Within a week, the group created the ConstitutionDAO, organized its followers on Discord (a messaging and community platform), and raised roughly $47 million in virtual currency.⁴ Armed with their new war chest, the group bid on, but ultimately failed to win, the Sotheby’s auction, losing out to a hedge fund billionaire who purchased the copy of the Constitution for $43.2 million (the Constitution DAO had withheld some funds to cover costs associated with winning the auction).⁵

Following their loss, the creators of the group were faced with what to do with the virtual currency sitting in the DAO’s treasury. Many of the community members sought refunds, only to learn that the transaction costs (also known as gas fees) would eat up much of their original contribution.⁶ Ultimately, the ConstitutionDAO’s founders decided to shut it down.⁷ The token issued in connection with the project, originally intended to be used to allow holders to vote on what the DAO would do in the future, lives on, with some holders still hoping to profit.⁸

What if the ConstitutionDAO had succeeded? Who would have “owned” the copy of the Constitution the group would have purchased? In a later interview one of the founders of ConstitutionDAO, Jonah Erlich, disclosed that the group had partnered with a traditional nonprofit organization that would have had legal custody of the Constitution.⁹ The fact that this new type of organization would be reliant on a traditional nonprofit provides excellent insight into the emerging world of DAOs. It also gives us an entry point to examine this new structure.

WHAT ARE DAOS?

In a traditional corporation or limited liability company, the organization is formed by filing paperwork with a government office, typically a state’s Department of State. By creating a legal entity, the people behind the organization are protected from liability. When someone sues a corporation over a contract dispute or other liability, the directors, officers, employees, members, and volunteers are not liable individually. Rather, it’s the corporation that must answer for its liabilities.

In a DAO, however, there is no formal legal entity. Built using the same blockchain technologies that underly the virtual currency ecosystem, DAOs are organizations that are never incorporated in any state (with limited exceptions). The founders create the DAO, and it simply exists.

While DAOs actual structures vary, most DAOs issue a token that gives members of the DAO voting rights. Once tokens are issued, in order to make decisions, all token holders are allowed to vote. The idea, touted by DAO supporters, is that this new structure democratizes organizational decision-making, placing it in the hands of the members. An oversimplified comparison would be a for-profit company that has no paid executives or board of directors, making every decision by allowing all shareholders to vote.

Although the ConstitutionDAO is a well-known example, DAOs are proliferating in the nonprofit community. Here are a few interesting examples: DiatomDAO is raising support to protect the oceans;¹⁰ KlimaDAO hopes to speed up solutions for climate change by increasing the price of carbon assets;¹¹ Bloomeria is using NFTs to increase biodiversity; ¹² and The Regen Network is issuing a token as part of a group of entities to realign the agricultural economy with ecological health.¹³

While each of the foregoing organizations uses the language of the DAO and decentralization, they also demonstrate how the DAO community encompasses many different structures. For instance, the Regen Network is comprised of a traditional C-Corporation, a traditional 501(c)(3) public charity, and a decentralized DAO program.¹⁴ The DiatomDAO is purely a decentralized entity, “owned and directed” by its token holders (see more on this below). The ConstitutionDAO, while operated as a decentralized DAO, would have relied on a traditional 501(c)(3) public charity (one named EnDAOment¹⁵) had it won the Sotheby’s auction and needed a legal entity with which to hold the copy of the Constitution. As you can see, while many groups use the mantle of “DAO”, the term encompasses many different structures.

WHAT ARE THE BENEFITS OF DAOS?

Now that we’ve discussed what DAOs are, and seen some examples, let’s step back to consider what DAO proponents like about the structure. In theory, a pure DAO offers each supporter the opportunity to participate in the group’s decision-making. If a member of a charitable DAO wants to make a grant, they would propose it to the rest of the DAO community. The members then hold a vote. Using this structure, a DAO represents a more direct form of organizational decision-making and, for donors, more direct-action philanthropy.

Further, by avoiding any legal structure, some DAO proponents believe this new structure will give DAOs greater flexibility. Without a state’s laws dictating how decisions have to be made or how boards have to be structured, a DAO might be nimbler. Some libertarians believe that DAOs, who have no real jurisdictional nexus to any state, might even be able to avoid generally applicable laws.¹⁶

WHAT ARE THE DRAWBACKS OF DAOS?

While there is a lot to be excited about by DAOs, they use an organizational structure in its infancy, with many more questions than answers. One critique is that the voting structure adopted by most DAOs (1 token = 1 vote) replicates existing problems with shareholder structures, namely, that the larger shareholders control organizational decision-making, alienating smaller shareholders. If one person holds 60% of the DAO’s tokens and the DAO implements a 50+1% vote threshold decision-making could be even more centralized than it would be in a traditional organization with a board and executives who can counterbalance a large shareholder’s interests. The DAO community has proposed some possible solutions to this problem, such as limiting votes to one per token holder, or creating non-transferable tokens to limit token holder hoarding. Each of these solutions have drawbacks, but they could drive decision-making closer to the idealized notion of the DAO.

Another issue is the legal uncertainty of DAOs. Assume that the libertarian notion that DAOs are legally unaccountable as organizations, since they are not organized in any state nor do they have any other jurisdictional nexus with any local, state, or federal government. That might put the DAO beyond the reach of regulators and law enforcement, but it would not exempt the individuals participating in or working for the DAO, all of whom are real people subject to normal laws. Actually, the idea of a group of people running an unincorporated organization isn’t new. In New York, for instance, such an entity would be deemed an “unincorporated association.” Under longstanding common law, an unincorporated association is not legally separate from the members who comprise it.¹⁷ That means that members of a DAO could be taking on direct legal risk from their participation in the DAO. If the DAO were to breach a contract, discriminate against an employee, or cause other real-world harm, the DAO’s members might be jointly and severally liable.

It’s also an open question whether regulators will share the libertarian view that DAOs are not subject to local, state, or federal laws. It wouldn’t be surprising to see the Securities and Exchange Commission (SEC) bring an enforcement action against a DAO, given that it has already notified the Decentralized Finance (DeFi) community that it considers many DeFI products analogous to products regulated by the Commission.¹⁸ The SEC has already brought an enforcement action against a Wyoming organization operating under the guise of a DAO, albeit only after the entity sought SEC approval to register two tokens as securities.¹⁹

Finally, DAOs in the philanthropic sector face the additional hurdle of providing tax-deductibility to donors. In general, a contribution to a non-charitable intermediary doesn’t allow a donor to take a tax-deduction. The answer to that question isn’t clear²⁰ as it depends on how the entity is treated for tax-purposes, whether its distributions would otherwise qualify for a tax-deductions, and whether it is considered an agent for the donors or beneficiary charities. A person hoping for a tax-deduction should contact a tax professional to examine the particular DAO’s structure and the taxpayer’s circumstances. To date, I’m unaware of any DAO specifically advertising the deductibility of contributions to its treasury, nor having considered tax-deductibility as part of their DAO structure (except, of course, for DAOs like Endaoment and Regen Network that operate using a traditional 501(c)(3) corporate structure).

