Speaking of Bed Bugs...

I read an article recently that really got my attention.  It was about the recent "rash" of bed bug sightings in hotel beds, and it approached the problem from the hotel perspective (See Smartmeetings, December edition, Page 32).  Specifically, it provided a sample "Pest Clause" for use by hotels in hotel contracts.

Yikes.

And, you have GOT to be kidding!

I can hardly express my revulsion at the thought(s)!  First, the prospect of bed bugs is a deal breaker for me.  I'd rather sleep in my car, thank you.  Second, any hotel using this clause has an impressive attitude (a lot of nerve, for one thing, and a deeply disturbing lack of confidence, for another).  

The sample "pest clause" promises that the hotel will take "..reasonable measures to avoid the presence of bed bugs in the hotel..."  Seriously?  Personally, I am not interested in the hotel's "reasonable measures," and neither are your members, let alone your volunteer leaders.  With all due respect to the author of the article, who is an excellent attorney, I want the hotel to drop everything else in the world, fix the problem RIGHT NOW, and to have fully leveled with me concerning any issue related to pest infestations.

As a lawyer, I would assume an association meeting planner had gone temporarily insane to consider entering into a contract that includes such a clause.  The clause protects the hotel, which is nice for the hotel, but a nonprofit (especially the staff of the nonprofit) could be severely harmed by such incidents.  The bad taste of the event is certain to linger in the memory of volunteer leaders and members alike for years.  And, if the staff is aware of such a clause and accepts it, volunteers are likely to include staff members in the blame for such an incident.  

A better approach to the bug infestation problem would be a clause that requires disclosure of significant infestations, both past and present, by the hotel.  The following is an example of a clause the parties might want to consider:

Hotel shall disclose to Group any significant instances of pest infestations on Hotel premises within the prior 18 months of the date the Agreement is executed, and continuing thereafter until conclusion of the Group's event at Hotel.  For purposes of this Agreement, "significant instances of pest infestations" include lodging of a verbal or written complaint about interior area pests or pest infestations from five (5) or more guests within any rolling 30-day period.  Disclosure shall include the nature of the complaint, dates of complaints, type of infestation, number of complaints, and actions taken by Hotel in response to said complaints.  In the event that Group determines in good faith that the pest infestation is likely to materially affect attendance at Group events or use of Hotel sleeping rooms, Group may, in its discretion, cancel this Agreement without penalty, elect that Group will be excused from all sleeping room attrition clauses as well as food and beverage guarantees set forth elsewhere in this Agreement, or accept action plans proposed by Hotel to prevent adverse effects of pest infestations.

Of course, it is important to tailor this clause to the circumstances, and to check with legal counsel concerning all hotel contract questions.  Meanwhile, may your meetings be happy and pest infestation free.

Facts Association Executives Need to Know About Antitrust Law

Although many business owners and managers pay little or no attention to antitrust laws, these laws pose a substantial threat to both businesses and their leaders.  Antitrust laws are complex and confusing, and violations of antitrust laws can arise from seemingly harmless conduct.  Worse yet, Federal Trade Commission (FTC) and Department of Justice (DOJ) enforcement resources are virtually unlimited, while very few individuals or businesses have the financial resources to defend themselves against a powerful government agency.  Indeed, in a recent case, the FTC attacked two Arizona dentists for agreeing between themselves not to do business with a particular insurance company.  The FTC sued and ended its assault only after both dentists were financially ruined, and their misdeeds published nationally.  Antitrust liability is NOT just for big business anymore.

Antitrust laws are set forth in the Sherman Act, Federal Trade Commission Act, the Clayton Act, the Robinson-Patman Act, and California’s Cartwright Act, among other statutes.  These laws prohibit combinations of competitors in restrain of trade, attempts to monopolize and other anti-competitive activities.  Since most association activities involve groups of competitors, the opportunity to unlawfully restrain trade is always present.

No Easy Fix: Unfortunately, there is no checklist of what is and is not safe conduct from an antitrust standpoint.  All antitrust analysis depends substantially on the surrounding facts and circumstances.  What is lawful for one group of individuals to discuss may be a violation for another group.  Further, activities of individual groups of association members and/or chapters may be attributed to a state or national association.  Also, inferences may be drawn from association, chapter or member activity.  Even though no specific conspiracy or agreement to restrain trade has actually occurred, it is possible for a violation to have occurred.

