In late June 2013, the New York state legislature passed the Nonprofit Revitalization Act of 2013 (NRA), which marks the first overhaul of New York’s charities laws in more than 40 years. The legislation grew out of the Feb. 16, 2012 report to Attorney General Eric Schneiderman by the Leadership Committee for Nonprofit Revitalization, a blue-ribbon panel appointed by the attorney general. The Revitalization Act encompasses many of the committee’s recommended improvements to update statutory provisions applicable to nonprofits and charitable trusts.

Attorneys who advise either officers and directors of charities or those who serve on boards of nonprofits should take note of this important piece of legislation. The changes will affect virtually every nonprofit corporation and wholly charitable trust in New York state that are governed under Not-for-Profit Corporation Law (NFPCL) and the Estates, Powers and Trusts Law (EPTL). The bill is awaiting action by Gov. Andrew M. Cuomo and, if enacted, would take effect on July 1, 2014.

This article examines the key provisions of the NRA that address governance issues; namely, audit oversight, related-party transactions, conflict of interest policy, whistleblower policy, authorizations of real property transactions and approvals of substantial transactions.

Background

The bill was introduced in the Senate by Sen. Michael Ranzenhofer and in the Assembly by Assemblyman James F. Brennan, at the request of the Department of Law. As stated in the Sponsor’s Memorandum in Support of the legislation, the purpose of the bill is “to reduce unnecessary and outdated burdens on nonprofits and to enhance nonprofit governance and oversight to prevent fraud and improve public trust.” In its Justification Section, the Sponsor’s Memorandum explains:

[T]he success of the nonprofit sector depends on maintaining the public’s trust. This requires that boards provide effective oversight over the charitable funds entrusted to them, and that the Attorney General have the necessary tools to protect charities and donors from fraud and abuse. This bill strengthens New York law to enhance governance and accountability by setting forth clearer expectations of board duties in key areas, such as providing financial oversight. It also includes new provisions to limit and, when necessary, remedy self-dealing.

Among other things, the legislation eliminates the current statutory classification of nonprofits into four types: A, B, C and D and replaces them with two categories, charitable corporations and non-charitable corporations. In addition, the legislation would raise the dollar thresholds for obtaining independently certified financial statements and submitting annual charitable reports to the attorney general. In several places the legislation includes references to a “key employee.” The term is defined in proposed subdivision 25 of NFPCL §102 as having the same meaning as in Internal Revenue Code §4958 regarding intermediate sanctions.

Audit Oversight

Every charitable corporation and charitable trust with revenue exceeding $500,000 registered to solicit charitable contributions in New York must file an independent certified public accountant audit report with the attorney general. The NRA requires those institutions to designate an audit committee of the board, consisting of at least three independent directors, for the purposes of overseeing the accountant and financial reporting processes of the corporation and the independent certified public accountant’s audit of the corporation’s financial statements. The corporation’s entire board may constitute the audit committee, provided that only independent directors are present at and participate in deliberations and voting relating to audit committee matters. The committee must adopt a charter.

The audit committee must, at a minimum, perform the following:

• Retain and evaluate the independent auditor who shall report directly to the audit committee

• Review with the independent auditor the scope and planning of the audit

• Review and discuss with the independent auditor the results of any audit

• Oversee adoption, implementation of and compliance with any conflict of interest policy or whistleblower policy adopted pursuant to the act, if the function is not otherwise performed by another committee of the board comprising solely independent directors.

Note that the definition of an “independent director” is contained in proposed subdivision 21 of NFPCL §102. A director is not independent if the director or a relative is an employee of the corporation or an affiliate; or is a director, officer or employee, or has a substantial financial interest in, an entity that has transacted business of $25,000 or more with the nonprofit in the past three years. Financial contributions do not count toward the threshold.

The comparable provision for charitable trusts are found in subdivision (b) of proposed new §8-1.9 of the EPTL.

Related-Party Transactions

The act requires every nonprofit corporation and charitable trust to take certain affirmative steps before entering into related-party transactions. “Related party” is defined in proposed subdivision 23 of NFPCL §102 as any director, officer or key employee of the corporation or any affiliate or a relative of such person; or any entity in which any of these individuals has a 35 percent or greater ownership or beneficial interest, or in the case of partnerships or professional corporations, a 5 percent or greater direct or indirect interest. “Related-party transaction” means any transaction, agreement or other arrangement in which a related party has a financial interest and in which the corporation or any affiliate of the corporation is a participant.

The comparable provisions for charitable trusts are found in subdivision (a) and (c) of proposed new §8-1.9 of the EPTL.

No corporation or charitable trust may enter into a related-party transaction unless: proper disclosure has occurred or there is prior knowledge on the part of board members and the board (1) considers alternative transactions to the extent available and upon reasonable diligence determines that such alternative transactions would not be more advantageous to the corporation; (2) determines by a two-thirds vote of the board that the related-party transaction is fair, reasonable and in the best interests of the corporation and approves such transaction, and the related party with an interest in the transaction is not present at and does not otherwise participate in any deliberation or voting relating thereto; and (3) contemporaneously documents in writing the basis for its determination and approval of the transaction.

