Newsletters

Non Profit Report - December 2011

Date: December 21, 2011

The Importance of Legal Audits
By: Jefferson C. Glassie & Megan C. Spratt

Legal audits provide a good opportunity for nonprofit organizations and associations to prevent unexpected liability by addressing and resolving problematic issues before they escalate. Risks of liability are a serious concern for nonprofit organizations and associations. A legal audit is particularly important if the association or nonprofit organization has recently undergone a change in management, so that preexisting problems are not attributed to the new leadership.

Most organizations conduct financial audits, but many neglect ensuring their legal house is in order by doing a legal audit. In a legal audit, your lawyer will review broadly the legal “health” of your organization by looking at legal documents, filings, and policies. Described below are some of the issues to be examined during a legal audit.

Corporate

It is usually advisable for nonprofit organizations and associations to incorporate in order to protect officers, directors, and members from personal liability. Tax-exempt organizations usually are nonprofit (or nonstock) corporations, which are formed by filing Articles (or Certificate) of Incorporation with governmental authorities in a state or the District of Columbia.
State nonprofit corporation law provides the rules for such corporations, and the Articles must be consistent with the law.
If a corporation incorporated in one state “does business” in another state, the other state law will likely require the corporation also to “register” or “qualify” to do business in that other state as a “foreign” corporation. If an organization opens an office or has employees in another state, that will usually trigger registration requirements; just having a bank account or holding a meeting in another state does not give rise to registration, and there are a number of activities that are in the middle of the spectrum.
Corporations typically have to file periodic reports listing officers and directors with the states, usually every year or two.
Just as Articles can be viewed as a “contract” with the state, Bylaws are like a contract with the members (or stockholders in a stock corporation). The Articles and Bylaws both must be consistent with state law and with one another. Bylaws govern the Board and member activities and governance, and should also reflect current practices, policies, and procedures.

Tax
Tax issues should clearly be a part of any audit.

It should be confirmed that all annual reports filed with the Internal Revenue Service (“IRS”) are completed carefully and filed in a timely manner.
The IRS determination letter granting Section 501(c)(3) or Section 501(c)(6) status should be part of the organization’s permanent record, and its activities should be conducted in strict compliance with its tax-exempt purposes described under the Internal Revenue Code. Should its activities run afoul of such purposes, the organization may be subject to substantial penalties and taxes. Even worse, the organization’s tax-exempt status may be in jeopardy.
Revenues that are not related to the exempt purpose, constitute a trade or business, and are regularly carried on are Unrelated Business Income subject to Tax (“UBIT”); these revenues include advertising, commissions, referral fees, and management or administrative fees. An organization pays the tax on net taxable revenues over expenses, but if the amount of taxable revenue reaches 30 or 40 percent of the organization’s gross revenue, tax-exempt status can be jeopardized.
The IRS permits tax-exempt organizations to set up other affiliated entities to conduct activities that may not be appropriate, such as a 501(c)(3) organization establishing a Section 501(c)(6) to lobby or a for-profit subsidiary to engage in marketing, but it is important to ensure appropriate structures are in place.
If a tax-exempt organization changes its mission or other aspects of its governing documents, the new or amended documents must be sent to the IRS.

Finances
It is crucial that the process for managing the organization’s money be designed and implemented to ensure proper spending and reporting.

The Board has ultimate responsibility and should have general oversight of the organization’s budget and finances.
Policies and procedures are vital for these purposes, such as those dealing with conflicts of interest, check cashing, financing, handling funds, and investments.

Contracts
A legal audit should also include a review of the organization’s contracts and its procedures on entering into contracts.

It is advisable to have a policy in place requiring legal counsel to review and approve all contracts and stipulating that only authorized officers have the authority to execute contracts.
Examples of provisions that should normally be included in contracts are warranties regarding the contracted-for goods or services, payment terms, indemnification, cancellation clauses, and licenses for the use of intellectual property.
To ensure that provisions like these are never left out, corporations often make use of standard-form contracts designed for their dealings with hotels and other vendors, and then tailor them to meet their particular needs.

Personnel
Again, policies and procedures are important.