Areas of Risk:  It is not possible to provide a complete or specific list of activities that amount to an antitrust violation.  However, it is helpful to identify areas of risk, where close attention can be paid to the possible anti-competitive nature of the agreements or activity involve.  Some areas of risk include discussions of the following:

•     Controlling or influencing current or future prices (for purchase or sale), controlling or influencing price increases or decreases, or stabilization or standardization of prices

•     What constitutes a “fair” profit

•     Procedures for establishing selling prices, cash discounts, credit terms

•     Control of sales levels, inventory levels or timing of sales

•     Allocation or division of markets or geographical divisions of markets among competitors 

•     Agreements, recommendations or suggestions that members refuse to deal with certain other persons or firms (boycott)

•     Whether or not the pricing practices of any competitor/industry member are unethical, or constitute an unfair trade practice

•     Agreements limiting or restricting advertising

Again, certain discussions relating to activities identified above will not amount to antitrust violations.  However, discussions relating to them require thorough prior antitrust analysis and guidance in the discussion.

Minimizing the Risk: To rationally cope with this risk, business owners and managers are wise to educate themselves about antitrust laws, and the likely application of these laws within their respective business.  A good place to start is with the association’s “antitrust policy.”  The association’s policy should serve to protect the association and its leaders, and help educate leadership and members about these laws and how to avoid liability under them.  Having a basic understanding of antitrust risks will help avoid inadvertent violations, and aid members in challenging and interrupting risky behavior before harm occurs.

First Aid: What further steps can be taken to avoid antitrust liability?  First, educate yourself about the law.  Be aware that even the most informal meetings between competitors in which risky topics are discussed can lead to liability.  When in group meetings, have the agenda reviewed for antitrust risk, then stick to the agenda.  Additions to the agenda that touch upon risky areas should be scrutinized.  Discussions during meetings should be monitored; in some instances, legal counsel should be present at the meeting.  Meeting minutes should be reviewed by the group’s Executive and/or Counsel.  Audio or video recordings of business meetings should not be permitted; if they exist, a policy should be adopted to provide for their systematic erasure.  If discussion leads to possible antitrust violations, discussion should cease immediately.  Meeting attendees should loudly object to risky discussions, and leave the meeting if risky discussions do not cease.  If a possible violation has occurred, seek counsel, and strongly advise attendees against discussion of the possible violation.  Note that “executive session” discussions are NOT truly confidential.

Antitrust law is a difficult and complex subject, and a cause for realistic concern for nearly all business owners, managers and associations.  The preventive measures noted above can help an association avoid these risks, potentially preventing a disaster.

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SAMPLE ANTITRUST STATEMENT

(To be read aloud by Chair / Facilitator at the beginning of any ASSOCIATION meeting/gathering.)

It is the policy of the [name of association] and its members to  comply with laws and regulations applicable to their activities.

Among other things, ASSOCIATION members and leaders are subject to antitrust laws that prohibit fixing prices, allocating geographic markets, unfair or deceptive practices, setting profit levels; boycotts, and most other anticompetitive actions.  ASSOCIATION will neither permit nor condone anti-competitive behavior, whether willful or inadvertent, in connection with any ASSOCIATION activity.

Additionally, discussion among two or more providers that suggests intentional or unintentional fraudulent activity is illegal.  For example, [insert a suitable example, such as: discussion of methods to enhance reimbursement by providing services that are not medically necessary may amount to a crime (conspiracy to commit fraud)].

Conversations involving discussion of matters that may violate applicable laws and regulations should always be avoided, even in private settings, and cannot be tolerated in connection with any ASSOCIATION meeting or activity.  Persons engaging in possible violations of ASSOCIATION policy during meetings or activities will be required to cease such activities, and if necessary, are subject to ejection by the presiding officer of the meeting.

Questions concerning antitrust or other laws or regulations connected to ASSOCIATION activities should be referred immediately to the Chief Staff Executive.

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[SAMPLE ANTITRUST POLICY]

Name of Association

ANTITRUST LAW COMPLIANCE POLICY AND GUIDELINES

It is the policy of the  ________ (INSERT NAME OF ASSOCIATION) and its members to strictly comply with laws and regulations applicable to their activities, including federal and state antitrust laws.  It is further the policy of ASSOCIATION to assist its members and volunteers in complying with federal and state antitrust laws.  ASSOCIATION members and leaders are expected to conscientiously adhere to antitrust laws.  ASSOCIATION will neither knowingly permit nor condone anti-competitive behavior, whether willful or inadvertent, in connection with any ASSOCIATION activity.

ANTITRUST LAWS

The antitrust laws seek to preserve a free competitive economy.  As a general rule, competitors may not restrain competition among themselves through understandings or agreements as to the price, the production or the distribution of their products, or other agreements that unreasonably restrict competitive capabilities or opportunities of their competitors, their suppliers or their customers.  The antitrust laws also prohibit monopolization and attempts to monopolize, unfair methods of competition, unfair or deceptive acts or practices, most discrimination in prices between different purchasers in the sale of a commodity, exclusive dealing arrangements, most tying sales and requirements contracts, some joint ventures/mergers/consolidations, and similar activities.   A more complete discussion of the antitrust laws (Sherman Act, Federal Trade Commission Act, the Clayton Act, the Robinson-Patman Act, and California’s Cartwright Act) is available upon request from ASSOCIATION.

