New York Adopts Substantial Changes to Laws Regulating Nonprofits

On December 18, 2013, New York Governor Andrew Cuomo signed the Nonprofit Revitalization Act of 2013 (the "Act") into law. Aptly described by the New York Office of the Attorney General as "sweeping reform legislation," the Act overhauls longstanding legal requirements that affect the operations, governance, and oversight of not-for-profit corporations and charitable trusts organized in New York and, to a lesser extent, other nonprofit organizations operating in the state. Most provisions of the Act will go into effect on July 1, 2014.

The Act makes the first significant revision to the Not-for-Profit Corporation Law (the "NPCL") in over 40 years and includes updates to other laws affecting nonprofit organizations. A number of the reforms affect organizations operating in New York regardless of their state of organization. In particular, the Act eliminates New York's sui generis "Type" classification scheme, replaces Department of Education consent requirements with a more streamlined notification process for certain organizations, and relieves smaller organizations that are fundraising in New York of the requirement to provide independent CPA review or audit reports to the Attorney General.

Although the Act removes many operational barriers currently plaguing nonprofit corporations, it also imposes new governance standards and requirements, some of which also apply to wholly charitable trusts. Some of the standards contained in the Act are similar but not identical to standards found in the Internal Revenue Code, which may create additional compliance challenges. New standards governing "related party transactions," prohibitions on employees serving as board chairs, and requirements pertaining to conflict-of-interest and whistleblower policies are likely to require amendments to bylaws and corporate policies.

Notable reforms include:

Rules easing administrative burdens for all nonprofits doing business in New York:

• Elimination of types. The Act replaces the NPCL's current classification scheme for nonprofit corporations, which categorizes them as either Type A, B, C, or D, with a simpler distinction between "charitable" and "non-charitable" corporations. Corporations formerly classified as Types B, C, or D will, after July 1, 2014, be identified as charitable corporations, while Type A corporations will be designated as non-charitable corporations. Any corporation formed on or after July 1, 2014 for both charitable and non-charitable purposes will be deemed to be a charitable corporation.
• Requires notice to the Department of Education rather than consent for many organizations. For all but certain organizations, such as schools, libraries, museums, and historical societies, the Act replaces the requirement of obtaining the Department of Education's consent to corporate filings with the Department of State with a requirement to provide notice of those filings to the Department of Education. This change will provide long-needed relief to numerous organizations, which, merely due to having education as one of their purposes, have been subject to the burdensome consent requirement.

New standards for audit oversight and thresholds for financial report requirements for organizations that fundraise in New York:

• Financial-reporting requirements. Charitable organizations that are required to register with the Attorney General because they solicit contributions in New York must, in addition to submitting an annual financial report, provide the Attorney General with certain documents. These filings become more robust as the level of an organization's annual gross revenue and support increases. The Act raises the thresholds triggering these additional reports.
  • Independent auditor's report. Currently, organizations that either receive gross revenue and support in excess of $250,000 or that pay outside fundraisers must provide an independent auditor's report with their annual financial report. The Act raises the threshold to $500,000 in 2014, $750,000 in 2017, and $1 million in 2021, and eliminates the requirement for organizations using outside fundraisers that otherwise do not meet these thresholds.
  • Independent CPA review report. Organizations receiving gross revenue and support between $100,000 and $250,000, which are currently required to provide an independent CPA review report with their annual financial report, are not required to do so under the Act, which raises the relevant threshold for that requirement to $250,000.
  • Unaudited financial information. Organizations receiving less than $250,000 need only provide unaudited financial information on forms provided by the Attorney General.
• Audit-process oversight. While relieving some organizations of the need to submit an independent CPA audit report, the Act imposes new requirements on any organization that is required to submit an audit report: the board, trustees, or an audit committee composed entirely of independent directors or trustees must oversee the organization's accounting and financial reporting processes and the audit of the organization's financial statements. The board, trustees, or committee must annually retain, or renew the retention of, the independent auditor and must review the results of the audit and related management letter with the auditor. Additional duties relating to oversight of the audit and auditor apply to organizations that have annual revenue in excess of $1 million. Only independent directors or trustees as defined in the statute may participate in deliberations or votes relating to the organization's audit. For any organization that had annual revenue of less than $10 million in its last fiscal year ending prior to January 1, 2014, the new requirements relating to audit oversight will not apply until January 1, 2015.

In addition to the rules described above, which affect nonprofits active in New York regardless of their state of organization, the Act also contains numerous provisions that expressly apply only to New York not-for-profit corporations and New York wholly charitable trusts.

Rules streamlining the operations of not-for-profit corporations:

• Long-overdue acceptance of advances in technology. The Act expressly authorizes the use of e-mail for the provision of written consents and notices and waivers of notice for meetings of members and directors. In addition, members may provide proxies by e mail. Corporations with over 500 members that provide notice of member meetings through newspaper publication must also post notices on their website. The Act also permits directors to conduct meetings by electronic video screen communication technology.
• Relaxed rules for approving real-estate transactions. Currently, not-for-profit corporations with boards of fewer than 21 directors may not sell, purchase, mortgage, or lease real property unless authorized by a vote of two-thirds of the entire board. Under the Act, a majority vote will suffice, unless a real-estate transaction would involve all or substantially all of the assets of the corporation, in which case a two-thirds vote is required. Boards with 21 or more directors may continue to approve all real-estate transactions by a majority vote. Committees of the board may also authorize real-estate transactions that do not involve all or substantially all of the assets of the corporation so long as they promptly report actions taken to the board.
• Alternative procedures for obtaining approval of fundamental transactions. The Act also facilitates fundamental transactions by not-for-profit corporations, including amendments to certificates of incorporation to change corporate purposes, mergers, sales of all or substantially all of an organization's assets, and dissolutions, by creating an approval process with the Attorney General as an alternative to the judicial approval process currently required for many corporations. The new Attorney General process is available in all but a few situations. The Attorney General retains the discretion to conclude that court approval is appropriate and an organization may apply to the New York Supreme Court if the Attorney General denies an application for approval.

