Nonprofit Corporation Legal Audit

All too often, the issue of legal compliance receives attention from a nonprofit corporation only after a conflict arises. Instead, a nonprofit corporation can better prevent conflicts and protect itself through regular legal audits. Financial audits alone, while important, will not sufficiently account for the bigger issue of overall compliance with state and federal laws.

A legal audit will include a wide range information-gathering, such as:

Organizational and Operation-related Documents

1. Articles of Incorporation (and any amendments)
2. Bylaws (and any amendments)
3. A list of current board members, officers, and (if applicable) members
4. Meeting minutes (board, membership, annual, special, committee, etc.)
5. Copies of governance-related policies (e.g., conflict of interest policy for directors and officers)
6. Copies of other policies (e.g., internal controls, HR-related)
7. Copies of financial statements and budgets
8. Copies of any contracts for services to be rendered or received
9. Copies of any leases and subleases for real or personal properties
10. Copies of insurance policies

Tax-exempt status and State-related documents

1. Application for 501(c)(3) tax-exempt status (IRS Form 1023)
2. IRS determination letter granting 501(c)(3) tax-exempt status
3. Copies of IRS Form 990 (for at least three years)
4. Copies of communications with the IRS
5. State tax-exempt status determination letter and initial filings
6. Copies of annual state filing requirements (e.g., Franchise Tax Board)
7. Copies of communications with the Secretary of State and/or Attorney General
8. Registrations to engage in charitable solicitations (where applicable)
9. Certificates of authority to conduct business in a jurisdiction
10. A list of jurisdictions in which the corporation conducts business, solicits funds, etc.

In reviewing these documents, questions should look both backward (i.e., have we done what is required?) and forward (i.e., what else can we do?), such as:

• Do the Articles of Incorporation and Bylaws correctly describe the nonprofit corporation as it operates today?
• Are the nonprofit corporation’s Form 1023 and past three filings of Form 990 available for inspection at the principle location?
• Have all board resolutions and any elections been properly executed?
• Has the purpose or activities of the nonprofit corporation changed significantly since applying for tax-exempt status? Do current documents reflect this change?
• Is the nonprofit continuing to meet certain critical financial ratios (e.g., solvency, public support test)?
• Have new laws affecting nonprofit organizations passed since the last legal audit?
• Are there new risks in the nonprofit corporation that should be insured?
• Are there contradictions in the policies and procedures that expose the nonprofit corporation to unnecessary conflict or unsound practices?

The above-mentioned suggestions are a starting point, not an exhaustive list. Depending on the nonprofit corporation’s structure, it may be imperative to thoroughly address other topics such as employees and membership. Additionally, there may be a separate need for legal audits of facilities (e.g., zoning, OSHA compliance) and programmatic activities (e.g., copyrights, licenses, risk assessment and management). While the beginning steps of a legal audit can seem overwhelming, that should not be a reason to avoid it. The benefits of a legal audit are two-fold—not only does it bring a sense of reassurance but it may also help a nonprofit corporation determine whether its current way of conducting business “makes sense.” In turn, a nonprofit corporation can reform or correct past practices—improving record keeping procedures, restating a patchwork of Bylaws or Articles amendments into one clean document, instituting a new filing system, and the like—to help facilitate rather than hinder the ability to undergo a legal audit in the future.

- Emily Chan

A summary of common problems with organizational bylaws is addressed in Gene Takagi’s “Basics About Bylaws."

Carter McNamara’s “Checklist for an Assessment of Legal Activities in U.S. Nonprofits Organizations” provides a sample checklist of legal issues, available here.

The Nonprofit Risk Management Center addresses charitable immunity and volunteer protection in its publication, “State Liability Laws for Charitable Organizations and Volunteers – 4th edition.”

Tamara L. Harper provides general tips for employee legal issues in her article, “Checklist to Help California Employers Comply with New Labor Laws,” available here.

See also George Webster’s article, “Association Legal Audits,” for more document examples in the information-gathering stage and South Florida Community Development Project’s article, “Self-Help Legal Audit,” for additional questions to consider when conducting a legal audit.