However, antitrust laws are often unclear in terms of applicability to any given conduct.  Whether or not an antitrust violation exists depends purely on the specific conduct and facts involved in each instance.  Notwithstanding the nebulous nature of the antitrust law, penalties for violating them, both civil and criminal, are severe.  Certain activities can result in felony criminal convictions with penalties of up to three (3) years in prison and $100K fines for individuals and $1,000K fines for corporations per offense.  Also, treble damages are available to private persons enforcing the antitrust laws.

Association members and leaders, in particular, have compelling reasons to understand and comply with antitrust laws because antitrust violation commonly consist of two elements: 1) concerted action with produces 2) an unreasonable restraint of competition.  Since ASSOCIATION’s activities involve meetings and activities of competitors (ASSOCIATION members), the concerted action element can generally be established without difficulty.  The only other element necessary to prove a basic antitrust violation is to show that the action amounts to an unreasonable restraint of competition.  So, agreements or activities of association members that are anti-competitive or have an anti-competitive effect, whether conducted as association business or not, could result in serious antitrust consequences.

MEMBER RESPONSIBILITIES

ASSOCIATION programs are carefully designed and monitored on an ongoing basis to ensure compliance with antitrust law.  Every ASSOCIATION member, whether organizational or individual, has a duty and responsibility under the law to avoid and prevent antitrust violations.  Every ASSOCIATION member needs to understand basic antitrust laws, to recognize areas of potential antitrust risk, and to overtly object to and refuse to participate in any activity that poses antitrust risk until that risk is properly assessed and cleared by legal counsel or other qualified advisor.

AREAS OF RISK

It is not possible to provide a complete or specific list of activities that amount to an antitrust violation.  However, it is helpful to identify areas of risk, where close attention can be paid to the possible anti-competitive nature of the agreements or activity involve.  Some areas of risk include discussions of the following:

•     Controlling or influencing current or future prices (for purchase or sale), controlling or influencing price increases or decreases, or stabilization or standardization of prices

 Note:   Discussion of prices established by third parties not influenced or controlled by the discussing parties is generally not, standing alone, anti-competitive or illegal.

•     What constitutes a “fair” profit level

•     Procedures for establishing selling prices, cash discounts, credit terms

•     Control of sales levels, inventory levels or timing of sales

•     Allocation or division of markets or geographical divisions of markets among competitors

•     Agreements, recommendations or suggestions that members refuse to deal with certain other persons or firms (boycott)

•     Whether or not the pricing practices of any competitor/industry member are unethical, or constitute an unfair trade practice

•     Agreements limiting or restricting advertising

Again, some discussions relating to activities identified above will not amount to antitrust violations.  However, discussions relating to them require thorough prior antitrust analysis and guidance in the discussion.

ASSOCIATION MEETINGS

To avoid even the appearance of impropriety, as well as to avoid inadvertent violation of antitrust laws, all association board and committee meetings will be conducted in accordance with the following rules:

1.    A written agenda will be prepared and distributed in advance of each meeting.  Agendized issues with potential antitrust implications will be reviewed and discussed by the chairman, executive director and legal counsel, if deemed appropriate.  Additions to the agenda having potential antitrust implications should be postponed, or discussions of such matters held with legal counsel or other qualified advisor present.
2.    Accurate, detailed meeting minutes of every meeting will be prepared and reviewed.  Audio, video or other recordings of meetings will not be permitted.  Minutes will be approved at the next meeting.
3.    In the event of concern regarding potential antitrust implications of a discussion, discussion must be discontinued pending resolution of the matter through the executive director or legal counsel, if necessary.
4.    In the event that any member has a concern about potential antitrust implications of discussion during a meeting, he or she shall interrupt discussion and state that concern immediately.  If discussion is not terminated and the concern resolved, the concerned member should state that he or she is leaving the meeting for that reason, and leave.
5.    Conversations involving discussion of matters in violation of this policy will not be tolerated at a association meeting, and violating parties may be ejected from the meeting by the chairman.

end of sample policy

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This document has been prepared for general reference only.  It is intended to inform association leaders and members of basic antitrust principles to assist them in acting responsibly in the conduct of association and members business activities.  It must not be considered as a substitute for competent legal advice.  It is recommended that interested persons confer with competent legal counsel concerning this and other significant legal issues.

Certification Programs: A Legal Issues Checklist

Establishing or operating a certification program is rarely a simple matter.  Certification programs frequently provide compelling membership value, and enviable revenue streams.  On the other hand, numerous issues arise with a certification program.  What are the issues?   The following is a list of some of the most crucial legal issues to address with any nonprofit certification program:

Certification of Products, Persons or Processes – It is critical for a certifying entity to be clear about what is being certified.  Are individuals being certified?  If so, the risks may be higher.  Are products being certified as suitable for a specific purpose?  Or is a process being certified?  It is important to be very clear about what is being certified, and what that certification means to interested parties, including the certified person or entity, and consumers of the products or services involved.

