line of business. Instead, the organization proposed to provide a service for members by providing a forum for networking and business promotion opportunities. Since its meetings focused on networking and referrals and generating business leads for members, not on improving business conditions, it was serving the private interests of members and was not eligible for exemption per § 501(c)(6).

Special thanks to Pillsbury 2018 Summer Associates Crystal Fomba (New York University School of Law, 2019) and Nicole Steinberg (Northwestern Pritzker School of Law, 2019) for their invaluable assistance in preparing the text.