Delaware is Corporation-Friendly

Delaware is a corporation-friendly state. Delaware statutes are very flexible when it comes to formation. Where New York might require three directors for a new nonprofit, Delaware only requires one. Unlike New York, California, Massachusetts, and other states with more complex nonprofit statutes, Delaware doesn’t have a nonprofit-specific statute nor does it impose complex regulations or restrictions on a nonprofit’s activities. Because Delaware nonprofits are formed under the same statute as for-profit non-stock corporations, governance and annual reporting are fairly straightforward and flexible.

Delaware also has a thoroughly developed body of corporate law. Delaware is an incredibly popular state for all types of entities, so many corporate attorneys have a working familiarity with Delaware corporate law even if they practice elsewhere.

Nonprofit Statutes Can be Onerous

Numerous states, including New York, California, and Massachusetts, have specific statutory regimes that govern nonprofits. In each of New York, California, and Massachusetts, a nonprofit must obtain permission to merge, sell its assets or dissolve. New York’s requirements related to a nonprofit’s internal governance can be complicated – they include audit requirements, restrictions on who may serve as the chair of the board, and required procedures for managing conflicts of interest. Certain kinds of real estate transactions may require regulatory approval. Electronic voting and meetings are prohibited or discouraged. Even the timing and content of board notices may be regulated. Most of the requirements are applicable to nonprofits of every size and can be challenging for nonprofits that don’t have large infrastructure and budgets.

Delaware has no such system of regulations. The Delaware Attorney General does not review and pre-approve corporate transactions. There is no required regulatory approval for real estate transactions. Meeting requirements are flexible. A Delaware nonprofit that chooses to dissolve can do so using the same simple process available to other Delaware non-stock corporations.

Most of New York’s, California’s, and Massachusetts’s most complex and onerous regulations are inapplicable to nonprofits that are formed elsewhere regardless of whether they operate, conduct activities, or solicit funds in those states. Foreign nonprofits are still required to register with charity regulators to solicit funds or hold assets in those states, and in many cases, to submit annual filings. A Delaware nonprofit soliciting funds in New York is not required to comply with New York’s myriad of internal governance requirements but must register with New York’s Charities Bureau and submit an annual filing called the CHAR500.

Best Practices Are Great – But Should Work for the Organization

To be clear, many of the requirements found in nonprofit-specific statutes are good for nonprofits. Statutes in states such as New York, California, and Massachusetts help ensure a nonprofit is well-run and responsive to its donors, the populations it serves, and the taxpayers. But many nonprofit-specific statutes are written as a one-size-fits-all solution in a nonprofit world filled with organizations of varying sizes run by individuals with varying levels of expertise. Nonprofits should consider adopting policies which help the organization avoid conflicts of interest, ensure the board is well-run, place proper financial controls on employees and officers, and help guarantee that the nonprofit succeeds in achieving its charitable mission. But those policies should reflect the needs of the particular nonprofit in question and may vary greatly from organization to organization. By incorporating in Delaware, a nonprofit can retain the flexibility to tailor its governance to meet its unique needs.

When Away From Home, Know The Rules

A nonprofit incorporated in Delaware (or any other state) is still subject to oversight by state charity officials in the states where the nonprofit operates. If a nonprofit operates in a state with active charity regulators, the nonprofit must remain vigilant of its registration and reporting requirements, as well as rules that govern charitable solicitation. Local rules regarding employment, banking, insurance, contracts, and liability still apply even if the group is incorporated in Delaware. In recent years we have seen a growing number of charity officials taking an active role in encouraging nonprofits to adopt “best practices” by bringing enforcement actions against groups that the regulators perceive as poorly-run. Therefore, even a Delaware nonprofit should be familiar with the rules in every jurisdiction where it operates – competent counsel is almost indispensable.

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As with most reactionary legislation and regulations, this ill-conceived proclamation fails to fully comprehend the collateral impact as it was guided by political expediency and the myth that high overhead cost equates with poor performance.