Inherent Risks of Certification Programs - Credentialing programs always involve risk.  The more successful a credentialing program, the more it will generate risk.  Nonmembers will want the credential.  Regulators may be threatened by it.  Plaintiff's lawyers, looking for deep pockets and insured parties, will see credentialing parties as potential defendants.  The credentialing program may end up being the defacto standard for the industry or profession.  Reasonable reliance on the certification as being fully appropriate could result in liability based on the certification or standard being negligently established.  There is also risk of liability if the certifying entity grants a certification to individuals/entities that the certifier knew or should have known should not have been certified.  The implications of these risks are that the certification standards MUST be properly promulgated and applied.

Due Process – Criteria for certification should be competently established; criteria should provide a fair and reasonable threshold of competence; and denial or revocation of certification must allow for appeal, including the right to a hearing and opportunity to be heard.

Defamation – Care should be exercised to avoid harming persons/companies that did not qualify for the credential, or that have not taken or passed any examinations.  However, lists of certified persons/entities may be published.

Grandfathering Issues – Care should be exercised when considering grandfathering certification, as actions may make a strong appearance of anti-competitive behavior, whether intended or not.  Intentional or purposeful grandfathering of some competitors within a particular market in order to provide them with an important or substantial advantage not available to other competitors is almost always (depending on the specific facts) going to be illegal.

ADA compliance – Certifying organizations should consider the effect of certification of disabled persons.  Obviously, care should be taken not to discriminate against disabled persons. 

Antitrust – As noted above, certification programs almost always raise serious antitrust issues.  Care should be taken to prevent the certification from having an anti-competitive effect, such as making the certification unavailable to nonmembers when doing so results in a significant economic disadvantage to the nonmembers.

Fairness Issues – Certifications should, to the greatest extent possible, be free of  bias, discrimination, subjectivity, partiality or inconsistency in terms of the certification, and how certification requirements are applied.

Professional Advice – Entities establishing certification programs are strongly advised to seek professional guidance in establishing the certification program, including qualified legal counsel.

Nonprofit Association Sponsorship Income: IRS Scrutiny Likely to Increase

According to Marcus Owens, former director of the IRS’s Exempt Organizations Division (the Division that oversees nonprofit organizations), there is evidence the IRS may be considering and/or preparing to step up its review of nonprofit corporation sponsorship revenues.  Mr. Owens points to the IRS’s increased use of questionnaires, which provide the IRS with more information than is provided by ordinary Form 990 tax returns. 

The IRS itself has disclosed that it is focusing on generation of UBI (unrelated business income), use and management of endowment funds, and executive compensation.  This increased focus includes generation of detailed information concerning sponsorship revenues. 

In light of these circumstances, nonprofits should review their UBI and sponsorship programs and revenues, and take steps to ensure they are managing and reporting those revenues correctly.   Even if those revenues have been incorrectly reported in the past, making corrections now will put the nonprofit in a much better position with the IRS than if the IRS discovers the error on its own and the nonprofit has made no efforts to address the matter.  Upon the completion of the review, associations would do well to draft and implement appropriate changes in policies and procedures for the future if deficiencies are discovered.

IRS Reluctantly Planning Mass Tax Exemption Revocations

The Bottom Line: ALL Tax-Exempt Organizations Must File Tax Returns 

According to an article in The New York Times published on April 22, 2010, a staggering one-fourth of all nonprofit organizations will have their tax exemptions automatically revoked on May 15, 2010, based on their failure to file annual tax returns.  The IRS also has a page on their website devoted to this subject.

Historically, nonprofit organizations with $25,000 or less in revenues have been exempt from filing requirements.  However, the Pension Protection Act of 2006 increased reporting requirements.  Even tax-exempt organizations with no revenue at all are required to file an annual return.  Organizations that fail to file a return for three consecutive years will apparently have their exemptions revoked on May 15th, although the IRS may provide the organizations with a limited amount of time to correct the filing deficiencies.

Presumably, only small, volunteer-operated nonprofits that do not have accountants or lawyers will be struggling with this issue.  The filing burden for small organizations is not great, and it is not too late to correct the situation.

Click this link to download an article I wrote entitled “Your Comprehensive Guide to the New Form 990”.  You can also access the link by visiting CalSAE online and clicking the link on the home page.

In Tough Economy Do You Cut D&O Insurance?

