CALIFORNIA LAW   DISSOLUTION

California Bill Regarding Nonprofit Dissolutions

Industrial robotic arms building DONE word

On May 27, 2014, California Assembly Bill No. 1529 (AB 1529), introduced by Assemblyman John Perez, was passed on the Assembly Floor. The goal of AB 1529 is to streamline the process for dissolving nonprofit corporations by creating two new dissolution processes. First, it establishes an administrative process that would allow the Franchise Tax Board (FTB) and Secretary of State (SOS) to dissolve nonprofits that have been inactive for some time. Second, it creates a mechanism for voluntary dissolution of a nonprofit corporation if certain conditions are met.

Administrative Dissolution or Administrative Surrender

In California, there are over 144,000 nonprofit corporations that provide a variety of services and programs. According to the bill’s analysis, some nonprofit corporations have been disbanded or have been inactive for a significant amount of time, but have not been dissolved. These entities continue to incur fees and fines and cause “unnecessary time spent by FTB and SOS staff to proceed through the dissolutions process.” AB 1529 attempts to relieve these burdens by giving the FTB and SOS authority to “administratively clear away the backlog of inactive nonprofit corporations.” Under the proposed law, a nonprofit would be subject to an administrative dissolution or administrative surrender if one of the following occurs:

  1. The nonprofit corporation’s corporate power are suspended or forfeited by the FTB for period of not less than 48 continuous months; or
  2. The nonprofit corporation was incorporated in California or qualified to transact intrastate business and has not filed a statement of information (SOI) with the SOS for a period of not less than 48 continuous months.

AB 1529 establishes procedures for providing notice of pending dissolution or surrender to the nonprofit corporation, and allows the nonprofit corporation to object to such action. If the nonprofit corporation timely objects to the dissolution or surrender (within 60 days of the administrative notice), it will have 90 days from its written objection to satisfy all debts and file a current SOI with the SOS. The FTB and SOS can also provide one 90-day extension to the nonprofit corporation to comply.

[Ed. Note that over 74,000 organizations have had their state tax-exempt status revoked by the FTB as of May 16, 2014. But revocation of tax-exempt status does not result in dissolution of the entity.] 

Voluntary Dissolution

The bill also attempts to ease the burden for a nonprofit corporation to voluntary dissolve. According to the bill’s author, “the current dissolution process, which involves winding down of the nonprofit corporation’s affair, is very cumbersome and protracted.” The new bill creates a mechanism for voluntary dissolution of a nonprofit corporation upon certification of certain matters by the entity – a similar mechanism already exists under California General Corporation law, known as a short form dissolution. (California Corporation Code Section 1900.5 ).

Under AB 1529, a nonprofit corporation can dissolve when it has not issued any membership and has filed a certificate of dissolution within 24 months from the date that the articles of incorporation was filed. The certification must also verify the following information:

  1. The corporation does not have any debts or liabilities.
  2. The tax liability shall be satisfied on a taxes-paid basis.
  3. A final franchise tax return.
  4. The corporation was created in error.
  5. Distribution of assets.
  6. No issuance of membership.
  7. That the corporation is dissolved.

The nonprofit corporation is dissolved once it files a signed and verified certification of dissolution with the SOS. The dissolution does not relieve the nonprofit corporation’s liability to creditors. The bill is supported by the California Society of Enrolled Agents, a professional organization of individuals who have earned the privilege of representing taxpayers before the Internal Revenue Service. The bill is currently in the Senate awaiting review.

Resources

Assembly Bill No. 1529

Assembly Bill No. 1529 Analysis

Third Reading – Assembly Bill No. 1529 Analysis

California Society of Enrolled Agents

 

Michelle Baker

Michelle Baker is a San Francisco-based attorney interested in social impact.

DISSOLUTION

10 Things Nonprofits Should Consider Before Electing to Dissolve

End

Times are still tough for nonprofits.  And many boards are grappling with the question of whether their organizations should be shut down.  Here is a quick list of 10 considerations for nonprofit boards thinking about dissolving their organizations:

  1. Can we continue to advance our mission effectively and efficiently?
  2. Do we have sufficient resources (not just financial) to continue our programs in a manner that still makes sense?
  3. What are our prospects for securing the resources we need to continue our programs?
  4. Can we realistically create new revenue streams without chasing dollars not truly related to our mission?
  5. How will our dissolution impact our clients/beneficiaries, staff, and other stakeholders, and can we take steps to mitigate the harm done to those most impacted?
  6. Are there other organizations that can fill the gap that would result from our dissolution, and can we transfer programs to such organizations to preserve services going to our clients/beneficiaries?
  7. Is a merger with another organization an alternative possibility we’ve thoroughly explored?
  8. Can we legally dissolve (if dissolution first requires us to pay off all of our liabilities and obligations or have them assumed by another party), and are we ready to dissolve?
  9. What resources will we require (e.g., lawyer, consultant) and what steps need to be taken (e.g., membership approval, Attorney General approval) for the dissolution?
  10. If we decide to dissolve, what legacy will we leave behind and how can we best honor the good work and accomplishments of the organization and its leaders?

