There are over 90,000 nonprofit organizations in New York that collectively employ 1.25 million people (18 percent of the state’s workforce) and generate more than $260 billion in annual revenues, according to www.independentsector.org. Following the Great Recession, the nonprofit sector faced significant financial headwinds that resulted in increased restructuring and, in some cases, dissolution, of many prominent nonprofits such as Saint Vincent Catholic Medical Centers, the New York City Opera, and The Big Apple Circus. The bankruptcy cases commenced by these organizations over the past several years provide useful guidance when navigating the complex intersection of federal bankruptcy law and New York’s nonprofit laws, especially with respect to the substantive and procedural requirements for asset sales and the transfer of restricted funds.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCA) was primarily intended to curtail what some proponents believed was growing abuse of the bankruptcy system. However, BAPCA also made certain “technical corrections” to the Bankruptcy Code that, among other things, addressed the administration of nonprofit bankruptcy cases. Specifically, provisions were added to sections 363, 541, and 1129 of the Bankruptcy Code to make clear that the transfer of a nonprofit’s assets in bankruptcy must comply with applicable state nonprofit laws. In New York, such laws include the Not-For-Profit Corporation Law (N-PCL) enacted in 1970 and amended in 2013 and 2016.
Sales of Substantially All Assets
Asset sales often play a key role in the restructuring or dissolution of nonprofit corporations. Outside of a bankruptcy case, the N-PCL allows routine sales to be authorized by a simple majority of either the corporations’ board of directors or a committee appointed by the board. Yet that statute includes stringent voting requirements for the disposition of “substantially all” of a nonprofit’s assets: approval by two-thirds of the corporation’s “entire” board or, for a board with 21 or more directors, the majority of the “entire” board. The term “entire” board is defined under the N-PCL as “the total number of directors entitled to vote which the corporation would have if there were no vacancies….” N-PCL §102(a)(6-a). As a result, gathering the necessary votes for a transaction of this size may be challenging for boards of nonprofits.
Further, it can be difficult to determine what constitutes “substantially all” of a nonprofit’s assets. For example, in the recent bankruptcy case of The Big Apple Circus, the debtor conducted a private sale of its only owned real property for $2.5 million and a separate public auction of its performance-related assets, such as its big top tent, trapeze, and intellectual property, which sold for $1.3 million. These were relatively significant transactions for the organization, but potentially not independently large enough to constitute “substantially all” of its assets. The Big Apple board prudently elected to satisfy the more rigorous voting requirements for both sales, rather than risk violating the approval thresholds of the N-PCL.
Once in bankruptcy, a nonprofit debtor must seek court approval of any use, sale, or lease of its assets outside of the ordinary course of business pursuant to Section 363 of the Bankruptcy Code. 11 U.S.C. §363(b). Courts interpreting that statute have held that transactions should be approved when they are supported by sound business reasons. See, e.g., Comm. of Equity Security Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063, 1071 (2d Cir. 1983). However, under section 363(d), which was added by BAPCA, such transactions may be approved “only in accordance with non-bankruptcy law applicable to the transfer of property by [such] debtor….” 11 U.S.C. §363(d).
In turn, Section 511 of the N-PCL permits the sale of substantially all of a New York nonprofit’s assets if: (1) “the consideration and terms of the transaction are fair and reasonable to the corporation,” and (2) “the purposes of the corporation or the interests of its members will be promoted” by the transaction. N.Y. N-PCL §511(d). With respect to the first prong, courts generally find that “fair and reasonable” consideration is a price consistent with fair market value, Bench Decision Regarding Debtor’s Sale Motion, at 5–6, In re HHH Choices Health Plan, Nos. 15-11158-MEW, 15-13265-MEW, 16-10028-MEW (ECF No. 359) (Bankr. S.D.N.Y. Aug. 23, 2016), which, as evidenced by the Big Apple Circus case, can be established through a public auction or even a private sale following appropriate marketing. The second prong focuses on the organization’s purposes, and New York courts have held that use of sale proceeds to pay down an organization’s debt constitutes a permissible purpose that promotes the interest of a nonprofit. Id.
Transfer of Restricted Funds
Nonprofits must also properly dispose of “restricted funds”—i.e., assets received and held by the corporation either for a charitable purpose or which is legally required to be used for a particular purpose—to the extent not expended through operations. Sections 541(f) and 1126(a)(16) of the Bankruptcy Code, also added by BAPCA, reiterate that any transfer of a nonprofit debtor’s property—whether outside or under a chapter 11 plan—must comply with applicable state law. The N-PCL requires dissolving nonprofits to distribute restricted funds to entities “engaged in activities substantially similar to those of the dissolved corporation.” N-PCL §1001(d)(3). This standard is broader in scope and less restrictive than the common law cy pres doctrine in New York, which permits transfers of property that will “most effectively accomplish the general purpose” of the donor or the organization. In re Matter of Multiple Sclerosis Serv. Org. of N.Y., 68 N.Y.2d 32, 35-42 (1986). Again, ascertaining whether a transferee’s activities are “substantially similar” to the nonprofit debtor is a factual matter. Thus, in the Big Apple Circus case, the debtor submitted a declaration supporting the transfer of restricted endowment funds that attested to the activities of each proposed recipient and established that such activities were, in fact, substantially similar to those of the debtor.
Through BAPCA, the Bankruptcy Code effectively incorporates applicable state law with respect to approving the transfer of assets by a nonprofit debtor. And under New York’s N-PCL, approval to sell substantially all of the assets of an insolvent nonprofit must be obtained from the state supreme court (solvent nonprofits may also seek approval from the attorney general). Thus, regulators and insolvent nonprofit debtors have disagreed regarding whether state court approval is required in addition, or perhaps alternatively, to bankruptcy court approval, despite the broad jurisdiction granted to bankruptcy courts.
In Saint Vincents’ 2013 bankruptcy case, the debtors avoided the issue by seeking approval of certain sales from both the bankruptcy court and the state supreme court, while reserving their rights to have the bankruptcy court decide all issues related to the transaction. Subsequently, in the 2015 bankruptcy case of Hebrew Hospital, Judge Michael Wiles of the Southern District of New York held that the bankruptcy court—rather than the state court—must approve such transactions, citing section 1221(e) of BAPCA, which provides that “[n]othing in this section shall be construed to require the court in which a case under Chapter 11 of title 11, U.S. Code, is pending to remand or refer any proceeding, issue, or controversy to any other court or to require the approval of any other court for the transfer of property.” HHH Choices Health Plan, at 3-5 (“[M]y interpretation of section 363 is that any determination that would be made by a state court, under section 511 of the Not-For-Profit Corporation Law, in the absence of a bankruptcy case, is now a determination to be made by [the bankruptcy court], and not the state court”). Shortly thereafter, the Big Apple Circus sought and obtained approval of its sale transactions solely from the bankruptcy court without any procedural or jurisdictional objection from regulators, stakeholders, or the court itself.
The Great Recession and its aftermath have drawn renewed attention to the interplay between the Bankruptcy Code and the N-PCL. By operation of these statutes, nonprofit debtors seeking to sell or transfer assets must not only satisfy traditional bankruptcy law standards, but also the more nuanced requirements of the N-PCL. However, while these debtors must establish a record satisfying both statutes, they likely only need the bankruptcy court’s blessing to proceed.
Christopher Updike is counsel in the Business Restructuring & Workouts Group of Debevoise & Plimpton. He represented The Big Apple Circus, mentioned in the article, on a pro bono basis in its Chapter 11 case.