Non-profit Nuances: Related Parties in New York's Revitalization Act of 2013
By: Rebecca A. Koval, Esq.
Last December, Governor Andrew Cuomo signed the Nonprofit Revitalization Act of 2013 into law. Among myriad changes that take effect on July 1, 2014, the law, which revises portions of fifteen different statutes, includes new definitions for "related party" and "related party transaction" under the Non-profit Corporation Law [hereinafter "NPCL"], and the plain language interpretation of these definitions carries implications for attorneys presently serving on boards of nonprofit corporations. In some cases, attorneys merely sit on the board; in others, these nonprofit corporations are also clients of the attorneys' respective firms. The legislative changes may affect attorneys who fit into one or both categories. Unfortunately, the statute fails to define key phrases on which attorneys' ability to comply with the law turns. The law desperately needs clarification that can only be provided by amendments to the law, opinion letters or guidance from the Attorney General's office, or court decisions from cases that will not be filed for months.
Why You Should Care
The changes grant much more power to the Attorney General in his enforcement capacity. Under NPCL Section 715(f), the AG can "bring an action to enjoin, void or rescind any related party transaction or proposed related party transaction that violates any provision of this chapter or was otherwise not reasonable or in the best interests of the corporation at the time the transaction was approved, or to seek restitution, and the removal of directors or officers." The AG may also require an individual or entity to do the following: 1) account for any profit received from the transaction and pay that amount back to the corporation; 2) pay back the corporation for any value derived from use of the corporation's property or other assets used in the transaction; 3) replace or return assets, property, income, or appreciation lost to the corporation as a result of the transaction; or 4) pay a sum up to double the amount of any benefit obtained improperly in the case of willful, intentional conduct. NPCL § 715 (f)(1)-(4).
The New Definitions
NPCL Section 102(a)(6)(23) states that "related party" includes:
(i) any director, officer or key employee of the corporation or any affiliate of the corporation; (ii) any relative of any director, officer or key employee of the corporation or any affiliate of the corporation; or (iii) any entity in which any individual described in clauses (i) and (ii) of this subparagraph has a thirty-five percent 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 five percent.
We do not know what the phrase "a direct or indirect ownership interest in excess of five percent" means. Possibilities for interpretation include equity ownership, paid-in capital, or an individual's income in any given year. "Relative" encompasses ancestors, domestic partners, spouses, sisters and brothers (full or half), children (natural or adopted), grandchildren, great-grandchildren, and all spouses of sisters, brothers, children, grandchildren, and great-grandchildren. NPCL § 102(a)(6)(22).
Furthermore, NPCL § 102(a)(6)(24) defines "related party transaction" as "any transaction, agreement or any other arrangement in which a related party has a financial interest and in which the corporation or any affiliate of the corporation is a participant." Any attorney who sits on a nonprofit board and meets the definition of related party makes any transaction, agreement, or other arrangement in which he or she has a financial interest a related party transaction. We do not know what the statute contemplates by the phrase "financial interest."
I Meet the Definition of Related Party--Now What Do I Do?
Initially, you need to know that the new statute eliminates the "Type" system of classifying nonprofit organizations. Under NPCL § 201(a), nonprofit corporations are now either non-charitable or charitable. Corporations formerly Type A are now all non-charitable, corporations formerly Types B and C are now all charitable, and corporations formerly Type D are either non-charitable or charitable, depending on their purpose statements. NPCL § 201(b)-(c).
As a general rule, nonprofit corporations cannot enter into related party transactions, "unless the transaction is determined by the board to be fair, reasonable, and in the corporation's best interest at the time of such determination." NPCL § 715(a). If you are a related party serving on the board of a nonprofit corporation that is considering a related party transaction, you must in good faith disclose the material facts that give rise to your interest in the transaction. NPCL § 715(a).
If you are a related party serving on the board of a charitable nonprofit corporation, however, the board may need to take additional steps. In this instance, if you are a related party with a "substantial financial interest" in the transaction, the board must do three things: 1) consider "alternative transactions to the extent available" before entering into the transaction; 2) approve the transaction "by not less than a majority vote of the directors or committee members present at the meeting"; and 3) document the basis for the board or authorized committee's approval of the transaction in writing at the same time as the vote, including its consideration of alternative transactions. NPCL § 715(b)(1)-(3). This section of the statute generates serious challenges for compliance.
The biggest problem stems from the fact that we do not know what "substantial financial interest" means. And since we do not even know what "financial interest" means as used in the definition of "related party transaction," we do not have the ability to extrapolate an existing definition to surmise possible interpretations. "Substantial financial interest" seems to require a monetary threshold, yet, the statute does not provide one.
Another void with which we must grapple is the lack of a definition for "alternative transactions to the extent available" as required in NPCL § 715(b)(1). This phrase might require boards to send out requests for proposals from other law firms if the board decision is whether to hire a board attorney's firm as legal counsel. The "extent available" portion seems to reflect a reasonableness approach, thus, "alternative transactions" might mean different things to different boards, possibly depending on size of the board, size of the corporation, or the time available to decide upon the transaction. Regardless, the possibility that a firm's attorney might put the business relationship between the firm and the nonprofit client in jeopardy simply by the fact that that attorney sits on the board is disconcerting.
Closing and Recommendations
While the statute provides the AG with tools to come after individuals and entities that fail to comply with the changes, it does not elucidate any guidelines that the AG will follow in evaluating whether related party transactions are in the best interest of the corporation. Additionally, the statute does not recognize good faith efforts at compliance.
Complying with the statute will require a combination of guesswork and risk-rewards analysis. Until we have a better handle on the new law, I caution against panicking. But it is in everyone's best interest to start contemplating the ramifications of the changes, especially where attorney board positions could put business relationships at risk.
Rebecca is a Buffalo native, and currently practice in Binghamton at Hinman, Howard and Kattell, LLP. Her practice areas include corporate law, credit union and banking regulation and compliance, and residential and commercial real estate. She completed her undergraduate studies at Washington and Lee University where she graduated magna cum laude with a B.A. in English. She graduated cum laude from SUNY Buffalo Law School.