WHAT’S NEXT FOR DAOS?

Despite the novelty of and the uncertainty surrounding DAOs, their popularity is undeniable. This was exemplified by the incredible enthusiasm around ConstitutionDAO. Taking advantage of the late 2021 surge in the value of many cryptocurrencies, DAOs provide an opportunity for the crypto community to put its assets to work in novel ways, including philanthropy. While they are evolving, DAOs will likely persevere, barring regulator intervention to shut them down.  Donors and charities looking to participate in the DAO community should do so carefully, and with the benefits of advisors familiar with the DeFi and DAO space.

1 https://www.sothebys.com/en/digital-catalogues/the-constitution-of-the-united-states

2 Id.

3 https://www.theverge.com/22820563/constitution-meme-47-million-crypto-crowdfunding-blockchain-ethereum-constitution

4 https://www.constitutiondao.com/

5 https://www.vice.com/en/article/qjb8xv/hedge-fund-ceo-who-bailed-out-gamestop-short-seller-bought-the-constitution

6 https://www.theverge.com/2021/11/24/22800995/constitutiondao-refund-progress-steep-gas-fees-cryptocurrency

7 https://www.theverge.com/2021/11/23/22799192/constitutiondao-shutting-down-lost-auction-refunds

8 The latest price quote for the PEOPLE token can be found at  https://coinmarketcap.com/currencies/constitutiondao/.

9 https://www.theverge.com/22820563/constitution-meme-47-million-crypto-crowdfunding-blockchain-ethereum-constitution.

10 https://diatom.fund/

11 https://www.klimadao.finance/

12 https://bloomeria.org/

13 https://www.regen.network/

14 https://www.regen.network/faq/organization

15 https://endaoment.org/

16 For instance, in his conversation on the Deep Background podcast, Erik Voorhees argued that a DAO could avoid the difficulties of employment law because no states employment laws would apply. https://www.pushkin.fm/episode/whats-the-deal-with-decentralized-autonomous-organizations/

17 See, generally, New York Elec. C. Assn. v. Local Union No. 3, (NY Sup. Ct. 1941), available at https://casetext.com/case/new-york-elec-c-assn-v-local-union-no-3

18 https://www.sec.gov/news/statement/crenshaw-defi-20211109

19 https://www.sec.gov/news/press-release/2021-231; https://www.coindesk.com/policy/2021/11/11/sec-stops-wyoming-based-dao-from-registering-2-digital-tokens/.

20 For an excellent discussion, see Prof. Samuel Brunson’s blog post https://lawprofessors.typepad.com/nonprofit/2021/11/charitable-daos-revisited.html.

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The reality is that most of the “default” third-party terms are invariably one-sided in favor of the vendor. Should things go awry as they did with the Blackbaud incident, it is vital to have the appropriate legal terms in the contract to protect your interests.  While it is impossible to provide an exhaustive list of issues to be considered in negotiating a contract, I recommend that the following five points should always be addressed prior to signing a third-party technology contract.

1. Adjust the Limitation of Liability Cap

Vendors routinely attempt to limit any claims for loss or damage that might be incurred.  Typically, they try to limit the recovery period to six months, or even less, of fees paid.  I suggest that the “cap” be set at some multiple of the contract value, and not be tied to monies paid to date. This avoids having limited recompense for claims that occur early on in the contract term.

2. Draft Exclusions to the Limitation of Liability Cap

Related to the first provision, most types of damage are “capped” at some pre-agreed dollar amount.  However, certain damage, because it poses a greater risk to your organization and its reputation, should be excluded.  As an example, damage that results from a data breach, indemnified claims and breaches of your confidential information should never be capped. In the case of the Blackbaud breach, such an exclusion would have allowed your organization to fully recover all losses and expenses.

3. Require Breach Notification and Credit Monitoring Expenses

The Blackbaud incident illustrates that breaches happen.  Although unfortunate, the reality is that no system or platform is “breach proof.”  Even if your vendors maintain all the various physical, logical and administrative security precautions that have been reasonably requested, breaches can occur.

If a breach occurs and notification is required, your vendor is obligated to notify you alone, not your end-user donors.  For this reason, I strongly recommend that you require any vendor that has access to personally identifiable information on your behalf, to agree to pay for all fines, expenses and costs related to the breach, including notification to your donors, regulatory fines, and credit monitoring services for the potentially affected individuals.  They should also be required to promptly notify you of any breach or suspected breach – my recommendation is within 48-72 hours.  Blackbaud took over two months to provide notification!  This is reprehensible – but they are now the exception that proves the rule: contractually obligate your vendors to timely notice.

4. Insist on Specific Cyber/Privacy Representations and Warranties

During the sales pitch, prospective clients are presented with polished and detailed marketing materials that exhaustively detail the various aspects of the vendor’s product, including the various cyber-security precautions they have in place.  However, most contracts provide scant details of the actual precautions to be undertaken.  Bottomline, if a vendor is getting access to any personally identifiable information, you should have specific and detailed cyber-security and privacy requirements spelled out in the contract.

5. Request Transition Services

Vendor relationships do not last forever.   When the time comes to change a vendor, the transition can be a lengthy and arduous process.  When the existing vendor is reluctant to assist with the facilitation of the transition, the client gets stuck with the logjam.  To mitigate this issue, I always insist on including a provision in the contract that requires the vendor to provide ongoing services and specific transition support at their current standard rates for a specified period of time.

In the sentiments of Robert Frost, good contracts make good vendors.  As the Blackbaud data breach illustrates, “stuff” happens.  While this is one of many third-party providers to suffer a data breach, the attack on Blackbaud serves as a stark example of why organizations need to take the time to carefully evaluate third-party vendor privacy and cyber security practices, as well as insist on specific contractual terms that define accountability and responsibilities in the event of an incident.  (And FYI, the NY SHIELD Act requires all organizations that collect information on NY residents to review all such contracts with third-party vendors to endure that such contracts impose specific technological, administrative and physical safeguards). Failure to do so could leave your organization with limited recourse and remedies when the worst happens.

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Generally, business interruption insurance protects an organization against lost income due to physical loss or damage to covered property resulting from covered peril. Some business interruption policies include special endorsements that insure against lost income sustained due to the existence of a communicable disease at the insured property or a government order prohibiting the use of the property. Other policies specifically exclude claims based on these circumstances. For example, policies entered into after the SARS outbreak in the early 2000s often exclude coverage for loss due to viral infections or contamination.

