One Size Does Not Fit All Organizations When It Comes to Legal Structures
In the business world it is common place for businesses to operate through multiple legal entities. Interestingly, the non-profit world has not embraced these strategies in the same way. We represent many established and growing non-profit and charitable organizations and many of them expand into new territories or cross national borders to scale their operations to meet demands. From time to time they will ask how best to structure their organizations to accommodate growth. The answer, like many, is never straight forward. One legal size rarely fits all organizations. Some lawyers or consultants decide upon on the ideal structure for any organization and then they impose that vision on every one of their clients. This mindset is unfortunately reinforced by model documents that on can find on-line or distributed by government bodies. Handle these with care.
A properly managed and operated nonprofit or charitable corporation will provide greater personal liability protection to its directors and officers and insulate program risk from its assets. This protection is known as the “corporate veil” and serves to isolate a corporation’s debts and liabilities within the corporation so long as directors and officers respect corporate formalities and fulfill their fiduciary duties of good faith, due care, and loyalty.
Non-profits can run multiple chapters, programs, etc. out of one entity. This approach can work for organizations with a higher risk tolerance or which place a premium on efficiency. With enough insurance and a good risk management program, a board may be comfortable with this type of structure. Nevertheless, organizations which hold all of their assets and programs in one consolidated entity run the substantial risk that a devastating claim could bring down the entire organization and all of its programs. Organizations working with children or vulnerable persons are particularly at risk in this scenario.
Conversely, a typical asset protection strategy will involve the establishment of different related entities to separate assets from potential liabilities and isolate the liabilities associated with each major program. For example, an organization with valuable real estate might hold those assets in a separate corporation to protect them from risks associated with their high risk programs. Similarly, endowment assets may be hived off into a separate foundation corporation.
Related entities can be created with varying degrees of autonomy from, or control by, the parent organization. The organization will have to consider this when establishing a parallel entity. If asset protection is the primary concern, maximum feasible separation should be the goal. On the other hand, affiliated entities can be burdensome to administer and decision making can be less efficient in a network than in a consolidated entity. Key decisions may have to be made multiple times. Multiple entities will increase the complexity of operations.
To maximize the potential protective benefits of conducting business through multiple entities, organizations must focus upon respecting the formalities of the arrangement. For example, where the two entities share resources, like employees, office space, or equipment, written agreements should document the terms of the shared arrangements to ensure that legal independence is maintained. It would be wise to memorialize shared intellectual property through license agreements. Inter-company resource transfers should carefully executed and documented through appropriate agreements, promissory notes, secured or unsecured loan agreements and the like. Each entity should hold and document separate board meetings.
In the end, decisions regarding the appropriate corporate structure for an organization often will boil down to trading off maximizing asset protection and maximizing efficiencies. Off the shelf solutions rarely meet an organizations needs.