In a perfect world, social entrepreneurs would be immune from lawsuits and left free to pursue their worthy goals. Unfortunately, this is not the case. Nonprofits are subject to most of the same laws that apply to regular companies. Nonprofits are also highly visible organizations, which makes them targets for criticism, regulation, and lawsuits. This article summarizes 5 ways to protect yourself and your young nonprofit from legal liability so you can concentrate on the important business of helping others. It is not intended as legal advice and is not a substitute for consulting with a lawyer.
Protect Yourself With Corporate Armor
Imagine that you formed a little league baseball team in a rundown neighborhood. On your first game day, your star player hits a ball straight through Grumpy McMeanerson’s stained glass window. McMeanerson decides to sue, and all of your personal savings are suddenly at risk. Don’t you wish you could wear magical armor to protect you against such eventualities? This armor exists. All you need to do is register your non-profit as a corporation.
Although incorporation is not always necessary, it carries many benefits, the most important of which is limited liability. Limited liability simply means that you will not be held personally responsible for your nonprofit’s debts. If your nonprofit is sued and a judge or jury decides to award judgment to the person who brought the lawsuit, the corporation, and not you, will be responsible for paying.
Forming a corporation has many other benefits. Registering as a corporation allows you to solicit tax-deductible contributions, which makes you more attractive to donors. Incorporating your nonprofit will also allow you to apply for tax exemptions and for special mailing discounts.
Before you incorporate, consider what kind of organization you expect to be. Most nonprofits aspire to incorporate as 501(c)(3) organizations (public charities or private foundations). If you expect your organization to be involved in partisan political activities, such as hosting political debates, you cannot incorporate as a 501(c)(3), and should instead consider a forming a 501(c)(4), or “social welfare organization.” For more information about this, see Limits on Political Campaigning for 501(c)(3) Nonprofits.
Incorporation occurs at the state level. In order to incorporate, you must file a completed application with your Secretary of State or Secretary of Commerce. This application usually requires you to submit a mission statement, the names of your board members, names of your principal officers, your organization’s by-laws and a plan for dissolution. For more on how to incorporate, see How to Obtain 501(c)(3) Tax-Exempt Status for Your Nonprofit; Nonprofit Organization FAQ. You can find examples of bylaws and more help at The Foundation Center’s Website: http://foundationcenter.org/.
After you incorporate, and depending on your state or city of incorporation, you may need to register for the right solicit funds. Consult your local Secretary of Commerce to find out whether this is necessary for your organization.
Respect the Corporate Structure
Just as untended armor can rust and let you down in battle, so too the corporate structure, if not maintained, can fail you when you most need it. The rule is simple: State and Federal governments extend a great deal of benefits to corporations. They ask just one little thing in return: that you behave like one.
If you do not behave like a corporation, and you are taken to court, a judge can look beyond the corporate structure and make your personal funds vulnerable to judgment. This doctrine, called “piercing the corporate veil,” is one of the most litigated issues in corporate law, and could come back to bite you if you don’t maintain your corporate armor. If you remember nothing else, remember these two things:
- Do your corporate homework. This means holding regular board meetings and preparing minutes of these meetings, documenting corporate decisions, and maintaining a current version of your bylaws, articles of incorporation, and your IRS tax determination. Keep these documents in your corporate record book, in your main office. For more information, see Nonprofit Formation Documents: Articles of Incorporation, Bylaws, and Organizational Minutes.
- Obey the golden rule: No Commingling. A corporation must have its own separate accounts. Transactions related to a corporation’s business, such as salaries or donations, must flow to and from the corporation’s separate bank account. Do not, under any circumstance, mix your funds with the corporation’s. Do not withdraw money from your corporation’s accounts for personal use, even if you intend to pay it back. Commingling funds is powerful evidence that you did not respect the corporate structure.
Protect Your Workers; Protect Yourself
What do nonprofit and for-profit corporations have in common? Both are subject to Federal and State laws affecting employees. Failure to comply with these laws makes you vulnerable to lawsuits as well as State and Federal action, including fines. Federal laws you should know about in the early stages of your non profit are: the Americans with Disabilities Act (ADA), the Occupational Safety and Health Act (OSHA); and Title VII of the Civil Rights Act. The following is an overview of these laws. More information on Federal laws can be found at http://managementhelp.org.