The most challenging element of any business interruption claim for COVID-19 related losses will likely be establishing that COVID-19 caused physical loss or damage to the insured property. Some state courts have held that, in certain circumstances, contamination of a property (e.g., due to smoke, noxious fumes, asbestos, etc.) is enough to establish physical loss. Whether contamination of a property by COVID-19 is enough to establish “physical loss or damage” is still an open legal question. Two lawsuits have already been filed by policyholders in California and Louisiana claiming, in part, that COVID-19 contamination at an insured property is a physical loss and, consequently, any resulting business interruption should be covered under the policy. French Laundry Partners, LP dba The French Laundry, et. al. v. Hartford Fire Insurance Company, et. al.;  Cajun Conti, LLC et. al. v Certain Underwriters at Lloyd’s London et. al.

Due to the challenges in establishing coverage for COVID-19 related losses, several members of Congress wrote a letter to insurance industry executives asking insurance companies to cover COVID-19 related losses as business interruption losses. Industry executives responded that “business interruption policies do not, and were not designed to, provide coverage against communicable diseases such as COVID-19,” setting the stage for further litigation of these claims.

New Jersey is considering a bill that would require insurance companies to cover COVID-19-related losses, including loss of use and occupancy, under business interruption policies in force on the date the Governor of New Jersey declared a state of emergency. Insurance industry groups have actively opposed this legislation. To date, no other state has proposed similar legislation.

Despite uncertainty surrounding coverage for COVID-19 related losses, nonprofits should not wait to notify their insurance company of a potential claim.  Business interruption policies often have very strict notice provisions. Policyholders who wait to file a claim may find coverage is denied because notice was not provided within the time frame outlined in the policy.

When filing a claim, remember to keep accurate records, track expenses, and document any losses meticulously. Insurance carriers typically require policyholders to file a “proof of loss” within a set period (often 60-90 days) after discovery of the loss. The proof of loss will set forth additional details about the claim including, among other things, the policyholder’s interest in the property, the value of the property damaged, and the time and origin of the loss.

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Criteria for cancellation. The first step is to think through the pros and cons of cancellation and what will need to happen before you know that you have to cancel the event. Maybe it is a certain amount of cancellations, instructions from local, state, or federal authorities, or a decision by leadership that the risk of holding the event outweighs the benefits. As of the time of this post publication, many local and state authorities are advising people to avoid mass gatherings. We have no idea when those recommendations may become less restrictive, leaving much uncertainty in the near and medium term.

Your organization should be sure it relies on the recommendations of experts but realize there are practical and public reputation concerns. Look at where your attendees are coming from, their means of travel, and the nature of the event. Even if you believe the relative risk of carrying on the event is low, from a health perspective, the organization may expose itself to a reputation risk if it is the only event carried on while other organizations are canceling theirs.

From a legal perspective, there may also be cutoff dates in your contracts where it gets more complicated to cancel the nearer to the event date you get, making the decision timeline more clear.

Is there a cancellation clause? If you think there’s a decent chance you will need to cancel or postpone the event, review  your major contracts. Check the cancellation provisions – many contracts have a specific process to follow if you want to cancel. You may also be able to request refunds of amounts already paid. Conversely, you may face liquidated damages if you cancel. Those damages typically increase as you approach the event date and/or are payable immediately upon notice that you intend to cancel.

Is there a Force Majeure Clause? Some contracts won’t have a cancellation provision, but they may have a “Force Majeure” clause (or it could have both). The standard F.M. clause allows either party to terminate the contract if performance becomes impractical or impossible, and the F.M. clause typically lists a number of sample scenarios. Those scenarios often include Acts of God, war, strikes, and other scenarios outside the control of either party.

Note that the language in the F.M. clause can vary, raising or lowering the bar for termination. Some contracts use the term “impractical” or similar.  With the current travel recommendations in effect through much of the world, organizations would likely be able to rely on a F.M. clause to cancel the contract, based on continuation or performance being “impractical”.  On the other hand, if the F.M. clause uses a stricter “impossibility” standard, the contract may not be able to be terminated under the F.M. clause unless transportation to or from the venue has been fully shut down or gatherings have been fully banned.

In addition to the actual language of the F.M. clause, check to see what the effects of a termination under the clause are – in some contracts, a force majeure termination relieves you of any future obligations but does nothing to return deposits or other funds already paid.

Consult your insurer. Hopefully, your organization obtained event insurance that covers cancellation and will cover risks associated with your event. As soon as you begin to seriously consider cancellation, notify your insurer. They may have insight into how to mitigate any potential loss related to the cancellation, as well as strategies to make sure the process goes smoothly.

Whether you plan to terminate the contract under a cancellation or force majeure clause, you’ll want to consult with legal counsel and your organization’s leadership. Make sure you’re prepared to deal with the consequences of cancellation, which may include cancellation fees, sunk costs, and rescheduling challenges. Then notify your venue and service providers. You’ll also need to come up with a plan for your attendees, including determining how much (if any) of the registration costs can or must be reimbursed, and whether the registrations can be rolled over to a future event.

How to talk to your contracting partners. The conversation should first start from one of disappointment and cooperation – you wish you could move ahead, but public health concerns make it impossible and it would be in everyone’s interest to postpone. You may also have specific instructions from governmental authorities prohibiting you from continuing (or strongly advising against going ahead) with the event. Ask your contracting partners to consider working with you to reschedule the event. Hopefully, they will understand and you can move forward cooperatively.

Of course, some of your contracting partners may not want to let the contract terminate. They may demand additional payments. We recommend that you enter into the discussion with an open mind to try to reach a resolution that, while imperfect, recognizes that you had a contract that was disrupted by events well outside of everyone’s control. Rescheduling the event is a solution that might work for everyone, although there may be some costs already accrued that you will need to resolve. If a mutually-agreeable solution can’t be reached, look to the contract’s cancellation or F.M. provisions, if available, for how to proceed.

A Legal Theory of Last Resort – Impossibility. If the contract doesn’t have a termination or Force Majeure clause and your contracting partners won’t cooperate, there is one last option. The law generally recognizes “impossibility” as a justification to terminate a contract, even in the absence of a specific clause in the contract (note this is separate from a Force Majeure clause that uses “impossibility” as the threshold for cancellation). “Impossibility” is a high bar – typical examples include where the venue is destroyed. But while courts say the theory is “applied narrowly”, it is permissible where performance becomes “objectively impossible.”  The factors a court looks at (at least in New York, but you can check your local laws) are “the foreseeability of an event occurring, the fault of the nonperforming party, the severity of harm, and other circumstances affecting the just allocation of risk.”

So if your contracting partners try to force you to pay the full price for an event that cannot go forward, and you don’t have force majeure or a cancellation provision to fall back on, consult with local counsel about the possibility of using impossibility to cancel the contract.

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While New York’s new law doesn’t affect nonprofits that are controlled by other nonprofits[i], the reasoning for New York’s change is instructive. It grew out of regulators’ and lawmakers’ concerns that a sole member structure is susceptible to abuse – a nonprofit controlled by one or two people is more likely to engage in self-dealing or private benefit transactions, both of which are prohibited under state and federal law.