I recently noted an association executive's question to other association executives relating to directors and officers insurance, as follows:

"I have a question and I would really like your input on what your association does. We currently have a D & O insurance policy. Several years ago the Federal Government created the Volunteer Protection Act, that protects volunteers. Most non-profit associations have volunteer officers and directors. In light of this Act, do your associations still carry D & O insurance?"

My response is that associations should, if possible, continue to carry directors and officers insurance.

Volunteer protection acts are not new. They have been around for many years. Without these laws, directors and officers insurance would probably be more expensive.  However, they should not be depended upon to act as a substitute for carrying an actual policy.

Insurance is important for many reasons, including the following:

• Volunteer protection acts are not particularly well crafted, or comprehensive. In some cases, they were hastily written and inconsistently worded.
• Volunteer protection acts include various exclusions, such as for actions against a director based on self-dealing, conflicts of interest, actions brought by the Attorney General, many actions grounded in tort law (intentional conduct, wanton conduct, reckless acts, gross negligence, etc.), and actions related to membership restrictions. Those exclusions from coverage have led some experts to suggest that any protection under volunteer protection acts is illusory (that is, it looks like you are protected, but you are not).
• Volunteer protection acts generally cover volunteers, not staff.
• Even assuming a director or officer is protected by a volunteer protection act, the act must be pled in court as a defense. This alone can cost tens of thousands of dollars, even assuming the defense is upheld.

Again, I highly recommend nonprofit organizations carry directors and officers insurance, along with an "employment practices" rider (65% of such cases are brought based on allegations of sexual harassment, hostile work environment or wrongful termination).

While economic conditions and cash flow problems may be substantial, directors and officers insurance is essential (not optional) for many nonprofit organizations.  For organizations that need directors and officers insurance, it should be maintained until the organization ceases to exist.  If, following careful review and discussion of the issue as well as solicitation of expert advice, the insurance is deemed optional by the board of directors, then termination of the insurance might be an appropriate step to take.

Top Ten Signs of a Dysfunctional Board

More than ten years ago I wrote an article bearing the above title.  The article has resonated with the boards of many of my clients, as well as association executives.  It seems to me there are still plenty of barely functional boards around, so I am republishing the article again at this time.  This time, however, I will add a few comments from a legal perspective where applicable.

I hope this article will help board members and association professionals learn to identify the underlying causes of dysfunction, and to avoid and/or minimize the negative behaviors that cause it.

ATTORNEYS AND CONSULTANTS who work with associations see their share of troubled boards of directors.  In fact, I believe troubled boards outnumber focused, efficient boards by a substantial margin.  Notwithstanding their problems, most boards seem to get by, but they could be better.

This article will point out some key indicators of a dysfunctional board.  While every association has a different way of working, the presence of more than a few of these signs is cause for concern.  Key indicators include:

Focus of Negative Attention on the Executive - when one or a minority of directors is openly critical of an executive, a great deal of resources tend to be devoted to that issue.  Distrust and struggles are likely to occur,along with frequently unfounded accusations against the executive.  Many times, if not most, the problem is with the board itself, not just the executive.

This behavior highlights the corporate rule of limited authority, which provides that directors (and all others, for that matter) have only the authority that is specifically delegated to them by law, bylaws or other corporate documents.  Here, a director’s opinions of the executive are irrelevant except to the extent expressed during a board meeting.  What matters is what the board thinks, not what one or two directors might think.  Further, directors acting on their dissatisfaction of an executive without board authorization is an interference with the board’s authority.

Overly Powerful Executive - sometimes executives amass so much “control” over the association that board members feel no need to do their job, or are reluctant or too intimidated to openly question what is happening.

It is lawful for a board to delegate substantial powers to its executive, however the ultimate responsibility for the organization remains with the Board, and fiduciary duties of each director remain in place.  Here, the fiduciary duty of care and the duty of inquiry require that directors be free to ask questions and challenge any organizational decision or action.

Last Minute Proposals - if important or controversial items of business are handled via last-minute (read: sneaky) proposals when there is no true emergency, the board is probably being manipulated.  Likewise, a board that is swayed by last minute proposals, and shallow or slick presentations without full analysis and discussion, is not doing its job.

Fiduciary duties of directors require they serve with the care of an ordinary prudent person.  A prudent director would want to carefully review, consider and discuss a proposal prior to acting on it, and should refuse to act on a last minute proposal, except in the case of a genuine emergency.

Power Struggles - power struggles shift the board’s focus from the business of the board to individuals or sub-groups gaining/maintaining “control.”  A board that is controlled by an individual or sub-group is inherently dysfunctional. So, whether right or wrong about the issues, controlling the board is harmful, while use of vision, influence, knowledge and ideas is completely appropriate and desirable.

Power struggles are not necessary illegal.  Instead, they highlight the probability that the group has strayed from its governing principles.  These principles are most likely grounded in the democratic process, rather than who can amass the most power.