The Executive Order sets limits on administrative expenses and executive compensation to any entity regulated by a list of thirteen specified state agencies if those entities receive more than $500,000 in annual state support and at least 30% of their annual funding from the State (or from New York City or other local jurisdictions through State funded programs). EO #38 became effective as of July 1^st, 2013. (10 NYCCR Part 1002)

The regulations require that “covered entities” shall not use State funds to pay Executive Compensation (10 NYCCR Part 1002.5) in amounts greater than $199,000 a year unless (i) the entity obtains a waiver from the state; (ii) the compensation is paid from other sources; or (iii) the compensation is for direct services, and

• the compensation, regardless of its source, is not greater than the 75^th percentile of compensation paid to comparable executives as established by state recognized compensation surveys; and
• the Executive compensation is approved by the entity’s board of directors or compensation committee after reviewing the comparability data and surveys.

EO #38 also limits Administrative Expenses (10 NYCCR 1002.2a), calculated as a percentage of total operating expenses, to no more  than 15% of the funds provided by the State or from State authorized funds. (This limit started at 25% in 2013 and was reduced to 15% in 2015.)

To complicate matters, the covered entity may obtain a waiver of the compensation and administrative expense limits if the entity can demonstrate “good cause” by showing that the availability and quality of the program services will be negatively impacted due to the nature, size, and complexity of the programs funded. If the covered entity fails to comply with these rules or obtain the appropriate waivers from one of the thirteen State Agencies (each of which appear to have their own process for obtaining a waiver), the entity is subject to suspension, modification or termination of its State funded service contracts and/or its Office of Mental Health (OMH) or Department of Health (DOH) license. Non-compliance can potentially be cured through a corrective action plan approved by the State. The entity can also file an administrative appeal of the sanctions.

The Conflict:

From the start, the proclamation has been controversial with state funded nonprofits and exceptionally difficult to administer. In response to an outcry from major health care providers a waiver system was enacted. In addition, further changes to the implementing regulations stirred additional controversy (10 NYCRR sub-part 69-4). The Department of Health (DOH) adopted amendments to address potential conflicts of interest involving early intervention program evaluators. This change in the conflict of interest rule in conjunction with the burden of the other limitations appears to have stimulated covered providers to challenge EO # 38 in court.

Tale of Two Cases:

Case 1  In an April 2014 decision, the Nassau County Supreme Court agreed with the challenging agency’s theory alleged in its suit (Agencies for Children’s Therapy Services, Inc. v. NYS Department of Health et al), which challenged the validity of the Governor’s action as a violation of the separation of powers doctrine. The suit claimed that the state legislature, not the Governor, had the power to enact rules governing state funded executive compensation, administrative expense limitations and conflict of interest rules at private facilities and that the legislature in its 2012 budget evinced no legislative intent to do so.

The Court held that the DOH “usurped the role of the legislature in making public policy assessments” and that DOH lacks “the authority to determine how much a for-profit entity may pay executives and how much to expend on administrative expenses.”

Case 2   In a very similar case brought in the Suffolk County Supreme Court (Concerned Home Care Providers, Inc. v. NYS Department of Health, et al.) the Court ruled that EO #38 and its implementing regulations were a constitutional exercise of Executive power. This decision was completely contrary to the holding in Agencies for Children’s Therapy Services, Inc. Suffolk County Supreme Court Justice Pines concluded that the regulations “are well within the legislatively mandated policy and “that inherent in such authority is the power to determine the terms of such contract so long as they do not deviate from other legal authority.”

The Appeal:

Emboldened by the decision of Judge Pines in Concerned Home Care Providers, the DOH appealed the adverse decision in Agencies for Children’s Therapy Services. On December 30^th, 2015 the Appellate Division 2^nd Department (New York’s intermediate Appeals Court) issued a surprising decision. It reversed the holding in Agencies for Children’s Therapy Services and found that the DOH had not violated the standards enunciated in the precedent setting Court of Appeals decision Boreali v. Axelrod.

 The Appellate Court ruled that the DOH is statutorily required to award service contract “on the basis of best value  . . . in a manner that optimizes quality, cost and efficiency.” The Court went on to state that “ the administrative cost and executive compensation limits contained in the use-of-funds rule are not inconsistent with the above statutory provisions or the underlying purpose of obtaining high quality services with limited available funds.” In what appears to be a stretch by the Court, it went on to determine that high quality services are made available “by ensuring that the DOH awards service contracts to agencies that will use most of the tax dollars they receive directly on the provisions of services rather than upon administrative overhead and executive compensation.”