New York’s restrictions on sole member structures comes at a time when charities regularly use corporate sole member structures as part of a variety of major transactions and strategies. Typically, the arrangement is used by a large, well-funded nonprofit that is either (i) forming a new entity in which to house a new activity, or (ii) taking control of an existing nonprofit.

A nonprofit sole member structure puts directors of the subsidiary in a challenging position because their fiduciary duties to the nonprofit can sometimes put them at odds with the interests and direction of the sole member. Below I walk through:  (i) what is a sole member structure; (ii) how sole member nonprofits are useful; (iii) when implementing a sole member structure, what are some challenges; and (iv) suggestions to help implement a sole member structure.

What is a sole member nonprofit?

Modern nonprofits are typically run by a board of directors that is self-sustaining – that means the board elects new directors to fill empty board seats. Historically, however, a nonprofit was a membership corporation and the “members” were responsible for electing the board. Who the “members” differed from organization to organization, but the members met at least annually and took an active role in electing the board of the organization. A good modern analogue is a labor union – the membership is active in electing the leadership, so even though the Board is still responsible for overseeing the union’s activities, the members can keep the Board in check. A membership structure parallels the shareholder structure of a for-profit corporations, where shareholders elect directors to the Board but are removed from the corporation’s day-to-day operations.

Many states’ laws still allow one person, or one corporation, to be the “sole member” of a nonprofit, retaining the right to elect and remove directors. There is no federal prohibition against that structure, provided that the controlled nonprofit and its Board observe all of the other rules applicable to 501(c)(3) organizations. The sole member structure, therefore, has been popular as a way to give individuals or large nonprofits the ability to keep control over a subsidiary nonprofit.

How are sole member nonprofits useful?

A sole member structure is really appealing when an individual or corporation creates a new nonprofit and wants to retain long term control over the nonprofit’s mission and activities. By making themselves the sole member, the founder can give themselves the power to appoint or remove board members. This allows the sole member to have a veto power over board decisions that the sole member disagrees with – they can always remove (or threaten to remove) board members who vote against the sole member’s interests.

Most founders use this veto power for good. The founder, who is passionate about the organization and its mission, is especially sensitive to mission creep. If they sense that board members are not pulling their weight or are moving the nonprofit in the wrong direction, the sole member can appoint new board members and remove the bad ones to get the nonprofit back on track.

Another scenario where we often see a sole member structure is a small nonprofit that is approaching an inflection point and is in need of assistance.  Enter a large financially-healthy nonprofit, able to take over back office and administrative functions for the smaller nonprofit. Both organizations recognize that the smaller nonprofit has developed goodwill, so they don’t want to just absorb the smaller nonprofit’s programs into the larger nonprofit – there’s a benefit to keeping the smaller organization as a separate legal entity, with its “brand” and support intact. The larger nonprofit’s board may also want to protect the larger nonprofit from liability by maintaining the separate legal entity.

Transaction costs are also much smaller in a change of control transaction involving a sole member compared to a traditional merger or acquisition – a sole member transition often requires little more than a minor revision to the bylaws to provide for a sole member. A formal merger with, or transfer of assets to, a larger nonprofit often requires regulatory approval and generally entails more legal fees and staff time to implement.

A third situation where we often see a sole member structure used is where a large nonprofit identifies a new market – either a new location where its programs can succeed, or a new type of program the nonprofit would like to implement. If the new market creates new types of legal or financial exposure, the large nonprofit might want to insulate itself by housing the new venture in a separate legal entity.[ii] The large nonprofit, to encourage the small nonprofit to be self-sufficient, could set the new nonprofit up as a separate 501(c)(3) public charit with its own board and staff. While there may be some start-up support, the goal is often to have the large nonprofit’s input be limited to high-level oversight and the appointment of the board members each year. The large nonprofit can ensure there’s no mission creep through its control of the board of the new nonprofit, but it owes no legal duty to the smaller nonprofit.

When implementing a sole member structure, avoid key pitfalls

Sole member structures can be very useful, especially when trying to quickly take over a nonprofit or when structuring a new organization to ensure it can be controlled going forward. It can also be an intermediary step to a full merger transaction.  But let’s step back for a minute to consider some of the practical and legal issues that can arise with sole member structures.

Donor Confusion

Donors want to know where their money and support is going. They want to feel like they understand the values of the organization they support and who is responsible for making decisions. That’s why nearly every nonprofit website includes an “About Us”, “Board”, or “Team” page that lets donors know who is in charge. By introducing a sole member structure, you risk confusing donors if the relationship isn’t clearly defined. Donors, especially your biggest donors, do not want to call up a board member to discuss a major decision, only to learn there’s another entity the donor has never heard of that controls the board.

Board Member Dilemmas

Nonprofit board members are often more familiar with the for-profit world than they are the nonprofit sector. In a for-profit, board members owe their fiduciary duties to the shareholders and the organization. That’s not the way nonprofit law works for 501(c)(3) organizations. In a 501(c)(3), even one with members, the board members’ fiduciary duties are owed to the organization and, tangentially, the public. But we have heard from board members at nonprofits controlled by a sole member who are confused or frustrated by the ways in which they believe decisions that would be in the best interest of their nonprofit are at odds with the sole member’s interests. For instance, the sole member may believe that entering into a management agreement with the controlled nonprofit would be in everyone’s best interests, but board members at the controlled nonprofit think the management fees the sole member wants to charge are too high.

Placed in that position, the controlled nonprofit’s board members can feel helpless – stand up for what they believe are the best interests of the controlled nonprofit and they risk being removed from the board, but yielding to the sole member could be a breach of their fiduciary duty to their organization. While it’s a difficult choice, legally the board members owe their loyalty first and foremost to the controlled nonprofit on whose board they sit. You need to make sure that board members are fully briefed on their obligations, both to protect the organization and uphold their legal duties as board members.

Staff Confusion & Fear

When staff members see a new organization come in as sole member, it can create anxiety about how operations will change. Nonprofits should clearly message what functions will and will not change. Similarly, governance, HR, and oversight functions should be reviewed to see how to efficiently operate with closely related organizations. In some scenarios, leaving in largely separate systems might make sense, whereas in others the new sole member might displace a number of the controlled nonprofit’s overhead functions.

Related Party Transactions

Governance best practices, along with many state laws, require independent board members to carefully review related party transactions. Wherever the sole member enters into a major transaction with the controlled nonprofit, best practice would require that only independent directors should be involved in reviewing and approving those transactions. The board of the controlled nonprofit is under a legal obligation to make sure that the transaction is fair to, and in the best interests of, that organization. In many cases, however, there is reluctance among board members to treat transactions with the sole member as creating a conflict of interest. Often we hear that the interests of both organizations are aligned, and the controlled nonprofit is wholly dependent on the sole member, so board members think it does not make sense to treat a transaction with the sole member as a conflict of interest. This conflates practical considerations with legal ones – just because a controlled nonprofit needs the sole member doesn’t mean it should accept any transaction with the sole member without proper consideration of alternatives.

