Additional amendments to the New York Not-for-Profit Corporation Law (N-PCL) went into effect on May 27, 2017. The amendments reform and repeal provisions of nonprofit governance and oversight requirements for nonprofits incorporated in New York, most notably with regard to related party transactions, independent director requirements, board committees, and conflict of interest and whistleblower policies. Although the newly amended provisions are intended to reduce compliance burdens created by the New York Nonprofit Revitalization Act of 2013 (2013 Act), nonprofits incorporated in New York, organizations which are registered with the New York Attorney General's Charities Bureau (Attorney General) to conduct charitable solicitations or conduct activities in New York should update their corporate documents, policies, and practices in order to benefit from the new forms of flexible governance arrangements which are now permitted—and in some cases, required—as a result of these new provisions.
Highlights of the latest changes are summarized below.
Easing Related Party Transaction Provisions
Generally, a nonprofit cannot enter into any transaction, agreement, or arrangement in which a "related party" (i.e., directors, officers, "key people," and their relatives) has a financial interest, either directly or through ownership in an outside entity, unless certain procedures are followed before the time such transaction occurs. Moving forward, the rules governing related party transactions have been relaxed.
- Committees May Approve Related Party Transactions: In addition to the board of directors itself, the amendments clarify that an authorized committee of directors may approve or ratify related party transactions.
- New Exceptions for De Minimis, Routine, and Common Benefit Transactions: The amendments codify prior guidance from the Attorney General and exclude the following transactions from the definition of "related party transaction":
- A transaction where the transaction itself or the related party's financial interest in the transaction is de minimis;
- A transaction that would not customarily be reviewed by the board or boards of similar organizations in the ordinary course of business and that is available to others on the same or similar terms; and
- A transaction that "constitutes" a benefit provided to a related party solely as a member of a class of beneficiaries that the corporation intends to benefit as part of the accomplishment of its mission, which benefit is available to all similarly situated members of the same class on the same terms.
The above transactions, which are commonly entered into by nonprofits, will no longer require advance approval by the board or an authorized committee. As before, there is no bright-line test for measuring a de minimis transaction or financial interest; the New York Attorney General evaluates the safe harbor for de minimis transactions under a facts-and-circumstances determination that considers the size of the nonprofit's budget and assets, and the size of the transaction or interest.
- Limited Defense for Related Party Transactions Which Were Not Properly Authorized: The amendments add ratification as a limited statutory defense that can prevent unwinding by the Attorney General of a related-party transaction that was not properly authorized. Under the 2013 Act, the N-PCL did not allow a nonprofit to approve a related party transaction after the fact, even if the transaction was fair, reasonable, and in the corporation's best interests.
In order to invoke the defense, the board of directors or authorized board committee must ratify the transaction before the nonprofit receives any request for information by the Attorney General concerning the transaction; document the violation and basis for the ratification in writing; and adopt corrective procedures to ensure future compliance. As a result of this change, nonprofits can consider identifying and ratifying prior related party transactions that may not have obtained the proper approval initially.
The amendments also add a defense to an action by any person or entity other than the Attorney General to enjoin, void, or rescind a related party transaction that the transaction was fair, reasonable and in the corporation's best interest at the time it was approved.
- Replacing "Key Employee" with "Key Person": The amendments introduce the term "key person" in the place of "key employee" in order to reduce confusion about who can constitute a related party for purposes of the related party transaction approval and, as discussed below, an "independent" director. The new term "key person" clarifies that a related party can include nonemployees if the person: (i) has responsibilities, or exercises powers or influence over the corporation as a whole, similar to the powers of a director or an officer; (ii) manages the corporation or a substantial portion of the activities, assets, income, or expenses of the organization; or (iii) controls or determines a substantial portion of the corporation's capital expenditures or operating budget.
Modified Standards for Director "Independence"
Under the 2013 Act, certain oversight functions, including deliberations or voting relating to audit, conflict of interest, and whistleblower matters, were required to be administered by a committee composed solely of "independent" directors or by the "independent" members of the full board of directors. The amendments eliminate the requirement for independent directors to oversee conflict of interest and whistleblower matters. Independent directors are now required only for audit oversight purposes for nonprofits required to file an independent certified public accountant's audit report with the Attorney General – which currently include New York-incorporated nonprofits, any entity required to register with the Attorney General to conduct charitable solicitations or conduct activities in New York with annual revenue in excess of $500,000 (this threshold will increase to $750,000 as of July 1, 2017, as discussed below). Such organizations should review the profiles of their current and prospective directors and the composition of their audit committees to ensure that audit oversight functions are carried out only by the directors who qualify as independent under the new standards.
The new standards largely make it easier to qualify as an independent director, though certain persons who were viewed as independent may no longer be considered independent.
- Key Persons Are Not Independent: The 2013 Act provided that employees of a nonprofit or its affiliates did not qualify as independent directors. The amendments expand this prohibition to include "key persons," which, as discussed above, may include nonemployees.
- Sliding Scale to Examine Financial Interest: The 2013 Act provided that an employee of, or an individual who has a substantial financial interest in, an entity that has made payments to or received payments from the nonprofit or an affiliate cannot qualify as an independent director of the nonprofit if the payments exceeded the lesser of $25,000 or 2% of the entity's consolidated gross revenues. The amendments remove the fixed threshold. Going forward, a sliding scale will determine when payments are significant enough to affect an individual's qualification as an independent director.