Dissolving a nonprofit is not necessarily an admission of failure.  It may instead be a recognition that another organization can now carry on your mission better.  You can read more about dissolutions in a prior post written by Emily Chan here.

 

BOARDS / GOVERNANCE   DISSOLUTION

Nonprofits and the Zone of Insolvency – Part Two

Earlier this fall, I wrote a post about Ron Mattocks' book: Zone of Insolvency: How Nonprofits Avoid Hidden Liabilities and Build Financial Strength.  Here are some questions and answers from the media kit associated with the book:

What are three steps on (sic) organization must take immediately upon realizing they've drifted into the zone of insolvency?

First the board and management team must come together and admit that they have a problem, i.e. that they have have wandered into the Zone of Insolvency.

Second, they must make a decision that they will not continue in the Zone of Insolvency, and every decision and every action moving forward must demonstrate their commitment to move out of the Zone of Insolvency.

Third, they must identify the behaviors that have allowed their organizations to drift into the Zone of Insolvency, and work consciously to change those patterns of behavior.

What does a board member need to know, legally, when it's operating [in the] Zone of Insolvency?

In principle, corporate law reduces individual liabilities for actions made when sitting on a corporate [board].  Various state laws offer some additional protections for those serving on nonprofit boards.  But there are limits to all these protections, and there has never been a time in history when nonprofit board members have such a high risk of being sued for their volunteer work on the board.  When governing in the Zone of Insolvency, a board should have special legal counsel to assure that no action benefits one party of interest while disadvantaging another.  And it is absolutely critical that adequate D&O Insurance be in force when governing a financially distressed organization.

In what ways must the board members of an organization operating in the Zone of Insolvency demonstrate a new level of commitment to the fiscal condition of the nonprofit?

The prudent board will understand that it is too risky to remain in the Zone of Insolvency, and will decide to move out of the zone.  Every action of the board moving forward should be a proof of the commitment to escape from the zone.  There are only three ways out: a financial turn-around, a merger, or filing for dissolution.  The board that chooses the financial turnaround must understand the risks, the resource requirements, and reasonable timelines.  The board that cannot accept the risk associated with a financial workout should opt for a merger or dissolution.

How has the legal arena changed for nonprofits in the past 20 years in terms of the obligations of board members in regards to the Zone of Insolvency?

The issue is increased accountability for boards of all corporations, including nonprofit boards, coming out of scandals such as Enron, United Way, Baptist Foundation of Arizona, WorldCom and others.  Sarbanes Oxley, the California Nonprofit Integrity Act of 2004, and the Zone of Insolvency all run parallel tracks pushing for increased corporate accountability.  As a result, there has never been a time in history when a nonprofit board member has been so likely to be sued in the course of his or her volunteer board work.  In 1992, the courts identified the Zone of Insolvency, making the governance of a financially distressed organization especially risky.  The nonprofit culture that tolerated or encouraged living in financial distress in years past is a very risky proposition in today's litigious environment.

Read Part One of this post here.

DISSOLUTION

Nonprofits and the Zone of Insolvency – Part One

I recently received a media kit from nonprofit management professional/consultant/author Ron Mattocks for his book Zone of Insolvency: How Nonprofits Avoid Hidden Liabilities and Build Financial Strength.  Such a timely topic.

According to Mattocks, even before the events of the past several weeks, "500,000 nonprofits operate in the zone of insolvency" and "1 out of 15 nonprofits may be totally insolvent."

Insolvency is generally defined as the condition of having more liabilities than assets.  Cash flow insolvency is the condition where debts cannot be paid as they become due. Mattocks defines the zone of insolvency as "a period of financial distress where reasonable people could at least foresee the possibility of total insolvency."  Where for-profit organizations enter into the zone of insolvency, members of the governing body may owe duties to credit holders as well as to the shareholders.

For nonprofits, "[t]he legal responsibilities of the board governing an organization in the Zone of Insolvency are expanded from a fiduciary responsibility to protect the assets of the corporation to a broader role of balancing all interests of all parties of the corporation … [and] this requires balancing the interests of all stakeholders, creditors, funders, customers, and the community at large."

Mattocks lists three ways out of the zone of insolvency:

  1. A financial turnaround
  2. A merger
  3. Dissolution

"The board that chooses the financial turnaround must understand the risks, the resource requirements, and reasonable timelines.  The board that cannot accept the risk associated with a financial workout should opt for a merger or dissolution."

Learn more about the book and its author here.

Read Part Two of this post here.

DISSOLUTION

Dissolution – Part Two (California)

The California Attorney General’s Publication CT–603 (12/06) – "General Guide for Dissolving A California Nonprofit Corporation" – outlines the basic process required by a California nonprofit corporation after its board of directors or its membership votes to cease operations but before any remaining assets are distributed:

  1. A vote by board of directors or majority of corporation to dissolve and prepare a certificate of election to wind up and dissolve (if applicable) and/or a certificate of dissolution.
  2. Prepare final state tax return and verify current status with Franchise Tax Board.
  3. Obtain dissolution waiver from the Attorney General’s Office before disposing of any remaining assets.
  4. Submit final dissolution package to the Secretary of the State’s Office.
  5. Submit final notice of submission to the Attorney General’s Office.