Strategies to Implement a Sole Member Structure     

Now that we’ve reviewed some common pitfalls, let’s talk about some relatively simple structural changes that can mitigate the possible downsides of a sole member structure. Remember, there are many reasons why a sole member structure can be beneficial. As with any governance decision, a sole member structure should be well-considered and tailored to the needs of each organization at which its implemented.

Staggered Boards and Limited Removal Rights

Nonprofits should balance the control of the board by the sole member with directors’ fiduciary obligations. One way to do that is to stagger board terms (for instance, three year terms with 1/3 of the board up each year) and place some limitation on the sole member’s right to remove directors. The sole member might still have the ability to remove directors, but that right can be limited to “for cause” removals or require ratification by a majority of the board. By insulating directors slightly from the sole member, directors will have the space to speak critically when they feel the organization is being led down the wrong path.

Independent Directors

Another possible solution is for certain board seats to be reserved for independent board members, individuals who are NOT appointed by the sole member. This will likely be limited to a small minority of the Board, but a small number of directors can play a big role in providing assurance to the whole board that transactions, including ones with the sole member, are in the best interests of the controlled nonprofit. Independent directors can also be useful barometers of the board’s performance and governance.

Clear Messaging

Internally and externally, the sole member and the controlled nonprofit should make sure it is clear how the entities are related and how they work together. Donors deserve to know if money given to one organization will end up supporting another organization (albeit indirectly). Regulators want to know that transactions are properly and fairly approved. Staff need to know to whom they are answering and who is setting policy internally.

In conclusion

Corporate sole membership structures can be useful to all everyone involved. They can help grow and manage complex organizations. Sole member structures can also mitigate legal exposure to their parent nonprofits. As with anything, board members should be prudent when contemplating a sole membership structure. Potential pitfalls can be mitigated by embedding certain structural safeguards to protect the controlled nonprofit’s independence, which should ultimately provide reassurance to the boards of BOTH organizations that a healthy corporate structure is in place.

[i] Where a corporate entity is the sole member and the corporate entity itself is owned or controlled by at least three people.

[ii] There are many other options (such as an LLC) that could accomplish this goal, but we won’t get into those in this article.

The post Sole Member Nonprofits Complicate Directors’ Fiduciary Duties appeared first on Perlman & Perlman.

Analogizing this to startup companies can be illuminating. Having founded and run several startups, as well as having advised founders as either an attorney or board member, it has become clear to me that while a variety of factors are needed for an enterprise to be successful, there are several key factors that virtually every startup need to exhibit and embrace in order to be successful.

Accepted wisdom is that most startups will fail. So what makes the outliers successful? In my experience, there are five key factors, and I share them here.

1. Don’t start with a product, start with an open mind.
Thanks to lesson from the book the “Lean Startup,” the days of “if we build it, they will come” has thankfully passed. Most companies are founded on a “big idea,” whose founders are, understandably, passionate and committed to pursuing their dream. So what goes wrong? One survey of failed startups determined that 42% of them identified the “lack of a market need for their product” as the single biggest reason.

The brilliance of the concept that an entrepreneur should develop a “minimal viable product” – build something small, fast and cheap, and then test it – is its simplicity. Remaining nimble, flexible and open-minded cannot be overstated. (Equally important, of course, is to make sure the appropriate inventions assignment agreements and contractor agreements are drafted to ensure that your company properly owns everything your employees and contractors create).

2. To build a viable business, you need to build a successful team.
Psychological research is rich in the documentation and study of dysfunctional groups (think of Tolstoy’s “unhappy families”.) In the world of startups, many failures are due to discord among the founders. Although most founders are people with high hopes and good intent, when you bring into the mix the differences of personality, background and skills, combined with variation in expectations, conflict is to be anticipated. In most cases where the founders fail to resolve or work around these differences, the demise of the company is not far behind.

Thus, instilling teamwork skills and practice into your company culture is the key to its success. From a legal framework, a “founders” or shareholders agreement that delineates the rights and remedies of shareholders should disagreements or conflicts arise is also essential.

3. When adversity strikes, resilience is essential.
Things will go wrong, terribly wrong with your startup. This is not due to bad luck, rather it is part and parcel of launching a new enterprise. Startups operate in a rarefied environment in which market conditions, competition and circumstances (both macro and micro) are constantly in flux. Startup teams must possess the ability to change products, adjust to the changing landscape of competition, shift industries, rebrand the business, or even tear down a business and start all over again.
Resilience in the face of the headwinds of adversity is essential. There are many studies examining what makes one individual more resilient than another. One commonly identified trait is referred to as the “internal locus of control”. Simply put, resilient individuals believe that “they,” and not their circumstances, are the driver of success. So when things go wrong, roll with the “punches” and remain focused on success.

4. Keep your friends close, and your advisors closer.
I have helped many startups screen and engage advisors. Advisors and board members can make a significant contribution to a startups success. By providing an imprimatur of credibility, imparting insightful wisdom, making key introductions, or raising seed capital, an advisor can give the startup the foundation it needs to keep on track.

Unfortunately, the reality is that most advisors will not workout. He or she may overpromise, lose interest, or become consumed by competing commitments. You can insure that your advisor agreements provide adequate equity and/or incentives to secure the advisor’s engagement, but also have reasonable “cliffs” and milestones to warrant that compensation is tied to value received.

5. Show me the money!
All too often I have seen the never-ending pursuit of founders for money become the crucible that becomes too heavy to bear. Thus some very good ideas and promising companies fail to get very far. Since raising money is so challenging, my advice is to ask for more money than you think you will need, take money when you can get it, and in most cases use a convertible note to quickly (and cheaply, relative to other approaches) bring in the money so that you can focus on growing your company.

Once you have the necessary funds to get things underway, make sure you are disciplined in your spending. That means keeping overhead in line with your cash, recruiting key first employees with a modest (but competitive) salary and a generous equity grant. (And if you don’t have an equity compensation plan/strategy in place for key employees, stop reading this and go get one!)

Increase your odds of success.
Launching a startup is a momentous endeavor, and one that promises both excitement and heartbreak. While there is simply no “formula” that guarantees success, keeping in mind some of the above lessons may increase your odds.

The post From Startup to Growth Company – Five Factors For Success appeared first on Perlman & Perlman.

Articles of Incorporation
The Articles of the Incorporation is the charter document filed with the Secretary of State to establish the corporation. It sets the name and address of the corporation, the authorized number of shares, the terms of each class and/or series of capital stock, and either opt-in or out-out of various other matters governing the corporation and as described in the applicable state corporation statute. It is the foundation you will build on.