Vote-Counting Prior to Meeting - counting and collecting vote commitments prior to a meeting is always inappropriate.  It generally results in conflict, distrust and weak decisions because decisions are made prior to full discussion and analysis.

Vote counting prior to a meeting is not illegal, but it presupposes a willingness to commit to a position without having heard the full discussion in the boardroom, an apparent violation of the statutory fiduciary duty of care.

Lack of Civility and Respect - a board that tolerates hostility, aggressiveness, or disrespect among board members, weakens itself and wastes time and leadership input.  A weak board finds it difficult to stop abuse, personal agendas and other disruptive acts.  It may have difficulty recruiting quality members.

Neither civility nor respect is legally mandated, but it's absence clearly weakens a board.

Board Micro-management - whether you are micro-managed or not, you already know what I mean.

Board micro-management may well violate an employment contract or existing policies, but it does not violate law.  A board is free to micro-manage its executive to the extent that it can afford to waste the time and resources of the organization.

Preoccupation with Bylaws and Parliamentary Procedure - while bylaws must be adhered to, and on occasion may require clarification or interpretation, disputes about bylaws or parliamentary procedures usually indicates more serious problems beneath the surface.  See “Power Struggles” above.

See comment at Power Struggles above.

Directors as “Representatives” - when directors act as representatives of their constituents rather than in the best interests of the whole, difficulties will abound.  Some directors go so far as to criticize the decisions of the board to their constituents -- a particularly disloyal and disruptive act.

Directors owe fiduciary duties of care, inquiry and loyalty (sometimes called duty of obedience) to the corporation, first and foremost.  While directors should be keenly aware of, and even biased in favor of local/regional points of view, the director must act in the best interests of the organization as a whole.  Thus, if a director knows that a certain action is of great importance to a certain region, but that the interests of the group as a whole require a different action, the fiduciary duty of loyalty requires the director to support that different action.

Rump Sessions - while discussing problems and ideas outside of a meeting is fine, unofficial group discussions outside of official meetings nearly always exclude at least some key stakeholders, and therefore undermine communication and trust.

Notice of all directors meetings must be given to all directors.  Meetings to which only some directors receive notice is not a meeting, and persons present at that so-called meeting can take no actions.  More importantly, when corporate business is discussed among subgroups of the board, other directors are excluded, and distrust is cultivated.  This does not mean that directors should not communicate with each other about important issues.  It merely means directors should be careful about such meetings in order to avoid cultivating distrust.

These are the basic signs that I have observed in my practice.  Are there others you could share?  Please let me know.  Next broadcast, I will present some ideas and methods for improving the functionality of boards.

Is An Executive Employment Contract Really Necessary?

A long time friend and client recently asked me whether a contract between a nonprofit executive and the nonprofit was really necessary. My friend correctly noted the contract would be difficult if not impossible for the nonprofit to enforce with an employee who is determined to leave. I have known other nonprofit leaders who seem to believe an employment contract is of little or no benefit to the nonprofit, and exists only to benefit the executive. The following are some of my thoughts on this subject.

An Employment Contract is Strongly Recommended

I strongly recommend a written employment contract between nonprofits and their executive. The contract benefits both the executive and the nonprofit in many ways. Although my client is most often the nonprofit itself and not the executive, the existence of a well-crafted contract is so beneficial that the disadvantages are far outweighed by the advantages.

An executive employment contract should, among other things, clarify the role and authority of the executive, describe in detail how the relationship may be terminated and each party’s obligations at the time of termination. This eliminates unnecessary battles over the power and authority of the executive, as well as costly and disruptive disputes that frequently occur when the employer-employee relationship ends. A well-written contract will almost always completely prevent these problems.

Executive Employment Is NOT The Same As Regular Staff Employment

One of the reasons a nonprofit executive is likely to want a written employment agreement is the executive is, by necessity, not entitled to some of the job security protections afforded an ordinary employee. That is, the board of directors must be able to let an executive go for any reason it deems necessary in the best interests of the corporation. If it does not like the direction of leadership, it needs to be able to -- and arguably has a duty to -- change that direction as soon as it can practicably do so. The same is not true with an ordinary employee. In theory, the lower level the employee, the greater need for the employer to have documented business reason or "cause" for terminating the employee.

Employment Contracts Serve The Nonprofit In Many Important Ways

The reason an executive would want a written contract, as noted above, is exactly the same reason the nonprofit should want one. Specifically, the contract should set forth the terms under which the nonprofit may terminate the executive with dramatically reduced risks of lawsuits. Further, the contract should spell out exactly how the termination decision should be made, thereby lessening the risk that the executive is terminated in a hasty or unlawful manner. In effect, the contract protects the nonprofit from substantial risks.