In the case of entities with consolidated gross revenue of less than $500,000, a director of a nonprofit who is a current employee of or has a substantial financial interest in such entity is still independent if payments the entity made to or received from the nonprofit in any of the last three fiscal years do not exceed the lesser of $10,000 or 2% of the entity's consolidated gross revenue. For entities making consolidated gross revenue between $500,000 and $10,000,000, the amount of the payments the entity made to or received from the nonprofit in any of the last three fiscal years may not exceed $25,000. Lastly, for entities with consolidated gross revenue of $10,000,000 or more, the amount of the payments the entity made to or received from the nonprofit in any of the last three fiscal years may not exceed $100,000.
The intention of this change is to tailor the independence requirements to circumstances where the amounts involved are more likely to compromise the independence of the entity's employees or substantially financially interested individuals.
- Providing Further Exceptions to "Payments": The exclusions from "payments" that could trigger disqualification as an independent director were expanded to include payments made by a nonprofit corporation at a fixed or non-negotiable rate or amounts for services received, as long as the services rendered to the nonprofit corporation are available to individual members of the public on the same terms and are not available from another source. This change allows payments for routine services (such as utilities and cable) without concern that employees of such companies cannot serve as independent directors of a nonprofit's board.
Revising Requirements for Committee Formation and Operation
Most nonprofits have a few board committees to assist in the board's ongoing oversight responsibilities, and such other work groups, task forces, or advisory committees as suit their needs at any given time. Although the amendments make it much easier to establish and define the membership of committees of the board, it adds new limitations on committee powers.
- Establishment and Appointment of Board Committees: Prior to the amendment, the creation of a board committee and appointment of members to the committee had to be approved by a majority of the entire board. Now, except for the executive committee or a committee that serves the same function, the board can establish and appoint the membership of other committees of the board by a majority vote of the directors present at a meeting at which a quorum is present. The prior requirement of a majority vote of the entire board will still apply to establishing and appointing the membership of the executive committee or its equivalent, unless the organization has thirty (30) or more directors, in which case a three-quarters (3/4) vote of those directors present at a meeting at which a quorum is present will suffice.
- Ex officio Committee Appointments: The amendments clarify that a nonprofit's bylaws may provide that directors who hold certain positions in the organization are ex officio (by virtue of their office) members of specific committees.
- Limitations on Committee Authority: Except for certain prohibited actions, committees of the board may exercise board authority to the extent specified by the board or in the nonprofit's certificate of incorporation or bylaws. In contrast, committees of the corporation, which may include non-directors, cannot exercise any board authority. Prior to the amendments, no committee could be delegated the authority to:
- Submit to members any action requiring members' approval;
- Fill vacancies in the board of directors or in any committee;
- Fix the compensation of the directors for serving on the board or any committee;
- Amend, repeal, or adopt new bylaws; or
- Amend or repeal any resolution of the board which by its terms is not so amendable or repealable.
The amendments expand the list of powers which are reserved by law to the board of directors and are "non-delegable" to any committee to include that committees cannot:
- Amend the certificate of incorporation;
- Elect or remove officers and directors;
- Approve a merger or plan of dissolution; or
- Adopt a resolution recommending to the members action on the sale, lease, exchange, or other disposition of all or substantially all the assets of a corporation or, if there are no members entitled to vote, the authorization of such transaction.
Procedural Requirements for Conflict of Interest and Whistleblower Policies
- Independent Director Oversight: As discussed above, the amendments eliminate the requirement for independent directors to oversee conflict of interest and whistleblower matters.
- Whistleblower Recusals: In lieu of oversight by independent directors, the amendments prohibit directors who are employees from participating in board or committee deliberations concerning the administration of the whistleblower policy. Further, the amendments introduce a whistleblower recusal provision that prohibits a person who is the subject of a whistleblower complaint from attending or participating in any board or committee deliberations concerning the complaint, though the board or committee can request that the person present background information or answer questions before the board or committee begins its deliberations.
Employees as Board Chair
While the 2013 Act would have introduced an absolute prohibition on employees from serving as chair of the board (or office with similar responsibilities, however titled), as of January 1, 2017, the amendments relaxed the bar on such dual service if two-thirds (2/3) of the entire board approves the appointment and documents the basis for the approval in writing contemporaneously. A nonprofit that elects an employee as its chair should document the decision and reasons for the decision in a board resolution and/or board meeting minutes.
Raised Thresholds for Financial Reports
Similarly, although contained in existing law, all nonprofits incorporated in New York and organizations registered with the Attorney General to solicit charitable contributions or conduct activities in New York should be aware of the new thresholds for financial reports and audits, which increase on July 1, 2017:
- Organizations with gross revenues under $250,000 will still file unaudited financial statements;
- Organizations with gross revenues between $250,000 and $750,000 must file annual financial statements with a CPA's review report; and
- Organizations with gross revenues over $750,000 must file annual financial statements with certified audit reports.
These filing thresholds will increase again on July 1, 2021. Organizations which are exempt from registering with the Attorney General are not subject to this filing requirement.
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For more information on previous changes to the N-PCL, please see our prior articles on the subject: New York Legislature Passes Nonprofit Revitalization Act: Comprehensive, Significant Changes to New York Nonprofit Corporation Law on Horizon (July 30, 2013), New York Nonprofit Revitalization Act Signed into Law (December 19, 2013), and New York Nonprofit Revitalization Act Update (May 25, 2016).