Bylaws
The Bylaws outline the rules and procedures that govern the internal management of your startup, such as how directors are elected, how meetings of directors and shareholders are conducted, and what officers are to be appointed and a description of their duties.

Shareholders Agreement
The Shareholders Agreement governs the relationship between the shareholders of the company and covers issues such as a shareholder’s right to transfer his or her shares and rights of first refusal.  The Agreement is significant for a variety of reasons, including when a co-founder departs the business or for taking on new shareholders (e.g., outsiders investing in your company).

Stock Purchase Agreement
A stock purchase agreement is made between each shareholder and the corporation; it regulates the transfer and sale of the corporation’s stock to the shareholder. It determines how much stock will be purchased, the price of the stock, and how the payment will be made (i.e. cash, IP, or another form or combination of consideration).  Stock purchase agreements come in two forms – non-restricted and restricted. Non-restricted stock purchases are the norm: you pay for your shares and you own them.  Restricted stock purchase agreements are used when a co-founder’s shares will vest over time, which, for a variety of reasons, is often a good idea.

Technology/Intellectual Property (IP) Assignment Agreement
Often, the value of a startup’s IP portfolio is what investors and venture capital firms evaluate when considering buying in.  Therefore, an IP assignment agreement is a key legal document for technology startups.  Please, don’t skip this one!  Startup founders should have complete ownership of all IP assets in writing. There are two typical types of IP agreements to consider:

• Technology Assignment Agreements assign startups any intellectual property created before forming the company. The technology assignment agreement is usually referred to in the stock purchase agreement as an IP transfer to the corporation and can be consideration (full or partial) for the stock received/purchased by the founder(s)/shareholder(s).
• Invention Assignment Agreements assign the new company IP ownership of any relevant work product created by employees after the company’s formation. A confidentiality and invention assignment agreement is typically signed by founder(s) and employees.

You may choose to incentivize employees with stock options. Two documents must generally be drafted in connection with the issuance of stock options: (i) a Stock Option Plan, which is the governing document containing the terms and conditions of the options to be granted; and (ii) a Stock Option Agreement to be executed by the Company and each optionee, and which specifies the individual options granted, the vesting schedule and other employee-specific information (and generally includes a form of Exercise Agreement).

And Don’t Forget These!  Additional Key Documents
83(b) Election Letter to IRS
If any of the founders’ stock is issued subject to repurchase, then such founder should choose to file an 83(b) election with the IRS. For an 83(b) election to be effective, it must be filed with the IRS within 30 days of the purchase date. The tax ramifications for failing to file an 83(b) election can be severe, so if you are a founder, and about to or recently formed a company, pay attention!

Employee Contracts and Offer Letters
It’s helpful for a variety of reasons to have offer letters and employment contracts. These legal documents are key to ensure employees understand what’s expected of them, and provide you remedies should people don’t workout.  They should clearly state the terms of employment (e.g., compensation, role responsibilities), required commitments, share vesting, company policies (e.g., vacation days).

Non-Disclosure Agreements
NDAs protect your startup by safeguarding your ideas and your intellectual property.  Get one drafted that works for your needs, and then use it.

The post Startup Alert : Key Agreements Every Startup Should Have appeared first on Perlman & Perlman.

In this post, we will take a bird’s-eye view of the contracting process, from identifying those items that are of essential importance to your organization to getting into the details of deposits, cut-off dates, and cancellation clauses.  Please be advised that this summary is not comprehensive, so I encourage you to seek an experienced advisor (event planner, attorney, development officer).

An Agreement

The first step is to identify the goals of the event.  Is it in celebration of a particular achievement? How many attendees are expected? Is it going to be formal or casual? Will there be activities, an auction, or dancing? What other criteria will help narrow down the search for a venue?

Once you identify a venue, you need to concur on the major points of the agreement.  If there are any “must-have” features or services for the event, be sure to identify and confirm that the venue provides them before delving into contracting. There’s no point in getting into negotiations only to realize the venue can’t accommodate the video presentation that is essential for the awards ceremony, for example.

Once there is agreement on the big-ticket items, in all likelihood the venue will send you a draft contract, based on a standard template. To lock down the booking, the venue may limit the time period to review and sign the contract. The venue wants a quick response because: a) it is holding that event space, hotel rooms, or other facilities for your organization, and b) the venue wants you to feel pressured to make a decision quickly and limit the negotiable items.

You should always make sure at the outset of negotiations that the venue provides sufficient time to talk to all of your organization’s decision-makers and have the contract reviewed by your advisor(s). For a major event, you might need to run the agreement by a board committee, the organization’s leadership, legal counsel, and an event planner.

Analyzing the Agreement

The Big Picture

Once you receive the contract, check that the big ticket items are correct – how much is the venue charging? If hotel rooms are being reserved, did the venue list the correct nights, number, and level of rooms? Were the correct conference rooms/event spaces listed? If you negotiated a discount for food/lighting/valet parking, did the venue include those items?

Never rely on a venue’s assurances that certain items or services will be provided if those items aren’t listed in the contract. Even if the venue has every intention to provide those items or services when you sign the agreement, there may be turnover in the venue’s event staff before your big event. All of a sudden you will get a whopping bill for the extra spot lighting that you thought was included, or your guests are asked to pony up for valet parking when you thought it would be comped. Make sure those items are explicit in the agreement to avoid misunderstandings down the road.

The Details

The big picture items are business decisions that anyone in a decision-making position should be able to review. Approval of those items will be driven by your sense of whether the terms are fair. The smaller details are equally important but require a closer review by someone with experience with events contracts.

Here are a few items that we frequently discuss with venues on behalf of our clients. While you may not always get the changes you ask for, it never hurts to ask, and often you can get the venue to budge from their initial offer.

Deposit

A venue almost always requires a deposit upon signing the contract. The further into the future your event, the less you should pay up-front. We recommend negotiating an initial deposit that does not exceed 10% of the overall cost. The venue may require additional deposits as the event date approaches.

A venue will typically frame the deposit as “non-refundable.” We try to remove such a reference, for a few reasons. If the venue has to cancel the agreement, it should refund your deposit. Similarly, if there is a “force majeure” event, something that makes the performance of the contract impossible, the venue should refund your deposit.

Headcount & Cut-Off Date

When the venue’s charges correlate to the number of people attending, the venue will want an estimate of the number of attendees before you sign the contract. They will typically take your minimum headcount, figure out how much revenue that number of attendees will generate, and require that your organization guarantee that revenue (a “Guaranteed Minimum”). A Guaranteed Minimum provides down-side protection for the venue – if your attendance numbers disappoint, the venue can still plan on receiving a minimum amount of revenue.