New standards and requirements for governance of not-for-profit corporations:

• Clarification of the meaning of "entire board". Under the Act, the "entire board" is defined to mean the total number of directors entitled to vote that the corporation would have if there were no vacancies. If the bylaws of a corporation fix the number of directors, "entire board" refers to that number. If the bylaws provide a minimum and maximum number of directors, the "entire board" consists of the number of directors within that range that were elected at the most recent election of directors. Under this standard, not-for-profit corporations that have difficulty filling vacancies may face challenges in obtaining votes sufficient to approve certain transactions. 
• New standards for approving compensation paid by not-for-profit corporations. Under the Act, no individual receiving compensation from a not-for-profit corporation may be present at or otherwise participate in any board or committee deliberation or vote concerning that person's compensation. But the individual may present information as background or answer questions prior to the commencement of the board or committee's deliberations or voting.
• Prohibition on employees serving as board chairs. The Act forces more separation between a not-for-profit corporation's management and board by prohibiting an employee from serving as the chair of the board or holding any other title with similar responsibilities. This provision of the Act does not go into effect until January 1, 2015.

New governance standards and requirements that apply to both not-for-profit corporations and wholly charitable trusts:

• New standards for approving related party transactions. The Act contains new standards and procedures for director and trustee approval of "related party transactions." Namely, the board must determine that the transaction is fair, reasonable, and in the best interests of the organization.
  • For charitable corporations and wholly charitable trusts, the board or an authorized committee must consider alternative transactions to the extent available, approve the transaction by not less than a majority vote of the board or committee members present at the meeting, and contemporaneously document the basis for approval, including the consideration of any alternative transactions. Directors, officers, trustees, or key employees who have an interest in a related party transaction must disclose the material facts concerning those interests.
  • A "related party transaction" is defined in the Act as any transaction, agreement, or any other arrangement in which a related party has a financial interest and in which the nonprofit or any affiliate of the nonprofit is a participant. A "related party" for these purposes includes directors, trustees, officers, and key employees of the organization or any of its affiliates; any relative of any of the preceding; and any entity in which any of the preceding has a 35% or greater ownership or beneficial interest or, in the case of a partnership or professional corporation, a direct or indirect ownership interest in excess of 5%. The Act also authorizes the Attorney General to bring actions to enjoin, void, or rescind any related party transactions that were not reasonable or in the best interests of the organization at the time approved and empowers the Attorney General to seek various remedies relating to those transactions, including the payment by anyone that receives an improper benefit of an amount up to double the amount of any benefit improperly obtained in the case of willful and intentional conduct.
  • While current standards under the NPCL relating to interested party transactions are framed in terms of a safe harbor under which transactions will not be voidable, the Act imposes new affirmative duties on governing bodies. In addition, due to the definition of "related party" in the Act, nonprofits with complex organizational structures may need to require more extensive disclosures from directors, trustees, officers, and key employees of their familial and financial relationships to avoid triggering these rules.
• Requirement of conflict of interest and whistleblower policies. Adding to the investment policy currently required under the New York Prudent Management of Institutional Funds Act, the Act mandates two new policies:
  • Conflict of interest policy. The Act requires all not-for-profit corporations and wholly charitable trusts to adopt a conflict of interest policy containing provisions defining a conflict of interest, providing procedures for disclosing conflicts, requiring that individuals with conflicts not participate in deliberations or votes on matters giving rise to conflicts, prohibiting those individuals from attempting to improperly influence deliberations or votes on matters involving a conflict, requiring annual written disclosures by directors and trustees, requiring documentation of the existence and resolution of the conflict, and providing procedures for disclosing, addressing, and documenting related party transactions.
  • Whistleblower policy. Nonprofit corporations and charitable trusts with 20 or more employees and that in the prior fiscal year have revenue in excess of $1 million are also now required to adopt a whistleblower policy. That policy must provide that no director, trustee, officer, employee or volunteer will suffer intimidation, harassment, discrimination, or other retaliation for reporting in good faith an action or suspected action taken by or within the organization that is illegal, fraudulent, or in violation of organization policy. The policy must contain provisions providing reporting procedures, including procedures for preserving the confidentiality of reported information, designating an individual to administer the policy, and requiring that the policy be distributed to directors, trustees, officers, employees and volunteers.

If a committee of independent directors is not responsible for adoption or implementation of and compliance with the conflict of interest and whistleblower policies, the Act delegates that responsibility to the board, trustees, or audit committee. Organizations that have adopted policies under federal, state, or local laws that are substantially consistent with the requirements of the Act will be deemed in compliance with the new law.

A New Model?

The Act is the product of a innovative collaboration between the Office of the Attorney General and the nonprofit sector. Last year, the Leadership Committee on Nonprofit Revitalization, a special body established by the Attorney General and consisting of representatives of the nonprofit community and the bar, issued a report to the Attorney General that contained numerous recommendations that formed the foundation for the Act. A copy of the Committee's report is available here. Several of the reforms included in the Act echo changes to governance standards adopted by California in its Nonprofit Integrity Act of 2004, raising the question of whether such changes might be on the horizon in other states.

Conclusion

Nonprofit organizations should review their bylaws and existing policies and procedures to determine what changes they will need to make in advance of the effective dates of the relevant provisions of the Act. To view the text of the Act, please click here. The Attorney General's press release is available here.

For more information, please contact any of the following attorneys in our Exempt Organizations Group:

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