Failure to complete these requirements in compliance or accurately may result in potential director liability for unauthorized distributions of remaining assets, certain outstanding debts or obligations, and breach of fiduciary duty to creditors. To help avoid these problems, organizations should keep accurate documents (e.g. meeting minutes and financial statements) and consider developing a plan of dissolution, describing in detail how debts and obligations will be paid or satisfied as well as the distribution of any remaining assets.

The "General Guide to Dissolving A California Nonprofit Corporation" is available here.

Instructions for completing the Certificate of Election to Wind Up and Dissolve and the Certificate of Dissolution, and additional filing requirements can be found on the Secretary of State’s "Dissolution Filing Requirements.”

- Emily Chan

DISSOLUTION

Dissolution

The well-known saying, “Honesty is the best policy,” rings especially true for nonprofit organizations and the topic of dissolution. Although a tough decision and perhaps one that many will want to avoid, it is important for organizations to (a) acknowledge in a candid and timely manner when they’ve reach the point where continued operation is not a favorable decision, and (b) take the necessary steps of properly “closing down.”

Dissolution discussions may arise for a number of reasons, from a fragile economy to the gradual deterioration of the charity’s viability. Fieldstone Alliance’s “Nonprofit Decline and Dissolution Reports” addresses why, when, and how to go out of business gracefully in hopes of “creating a climate” to stimulate discussions about this “important and yet poorly understood element of an organization’s life cycle.” The report lists many “warning signs” but by no means conclusive reasons for dissolution (many organizations “have experienced one or more of these perilous circumstances and have successfully overcome the problems”) such as:

  • Loss of all or a significant portion of support from a key funding source.

  • The “chasing dollars” syndrome of developing programs primarily to attract dollars that did not serve the purpose of the organization, failed to reach service goals, or was poorly planned.
  • Sudden and dramatic expansion of services beyond the organization’s expanding capability.
  • Falling behind on financial obligations followed by quick-fix financial strategies that did not ultimately solve the financial crisis.
  • Consistent inability to meet service and financial projections due to unrealistic goals, untested assumptions, and a poorly-thought-through plan.
  • Departure of key board and staff as a by-product of the organizational decline process.

Fieldstone Alliance advises organizations to answer the question of dissolution with “a conscious decision about the organization’s future rather than just letting it happen” and thus allowing “a failing organization to linger endlessly.” Some of Fieldstone Alliance’s suggestions for how to address dissolution include:

  • Developing a six to 12-month operation plan with specific goals and bench marks (staffing, financing, cash flow, service projections, etc.) to arrive at an objective assessment of the organization’s condition and viability.

  • Develop a set of criteria to assess the soundness of the plan, helping to avoid “let[ting] hope override reality and emotion prevail over reason.”
  • Convene an ad hoc committee of the board for the purpose of considering the question of continuation in light of the information, thereby ensuring the question will be dealt with now rather than later.

Once an organization decides to dissolve, they have a two-fold task. First, an organization must adhere to the dissolution filing requirements. Second, as La Piana highlights, “a nonprofit should not simply close its doors and go away… leaders must [also] determine a way of closing down that preserves any possible services or funds for its mission.”

Because nonprofit organizations are operated for the public benefit and many members involved in the dissolving organization will continue to work in the nonprofit sector, an organization facing dissolution should consider additional aspects such as:

  • Being honest with major funders who may in turn, help with transitional funding.
    Transferring any strong and valuable programs to another organization through some form of strategic restructuring.

  • Notifying and negotiating all outstanding contract obligations in order to leave the reputation of the staff and board intact and the organization’s good name unsullied.
  • Determining what level of service can be maintained.
  • Identifying clients most at risk due to the loss of service and taking steps to minimize it such as identifying other service providers to which such clients can be transferred in a smooth transition.
  • Negotiating less than full payments with creditors. Some may be willing write off the debt as a donation.
  • Seeking consultants to address other areas such as attorneys for legal loose ends and requirements, a real estate agent or lawyer for valuation and disposition of real property, and career counselors to help staff with their subsequent job search. Rare exceptional cases involving very large institutions may even consider social workers or psychologists to help the staff cope.

While a dissolution is often naturally accompanied by feelings of shame, guilt, or resentment, the Fieldstone Alliance reminds organizations that “[v]oluntary dissolution of a nonprofit corporation doesn’t mean the end of the world; it simply means there may be other, better ways to get the job done.” Some may dissolve due to mismanagement; others may be “victims of changing times, fewer dollars, and other circumstances beyond their control”; and the remaining may adjust and learn to operate in new ways with fewer dollars. Regardless of which route an organization ultimately follows, all decisions should initially begin with an honest discussion about dissolution, “considered and managed in thoughtful and responsible ways.”

La Piana’s tips on Dissolution are available here.

More information can be found in the Fieldstone Alliance’s “Nonprofit Decline and Dissolution Report.”

- Emily Chan