A Guaranteed Minimum is great for a venue, but bad for your organization. If attendance changes for the worse, you are stuck with a bill for services you didn’t need. Therefore, we recommend including a subsequent “Cut-Off Date” in the contract, which is a date by which your organization may provide an updated headcount to the venue. Any updates to your headcount prior to the Cut-Off Date won’t incur liability for your organization – the venue will link the Guaranteed Minimum to the revised count.

Depending on the type of event, the Cut-Off Date may still be several months before the event date. You should try to negotiate for as much time as possible before you provide a firm number that the venue will link to your Minimum Guarantee.

The venue will likely tell you that any increase will be subject to availability (especially with hotel contracts), and that’s fine. You should be more interested in the ability to lower your attendance numbers, rather than increase them. The venue will (almost) always try to accommodate an increase in attendance, because it will be able to charge you more. But venues try to lock you into a minimum attendance number, and charge you a penalty if you fall below that number (see Attrition, below).

Bottom line –ask for as much time as possible before you have to provide a firm headcount to the venue.

Attrition

The venue has to plan ahead – it may need to contract with vendors, enter into additional service contracts, and make other expenditures to prepare for a large event. That’s why the venue wants a Guaranteed Minimum (see above). But what happens if your event falls one person, or one percent, short of the Guaranteed Minimum?

Some contracts include “Attrition” clauses, which allow your event to fall within a certain number or percent below your Guaranteed Minimum before you suffer a penalty. We routinely see Attrition clauses ranging from no Attrition allowance to a twenty percent (20%) Attrition allowance. Depending on how confident you are in your attendance numbers compared to the Guaranteed Minimum, you may want to include the Attrition number as a top item for negotiation.

Bottom line – negotiate the largest Attrition allowance you can.

Cancellation

A “force majeure” clause allows either party to cancel if something outside of your control makes it impossible to hold the event. Typical examples are natural disasters, power outages, etc. If the contract doesn’t have a force majeure clause, request one. Make sure that the venue doesn’t include anything within the force majeure clause that is actually within its control – for instance, some force majeure clauses include a “labor stoppage” provision. Make sure that the clause is written so that if the venue causes its own labor stoppage (i.e. it violates a CBA with its unionized workers), the venue is not off the hook from your contract.

Cancellation by your organization

Venues like to protect themselves against possible losses. Once your contract is signed, the venue will hold space for your event, potentially turning away other business that would have come its way. In exchange for missing out on those opportunities, the venue will ask that your organization pay a fee if you have to cancel your event (a “Cancellation Fee”).

Typically, the Cancellation Fee is computed on a sliding scale, increasing as you get closer to the event. Some contracts compute the Cancellation Fee as a percentage of the Guaranteed Minimum.

Regardless of the amount of the Cancellation Fee or how it is computed, we always require venues to include language in the contract that would diminish or eliminate an organization’s penalty if the venue is able to find a replacement event. It’s only fair that if you cancel three months out from the event, and the venue finds another organization to host an event on the same night for as much or more money, you shouldn’t have to pay anything. The venue didn’t suffer any loss, so it has nothing to recoup.

The contract should include language that if you cancel, the venue will use commercially reasonable efforts to market the event space to other potential customers. If the venue finds a replacement client, it should then credit any replacement revenues against what you owe in Cancellation Fees.

Finally, make sure that any amounts due as a result of a cancellation are due after the event date. Otherwise you may find yourself in the sticky situation of paying a cancellation fee, then asking the venue for a refund if they found a replacement event.

Bottom line – minimize your exposure by limiting cancellation penalties and requiring the venue to seek a replacement event.

Cancellation by the venue

While you want to limit your exposure if your organization has to cancel the event, you also need to protect against a cancellation by the venue. Some venues like to retain the ability to cancel for any reason – others just want the ability to cancel for cause. Regardless, a cancellation by the venue can throw a huge wrench into your plans.

If the contract lets the venue cancel without cause, make sure the venue will cover your organization’s costs to secure a replacement venue in addition to returning any amounts you’ve already paid. To be fair, the contract can state that you will use your best efforts to limit any replacement venue to one that is similar in quality.

Bottom line – if the venue cancels you should recover your deposits at a bare minimum, but push to get the venue to cover any additional costs your organization or attendees will have to bear if you have to book a replacement space.

Tax-Exempt Status, Taxes & Cancellation by Your Organization

Make sure the venue acknowledges your group’s tax-exempt status in the contract. Depending on the state or locality, you may not have to pay certain taxes. If you are booking an event outside the state where your group normally operates, there may be certain registrations required before you’re able to take advantage of any exemptions. The venue may be able to walk you through what is needed – otherwise you should check with counsel to see what your options are.

We also suggest including a clause in the contract that allows clients to cancel if the venue’s actions would in any way jeopardize the organization’s exempt status or reputation. The chance that the venue’s actions would ever trigger such a cancellation is small, but it’s real. In addition, if your group is a values-based nonprofit, you may want to include language that allows an out if the venue violates such values. You may also wish to include a rider requiring the venue to acknowledge your group’s values and a covenant that the venue will not take any action which would materially violate, or cause your group to violate, your values.

Indemnities and Insurance

Venues always require that your group indemnify them against any damages caused by your group or attendees. This is standard is not worth fighting over, however, make sure the venue doesn’t overreach. The indemnity should not include anything which may have actually been caused by the venue’s actions or negligence. Exclude any indemnity for damages that are ordinary wear and tear.

You should also ask for a similar indemnity. You (and your attendees) should be protected from damages caused by the venue’s actions. Ideally, your indemnity should mirror that of the venue.

The venue will ask for your group to provide proof of insurance, or at least represent that you have adequate insurance. Be sure to ask the venue to provide similar proof or a similar representation. We recommend that you secure event insurance, which will help provide some relief if something happens to the event that isn’t foreseeable or fully covered by the representations and warranties in the contract.

Compliance

As with any contract, it’s a good idea to request a generic representation from the venue that it is in compliance with applicable laws and regulations. You may want to give some examples (building code, fire code, food handling, and ADA compliance are some common representations to ask for).

Nonprofits must always be aware of state fundraising regulations and whether the activities surrounding the event will trigger any registration obligations with a state charity official. Whether the nonprofit or its event planner are required to register will depend on the nature of the event, what the activities are in support of the event, and what the event planner does on behalf of the nonprofit.

For the event planner, it’s important to ascertain if they will be selling tickets or soliciting sponsors for the event and/or contributions on behalf of the nonprofit, or if they are just taking care of the logistics and providing tools to the nonprofit’s staff.  Are they providing fundraising advice? Depending on where the event is held and where solicitations are being made, the event planner and the nonprofit may need to register with one or more states. Their contract may need to have certain required provisions and may need to be filed with the state. It’s advisable to review this with legal counsel to ensure the nonprofit and the event professional are fully compliant with applicable law.