It is advisable to have an employment manual or handbook in force. The courts will often look to such manuals or handbooks as stating the terms and conditions of employment, particularly where there is no individual contract.
Most state laws provide for “employment-at-will,” but that does not mean employment can be wrongfully terminated (e.g., for discriminatory reasons).
Under the federal Fair Labor Standards Act, employees must be paid overtime (time and one-half) for hours worked over forty per week. Executive and managerial employees are exempt from this requirement.
Another issue that arises relates to the distinction between employee and independent contractor status. Employees must have income taxes and social security withholdings made, and contractors do not. If a person has a contract, pays his own insurance, has his own office, and works for other clients, the person is probably a contractor, but there are many shades of gray, particularly with more telecommuting employees.

Meetings

Nonprofit organizations and associations conduct many meetings and having proper contracts in place with hotels and other service providers is advisable to spell out required duties.
The Americans with Disabilities Act, as well as copyright laws on obtaining permission for music at events, must be followed when holding such meetings.
Also, state law mandates notices, voting, and other requirements for member and Board meetings. Parliamentary procedure should be followed, and minutes kept of meetings (although tape recordings and draft minutes should not be retained).

Publications

It is important to have contracts in place governing the production and distribution of publications, particularly to ensure intellectual property ownership and permission. Policies should be maintained to ensure that rights of others are not infringed, or other persons defamed.
Editorial and advertising policies should also be in force setting forth terms and conditions for the publication. Advertising policies should state all terms of insertion and cancellation, for example. Antitrust risks may arise if advertisements from competitors of members are prohibited.

Intellectual Property

The most valuable property of a nonprofit organization often is its intellectual (or intangible) property, such as trademarks and copyrights.
The name and logo (i.e., trademarks) of the organization may be its most valuable asset and must be properly used to maximize protections. Trademarks generally should be registered, and the registrations renewed on a timely basis.
If your organization licenses its trademarks to others, such as chapters, it is important to have license agreements in place to maintain the style and quality of the marks and to ensure that all uses of your organization’s marks are subject to prior review and approval; the failure to do so may risk abandonment of the marks or diminished value.
Copyrights also must be protected, and the nonprofit organization or association should neither let others use its copyrighted material without permission nor use the copyrighted materials of others without permission. Your organization must have a process in place to ensure that staff obtains permission from speakers, authors, and others who contribute intellectual property for use or publication by the organization (such as exam test items).
Published notices about the organization’s intellectual property are not legally required, but are highly recommended. These are the ™ symbol or ® symbol for trademarks – the latter only for registered marks – and Copyright or © symbol for copyrights with the year of publication and name of the copyright owner.
It is important to pursue infringers, even if the infringement doesn’t seem serious at the time, because the failure to pursue can lead to loss or reduced value and strength of the property.
Member lists and mailing lists are also viewed as intellectual property, both as copyrights or trade secrets.

Insurance
Appropriate and sufficient insurance is necessary to adequately protect against legal claims.

Your organization’s insurance should cover most anticipated legal claims, damage awards, and attorneys’ fees (usually with a retention or deductible amount).
A Commercial General Liability policy (also called an office policy) prevents against “slip and fall” and similar types of liability.
A Directors and Officers policy is also advisable, but it is important to have a broad form policy that not only protects the officers and directors, but also the organization itself (so called “entity” coverage) and other volunteers, staff, and agents.
If a legal claim or lawsuit is received, or if there is knowledge that such a claim is expected, it should be promptly reported to the insurance company or agent.

Affiliates

If your organization has affiliates, such as regional, state, or local chapters, the organization’s Bylaws should be clear about the terms and conditions for affiliation.
The affiliates’ governing documents need to be consistent with those requirements, and there should be clear charter or affiliation agreements in place to carefully describe the relationship.
A group tax-exemption is also available from the IRS for such subordinate organizations and eliminates the need for separate tax-exemption applications for the affiliates.

Conclusion
A legal audit is like an insurance policy: you notice the cost right away, but you reap the benefits a hundred fold if you discover and de-fuse a big problem. A legal audit can be structured so that the review occurs all at once or in phases to meet budget constraints. Finally, a legal audit does not need to be conducted every year, but should be conducted periodically.

Tips on Investigating Discrimination and Harassment Complaints -- What Every Association Should Know
By: Tiffany M. Releford

An employee complains to the Human Resources Manager that he/she is being discriminated against by another employee. What happens next? What action should be taken to investigate the complaint?

