10 Most Common Bylaw Problems Facing Nonprofit Organizations (Part III)May 12, 2016 – Articles Nonprofit Roundup Blog
We have been counting down the most common bylaw problems facing nonprofit organizations. So far, we have discussed a number of problems ranging from the proper length of notice periods to an honorary board member's potential liability. For more on these problems and others, see our prior posts (Problems 10-8; Problems 7-4). Below are the top three most common bylaw problems we encounter.
3. Members – In the nonprofit world, members are akin to shareholders. But, in the IRS’ eyes, not every nonprofit organization should have “members” as that term is defined under state law. For example, the IRS has ruled that a nonprofit organization exempt from federal income tax under Code Section 501(c)(3) should only have members if such members are also nonprofit organizations. The IRS does not like to see individuals as members of Code Section 501(c)(3) nonprofit organizations because, under state law, such members control the nonprofit organization through various voting rights. As such, a nonprofit organization’s bylaws (and articles of incorporation) should clearly state whether the nonprofit organization has (i) members, as that term is defined under state law, (ii) merely dues-paying or associate members or (iii) no members at all. The differences between the types of members a nonprofit organization can have are subtle, but very important from both a state and federal law perspective. A Code Section 501(c)(3) nonprofit organization that has individual members may want to take steps to convert to a non-member, nonprofit organization under state law to avoid any issues with the IRS and to improve the efficiency of its internal governance.
2. Quorum Rules – It is extremely important to have clear rules on how the board can establish a quorum. Many nonprofit organizations have quorum requirements that are either lower than what is required under state law or that are too high and prevent the board from being able to easily conduct business. Generally, a quorum should be a majority of the directors then in office. Requiring a majority of directors to establish a quorum ensures that a fair representation of the nonprofit organization’s governing board is present for deliberations and voting on important business decisions.
1. Power to Bind – Often, a nonprofit organization’s bylaws simply state that the President shall have the power to execute checks, agreements and other documents on behalf of the nonprofit organization. Giving so much unchecked power to one individual is anything but a best practice. Instead, a nonprofit organization’s board of directors should take the time to create a detailed signatory and disbursement policy that sets forth who may bind the nonprofit organization, for how much and with what type of approval. Adopting a detailed signatory and disbursement policy will ensure that no one individual has authority to bind the nonprofit organization without first receiving proper approval.
In sum, problems with a nonprofit organization’s bylaws stem beyond the four corners of the page. The problems can affect board relations, an individual’s personal liability and even the validity of the nonprofit organization’s actions. For these reasons, it is important to conduct an annual review of your nonprofit organization’s bylaws to ensure they are comprehensive, clear, lawful and in line with best practices.