Finally, there are numerous IRS rules regarding how to treat the deductibility of ticket purchases for events or items won at auction. For instance, charities must notify purchasers what amount of the portion is considered a contribution versus a payment for goods and services.  There are rules regarding the deductibility of items donated for an auction. Finally, nonprofits must always be aware of their obligations for receipting donors.

Conclusion

Events are complex. A good contract helps provide a framework for the logistics of the event, and protects you if something goes wrong. Make sure you take the time to carefully review the contract, and ask for expert advice whenever you are uncertain.

The post Event Contracts for Nonprofits – When to Push Back appeared first on Perlman & Perlman.

In the latest denial, the charity applicant was formed to promote local agricultural products within the restaurant and hospitality industry by establishing and operating food hubs across the state. Its clientele consisted primarily of farmers, restaurants, and retailers. In its ruling, the IRS said the applicant did not qualify for exemption under Section 501(c)(3) of the Internal Revenue Code because it was not operating exclusively for charitable purposes. Quoting a revenue ruling from 1972, the IRS said that “an organization is not exempt merely because its operations are not conducted for the purpose of producing a profit.” Stating that the services, in this case, were provided at cost and solely for exempt organizations “is not sufficient to characterize this activity as charitable within the meaning of Section 501(c)(3).” The IRS concluded that more than an insubstantial part of the applicant’s activities was devoted to a non-exempt (i.e., commercial) purpose, and was therefore not organized exclusively for charitable, educational or religious activities within the meaning of Section 501(c)(3) of the Code.

In other words, according to the IRS, you can be charitable, or commercial, but not both. However, there is a growing segment of the charitable sector actively engaged in revenue-generating activities without any problems.

The primary conflict resides in how the IRS defines “commercial” and how the commercial facets of the organization are utilized. Whether the activity is a “trade or business ordinarily carried on for profit” dictates its status (B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978). Another factor is whether the activity competes with other for-profit businesses and if it does, is it distinguishable from those other commercial entities?

In Denial 201641027, another tax-exemption denial based on the presence of too much commercial activity by a charity, the IRS decided that a group organized to assist community residents to gain access to quality patient care was commercial, not charitable. This despite the fact that such efforts have generally been granted exemption in the past, and there is a series of revenue rulings upholding such exemption. The IRS did not explain why they thought this case was different.

The IRS’s hostility to nonprofit commercial activity inhibits charities that want to deliver good works using a commercial model. In the last year alone, the IRS has handed down denials to groups that operated a public market (to ensure the availability of fresh, healthy food in the community); a record label (to provide at-risk youth the resources to intern in the entertainment industry); a farmer’s market (to contribute to the sustainability and development of markets that make fresh and healthy foods available to all people); and selling laptop computers (above cost but below market) to students to further educational objectives. These rulings have been based primarily on a determination that the charities were using commercial means to accomplish admittedly charitable and educational ends.

In issuing these rulings, the IRS appears to be resurrecting the obsolete, discredited “commerciality doctrine,” which says that a nonprofit cannot be charitable if it engages in activities which are primarily commercial, even if the activity benefits only the general public or a charitable class. The commerciality doctrine was abandoned years ago because it stifled innovation and did not reflect changes that were happening in the philanthropic sector. If unchecked, the doctrine would threaten the exemption of community health centers, university bookstores, the NCAA, technical assistance groups, and any other charity that competes with private business or relies primarily on earned income to sustain itself. Quite simply, the doctrine is outmoded and is bad tax policy, hence its abandonment.

There are ways to avoid the clash between commercial and charitable facets of these organizations. One option is separating highly commercial activities into subsidiaries or affiliated service organizations. And in many other cases, charities can conduct the commercial activity in-house, so long as they have a substantial amount of other activity. There may be other reasons to perform commercial activity outside of the charity entity, but jeopardizing the charity’s tax status does not have to be one of them.

We’ll be writing more about private benefit and commerciality for nonprofits and hybrids in the next few months. Stay tuned as the story develops.

The post IRS Declares War on Commercial Charities appeared first on Perlman & Perlman.

On October 25, 2016, in the Matter of Yoga Vida NYC,  a decision sure to have rippling effects through many industries, the New York State Court of Appeals–the highest court in New York State — ruled sensibly and logically, that certain yoga instructors were independent contractors, not employees. Specifically, the Court found that substantial evidence supported a finding that non-staff yoga instructors were independent contractors where the non-staff instructors:

1) set their own schedules; 2) chose how they were paid (hourly or on a percentage basis); 3) were paid only if a certain number of students attended their classes; 4) were not restricted as to where they could teach (whereas staff instructors who were employees could not work for competitors within certain geographical areas); 5) could inform students of classes they taught at other locations; and 6) were not required to attend meetings or receive training.

The Court further opined that evidence of incidental control by the yoga studio, including an inquiry by the studio as to whether the instructors held proper licenses to teach yoga; the fact that the yoga studio published a master schedule on its website; and the fact that the studio provided space for the classes, did not support the conclusion that the instructors were employees.

Employers should understand that, depending on the facts, some yoga instructors or other kinds of instructors may be deemed to be employees while others will be deemed independent contractors.

NYC Now Protects Freelancers/Independent Contractors

On November 16, Mayor de Blasio signed into law a bill that protects New York City freelancers/independent contractors by requiring that whomever hires a freelancer provide a written contract for the freelancer’s work, pay him/her in full and on time, and that the hiring party does not retaliate against the freelancer for exercising his/her rights.

More specifically, the law requires any person or entity who engages a freelancer to have a written contract with that freelancer for any work over $800.  The contract must itemize all services to be provided, the value of those services, the rate, the method of payment, and the payment due date or the mechanism by which such date will be determined.

The client must pay the freelancer on a timely basis and may not require the freelancer to accept less than the full amount of the contract in exchange for timely payment. If the contract does not provide the payment date or the mechanism by which such date will be determined, payment must be made no later than 30 days after the completion of the freelance worker’s services under the contract.

The party engaging the freelancer/independent contractor bears the burden of showing there is a written contract if any dispute arises regarding the terms of engagement.

The freelancer may bring a complaint with the Director of New York City’s Office of Labor Standards or bring an individual cause of action in state court. Violation of this law may result in damages equal to the value of the services, double damages, statutory damages, injunctive relief and attorney’s fees and costs. Where there is evidence of a pattern or practice of violations, the Corporation Counsel may bring a civil action in court on behalf of the City, and a civil penalty up to $25,000 may be imposed.  The law takes effect in 180 days from its signing, or on May 15, 2017.

Any nonprofits that are planning to engage freelancers should be mindful of this new law and ensure their independent contractor engagements are in writing and compliant with the new law.

In light of the above developments, it would be wise for New York employers to confer with their employment counsel to ensure their workers are properly classified and that their independent contractor agreements are properly drafted.

The post New Legal Developments Affect New York Organizations Using Independent Contractors appeared first on Perlman & Perlman.