As we all know, nonprofit executives generally work in constantly changing environments. Members of the board of directors (hereinafter, “directors”) constantly turn over, so the board itself is constantly changing. These changes can result in an unstable situation for both the nonprofit and the executive, as the change of even one or two directors can dramatically change the relationship between the board and the executive. An employment contract adds stability and continuity to this situation by setting forth terms under which the executive is overseen, evaluated and terminated. Abrupt changes in relationship between an executive and his or her board are far more likely to result in serious disputes or litigation. Thus, the employment agreement is again an asset to the organization in that it lessens the likelihood that the organization will be seriously disrupted by misunderstandings, disputes or even litigation between the organization and the executive.

Concerning my friend’s point that the contract is probably not enforceable against the employee, I agree only in part. Indeed, no court would attempt to force an employee to work for an employer and many circumstances of an executive’s violation of a contract may not lend themselves to enforcement (the cost of enforcement in terms of time and money can be very high). Still, most executives will abide in the agreement unless the situation is a very ugly or negative one. Meanwhile, the contract continues to protect the employer in many other ways and serves as the basis for recovery if legal enforcement of the contract against the executive is deemed necessary.

Conclusion

Long story short, I strongly recommend a written contract exist between a nonprofit and its executive. True, an employment contract benefits the executive, but the advantages and security a nonprofit receives from the contract more than justifies its existence.

Tax Time Coming Up - UBIT Guidelines for 501(c) Organizations

Characterization of association income is sometimes a tricky subject.  Most association executives are well aware of unrelated business income (UBI) principles, but are understandably cautious about characterizing that income.  This post will attempt to refresh your understanding of UBI, give you examples of common income characterizations, and provide guidance on when to call on tax and legal advisors with UBI questions.  You can find detailed information by clicking here for official IRS documentation IRS guidelines on UBIT, revised March 2009.

UBI Basics

Although an organization may be exempt from state and federal income tax, it still may be liable for tax on its unrelated business income (UBIT). Unrelated business income is income from a trade or business, regularly carried on, that is not substantially related to the performance by the organization of its exempt purpose or function except that the organization needs the profits derived from this activity. 

The rationale for taxing UBI is to place for-profit and non-profit entities on equal footing for tax purposes: nonprofits are not allowed the competitive advantage of exemption from tax concerning their programs that are not conducted primarily in furtherance of their exempt purpose.

An exempt organization that has $1,000 or more gross income from an unrelated business must file Form 990-T, and may be required to pay unrelated business income tax (UBIT), at corporate tax rates.  Corporate tax rates are 15% of the first $50,000 of taxable income; 25% of the next $25,000 of taxable income; and 34% of taxable income in excess of $75,000.  Additionally, income in excess of $100,000 is subject to a surtax of 5% until the tax benefit of the lower rate structure is recovered ($11,750 in tax).

An activity is an unrelated business, and subject to UBIT, if it meets all three of the following requirements:

• It is a trade or business,
• that is regularly carried on, and
• that is not substantially related to the furtherance of the exempt purpose of the organization.
  

The term "trade or business" generally includes any activity carried on for the production of income (that is, the motive is to generate a profit) from selling goods or performing services.   Many non-UBI activities of associations could be considered a trade or business.

Business activities are generally considered "regularly carried on" if they show a frequency and continuity, and are pursued in a manner similar to, comparable commercial activities of nonexempt organizations.  An annual tradeshow or golf tournament is generally not considered regularly carried on; operation of an insurance brokerage program is regularly carried on.

Determination of whether a business activity is "substantially related" to exempt purposes can be difficult.  It requires careful review of the relationship between the activities that generate income and the accomplishment of the organization's exempt purpose. A trade or business is substantially related to exempt purposes when the business activities are carried out primarily to achieve exempt purposes, not simply for the production of income needed to carry out the exempt purpose.  In other words, the activities which generate the income must contribute importantly to the accomplishment of the organization’s exempt purposes to be substantially related.

Characterizing UBI

As noted above, characterizing association income can be tricky.  There is no “approved list” of activities that are related or unrelated.  Each situation must be analyzed based on its own facts.  Some situations are simple, and some are so difficult that they lead to litigation.   The vast majority of situations are not difficult.  The key is to know when to characterize business income yourself, and when to call on an expert.

The following circumstances generally do not constitute an unrelated trade or business:

• All of the work of the trade or business is performed for the organization without compensation. Some fund-raising activities, such as volunteer operated bake sales, may meet this exception.
• The trade or business is carried on by an organization described in section 501(c)(3) organization primarily for the convenience of its members, students, patients, officers or employees.  A typical example of this is a cafeteria or coffee shop.
  