Under the act, the attorney general has the authority to take a myriad of steps with regard to related-party transactions. For example, the attorney general may (1) bring an action to enjoin, void or rescind any such transaction or proposed transaction that violates any law or is otherwise not fair, reasonable or in the best interests of the corporation or (2) seek other relief, including damages, restitution and the removal of directors or officers, or even seek to require any person or entity to pay, in the case of willful conduct, an amount up to double the amount of any benefit improperly obtained.

Conflict of Interest Policy

The legislation would enact a new NFPCL §715-a to provide that every nonprofit corporation and charitable trust adopt a conflict of interest policy to ensure that its directors, officers and key employees act in the corporation’s best interest and comply with applicable legal requirements. The policy must include, at a minimum, the following:

• Procedures for disclosing a conflict of interest to the audit committee or, if there is no audit committee, to the board

• A requirement that the person with the conflict of interest not be present at or participate in board or committee deliberation or vote on the matter giving rise to such conflict

• A requirement that the existence and resolution of the conflict be documented in the corporation’s records.

Annually, directors or trustees must submit a statement disclosing any potential conflicts of interest.

Significantly, subdivision (d) of proposed §715-a provides that if the corporation has adopted and implemented a conflict of interest policy pursuant to federal or state law that substantially meets the requirements of §715-a, then the corporation is deemed in compliance with the section. It is conceivable, though not certain, that entities adopting policies along the lines of those recommended by the Internal Revenue Service pursuant to IRC §4958, may be deemed satisfactory.

Conflict of interest provisions applicable to charitable trusts are found in subdivision (d) of proposed new §8-1.9 of the EPTL.

Whistleblower Policy

Proposed new NFPCL §715-b and subdivision (e) of EPTL §8-1.9 would require that every nonprofit corporation and charitable trust, respectively, that has five or more employees and in the prior fiscal year had annual revenue in excess of $1 million must adopt a whistleblower policy to protect from retaliation persons who report suspected improper conduct. The policy must provide that no director, officer, employee or volunteer of a corporation who in good faith reports any action or suspected action taken by or within the corporation that is illegal, fraudulent or in violation of any adopted policy of the corporation shall suffer intimidation, harassment, discrimination or other retaliation or, in the case of employees, adverse employment consequence.

Any whistleblower policy must include the following provisions at a minimum:

• Procedures for reporting violations or suspected violations of laws or corporate policies, including procedures for preserving the confidentiality of reported information

• Procedures for handling and investigating violations or suspected violations of laws or corporate policies

• A requirement that an employee of the corporation be designated to administer, implement and oversee compliance with the whistleblower policy, and to report to the audit committee or other committee of independent directors or, if there are no such committees, to the board

• A requirement that a copy of the policy be distributed to all directors, officers, employees and volunteers, with instructions on how to comply with the procedures set forth in the policy.

Similar to the provision regarding conflict of interest policies, subdivision (c) of this section provides that if a corporation has adopted and implemented a whistleblower policy pursuant to federal or state law that substantially meets the requirements of §715-b, the corporation is deemed in compliance. In this instance, it remains to be seen, for example, whether adherence to Labor Law §740 would be sufficient to satisfy §715-b.

Real Property Transaction Authorizations

The NRA reduces the threshold for board approval of routine real estate transactions. It allows a charitable corporation to conduct most purchases, sales, mortgages or leases of real property with the authorization of a majority of directors or a committee of the board. Notably, however, if the purchase, sale, mortgage or lease of the real property would constitute all or substantially all of the assets of the charitable corporation, it requires the approval of two-thirds of the entire board or, if there are 21 or more directors, a majority of the entire board.

Approvals of Substantial Transactions

The act allows a charitable corporation that seeks to sell, lease, exchange or dispose of all or substantially all of its assets to conduct a one-step approval process consisting of the attorney general’s approval, instead of the more cumbersome two-step process currently in place (court approval followed by the attorney general’s review). Similarly, charitable corporations that seek to merge or consolidate are allowed to seek approval from the attorney general alone, rather than requiring court approval followed by the attorney general’s review. In either case, if the attorney general does not approve a transaction, the charitable corporation has the option to seek court approval.

Conclusion

If signed by the governor and enacted into law, the NRA would be a landmark piece of legislation that changes the landscape for charitable organizations operating in the state of New York. While the foregoing has been a brief description of the legislation, if enacted into law, regulations may be issued which provide additional detail. It is essential for directors, trustees, officers and key employees to familiarize themselves with its provisions if enacted as well as any associated regulations.

Coleen Friel Middleton was of counsel at Wilson Elser Moskowitz Edelman & Dicker at the time this article was submitted. Mark Thomas is a partner at the firm.