INTRODUCTION
Nonprofit entities play an ever-growing role in our society, including assisting people in need to building communities, from protecting animals to aiding our environment, and attending to the physical, mental, and spiritual needs of our peoples, fauna, and flora. Nonprofit entities also take many forms from corporations to religious societies. With this growth in nonprofits comes the challenges of managing a nonprofit entity’s growth and possible decline, including knowing when to pivot or even close operations to pursue new goals or better fulfil the intended mission.
Our society is filled with well-meaning people who strive to do good things through nonprofit entities, but sometimes despite their best efforts there may come times when nonprofits need to merge, reorganize, or close. This article discusses in general terms several options available to nonprofits when a pivot or closure is a strategy to be considered.
MERGERS AND ALTERNATIVE ARRANGEMENTS WITH OTHER NONPROFITS
Nonprofit leaders in need of transition often learn that there are many nonprofits doing similar work, but fewer dollars available for their operations. For example, the number of nonprofit entities providing homeless services has grown exponentially in the past several years, while the monies available for homeless services have not grown at the same pace. Revenue and fiscal difficulties are the most common reason for a nonprofit to consider closure. However, closure is not the only path available.
Nonprofits that are struggling with revenue challenges may first want to consider whether another nonprofit with a similar mission would be a good partner for a merger. Mergers of nonprofits are possible, as with for-profit entities, and involve two entities combining into one surviving entity. Combining in a merger can often allow the shared mission of the nonprofits to be better supported and thrive long term. Additionally, if a nonprofit is facing revenue challenges, merging with another nonprofit allows the dedicated supporters and funding sources to continue supporting the surviving nonprofit entity.
Alternatives to mergers including creation of a parent-subsidiary structure, in which each nonprofit continues in existence but one is a subsidiary of a parent nonprofit, which protects the assets of the parent nonprofit from the liabilities of the subsidiary nonprofit, and both boards continue in existence. Similarly, two or more nonprofits (or a nonprofit and a for-profit entity) could create joint venture arrangements, whereby the separate nonprofits continue to exist but have a joint venture for certain aspects of their work. A collaboration agreement between two nonprofits is similar to a joint venture agreement, but less formal, and may involve shared programming, shared management such as human resources or finance functions, or shared resources such as office space. A sale of assets is also possible, in which one nonprofit sells its assets to another nonprofit, often including real estate or other tangible assets or contracts. Typically, a sale of assets will also be accompanied by a closure of the nonprofit selling its assets. All of these alternative arrangements can also later lead to mergers, as well, meaning these alternative arrangements do not preclude a later merger.
Regardless of whether a nonprofit is considering a merger or an alternative arrangement, a plan must be created for this purpose. This plan is developed and then considered and approved by the affected boards or members as well as governmental agencies.
There are numerous considerations for merging or entering into alternate arrangements with another nonprofit. Some major considerations relate to continuation of contracts and grants, the need for assignments of rights to contracts or other legal documents, merger of physical offices and termination/assumption of leases, board approvals, combining boards in a merger, governance document compliance, the nonprofit structure (e.g. cooperative or corporation) and whether the structure is changing (and its legality), and effectively merging employees. Additionally, if a merger or alternative arrangement is contemplated across state lines, the laws of both states relating to nonprofits must be taken into account.
Other considerations may include whether the “cultures” of the two nonprofits are a good fit, whether the missions are sufficiently similar for merger to be successful, and whether the revenue challenges of one nonprofit will be alleviated by merger. Support for the merger or alternative arrangement by both entities’ boards, donors, employees, and others will be crucial for a successful merger. Government notice or approvals for the merger or alternative arrangements are also required, typically at both the federal (e.g. IRS) and state attorney general level, as well as notice to the Corporations Division.
Contractual agreements for mergers of nonprofit entities follow the same general format as mergers of for-profit business entities, with the added requirement of notice to the appropriate state and federal authorities, including the IRS. Legal counsel is highly advised for mergers, in order to ensure that all terms are understood and agreed upon, and all legally required steps are taken to effectively and legally complete the merger process.
Mergers of nonprofits are generally not suited for situations in which a nonprofit has leadership challenges or unresolved personnel or publicity problems. Additionally, if a merger will not alleviate revenue challenges, or if there is a lack of board or donor support, then a merger may be ill-advised. Trying to “force” a merger through when there is a lack of support or lack of natural fit is likely to make the merger unsuccessful in the long-term. If a merger with another nonprofit is considered and rejected, then nonprofits can consider various alternative arrangements discussed above, or may consider various forms of dissolution.
