With 2022 under way, nonprofits incorporated in Washington should familiarize themselves with the newly updated Washington Nonprofit Corporation Act to determine whether updates to their articles, bylaws or general practices are warranted.
Most provisions of the new law, which was signed into law by Gov. Jay Inslee in spring 2021 and is codified at RCW 24.03A, took effect on January 1 of this year. The new act represents more than a decade’s worth of work by volunteer attorneys, nonprofit stakeholders and the legislature and replaces, modernizes and makes substantial additions to the state’s existing nonprofit corporation act — which was passed in 1967 and far overdue for revision.
While the new act does not require existing Washington nonprofits to re-incorporate or amend their articles of incorporation per se, it applies to all nonprofits incorporated under the previous act (in addition to foreign nonprofits registered in Washington). The new act also introduces many new statutory defaults that nonprofits may not want applied to their governance structure.
This alert is not intended to capture every change provided by the new act; rather, it is a high-level summary of the major modifications that may impact existing Washington nonprofits.
Board of Directors
The new act includes a number of provisions that affect the boards of both member and non-member organizations, and charitable and non-charitable entities. For starters, the new act sets a maximum term of five years for directors, which cannot be modified by the organization’s governing documents. Organizations whose bylaws in effect on January 1, 2022 provide for a longer term are exempt from this restriction until they are amended, and the restriction does not prevent directors from being reelected for subsequent terms that exceed five years in the aggregate. The new act also expressly allows for individuals under age 18 to be elected to the board, but places certain restrictions on their ability to act on behalf of the organization. In addition, organizations that are recognized by the IRS as 501(c)(3) public charities, or that are in the process of seeking tax exempt status as a public charity, must have a minimum of three directors. This new requirement aligns Washington law with existing IRS guidance for such organizations.
The new act also clarifies the standards of conduct expected of nonprofit directors, expressly stating that directors are not trustees with respect to the nonprofit corporation or any of its property, and have fiduciary duties typical of corporate directors. Previously, the statute was silent on the issue, leaving a question as to whether directors of charitable nonprofits had the same fiduciary duties as for-profit directors, or were subject to heightened duties of trustees with respect to their organization’s charitable assets.
Finally, the new act introduces several changes to board operations. New defaults (which can be changed via governing documents) require 48 hours notice for special board meetings and allow for oral notice, email notice without an opt-in and remote participation in the case of all meetings. The new act also grants emergency powers to directors, allowing them to act without a quorum if a quorum cannot be obtained due to a catastrophic event. Finally, the new act clarifies the ability of non-directors to serve on board committees – prohibiting them from serving in a voting capacity unless a committee is strictly advisory in nature and has no delegated board powers.
Unlike the prior act, the new act clearly defines and distinguishes “charitable corporations” from other nonprofit organizations. Charitable corporations, which include organizations eligible for tax exemption under IRC 501(c)(3) or considered charitable under other applicable law, are subject to a number of updated, clearer provisions regarding the treatment of charitable assets:
- Restricted gifts are more clearly defined and do not create a charitable trust, or the accompanying obligations, without an express statement from the donor. The new act also expressly defines “gift instrument” – the method by which a gift restriction is created – and details the process by which a gift instrument may be modified. Charitable organizations should be aware that a gift instrument may include a written solicitation made by the nonprofit, and should be careful to avoid using language in solicitation material that may unintentionally create a restricted gift.
- Whereas charitable assets were previously governed by Washington’s trust law, they are now included under the new act. The new act contains provisions prohibiting the disposition of charitable assets for non-charitable purposes (in a dissolution proceeding, fundamental transaction or otherwise), and tasks the Washington Attorney General’s office with enforcement of such prohibitions.
- In addition to the above, the new act gives the Attorney General broader powers to act with respect to charitable assets. The Attorney General must approve fundamental transactions where charitable assets are involved and modifications to gift restrictions. The Attorney General also has the power to investigate suspected abuses of charitable assets and to institute proceedings arising from such investigations.
The new act also introduces several provisions that align Washington law with sections of the Internal Revenue Code applicable to 501(c)(3) organizations, in addition to the board size requirement noted above. The IRC’s limitations on private foundations with respect to qualifying distributions, self-dealing, excess business holdings and investments, and taxable expenditures are expressly incorporated by reference. A separate section of the new act clearly defines conflicts of interests and how they should be dealt with, in line with IRS guidance on the topic. Finally, the Attorney General’s powers of investigation are limited with respect to religious organizations, similar to the treatment of such organizations under the Treasury Regulations.
While the new act affects all Washington nonprofit corporations, its most significant effects will be felt by nonprofits with members. The prior act was largely silent on many aspects of membership organizations and their relationship with their members, and the new act fills this gap by clearly defining what constitutes a “member,” the rights to which such members are entitled by default and other important aspects of membership. As a result, it will be especially important for membership organizations to review their bylaws and articles to ensure that both (1) their governing documents are not in conflict with the new act, and (2) the effects of default rights and restrictions introduced by the new act are appropriately addressed in such documents. These include:
- A nonprofit corporation in existence prior to January 1, 2022 will only be deemed to have members if either (i) its articles expressly say so or (ii) if the bylaws state that the organization has members and provide the right for members to vote on either the election of directors or fundamental transactions (e.g. merger, dissolution, conversion). New nonprofits formed after January 1, 2022 will only have members if provided in the organization’s articles.
- Members, regardless of their tenure, now have the right to inspect certain corporate records and demand annual financial statements of the organization. Members also have certain approval rights over fundamental transactions, as further discussed below. These rights cannot be limited or modified, except in the case of religious organizations (which can modify this right through their governing documents). In addition, there are new restrictions on the use of a membership list for commercial purposes by members or non-members.
- New statutory defaults provide that:
- memberships may not be transferred
- bylaws may not generally be amended without the approval of a majority of members
- members have no additional voting rights beyond the election of directors
- meetings may not be held remotely
- membership does not require a capital contribution
- the vote of 2/3 of the directors may terminate a member’s membership.
Organizations wishing to change these defaults must revise their governing documents to provide otherwise.
- Two or more members are permitted to enter into a voting agreement, if (i) the articles or bylaws expressly allow for one or (ii) the effective date of the voting agreement is before January 1, 2022.
- The new act gives membership organizations the right to terminate a member who does not respond to communications or contact the organization for an extended period of time, in addition to any termination rights provided in its governing documents. This right cannot be modified.
Finally, the new act adds substantial detail to the steps required of nonprofit corporations that wish to undertake “fundamental transactions,” and the nature of such transactions allowed by the new act. Fundamental transactions include:
- entity conversion and redomestication
- amendments to the organization’s articles
- dispositions of assets
Generally, these transactions are subject to the approval of the organization’s board of directors and members (in the case of a membership organization). In addition, charitable organizations and organizations holding charitable assets must obtain the Attorney General’s approval before proceeding and ensure that charitable assets are not diverted from their charitable purposes. Charitable nonprofits must also report any substantial changes to their purposes on their annual report to the secretary of state. Nonprofit corporations interested in pursuing a fundamental transaction will need to carefully review the portions of RCW 24.03A that apply to their respective proposed action to ensure compliance.