Foremost, the key to investigating a complaint is to be consistent, have a predefined process in place, follow that process, and understand the objectives of the investigation. A good investigator is one that understands the policies of the organization and/or association, uses discretion and confidentiality in conducting an investigation, and is fair and impartial. The first thing to do is to determine what level of investigation is needed. Is it a matter of calling the affected parties and interviewing them by phone, or is further action required, such as consulting with legal counsel and having counsel conduct an investigation? If you decide no investigation is necessary, document the decision and the reasoning, and inform the complainant of the decision. If the complainant comes back with more information/detail, review the additional information and determine if an investigation should now be undertaken.

In planning the investigation, determine who will investigate, who will make the final determination, and who will receive a final report. Keep in mind the scope of the investigation. Make sure to understand the issues involved and the proper witnesses who should be contacted. After the scope has been determined, strategize how the interviews will be conducted. Be sure to think about the order of the interviews: do you want to interview the complainant first or the accused? Once you have an order in mind, make an outline of questions and start by interviewing those with relevant knowledge, including the complainant.

It is recommended that the interviews be done in a private location if possible; however, it should be made clear to the parties involved who can be present for the interviews. Before the interview, review all the relevant information such as the complaint and documentation supporting the complaint. Make sure that during the interviews, the individuals are given enough details so that they can respond in a meaningful way. However, be general about the complaint so as not to suggest answers to the interviewees and taint the investigation.

Start off your interviews by identifying yourself as the interviewer, explain the general purpose of the investigation, explain the consequences for failure to cooperate, if any, and ask for and obtain all relevant documents and other evidence. While conducting the interview, in addition to listening to what is being said, pay attention to what is not being said. Note the interviewee’s tone of voice, demeanor, pauses, silence, hostility, contradictions, and emotional reactions. Sometimes what is said and what is not said help to determine the interviewee’s credibility. Credibility may involve whether the story is consistent, if there a bias, or if the interviewee has a hard time remembering the facts. Your notes should state the date of the interview, who was in the room, what is said, and documents that the witness agrees to provide. As an investigator, you should never express an opinion or judgment but should remain objective. In addition, you should also be vigilant during the interview and not ignore new issues that arise during the investigation. It is also important that when interviewing the complainant, you be supportive but remain neutral. Be sure to tell the complainant that you will get back to them with the results of your investigation. Also remember to review your notes immediately after the interview to make sure you clean up any inconsistencies or errors while the interview is still fresh in your mind.

Once you have concluded your investigation, you should come to a conclusion. Often, the individual conducting the investigation is concerned about coming to the wrong conclusion. It is imperative to note that you do not have to be 100% certain of your decision after an investigation; however, you do have to take a position that is reasonable based on all the facts. Use logic and ask yourself, does the story make sense? If, after an investigation, there is not enough evidence to prove the complainant’s claims, do not infer that the complainant is a liar, but state that there was not enough evidence to prove complainant’s claim. Remember, the objective of the investigation is to reach a reasonable conclusion, establish a defense to a harassment/discrimination complaint by showing that an investigation was conducted, and defeat any claim for punitive damages.

Lastly, and most importantly, follow up with the complainant to let them know that you have conducted the investigation and what action, if any, will be taken as a result. Keep a written record of what you said to the complainant and when.

In addition, regardless of whether complaints of harassment and/or discrimination have been alleged, organizations and associations should consider implementing annual training on discrimination and harassment. The purpose of the training is to present employees on all levels with basic information about what constitutes harassment and discrimination. After an initial harassment and discrimination prevention training session, refresher courses should be given on an annual basis. This training can be done at minimal expense to the association or organization. Remember, the benefit of harassment and discrimination training is not only to create a work environment free of harassment and discrimination, but also to reduce the chance of legal action against the association or organization based upon a harassment and/or discrimination complaint. Regardless of the method of training provided, it is imperative that organizations and associations provide employees with access to informational resources on harassment and discrimination. These resources can be included in employee handbooks or kept in the Human Resources office.

Overall, these issues can be complicated, so always ask for advice from experienced counsel, if you are unsure or would like more information on harassment and discrimination training.