Not-for-profit corporations continue to struggle with the extent to which they should engage in formally routine business dealings with their board members in light of New York’s groundbreaking “Nonprofit Revitalization Act of 2013” (the “Act”). Over a year and a half has elapsed since the Act went into effect, impacting every not-for-profit corporation in New York. Yet, despite this passage of time, not-for-profit executives, employees, and counsel are still grappling with the Act’s “conflict of interest” provisions which, among other things, govern transactions between a not-for-profit corporation and its directors. According to some, given the ambiguity of several portions of the Act, the dearth of interpretive caselaw, and the governmental oversight provided by the Act, the Act has had a profound chilling effect on mutually beneficial and overwhelmingly fair deals and contracts – including those for legal services, advisory services, insurance, goods, or commodities, all of which were often provided at a steep discount – between a not-for-profit corporation and its directors about which, prior to the enactment of the Act, the corporation and its directors would not have even thought twice.
But the discontinuance of these valuable business relationships does not appear to have been the desired intent of the Act. After all, the purpose of the Act’s conflict of interest provisions is to, at least superficially, ensure the fairness of transactions between the corporation and, among others, a director, any relative of his or hers, any entity in which he or she has a thirty-five percent or greater ownership or beneficial interest or, in the case of a partnership or professional corporation, a direct or indirect ownership interest in excess of five percent (collectively, for purposes of this blog, such a person or entity is a “related party”).
The Act seeks to accomplish this goal by providing that no corporation shall enter into any transaction with a related party “unless the transaction is determined by the board to be fair, reasonable and in the corporation’s best interest at the time of such determination.” NY Not-for-Profit Corporation Law (“N-PCL”) 715(a). The Act also requires the director (or officer or key employee) to disclose all “material facts” regarding his or her interest in the transaction.
While these provisions seem to make eminent sense, they have nevertheless left executives, in-house counsel, and directors scratching their heads with respect to what is “fair” and “in the corporation’s best interest.” Also, because of the ever looming threat of governmental scrutiny of such a transaction, the Act has curbed enthusiasm for compensated business relationships between corporations and directors. The Act has, perhaps inadvertently and perhaps only temporarily until all the definitions within the Act are fleshed out sufficiently, dampened the desire on both ends to continue those relationships.
For sure, the Attorney General’s Office is not seeking to eradicate all such mutually beneficial relationships between the corporation and a related party. In this regard, contained in the NYS Attorney’s General’s Guidance Document issued in April 2015 regarding “Conflicts of Interest Policies Under the Nonprofit Revitalization Act of 2013” (the “AG Guidance”) are four (4) types of transactions between a corporation and related party that, according to the Attorney General’s office, are exempt from the Act (although they are still subject to other safeguards under law, as pointed out by the AG Guidance).
The Act is even more rigorous where the corporation involved is a “charitable” not for-profit-corporation (meaning, one whose purpose is charitable, educational, religious, scientific, literary, cultural or for the prevention of cruelty to children or animals) and a related party has a “substantial financial interest” in the transaction.
The term “substantial financial interest” is not defined by the Act. Where such a “substantial financial interest exists” – and given the strict oversight under the Act, one would be wise to construe the term broadly until more guidance is provided thereon – the board of directors (not including the director implicated in the transaction) or authorized committee thereof shall, prior to entering into the transaction, consider alternative transactions to the extent available; approve the transaction by not less than a majority vote; and memorialize in writing the basis for the approval, including its consideration of any alternative transactions.
Perhaps the caution some not-for-profit corporations and their directors are presently exercising under the Act is ephemeral, and as time goes on related party transactions will return to their prevalence pre-Act. But it is also quite possible that the Act will permanently reduce the number of mutually beneficial, and, often times, dramatically discounted, transactions between corporations and related parties, with the corporation relying upon the expertise of its board members without any compensation – which may be a severe, unintended consequence of the Act.