California Nonprofit Corporations
The California Nonprofit Corporation Law (Cal. Corp. Code §§ 5000-10841) governs the formation, operation and dissolution of various types of California nonprofit corporations. The majority of California nonprofit corporations are one of the following types: (i) the public benefit corporation, (ii) the mutual benefit corporation and (iii) the religious nonprofit corporation. Each of these subtypes of nonprofit corporations differs from the other in the following respects: the purposes for which each is organized, the manner in which its assets may be distributed, and the manner in and extent to which it is regulated.
Public benefit corporations may be formed for any public or charitable purpose and may be used by foundations, community chests and hospitals. Public benefit corporations are governed by Cal. Corp. Code §§ 5110-6910 and are subject to extensive governmental regulation and supervision. Public benefit corporations may not make distributions of corporate assets to members at any time.
Mutual benefit corporations may be formed for any lawful purpose and are often the corporate form of choice for societies, fraternal orders, trade and homeowners’ associations, clubs and similar organizations conducted for their members’ benefit. Mutual benefit corporations are regulated by Cal. Corp. Code §§7110-8910 and are subject to less comprehensive state regulation and supervision than the public benefit corporation. Assets may be distributed to members only upon dissolution of the mutual benefit corporation.
Religious corporations may be formed primarily or exclusively for religious purposes such as churches, seminaries and other religious organizations like hospitals and schools if the organization’s primary purpose is religious in nature. Note also that some religious organizations may wish to consider a unique form of organization called a ‘corporation sole’ as an alternative to a religious corporation.
For a more detailed discussion and comparison of these various forms of organization, please see Advising California Nonprofit Corporations (2nd ed. Cal CEB 1998).
In addition to the three major nonprofit corporations outlined above, there are several minor types of nonprofit corporations recognized by California law including, without limitation, the consumer cooperative corporation; the corporation sole, and other special purpose corporations such as societies for the prevention of cruelty to children and animals, chambers of commerce and boards of trade; small business development corporations, and agricultural nonprofit cooperative associations which are also subject to General Corporation Law.
A nonprofit corporation in California is managed by its board of directors and operated by its officers and employees. Instead of shareholders, a nonprofit corporation may, but is not required to, have members. Nonprofit corporations, of course, are specifically organized to not earn profits. No part of the income or surplus of a California nonprofit corporation may be distributed to its members, directors or officers; however, reasonable compensation may be paid for services rendered.
A nonprofit corporation has an existence of its own, independent of the terms of office or employment of members, directors or officers. It can sue or be sued in its own name and can own real estate in its own name.
Advantages of Incorporation: Pros and Cons of Nonprofit vs. For-profit
The principal advantage of incorporation, either as a nonprofit or a for profit corporation, is that it protects the shareholders or members from personal liability for the obligations and liabilities of the corporation, including unlawful actions of officers, directors and staff acting on behalf of the corporation. In addition, incorporation establishes continuity of existence which may be for a set period of time or perpetual unless earlier terminated or dissolved as described herein. Corporations (both nonprofit and for-profit) are subject to a body of statutes that provide very specific guidance as to their formation and operation; and incorporation brings stature to the organization and implies stability.
Where profit is not a goal and the enterprise can be funded without the need for access to capital, the nonprofit corporation is the preferred vehicle for pursuing social objectives. Although nonprofit corporations are not prohibited from engaging in commercial activities, the directors of a nonprofit are duty-bound to devote primary attention to the promotion of the social mission of the corporation rather than the production of net income or profits.
On the other hand, if access to capital markets is needed, a for-profit corporation (or limited liability company, discussed here) is likely to be the preferred option because nonprofit corporations cannot issue capital stock. The directors of a for-profit corporation, however, owe strict duties to the shareholders to maximize profits and value. Therefore, unless the directors and managers can tie the social mission of their for-profit corporation directly to its business purpose, they can be sued for breach of their duties to shareholders and for misuse of corporate assets if they focus too much on the social mission and forego profits. This problem can be avoided where all shareholders agree to pursue a social mission or devote a percentage of revenues to charitable causes. Such agreements may be temporary because a change in control—or a drop in earnings—can lead to amendment or termination of shareholder agreements with stated social mission purposes.