NONPROFIT DISSOLUTION
If a nonprofit has decided to wind down its operations and dissolve, there are numerous steps to keep in mind in order to efficiently close its doors. The following sets out requirements for nonprofit corporations.
(1) Vote to dissolve and prepare and approve dissolution plan.
First, the nonprofit leaders will need to consider and hold a vote to move forward to dissolve the organization. This should only occur after other alternatives are considered, and the process must comply with the applicable governance documents such as bylaws and board meeting rules. State law may allow votes to be conducted through written consent, but in-person discussion and voting is preferred so that the dissolution plan is fully supported. Once the decision to dissolve is made, the board must next consider a dissolution and asset distribution plan (“the plan”) that will detail how the nonprofit will handle its remaining assets, including grants with restricted funds, contracts, and other ongoing obligations. The board will need to both develop and approve a dissolution plan involving disposition of the assets and payment of the liabilities of the nonprofit. This is a complicated process, and must be carefully thought out, often by a board subcommittee tasked with this assignment and working with legal counsel. The subcommittee or board that creates the dissolution plan must comply with the nonprofit’s articles of incorporation and other legal requirements throughout this process.
(a) Filing Dissolution Plan
Once the plan has been created and approved by the nonprofit leaders, nonprofits will be required to file these dissolution documents with the State. However, a few tasks are best accomplished during and shortly after this first step, as discussed below.
(b) Compliance with Nonprofit Laws and Contract Requirements and IRS Rules
State laws such as Oregon’s Nonprofit Corporation Act must also be considered for compliance. This law sets out restrictions on asset transfers and filing requirements for dissolution, including Oregon Attorney General approval requirements. Similarly, Washington has its own guidelines set out in Washington’s Nonprofit Corporation Act (NCA). Notably, Washington’s NCA does not restrict transfers that are part of a dissolution as dependent on attorney general approval. The state Secretary of State’s corporations or business division likely requires articles of dissolution be filed as well.
Additionally, for nonprofits, certain funding or services contracts, donation restrictions, or other limitations may exist in various contracts and agreements involving the nonprofit. For these reasons, careful attention must be paid to all of the nonprofit’s existing contracts and agreements and funding sources to ensure compliance with all existing requirements and obligations. If, for example, a grant requires the nonprofit to remain in existence for the entire term of the grant, but the nonprofit may close before the term of the grant expires, then special attention to handling the grant agreement and funds may be required. Often, nonprofits may need to separately account for different revenue and funding sources to ensure proper handling of each source and type of revenue.
Also, IRS rules impact the ability of some nonprofits to dissolve and distribute assets. For example, a recognized public benefit corporation or religious corporation’s assets can only be distributed to another public charity or religious corporation recognized as exempt under Revenue Code Section 501(c)(3). Numerous other tax law considerations may be implicated, depending on the structure for the winding down, and close cooperation with a tax adviser or tax lawyer is crucial at this step. Certain tax filings will also be required for the IRS relating to dissolution, the timing of which should be established in the dissolution plan.
(c) Employee notices and WARN Act notifications.
Notifying employees at the appropriate time of the anticipated dissolution is necessary. Employees may be offered severance agreements as part of this process. Often key employees may be offered additional compensation to remain working for the nonprofit through the closure, and compliance with Pay Equity laws must be considered. Compliance with the federal and state WARN Acts may also be required during this step. These WARN acts may require employers, including nonprofits, to give employees 60 days’ notice of closures. The WARN acts generally apply to employers with 100 or more employees regardless of the type of nonprofit, although exceptions may apply to.
(d) Notice to Donors and Supporters and Community, and Voting Requirements
Informing donors and supporters and the general community once the nonprofit has decided to dissolve makes the wind-down period run smoothly. The timing of this notification and the content and manner of the notice may vary depending on the role the person or entity plays with the nonprofit. For example, larger donors may deserve a phone call, whereas persons merely subscribing to a blog may receive a written blog notice. The terms of any donations or grants must also be considered. Some nonprofits may have a grants manager, or a designated person in charge of coordinating and managing grants and donations. This person should be familiar with the grant and donation terms, including identifying grants that may be restricted and need to be returned to the donor. Nonprofits may especially need to consider continued relations with the donors, supporters, and community because these same supporters may be resources for future nonprofit start-ups or possible employers for departing employees.
