The Dangers of Incorporating Nonprofit Corporations
| Publication year | 1984 |
| Pages | 765 |
| Citation | Vol. 13 No. 5 Pg. 765 |
1984, May, Pg. 765. The Dangers of Incorporating Nonprofit Corporations
Lawyers accustomed to working with corporations for profit should be aware that several pitfalls exist when incorporating nonprofit corporations in Colorado. The Colorado Nonprofit Corporation Act ("CNCA"),(fn1) under which most nonprofit corporations are incorporated, gives much discretion to drafters of the incorporation documents. Since reference to the Colorado Corporation Code(fn2) is generally prohibited, the drafter of nonprofit corporation documents is not restricted by its strict provisions.
Although corporations for profit may indulge in practices forbidden to nonprofit corporations, the latter enjoy greater freedom in structuring their organizations. However, this freedom can be dangerous to unwary drafters. Perhaps the most serious danger lies in the tax consequences of incorporation---if tax-exempt status is sought, a multitude of representations and prohibitions must be inserted in the articles of incorporation.
This article highlights the dangers of incorporating nonprofit corporations unless the drafter inserts certain provisions in the articles of incorporation and is aware of the requirements for tax-exempt status. It also discusses the opportunities available for drafters to tailor each organization's bylaws and articles of incorporation to that organization's specific needs and purposes. In this respect, it is important for the drafter to take full advantage of the liberal nature of the CNCA.
The CNCA governs the birth, life and death of most charitable, fraternal, cultural and other nonprofit corporations organized and operating in Colorado.(fn3) Excepted from the CNCA's purview are entities organized under pre-1968 predecessors to the CNCA, including the Corporations Not-for-Profit Act and acts applying to religious, educational and benevolent societies and joint stock religious or benevolent associations, unless these entities elect to accept the CNCA provisions.(fn4) Labor unions, cooperative marketing associations and insurance companies may not take advantage of the CNCA and must be organized under other laws.(fn5) Finally, additional statutes may apply in tandem with the CNCA, depending upon the function of the proposed nonprofit corporation. For example, the Nonprofit Hospital, Medical-Surgical, and Health Service Corporation Act makes several additions and substitutions applying to nonprofit hospital and health service corporations.(fn6)
Provisions of other acts which are applied in tandem with the CNCA deal with such nonprofit organizations as telegraph companies, ditch and reservoir companies, flume and pipeline companies, water users' associations, toll road companies, bridge and ferry companies, cemetery companies, and church and religious societies.(fn7) The drafter should pay close attention to these supplementary provisions, for many of them mandate that additional representations, generally in the nature of territory and project descriptions, be inserted in the articles of incorporation. For example, the articles of a ditch and reservoir company must specify the source and point from which the water will be taken, the location of any proposed reservoir, the line of any proposed ditch or pipeline, and the use to which the water will be applied.(fn8)
A nonprofit corporation may be organized for any lawful purpose.(fn9) Indeed, an astonishingly wide spectrum of organizations may incorporate under the CNCA: condominium homeowners' associations, churches, medical research groups, hospitals, parochial schools, agricultural junior clubs, political campaigns, antique automobile clubs, civil rights organizations, and sports leagues are examples. Purposes may range from stamping out designated social evils to maintaining common areas of a residential complex. The only requisite is that the corporation not be exploited for direct monetary gain.(fn10)
No income or profit may be distributed to members, directors, or officers, except that income or profits may be distributed to a member that is another nonprofit corporation.(fn11) Reasonable compensation may be paid to officers, directors and members for services rendered, and the corporation may distribute assets to members upon dissolution or final liquidation, if permitted under the CNCA, the articles of incorporation and the bylaws. The corporation may also "confer benefits upon its members in conformity with its purposes."(fn12)
Except for water companies, nonprofit corporations may not have or issue stock or pay dividends.(fn13) They are also prohibited from making loans to directors and officers. Indeed, the penalty for making a forbidden loan is severe: any director or officer assenting to
or participating in a forbidden loan is liable to the corporation for the amount of the loan until it is repaid, even if the director or officer is not the borrower.(fn14) In many areas, however, nonprofit corporations may take liberties that would astonish lawyers used to traditional corporations for profit.
Unlike a corporation organized under the Corporation Code, a nonprofit corporation's name does not have to indicate the fact of incorporation. The words "corporation," "company," "incorporated," or "limited," or their abbreviations, are not a required part of a nonprofit corporation's name. The CNCA requires merely that the name not mislead anyone as to the purposes of the nonprofit corporation and that it not be similar to the name of any other corporation doing business in Colorado or any name reserved or registered under Colorado law. It also requires that the name be transliterated into English letters if it is a foreign name and, if the name consists of initials, it must have a space or period between the initials.(fn15)
The CNCA permits a wide choice of organizational structures in order to accommodate the limitless varieties of organizations incorporating under its provisions. For example, nonprofit corporations may have one or more classes of members or may elect not to have members at all. If the corporation elects not to have members, that fact must be noted in the articles or bylaws.(fn16)
The provisions regarding members are mostly optional, not obligatory, in tone. Members have such qualifications and rights as are set forth in the articles or bylaws.(fn17) They may have voting rights of any kind, or no voting rights, even on major issues such as merger or dissolution. If there is no provision on voting, each member is entitled to one vote, regardless of class, on each matter submitted to him.(fn18) This means that if the articles do not designate the subjects on which members may vote, the directors may decide which matters shall be submitted to a membership vote.
An annual meeting of members must be held "at such times as provided in the bylaws," but the failure to hold the meeting at the designated time does not work a forfeiture or dissolution of the corporation. Indeed, no penalty is...
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