A nonprofit corporation attains its separate legal status through the filing and approval by the California Secretary of State of its articles of incorporation. This document is in essence a contract between California and the nonprofit corporation to which California grants individual legal status in exchange for the corporation’s commitment to follow its rules. One or more persons may form a nonprofit corporation by filing articles of incorporation in the form required by the California Secretary of State. If initial directors are named in the articles, each must sign and acknowledge the articles; otherwise, the articles shall be signed by one or more incorporators. One additional fully executed copy of the articles must be provided to the Secretary of State for delivery to the California Attorney General.
The following discussion is directed to the most common type of California nonprofit corporation, the public benefit corporation. The articles must include the following information: the name of the corporation; the following statement: “This corporation is a nonprofit public benefit corporation and is not organized for the private gain of any person. It is organized under the Nonprofit Public Benefit Corporation Law for (public or charitable [insert one or both]) purposes.” The articles must also include the corporation’s initial agent for service of process (an individual or entity located in California appointed by the corporation to accept service of process on behalf of the corporation). The statutory agent agrees to accept official documents such as pleadings in a law suit or legal proceeding and deliver them to the officers and directors of the corporation. The articles may set forth other provisions such as a limitation on the duration of existence, classes of members, if any, voting rights and any other provision for the conduct of the affairs of the corporation not in conflict with California law.
A nonprofit corporation may not use, and the Secretary of State will not file, articles which set forth a name which is likely to mislead the public or which is deceptively similar to the name of another California corporation or any non-California corporation which is authorized to do business in California or which has registered its name with the California Secretary of State. The availability of a name may be checked by accessing the website of the California Secretary of State at http://www.sos.ca.gov/business/.
It is possible to reserve a name, if available, by payment of a fee for a period of 60 days. There are further limitations on name choices for California nonprofit corporations in that such names may not contain the words “bank,” “trust,” “incorporated” or “corp,” among others.
If the nonprofit corporation intends to obtain exemption from federal and state income taxation [assuming the state has an income tax], the articles of incorporation must conform with applicable statutes and regulations (discussed in the “Recordkeeping, State Reports, and State Taxes” section below). Samples of articles of incorporation and related materials can be found at:
The California Secretary of State’s office (California nonprofit, nonstock corporations, mutual benefit) http://www.sos.ca.gov/business/corp/pdf/articles/corp_artsnp.pdf
Insight. Center for Community Economic Development (California model articles of incorporation for nonprofit public benefit corporation (and includes a model cover letter for filing and with model name reservation request) http://www.insightcced.org/uploads/publications/legal/Ch2_Articles%20of%20Incorporation.pdf
Management and Control
Once the nonprofit corporation has been established, the initial board of directors should meet (in person or/by written consent instead of a board meeting) to ratify the acts in connection with the initial formation of the corporation and adopt bylaws which set forth the rules and procedures governing the decision-making process of the board of directors and the general operation and management of the corporation consistent with the applicable California statutes and the corporation’s articles of incorporation.
Typically, the bylaws of a nonprofit corporation contain provisions governing member, director and officer qualifications, powers, and duties; voting; filling of vacancies; meetings; property holding and transfer; indemnification of directors and officers; committees; bank accounts; fiscal year audits and financial reports; conflicts of interest; and amendment and dissolution procedures.
