By Anita L. Pelletier, Esq., Michael J. Cooney, Esq. and Brian W. Mahoney, Esq.
The Fire Chief of Main Street Fire Company, a volunteer fire company, has a son who owns a catering company, GoodFood. The Main Street Fire Company hires GoodFood to cater the annual picnic. The event is a success! All is good except that GoodFood is a “related party” and failing to approve the transaction as required by the New York Not-for-Profit Corporation Law could result in the contract being declared void. What’s more, GoodFood might have to repay the payment it received to the Main Street Fire Company as well as a penalty to the New York State Charities Bureau.
In December of 2013, Governor Andrew Cuomo signed into law the New York Nonprofit Revitalization Act of 2013 (the “Act”). The intent of the Act was to streamline administrative processes and promote sound governance practices. While the Act accomplished much of what it set out to do, there are also many traps for the unwary.
One change that will impact membership organizations like volunteer fire companies is the ability to now provide notice of members meeting by electronic means. The Act now allows notice to be provided by e-mail or fax. Prior to the Act, the only forms of notice for most organizations were by mail or by personal delivery. There was an exception for organizations with more than 500 members to use notice by publication, which is still allowed, but with the added requirement that the notice also be posted on the organization’s home page.
The Act also changes how not-for-profit organizations deal with real property. Under prior law, any transaction involving real property (e.g. purchase, sale or lease) needed to be approved by two-thirds of the entire board of directors—even if the transaction was a relatively minor one for the organization.
Under the Act, board approval is only required if the real property constitutes “all or substantially all” of the organization’s property. In other cases, action by a committee of the board is sufficient. Another welcome change is a simpler structure for committees.
The distinction between standing, ad hoc, and special committees is gone. In its place, there are two types of committees: committees of the board and committees of the corporation. A committee of the board must be elected by, and comprised solely of, members of the board of directors; it may exercise the powers of the board that are delegated to it, subject to a few exceptions that are off limits (e.g. setting compensation for directors). A committee of the corporation, on the other hand, must largely be advisory only, but may include individuals who are not board members (for example, members).
A second area of focus of the Act is to require that organizations are governed, to some extent, by individuals who have no financial interest in the organization or its activities. For example, effective January 1, 2016, no employee of an organization may serve as the chair of the board or any other position holding similar responsibilities. This restriction is intended to ensure that the chair’s judgment is unclouded by personal interests. The Act also introduces rigorous independence standards for directors overseeing the organization’s audit processes. While most volunteer fire companies will not be required to comply strictly with the audit oversight requirements because they are exempt from registration with the New York State Charities Bureau, the independence standard is still relevant for conflicts and whistleblower oversight. Specifically, the adoption, implementation or and compliance with the organization’s conflict of interest policy and whistleblower policy (both described in more detail below) must be handled by a committee of the board consisting entirely of independent directors or the board of directors, with only independent directors participating.
Therefore, all nonprofit organizations must take care to identify “independent directors” as defined by the Act. It is not enough to simply identify the directors that are employed by the organization. Examples of individuals who are not be independent directors:
a former employee whose employment ended two years ago;
a director whose son was paid more than $10,000 for services (see catering example above); or
a director employed by a company that receives payment for goods or services in excess of $25,000 (or two percent of consolidated gross revenues, whichever is less) from the organization during any of the last three years.
The Act now requires every not-for-profit corporation that has more than 20 employees (whether full- or part-time) and annual revenue over $1 million in its most recent fiscal year must adopt a whistleblower policy. The whistleblower policy must include: procedures to report violations of laws or corporate policies, including procedures for anonymous reporting and protection of whistleblowers; designation of a person to be responsible for administering the policy; and a requirement that the policy be distributed to all directors, officers, and employees, as well as volunteers who perform substantial services.
Conflict of Interest
Most not-for-profit organizations have adopted conflict of interest policies to ensure that their resources are used appropriately. Under the Act, conflict of interest policies are mandatory for all New York not-for-profit corporations. Moreover, the policy must conform to very specific statutory requirements. Even with these specific requirements, most existing conflict of interest policies would be in substantial compliance with the Act’s requirements.
There is an issue, however, in a new section dealing with “related party transactions” which are off-limits unless the board of directors or an authorized committee of independent directors determines that the transaction is “fair, reasonable and in the best interests of the organization” at the time the transaction is approved. The reach of these related party transactions is broad, and there is no small or ordinary course exception for the types of transactions covered.
For example, a board member has a daughter that owns local bakery. The organization wants to purchase bagels and doughnuts for its meetings at the bakery. These purchases are related party transactions that must be preapproved. If the purchases are not preapproved as required by the Act, the purchases can rescinded and penalties may be imposed merely because the proper approval process was not followed.
Related parties include directors and officers of a not-forprofit organization, key employees, as well as the relatives and business controlled by such people. Interestingly, the category of “key employees” includes any individual or business exercising “substantial influence” over the organization, and may even include individuals who are not actually employees. For example, a company that makes a substantial contribution to the organization may be a “key employee” (although it is not employed by the organization). Likewise, the grandson of the founder of the organization would also be considered a related party.
To be clear, an organization is not prohibited from entering into a related party transactions. However, because of the potential for penalties and cancellation of related party transactions, organizations should be very attentive to these provisions. Safeguards should include procedures to identify related parties, recognize related party transactions before they are entered into and approve any related party transaction as required by the Act.
Lastly, the Act enhances the New York Attorney General’s power to oversee the activities of not-for-profit corporations and to bring enforcement actions. The Attorney General has long had oversight over major transactions of not-for-profit corporations, as well as powers to deal effectively with fraud and misuse of charitable assets. The Act explicitly expands this authority by allowing the Attorney General:
to bring legal action to enjoin or rescind a related party transaction or proposed transaction;
to rescind a compensation agreement between the organization and an officer, director or employee;
to seek damages, restitution and removal of officers; and in cases involving intentional violations, to seek double damages as a punitive/deterrent measure.
This expanded power illustrates the importance of complying with the provisions of the Act.
In conclusion, the Act provides organizations with certain benefits, but it also imposes a greater burden of compliance. Some areas have been clarified and governing boards are now provided greater operational flexibility with respect to the use of e-mail and other electronic means of communications. On the other hand, organizations must now be conscious of new procedures, especially around conflicts of interest and independent governance.
Anita L. Pelletier, Esq., is counsel at Nixon Peabody LLP. Michael J. Cooney, Esq., is partner at Nixon Peabody LLP. Brian W. Mahoney, Esq., is an associate at Nixon Peabody LLP. All specialize in representing and advising tax-exempt organizations.
This story appears in the September/October edition of The Volunteer Firefighter magazine, just one of many benefits of FASNY membership.