OSHA applies to all employees, and has two commandments: 1) Keeping your workplace free from recognized hazards (that is, dangers you could spot or smell on a walk through your facilities); and 2) Compliance with OSHA regulations about Recordkeeping, Reporting a serious injury or death, Posting, and submitting to OSHA Inspection.
OSHA’s recordkeeping and posting rules differ depending on the number of employers you have, the type of work you do, and whether an injury has occurred in your workplace. For specific rules, please refer to Osha’s website at http://www.osha.gov/). As a first step, before you hire an employee, you must post an OSHA poster informing workers of their rights and obligations under the law. These are available free from OSHA’s website. For more information about OSHA’s recordkeeping requirements, see OSHA Compliance: Recordkeeping, Reporting, Posting, and Inspection Rules, and OSHA: Complying With Workplace Health and Safety Laws.
The ADA applies to organizations with 15 or more employees, and requires employers to provide disabled individuals with the same work benefits as other individuals. In other words, it generally prohibits discrimination in hiring, promotions, training, pay, and social activities. Exceptions to this rule may apply if extending these rights to the disabled individual would cause your organization undue hardship. Find out more at http://www.ada.gov/.
Title VII of the Civil Rights Act applies to employers with 15 or more employees, and prevents discrimination based on race, color, religion, sex, and national origin. There is a very limited allowance to discriminate based on religion, sex, or national origin if one of these qualifies as “a bona fide occupational qualification reasonably necessary to the normal operation of that particular enterprise.” For more information on Title VII, seek out the Equal Employment Opportunity Commission at http://www.eeoc.gov/.
In addition to Federal Laws, cities and states are allowed to have their own rules protecting employees. Some cities and states also prevent discrimination based on sexual orientation. Check with your local Secretary of Commerce to find out which laws apply more stringently in your state of incorporation.
Share Risk
Take a cue from Kindergarten and share. Only this time, share risk. If you are uncomfortable about the legality of a certain course of action, if your application to the IRS for 501(c)(3) tax-exempt status is denied, if you intend for your organization to be politically involved and are not sure how to register as a 501(c)(4), consult a lawyer. A lawyer will help you navigate the process of starting your nonprofit, and the fact that you sought legal help may help demonstrate your good faith.
Another way to reduce your risk of legal liability is to purchase insurance. The following are some of the more common types of insurance nonprofits buy, and their functions. Every insurance provider is different, so you should carefully read each policy to ascertain whether it provides adequate coverage for your organization’s work.
Workers’ Compensation: Protects your organization from lawsuits brought by injured employees. This insurance provides your employees injured on the job with compensation for medical care in exchange for their giving up their right to sue you. Almost all states, with the notable exception of Texas, require organizations to purchase workers’ compensation insurance. Some states, such as Wyoming, require workers’ compensation insurance only for workers engaged in hazardous activities. Contact your board of commerce to find out about the rules in your state of incorporation.
Director’s and Officer’s (D & O) Insurance: Protects Directors and Officers from lawsuits relating to wrongful termination or discrimination, and reduces the risk of personal loss if board members fail to promote the effectiveness of the organization. This insurance is limited by the good faith rule: it does not shield Directors and Officers from the consequences of willful misconduct.
Liability Insurance: Protects the nonprofit from law suits in the case of bodily injury or property damage to people outside the nonprofit.
Property Insurance: Covers loss of property or assets belonging to the organization.
Errors and Omissions (E & O) Insurance: Covers negligence and errors made by employees, and usually includes legal defense costs, court costs, and limited judgment costs.
Volunteer or Student Liability: This insurance covers injuries to volunteers and students, and may be particularly useful if you intend to hire a number of volunteers to work in potentially risky situations, such as community rebuilding projects.
For more information about insurance, see Insuring a Nonprofit Organization, by Donald A. Griesmann, Esq.
Make Friends With Similar Organizations
Establishing connections with other nonprofits formed in your area is an easy, free way to reduce risks and improve your organization’s reputation. Established nonprofits in your area know what you are going through: they’ve suffered the incorporation forms, worried about their workers, selected insurers, and chosen their board members. By forming a relationship with established organizations in your state, you can learn from their mistakes and profit from their wisdom.
These alliances will continue to serve you later on, once your organization is established. Funders like to see organizations working together, and working with a larger organization will increase your visibility, just like being the opening act for a famous band. You can search organizations in your neighborhood at http://www.idealist.org/.
