Policing Charitable Organizations: Whose Responsibility Is It?

• Author: Maxwell B. Kallenberger
• Position: J.D./D.C.L., 2016, Paul M. Hebert Law Center, Louisiana State University.
• Pages: 661-689

Policing Charitable Organizations: Whose Responsibility Is It? TABLE OF CONTENTS Introduction .................................................................................. 662 I. The Charitable Landscape of Louisiana ....................................... 663 A. The Charitable Distinction ..................................................... 663 B. How is a Charity Formed? ..................................................... 664 C. Distinguishing For-Profits from Charities ............................. 665 D. Roles of Charitable Officers and Directors ............................ 666 E. Fiduciary Obligations of Charity Directors ............................ 666 1. The Duty of Care ............................................................. 667 2. The Duty of Loyalty ........................................................ 668 II. Overview and Analysis of the Current Charitable Enforcement Model ...................................................................... 669 A. The Need for Proper Oversight in the Charitable Sector ....... 669 B. Director and Organization Accountability in Different Business Sectors ..................................................................... 670 C. Charitable Enforcement through the State Attorney General .................................................................... 672 D. Regulation of Charities through the IRS ................................ 673 E. Watchdog Oversight of the Charitable Sector........................ 675 F. Charitable Enforcement in Louisiana ..................................... 675 G. Limitations and Restrictions on the State Attorney General’s Oversight in the Charitable Sector ......................... 676 H. Standing to Sue in the Charitable Arena ................................ 678 III. Scholarly Proposals for Improvement to Oversight ..................... 679 A. New State Agency .................................................................. 679 B. State Charity Commission Working in Conjunction with the State Attorney General ............................................. 680 C. Federal Regulatory Commission ............................................ 681 D. Exclusive Regulation by the IRS ........................................... 682 E. Expanding Standing in Charitable Director Suits .................. 683 F. Self-Regulatory Organization ................................................ 684 IV. Proposal for a State Self-Regulatory Nonprofit Organization ..... 685 A. The LCRO’s Structure, Responsibilities, and Model for Enforcement ..................................................................... 685 B. The Necessity of a Self-Funded Model .................................. 686 662 LOUISIANA LAW REVIEW [Vol. 76 C. The Benefits of a New System of Oversight .......................... 687 D. LCRO Problems to Consider ................................................. 687 Conclusion .................................................................................... 689 INTRODUCTION The director of a small charity faces a tough predicament. He needs money for growing medical expenses. He knows he can quietly dip into his charity’s funds to meet these mounting obligations. However, the question he is most concerned about is: Will anyone notice if funds are missing? Traditionally, the state attorney general’s office has been responsible for overseeing a state’s charitable sector and ensuring directors’ compliance with fiduciary standards. 1 Scholars have long criticized the current charitable oversight system. 2 Louisiana is no exception. In Louisiana, no decisions have been reported of the attorney general bringing suit against a charitable director for violating good governance standards. In fact, even when parties other than the attorney general challenge a charitable organization’s operations, courts have passed on the opportunity to decide cases using laws relating to nonprofit organizations, choosing instead to decide the cases using contract law. 3 Despite many calls for change in the enforcement model for charitable oversight, 4 states have left the authority to police charities with the respective state attorney general’s office. 5 Many commentators believe that state attorney general offices are understaffed and underfinanced, and this lack of resources prevents them from holding directors accountable for violating their fiduciary responsibilities. 6 Given the challenges facing the current system of enforcement, these same scholars have suggested a Copyright 2015, by MAXWELL B. KALLENBERGER. 1. Thomas Lee Hazen & Lisa Love Hazen, Punctilios and Nonprofit Corporate Governance—A Comprehensive Look at Nonprofit Directors’ Fiduciary Duties , 14 U. PA. J. BUS. L. 347, 403 (2012). 