• The trade or business consists of selling merchandise, substantially all of which the organization received as gifts or contributions. Many thrift shop operations of exempt organizations would meet this exception.
• Amounts received in exchange for the use of the association’s name or logo (or any valuable intangible right) are royalties.  Many association affinity and/or endorsement programs generate royalties that would fall within this exception.
• Trade shows and conventions carried on as part of the association’s exempt purpose.
• Associate member dues revenues, provided the associate member category has a genuine purpose other than producing income.  The key is the motive of the association:  the reasons the association accepts associate members must relate directly to or advance the mission and purposes of the association.  That an association member has a right to participate in association activities (not necessarily voting, but valuable activities) may help make the case that associate members are not admitted solely for purposes of generating revenue.
• Revenues from the rental or licensing of membership mailing lists.  This does not include an active role in the promotional use of membership lists.  It is acceptable for the association to control who rents the list, collect payment and analyze results of the mailing to determine if the mailing was successful.
• Annuities received, in most cases.  Consultation with an advisor concerning the taxability of this type of income is recommended.
• Generally, rents from real property and incidental rents from person property leased with real property, except if the property is debt-financed.  Consultation with an advisor concerning the taxability of this type of income is recommended.

The following circumstances are generally considered unrelated business activities:

• Revenues received in exchange for advertising in association publications.  Calculation of the UBIT is sometimes exasperatingly complicated.  A qualified accountant should be involved in determining the amount of advertising income that should be regarded as UBI. [Incidentally, the line between advertising and acknowledgements of support can be fine, particularly as it relates to sponsorships.  Some sponsorship benefits, such as discounted booth or magazine advertising space and logo placements on magazines and trade show banners, are likely to translate into more than mere acknowledgements.  Such benefits may be viewed as paid-for advertising, on which the association would owe UBIT.]
  
• Income generated from subsidiaries or other “controlled” organizations, in most cases.  Consultation with an advisor concerning the taxability of this type of income is recommended
• Insurance program revenues, other than royalties.  Consultation with an advisor concerning the taxability of this type of income is recommended.

UBI and Certification Programs

Certification programs can be difficult to characterize as related or unrelated.  Certification programs are frequently organized as public benefit entities (generally exempt pursuant to Section 501(c)(3) of the Internal Revenue Code).  As a public benefit entity, the organization operate exclusively for public benefit purposes.

A certification program intended at improving competence is likely to be viewed as having a substantially related, public benefit purpose.  Conversely, a certification program aimed at enhancing member marketability or the image of the profession is not a public benefit purpose; the genuine exempt purpose of the program is considered merely incidental.  The effect of these rules is that the IRS generally regards public benefit corporation certification programs as unrelated, and therefore subject to UBIT.

UBIT Strategy

Remember, UBI is a good thing.  It is better to have had the income and pay taxes on it, than never to have had the income.  That said, the less the tax, the better.

As a general rule, all sources of association revenue should be reviewed to identify UBI issues.  If the characterization cannot be made readily, careful analysis of the circumstances will be required.  The objective is to characterize the income as unrelated or related business income, and file tax returns accordingly.

Agreements relating to income programs should be written to connect the program to the exempt purposes of the association as closely as possible.  Also, agreements relating to the income program should, if applicable, be separate for non-UBI and UBI components.  For example, an association might have two agreements pertaining to its sponsored insurance program:  One for royalties for use of the association’s name and logo, and another for fees for administrative services the association will perform under the program.  The royalty income should be tax free, and the administrative fees subject to UBIT.

Limits on UBIT

Not surprisingly, there are limits on how much UBI an association (501(c)(6) exempt) can receive with undermining its tax exemption.  An association that is primarily engaged in generating UBI is likely to be viewed as not operating primarily (generally, greater than 50% of resources) for exempt purposes.  In such cases the association may wish to establish a for-profit subsidiary to conduct the unrelated activities.  If your UBI approaches 30 to 40 percent of total revenues, this issue should be taken very seriously.

Analysis of how much UBI a charitable organization (501(c)(3) exempt) can receive is more difficult, because a c-3 organization must be organized exclusively for charitable, educational or similar purposes.  Authoritative guidance on how much UBI a c-3 may generate is lacking, but it most definitely is less than would be acceptable for a c-6 organization.  C-3 organizations with UBI revenue streams should consult with expert advisors.

When assessing whether or not an organization has too much UBI, it is important to distinguish between non-dues revenues and UBI.  Non-dues revenue is frequently “related” business income.  There is no limit on the amount of non-dues revenue an association may make, provided the association operates in a manner consistent with its exempt status.

Conclusion

Characterization of income of an association as either related business income (tax exempt) or unrelated business income (subject to UBIT) is critical.  In some instances the characterization is relatively simple; in others it is appropriate to consult with expert tax and legal advisors.

[This post contains numerous generalizations concerning complicated matters.  Generalizations are helpful for educational purposes, but are not necessarily accurate when applied to specific situations.  As such, the reader is cautioned not to rely on the information set forth in this article as professional advice, or as a reliable characterization of income of any particular enterprise.]