Clearly, the Court bought into the often challenged and widely discredited theory that lower overhead and executive compensation expenses ensure optimized quality, lower costs and better efficiency. From where and how the Court formed this notion is not clear. —I suspect they simply believe it is common knowledge.  Unfortunately for New York service agencies and the philanthropic sector at large, there is nothing common or empirical about this equivalence. This decision illustrates the uphill battle that the charitable sector faces in convincing the public and our public servants that broad restrictions on the ability of charities to use their funds to appropriately scale and attract much needed talent is counter-productive and ultimately handicaps service providers’ ability to impact and solve difficult social problems.

The New York State Court of Appeals (New York’s top Appellate Court) has issued a stay of the decision in the Agencies for Children’s Services decision pending the outcome of its decision on the appeal of the lower Court’s decision. We shall see if these justices fall prey to the same misguided notion of charitable efficiency and impact which guided the decision of the lower Court.

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1.         Clearly Describe the Promotion

 Companies should clearly disclose the following key terms of any cause marketing promotion:

a.       the name and mission of the charity receiving a donation;

b.      the benefit the charity will receive from each purchase of the product or service;

c.       any flat donation, minimum guarantee, or donation cap;

d.      any consumer action required for the charity to receive the donation; and

e.       the start and end dates of the campaign.

Many groups have already adopted the above disclosures as part of existing best practices in the cause marketing industry, most of which were previously established by the Wise Giving Alliance. The Attorney General recommends that these key promotional terms be displayed in a clear and prominent format and size, and close to the text used in marketing the promotion. The Attorney General has also put forth a template “donation information” label for disclosing key promotional details on products or websites. While standardizing the disclosure of material terms may be a helpful tool in providing consumers with consistent disclosures, companies may find it challenging to implement the recommended label format within the available product packaging space.

2.         Allow Consumers to Easily Determine the Donation Amount

 Companies should indicate that a fixed dollar amount per unit purchased will be donated to charity, to enable consumers to easily determine their charitable donation. If the campaign is not based on a set donation per unit sold, the Attorney General recommends using a fixed percentage of the sales price rather than vague statements such as that “profits” or “a percentage of proceeds” will be donated. This recommendation is also in line with existing best practices, and will hopefully help companies focus on not merely providing a truthful disclosure, but one that allows consumers to evaluate the actual impact of their purchase.

3.         Be Transparent About What Is Not Apparent

The Attorney General recommends that companies disclose all facts related the cause marketing promotion that are not apparent to the consumer, such as:

a.       Where a flat donation has been or will be paid to the charity, make clear that consumer action will not trigger a donation.

b.      Make clear if the intended donation is an in-kind donation rather than a cash contribution, such as donating a book to a children’s literacy organization for every purchase made.

c.       Where a ribbon, color, logo, or other indicia associated with a charitable cause is used in connection with a cause marketing campaign, the Attorney General recommends that the company clearly disclose whether a consumer’s purchase will trigger a charitable donation. If cause marketers are required to affirmatively state that no charitable donation will be made whenever an awareness symbol is used, this recommendation could have the effect of discouraging charitable awareness campaigns.

d.      Where there is a set minimum guaranteed donation, there should be enough products available for sale to comfortably exceed the minimum donation.

e.       Where there is a set cap on the donation, make sure the market is not flooded with products.

4.         Ensure Transparency in Social Media

Companies conducting cause marketing campaigns via social media are encouraged to clearly disclose all terms of the social media campaign, including campaigns where a charitable donation is made without the purchase of any products or services, such as where a consumer “likes” a Facebook page, or follows a company’s Twitter feed. This recommendation moves beyond the typical focus on campaigns in which consumers purchase a product to benefit a cause. The Attorney General also recommends that companies provide a means for consumers to track the campaign’s progress in real-time, and alert consumers to the campaign’s end. This recommendation may be challenging to implement in promotions involving product sales (e.g., due to returns and other sales reconciliations).

5.         Tell the Public How Much Was Raised

 The Attorney General recommends that cause marketers and charities disclose the results of their campaigns on their websites soon after the completion of any cause marketing campaigns.This represents a newly-articulated industry best practice.This requirement could discourage companies from experimenting with innovative cause marketing campaigns for fear that post-campaign reporting will reveal poor sales results.

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