Additionally, if a nonprofit has ongoing clients or customers, careful management of these relationships may be needed, especially if clients are for health or welfare services.
Some nonprofits have voting members or classes of voting members, such as cooperatives or mutual benefit corporations, and votes may be required prior to or as part of adoption of a dissolution plan. Careful attention should be paid to these voting requirements, as a dissolution plan could be challenged or fail if the voting process and requirements are not met.
(e) Notice to Creditors
Creditors of the nonprofit must be notified of the impending closure at an appropriate time, typically dictated by applicable state law and stated in the dissolution plan. This may include leaseholders for leased office space, leaseholders for office equipment such as copy machines or computers, phone companies, internet providers, as well as independent contractors providing services to the nonprofit. Claims typically are in three categories, known claims, contingent (not fixed) claims, and unknown claims, and provision for resolving all three categories of claims must be made. Disposition of the creditor claims is required as part of the dissolution process.
(2) Filing Documents with Appropriate State Authority
Once dissolution is approved, documents must be filed with the appropriate state authority. Typically, this is a division of the secretary of state’s office. The Secretary of State’s office will typically have an Articles of Dissolution form for the nonprofit to fill out and submit. Some states, such as Oregon, require notification to the state attorney general’s office. In Oregon, nonprofit corporations’ and religious corporations’ distribution plan needs to be submitted to and approved by the Department of Justice. Importantly, this is also a requisite for companies that may have been exempt from registering with the DOJ. A complete charitable activities form, list of beneficiaries, and submitting financial reports are among the documents that are to be submitted to the DOJ.
Articles of dissolution are generally effective once they are filed, unless a nonprofit elected to specify a later date. The nonprofit’s existence past this point, is only to carry out activities necessary for winding-down and liquidation. Specifically, the nonprofit should be paying off debts and distributing assets according to its plan. The registered agent still has authority to carry out these duties, however if a registered agent or other nonprofit employee or board member exceeds the authority outlined in the plan, such actions expose the agent or employee and the nonprofit to financial liability.
(3) Winding Down and Closing Shop
Winding down a nonprofit looks different than winding down other businesses. All assets must be transferred to another tax-exempt organization or to the government. In effect, property, e.g., desks, chairs, and supplies, cannot be given to board members, staff, volunteers, or even clients or beneficiaries of the nonprofit. Instead, a nonprofit may sell those assets, but it is only lawful if they are sold at fair market value.
Depending on how publicly advertised the nonprofit’s closure is, creditors may become aware of the closure once the winding down process begins. Notifying creditors is typically not required, however, it is strongly recommended. Notification involves informing creditors of the closure to allow them to bring any potential claims against the nonprofit. Once creditors are notified, they typically will have 120 days to bring claims. Peace of mind, certainty, and limited liability are among the benefits of notifying creditors as soon as possible.
Once all assets are sold or transferred, there may be a final notice filing. In Oregon, the attorney general should be notified once all or substantially all assets are transferred. Generally, federal tax authorities need to be notified through a schedule N filing.
(4) Community Support through Dissolution
Closing a nonprofit typically involves much more than simply making filings, selling assets, and paying liabilities. The effects of closure are felt throughout the community. Nonprofits may elect to aid clients, beneficiaries, and donors by referring them to other organizations. Employees may be referred to the Employment Department and other assistance for support with job searching or job retraining. Further, fostering a supportive relationship with donors through the dissolution is another form of continuing to support the community, and may include steering donors to a like-minded nonprofit for future support.
NONPROFIT CONSERVATORSHIP AND RECEIVERSHIP
When selecting the right method for reorganization or dissolution for a nonprofit organization, it is important to assess the reasons for the desired reorganization, in addition to determining the remaining assets and amount of outstanding liabilities. If a nonprofit is opposed to filing for bankruptcy, nonprofit entities should consider bringing a proceeding in court to appoint a conservator or receiver.
(1) CONSERVATORSHIP
Rather than liquidating all assets and closing the nonprofit, a court could appoint a custodian to manage the affairs of the nonprofit, with a goal of salvaging it as a going concern and eventually handing control back to the nonprofit’s board, governing body, or membership.