Samples of bylaws that may be adapted for California nonprofit corporations can be found at:
- Insight. Center for Community Economic Development (California model bylaws for a nonprofit membership corporation) http://www.insghtcced.org/uploads/publications/legal/Ch4_CA%20model%20membership%20nonprofit%20bylaws%202006.pdf
- Insight. Center for Community Economic Development (California model bylaws for a nonprofit non-membership corporation) http://www.insightcced.org/uploads/publications/legal/Ch5_%20CA%20model%20nonmemberhship%20bylaws%202006.pdf
- American Bar Association, Business Law Section Pro Bono: ABC Toolbox (Nonprofit Bylaws - California) http://www.abanet.org/buslaw/committees/CL600000pub/abc/toolbox/governance/bylaws_cali.doc
Liability of Members, Directors and Officers
Because of the importance of attracting services of directors and officers of nonprofit corporations and the sometimes prohibitive cost of appropriate liability insurance, it is the public policy of the State of California to provide protections to individuals who perform these functions. With specific exceptions outlined below, no law suit for monetary damages shall be recognized against a person serving without compensation as an officer or director of California nonprofit corporation arising out of a negligent act or omission of such person while he or she is performing such duties so long as such person acts in good faith and in a manner he or she believes is in the best interest of the corporation. This limitation on liability applies to nonprofit corporations that are exempt from federal income taxation under Sections 501(c)(3) or 501(c)(6) of the Internal Revenue Code and further provided that the nonprofit corporation maintains liability insurance policies with amounts of coverage based on the corporation’s annual budget.
To the extent an officer or director of a nonprofit corporation uses corporate funds to pay private debts or fails to observe typical corporate formalities (recognizing the corporation as a separate legal entity), or as necessary to prevent fraud on creditors, the officers or directors committing such acts maybe personally liable for damages resulting for such acts.
Mergers, Acquisitions and Dissolution
The requirements related to mergers of California nonprofit corporations are in Cal. Corp. Code § 6010-6019.1 for public benefit corporations; Cal Corp. Code § 9640 for religious corporations; and Cal. Corp. Code §§ 8010-8019.1 for mutual benefit corporations. For sake of simplicity, and since public benefit corporations are the most common form of California nonprofit corporations, the following discussion is limited to public benefit corporations.
A California public benefit corporation may merge with any domestic for-profit corporation, a foreign corporation or other business entity but only with the prior written consent of the California Attorney General. A public benefit corporation may merge with another California nonprofit corporation or foreign nonprofit corporation (if such corporation’s articles of incorporation state that its assets are dedicated exclusively to charitable, religious or public purposes) without the consent of the California Attorney General.
The merger process may be summarized in the following steps:
i) The board of each corporation that wishes to merge must approve an agreement of merger which contains the following information:
- The terms and conditions of the merger;
- Any amendments to the articles of incorporation that are required for the corporation who will survive the merger, or continue to exist after the merger is effected;
- Amendments to bylaws of the surviving corporation, if any;
- The name and place of incorporation of each corporation participating in the merger;
- The manner of converting memberships of the corporations into the surviving corporation; and
- Any other provisions or details required by the parties.
ii) The terms of the merger must be approved by members of the participating corporations and as may otherwise be required by each party’s articles of incorporation;
iii) The merger agreement must be signed by the authorized officers of the participating corporations;
iv) The surviving corporation must then file with the Secretary of State the agreement of merger with an officer’s certificate from each participating organization, setting forth specific facts relating to the voting and approval of the merger required by each participating corporation.
It is also possible for a California for-profit corporation and a nonprofit corporation to merge. The requirements for such merger (approval of the boards of the participating corporations, appropriate votes, execution and filing of a merger agreement) are detailed in the California statutes governing nonprofit and for profit corporations.
A nonprofit corporation may voluntarily dissolve and wind up its affairs by either approval of the board of directors or approval of a majority of the members of the nonprofit corporation. The board of directors may choose to dissolve upon the occurrence under one of the following events: (i) a bankruptcy; (ii) a corporation which has not conducted business within the last five years and which has already disposed of all its assets; (iii) the corporation has no members; or (iv) the corporation’s articles provide for termination of its existence as of a specific date.
Once a corporation has decided to dissolve and wind up its affairs, it must file a dissolution certificate evidencing its intent to dissolve with the Secretary of State and the Attorney General. The certificate must be signed by a majority of the directors or by one or more members. It must recite the number of votes in favor of dissolution and whether the decision to dissolve was made by the board or by the members. Once the corporation initiates the dissolution process, it may no longer conduct its normal activities except as necessary to wind up its affairs and/or to prepare for a sale or disposition of it assets or both. Another notice of dissolution must then be provided to all members who did not vote in favor of dissolution, the Attorney General and all known creditors and claimants whose names and addresses appear in the corporation’s books and records. A corporation voluntarily dissolving must provide notice to creditors and claimants explaining how to make a claim against the dissolving corporations and provide a deadline no earlier than 120 days from the date of notice within which such creditors may submit a written claim to the corporation.