2. See infra Part III. 3. See, e.g. , New Orleans Opera Ass’n, Inc. v. S. Reg’l Opera Endowment Fund, 993 So. 2d 791, 799 (La. Ct. App. 2008) (deciding the case on contract law rather than nonprofit law when a charitable trust was accused of misappropriating assets). 4. See infra Part III. 5. See, e.g. , CAL. CORP. CODE §§ 5142(a)(5), 5250, 6511 (West 2014); N.Y. NOT-FOR-PROFIT CORP. LAW § 112 (Mckinney 2014); REVISED MODEL NONPROFIT CORP. ACT §§ 1.70, 3.04(b)–(c), 8.10 (a), 14.03–.04 (3d ed. 2008). 6. James J. Fishman, Improving Charitable Accountability , 62 MD. L. REV. 218, 262–63 (2003). 2015] COMMENT 663 variety of new models that are a better fit to enforce charitable fiduciary standards. 7 This Comment proposes a self-funded state regulatory organization that is responsible for charitable oversight and regulation within Louisiana, replacing the current regulatory system under the attorney general’s office. No perfect model or answer exists to the problem of properly regulating the charitable sector; however, this self-funded organization would help ensure proper regulation of Louisiana’s charitable sector and place authority in a dedicated enforcement body, whose only task would consist of overseeing charities. Part I of this Comment provides an overview of charitable organizations and director fiduciary standards. Part II explains the current model of enforcement and the problems with the system. Part III discusses various scholarly proposals for new models of enforcement. And finally, Part IV explains why a self-funded regulatory organization best ensures proper oversight of charities and their directors. I. THE CHARITABLE LANDSCAPE OF LOUISIANA The provisions governing charitable organizations operating in Louisiana are placed in Titles 12 and 51 of the Louisiana Revised Statutes. 8 State law governs the organization and regulation of charities, and many states enact such laws to regulate charitable organizations. 9 Similar to statutes governing for-profit corporations, 10 these regulations are necessary for charitable organizations seeking to operate legally in Louisiana. 11 A. The Charitable Distinction An important distinction exists between a nonprofit organization and a charity. The term “nonprofit” is a state law organizational concept, making an organization eligible for certain state law tax benefits. 12 If an 7. See infra Part III. 8. LA. REV. STAT. ANN. §§ 12:201 to :275 (2010); LA. REV. STAT. ANN § 51 (2003, 2012, & Supp. 2015). 9. See Fishman, supra note 6, at 222; see also N.Y. NOT-FOR-PROFIT CORP. LAW § 35; CAL. CORP. CODE §§ 5001–10845. 10. See LA. REV. STAT. ANN. §§ 12:1-101 to 1-1704 (containing Louisiana’s Business Corporation statutes) (Supp. 2015). 11. See LA. REV. STAT. ANN § 12:203 (setting forth the requirements to form a nonprofit corporation in Louisiana). 12. Applying for Exemption – Difference Between Nonprofit and Tax-Exempt Status , IRS, http://www.irs.gov/Charities-&-Non-Profits/Applying-for-Exemption-Difference-Between-Nonprofit-and-Tax-Exempt-Status [http://perma.cc/CBY3-SU SM] (last updated Mar. 4, 2015). 664 LOUISIANA LAW REVIEW [Vol. 76 organization forms as a nonprofit at the state level, it will not automatically receive federal tax exemption status. 13 The Internal Revenue Service (“IRS”) is responsible for granting tax-exemption status through a set of requirements that an applying organization must meet. 14 Whereas a nonprofit is a state law status, the classification of “charity” is based on the IRS’s determination that a nonprofit meets specific requirements for tax-exemption. 15 Section 501(c)(3) of the Internal Revenue Code states that an organization formed and operated for a charitable purpose will automatically receive tax-exemption from the IRS. 16 Additionally, the organization cannot benefit private interests, and net earnings of the organization cannot benefit private individuals. 17 B. How is a Charity Formed? Generally, a charity will form under its state’s nonprofit corporation act, making it a specific type of nonprofit. 18 Charities may also form as charitable trusts. 19 Charitable organizations formed as neither trusts nor corporations are rare, and the law that applies to those types of organizations is vague and ambiguous, blurring the line of whether they truly fall under the definition of a charity. 20 In a similar fashion, the law that applies to charitable organizations is also poorly defined and has developed slowly in comparison to for-profit corporation law. 21 13. Id. 14. Id. 15. See Types of Tax-Exempt Organizations , IRS, http://www.irs.gov/Charities-&-Non-Profits/Types-of-Tax-Exempt-Organizations [http://perma.cc/7M76-QV4A] (last updated Jan. 15, 2015). 16. I.R.C. § 501(c)(3) (2012). A complete overview and analysis of the tax-exempt determination process is beyond the scope of this Comment. For an overview of this process, see Karen Donnelly, Comment, Good Governance: Has the IRS Usurped the Business Judgment of Tax-Exempt Organizations in the Name of Transparency and Accountability? , 79 UMKC L. REV. 163, 169–72 (2010). 17. Exemption Requirements – 501(c)(3) Organizations , IRS, http://www.irs.gov...