Under Oregon state law, ORS 65.667, a court may appoint one or more custodians to manage the affairs of the nonprofit or to wind up and liquidate the nonprofit. The court will hold a hearing, after providing notice to all parties to the proceeding or any interested persons, before appointing a custodian. When appointed, the court bestows certain powers onto the custodian to exercise all powers of the nonprofit, through or in the place of the nonprofit’s board, governing body, or membership, to the extent necessary to manage the affairs of the nonprofit in the best interests of the nonprofit and its creditors.
(2) RECEIVERSHIP
Receivership, on the other hand, is similar to a chapter 7 bankruptcy where a receiver is appointed to liquidate assets and close the organization. Receiverships in Oregon are also governed under ORS 65.667 and the Oregon Receivership Code, enacted in 2017.
Like in a conservatorship, a court may appoint one or more receivers to manage the affairs of the nonprofit after providing notice to all parties to the proceeding or any interested persons. The receiver has different powers than a conservator. In contrast, the receiver may dispose of all or any part of the assets of the nonprofit wherever located, at a public or private sale, subject to any trust or other restrictions, and may sue and defend in the receiver’s own name in all courts in Oregon.
NONPROFITS AND BANKRUPTCY
(1) Chapter 7
Bankruptcy offers nonprofits the same tools for recovery as other companies, with added protections. Nonprofits can choose to restructure debts or choose to cease operations. Chapter 7 allows a debtor to cease operations and liquidate the business. A benefit of a nonprofit’s status is that nonprofits are ineligible for involuntary bankruptcy. It follows, they cannot be involuntarily converted to chapter 7.
If a nonprofit voluntarily chooses to pursue chapter 7 bankruptcy, a trustee will be assigned to the case. The trustee is tasked with liquidating nonexempt assets to maximize creditor recovery. Trustee’s also have the power to recover assets that may have been improperly transferred; the trustee may set aside a preferential transfer made to a creditor within 90 days of the filing of the petition. Creditors are paid depending on their status, i.e., priority, secured, unsecured, with lower priority creditors having to wait until the higher priority creditors are paid in full before receiving any compensation.
Nonprofits should keep in mind that sales of assets in a bankruptcy must still comply with non-bankruptcy law, according to Section 1129(a)(16) of the Bankruptcy Code. Thus, for example, if a state attorney general must review and approve a sale of substantially all of a non-profit’s assets under state law (like many healthcare businesses), the non-profit debtor must comply with those requirements in bankruptcy.
Importantly, corporate debtors are unable to receive a discharge of debts at the end of the chapter 7 case, unlike individual debtors. The rational is to prevent businesses from evading their debts by frequent liquidations. The debt survives liquidation and liability will resume if the corporation resumes operation. So long as the business remains inactive, no further action is required.
(2) Chapter 11
Bankruptcy Code Chapter 11 allows nonprofit entities under financial stress to restructure their debts and pay their creditors over time. A nonprofit entity is eligible to file a reorganization plan under Chapter 11 so long as it is organized as a corporation, business trust, joint stock company, or association with the power and privilege of a private corporation. Most non-profits are considered either corporations or associations. Accordingly, they are eligible to file a reorganization case under Chapter 11.
When nonprofits file Chapter 11 bankruptcy, the are required to propose a feasible plan for the repayment of their creditors. To be feasible, the nonprofit must show that it has the ability to make the proposed payments to its creditors under the plan and that plan must not have the likelihood to be followed by a liquidation, or the need for further financial reorganization. Nonprofits should be aware that their plan may not be confirmed if it is solely based on post-petition fundraising campaigns. Once a reorganization plan is created and approved by the Bankruptcy Court, the nonprofit entity is charged with carrying out the reorganization plan and eventually emerging from bankruptcy as a financially stronger entity.
Nonprofits must keep in mind that, if using the Chapter 11 process, there may be some funding or grant sources that are reluctant to award money to the nonprofit while it is in a Chapter 11 proceeding, such that funding or grants that were previously available may no longer be available.
CONCLUSION
As discussed above, for nonprofits having revenue or funding challenges, or other issues leading to closure discussions, there are many options to consider. Some of these options help preserve the entity in a different form, some help reorganize, and some help with closure. Each nonprofit’s circumstances are different, but this article provides an overall discussion of various options to be considered by a nonprofit’s board or governing body or membership. All of the options discussed above are extremely technical to implement, and legal representation through the process is highly recommended.
This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.