It is possible to seek court intervention and supervision of the dissolution of a California nonprofit corporation if requested by the corporation itself, the Attorney General, or by three or more creditors. When a corporation has been wound up without court involvement, a majority of directors must sign and verify a certificate of dissolution which states, among other things, that the corporation has been wound up, that it has filed its last franchise tax return, that it is dissolved, and that all debts and liabilities have been paid, the information regarding the name and address of the person, corporation or governmental entity who has assumed or guaranteed payment of the corporation’s liabilities. Before the certificate of dissolution will be accepted for filing by the California Secretary of State, the Attorney General must attach either a waiver of objections to the distribution of the corporation’s assets or a statement that the corporation has no assets.
In addition to voluntary dissolution proceedings, it is possible for at least half of the directors then in office, a person(s) holding at least 1/3 of the voting power, the Attorney General or any person authorized in the corporation’s articles to file an action in Superior Court for an involuntary dissolution. The grounds for such a lawsuit include abandonment of corporate activities for more than one year; deadlock with respect to ongoing management and operation; fraud, mismanagement or misapplication of assets or corporate property; or expiration of the corporation’s term of existence set forth in its articles. The Attorney General may also bring an action to obtain dissolution on similar grounds set forth in Cal. Corp. Code § 6511(a).
The court may appoint a provisional director to break a tie or management deadlock, or it may appoint a receiver to take over and manage the orderly disposition of the corporation’s assets.
The powers of the court in an involuntary proceeding are set forth in Cal. Corp. Code § 6516 and include, among other things, management of claims against the corporation and approval of payments of such claims and/or retention of assets to provide a fund for payment of claims. The court may also review and approve final accounts of all directors or others charged with winding up the operations of the corporation. The mechanics for notice to creditors and claims payments are set forth in Cal. Corp. Code § 6517.
Recordkeeping, State Reports and State Taxes
Every nonprofit corporation in California is required to keep adequate and correct books and records of account and minutes of meetings of the members, board and board committees. It shall also maintain a record of its members, names, addresses and class of membership held by such members.
No later than 120 days after the close of its fiscal year, unless the corporation receives less than $25,000 in gross revenues or receipts during its fiscal year, the board is required to send an annual report to members. The annual report must contain a report of its assets and liabilities as of the fiscal year end, principal changes in such assets and liabilities, the revenues and receipts of the corporation for the fiscal year, its expenses and disbursements, as well as a statement of any indemnification payment of $10,000 or greater by the corporation to or on behalf of any officer or director. The obligation to report indemnification disbursements applies to without regard to the corporation’s gross revenues or receipts unless such indemnification is approved by the members. The annual report must be accompanied by the report of the corporation’s independent accountants or, if none, a certificate of an authorized officer that such statements were prepared without audit from the corporation’s books and records.
Corporations are also required to file with the California Secretary of State within 90 days of the filing of its articles of incorporation and every other year thereafter a Statement of Information containing the following information: (i) the names and addresses (business or residence) of its chief executive officer, secretary and chief financial officer; (ii) the street address of its principal office in California; (iii) the mailing address of the corporation if different than that of its principal office, or if its principal executive office is outside of California. The Statement of Information shall also include the name of the corporation’s statutory agent and his, her or its business or residence address. The link to this form on the California Secretary of State website is http://www.sos.ca.gov/business/. The form or a statement that no changes have been made since the last filing must be sent during the five calendar months before the anniversary of the filing of the articles.
In addition, upon the request of an assessor, a corporation must make available its business records relating to property it owns at its principal office in California or at a place mutually acceptable to the assessor and the corporation.
California tax laws also apply to nonprofit corporations in unique ways. Primarily, qualifying nonprofit and charitable entities are exempt from state income tax. Additionally, California law generally exempts from property tax the property a qualifying nonprofit organization uses for religious, hospital, scientific, or charitable purposes. California law also provides a broad property tax exemption for property used for religious worship.
On the other hand, California, unlike some states, does not generally exempt sales to or by nonprofit organization from sales tax or use taxes. However, some specifically enumerated exemptions that may apply to nonprofit organizations are interspersed throughout California’s sales and use tax provisions. These exemptions include, for example, flags sold by nonprofit veterans organizations, sales by certain youth organizations, and sales by certain charitable organizations engaged in the relief of poverty.
Finally, nonprofit organizations will be subject to employment taxes to the extent that they meet the definition of “employers” and to the extent that they have persons meeting the definition of “employees” working for them.
Nearly every type of activity by a nonprofit corporation can become the target of some kind of a claim by a firm or an individual that alleges damage or injury by the corporation or individuals responsible for it (i.e., directors, officers or employees). Even if the claim is without merit, the costs of defending against the claim can be very substantial.
To encourage qualified individuals to accept positions as directors and officers, many nonprofit corporations purchase insurance to cover director and officer (D&O) liability. In addition, most responsible nonprofit corporations purchase a basic comprehensive general liability policy that covers liability for accidents in the corporation’s offices, at sponsored meetings and the like.
Liability insurance for nonprofit corporations is often a very complicated matter. Consultation with an experienced and knowledgeable agent or consultant is essential in order to obtain the right coverage at the lowest premium.
Alternatives to Nonprofit Corporations
Nonprofit and charitable enterprises may also operate as unincorporated associations. (See generally Title 3 of the California Corporations Code.) A ‘nonprofit association’ is defined by statute as “an unincorporated association with the primary purpose other than to operate a business for profit.” “Unincorporated association” is defined as an “unincorporated group of two or more persons joined by mutual consent for a common lawful, purpose, whether organized for profit or not.” Unincorporated associations lack the statutory formation requirements and regulations impacting other business entities. The primary disadvantages of using the unincorporated association form include uncertainty of the laws governing the association and its members (including such issues as personal liability for torts, standards of care for officers and directors, lack of express statutory authority giving officers, directors or members authority to act by and on behalf of the association). Given these uncertainties, the task of drafting organizational and operating documents that may relieve some of these uncertainties is more challenging. The California Secretary of State has provided a link to the appropriate form for reservation of an incorporated nonprofit organization at: http://www.sos.ca.gov/business/other/forms/lp-una-128.pdf. For a more detailed discussion of unincorporated associations and their advantages and disadvantages in the nonprofit sector, please see Advising California Nonprofit Corporations (2nd ed. Cal CEB 1998), Chapter 2, §§ 2.2-2.8.)
A nonprofit organization in California can also organize itself as a charitable trust. Trusts are arrangements whereby one or more parties (individuals or corporations) agree to hold legal title to certain property for the benefit of a charity or for other charitable purposes. The applicable California law relating to charitable trusts is set forth in §§ 15000-19403 of the California Probate Code. Charitable trusts must be registered with the Attorney General’s Registry of Charitable Trusts. See Supervision of Trustees and Fundraisers for Charitable Purposes (California Government Code §§ 12580-12599.7). See § 2.9 of Advising California Nonprofit Corporations (2nd ed. Cal CEB 1998) cited below for further discussion.
- Oleck and Stewart, Nonprofit Corporations, Organizations & Associations (Prentice-Hall, 1994, Cum. Supp. 2002)
- Jacobs, Jerald A., Association Law Handbook (ASAE & The Center for Association Leadership 4th ed., 2007)
- Nonprofit Governance and Management (American Bar Association and American Society of Corporate Secretaries, 2002)
- Guide to Nonprofit Corporate Governance in the Wake of Sarbanes-Oxley (American Bar Association Section of Business Law, 2005)
- Guidebook for Directors of Nonprofit Corporations (American Bar Association Section of Business Law 2d ed., 2002)
- Advising California Nonprofit Corporations (2nd ed. Cal CEB 1998)