Thursday, August 3, 2017
Surprising Quirks of Texas Nonprofit Corporation Governing Documents
How do the governing documents (certificate of formation and bylaws) of a Texas nonprofit corporation differ from those of a Texas for-profit corporation?
Quite a bit, actually. Below is a non-exclusive list of ways in which the certificate of formation and bylaws of a Texas non-profit corporation often differ from those of a Texas for-profit corporation. Some of these differences may be surprising to those who more frequently deal with for-profit corporations.
1. Fewer restrictions on the name of a nonprofit corporation. Section 5.054 of the Texas Business Organizations Code (TBOC) requires that the name of a Texas for-profit corporation include the word “company, corporation, incorporated, or limited” or an abbreviation of one of those words, such as “Inc.” or “Co.” There is no such requirement for a Texas nonprofit corporation.
2. More restrictions on the purpose of a nonprofit corporation. Section 2.001 of the TBOC provides that a Texas for-profit corporation is generally permitted to have any lawful purpose. Section 2.003 of the TBOC restricts any Texas corporation (whether nonprofit or for-profit) from engaging in certain prohibited purposes, such as unlawful activities or operating as a bank, trust company, savings association, insurance company, cemetery association (with certain exceptions), or abstract or title company. Section 2.002 of the TBOC limits a nonprofit corporation to only one or more of the following purposes:
a. Serving charitable, benevolent, religious, eleemosynary, patriotic, civic, missionary, educational, scientific, social, fraternal, athletic, aesthetic, agricultural, or purposes;
b. Operating or managing a professional, commercial, or trade association or labor union;
c. Providing animal husbandry; or
d. Operating on a nonprofit cooperative basis for the benefit of its members.
Section 2.010 of the TBOC also restricts the permissible activities of a nonprofit corporation.
Moreover, a nonprofit corporation desiring status as an organization exempt from federal income tax under Section 501(c)(3) of the Internal Revenue Code (the Code) must comply with Section 501(c)(3) of the Code, which requires nonprofit corporations to be “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals.”
In its Instructions to Form 1023 (Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code), the Internal Revenue Service (IRS) suggests including the following language as the nonprofit corporation’s purpose to ensure compliance with the purpose requirement in Section 501(c)(3) of the Code: “The organization is organized exclusively for charitable, religious, educational, and scientific purposes under Section 501(c)(3) of the Internal Revenue Code, or corresponding section of any future federal tax code.”
3. May have no members or no board of directors. Every for-profit corporation has at least one shareholder and at least one director, but under Section 22.151(a) of the TBOC, a nonprofit corporation need not have any members – it may be managed exclusively by the nonprofit corporation’s board of directors. Alternatively, Section 22.202 of the TBOC provides that a nonprofit corporation may have no board and may instead be managed exclusively by its members. If the nonprofit corporation elects to have no members or no board of directors, Section 3.009(1) of the TBOC requires a statement to that effect in the nonprofit corporation’s certificate of formation.
4. Must have at least three directors. If a Texas nonprofit corporation elects to have a board of directors, it must name at least three people to serve as directors of the corporation under Section 22.204 of the TBOC. For-profit corporations are only required to have at least one director under Section 21.403 of the TBOC.
5. Action by written consent of less than all directors. Sections 6.201 and 21.415(b) of the TBOC permit the board of directors of a Texas for-profit corporation to take action by unanimous written consent in lieu of holding a formal meeting of the board, but only if the written consent is signed by all of the directors. On the other hand, Section 22.220 of the TBOC permits the board of a nonprofit corporation to take action by written consent signed by the number of directors necessary to take the action at a meeting in which all of the corporation’s directors are present (typically, a majority), if non-unanimous written consents are authorized in the nonprofit corporation’s certificate of formation or bylaws.
6. Board committees generally must have at least two members and only a majority of the committee need be directors. The board of a Texas for-profit corporation may establish a board committee composed of one or more directors under Section 21.416(a) of the TBOC. If a Texas nonprofit corporation wishes to establish a board committee, it must comply with Section 22.218(b) of the TBOC, which requires that the board committee consist of at least two persons. That Section permits persons who are not otherwise directors be named to the committee so long as at least a majority of the committee members are directors of the nonprofit corporation. A nonprofit corporation which is a religious institution may establish committees composed entirely of non-directors.
7. President and Secretary cannot be the same person. A Texas for-profit corporation is required to have a President and a Secretary under Sections 21.417 of the TBOC, but such offices may be held by the same person under Section 3.103(c) of the TBOC. Conversely, Section 22.231(a) of the TBOC requires that the offices of President and Secretary of a Texas nonprofit corporation be held by different persons.
8. Directors may vote by proxy. Section 22.215 of the TBOC permits a director of a Texas nonprofit corporation to permit someone else to vote on the director’s behalf by granting a proxy to the other person, if proxy voting is permitted by the nonprofit corporation’s certificate of formation or bylaws. There is no analogous provision applicable to Texas for-profit corporations. Directors of a for-profit corporation must vote for themselves - either in person, by written consent, or via electronic means, such as attending a meeting via teleconference.
9. Liquidating distributions for charitable purposes. A Texas for-profit corporation exists for the financial benefit of its shareholders, and after all of its creditors have been paid or reserved for, liquidating distributions from a for-profit corporation are to be made to the corporation’s shareholders under Section 11.053(c) of the TBOC. On the other hand, nonprofit corporations exist only for one or more of the non-profit purposes described above. Upon liquidation of a nonprofit corporation, Section 22.304(a)(2) of the TBOC generally requires that any assets of the nonprofit corporation remaining after all creditors have been paid must be paid to one or more 501(c)(3) organizations. For the nonprofit corporation itself to qualify as a 501(c)(3) organization, the nonprofit corporation must include a provision in its certificate of formation requiring that liquidating distributions will be made for charitable purposes.
The IRS’s Instructions to Form 1023 suggest the following language to meet the dissolution clause requirement in Section 501(c)(3) of the Code: “Upon the dissolution of this organization, assets shall be distributed for one or more exempt purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code, or corresponding section of any future federal tax code, or shall be distributed to the federal government, or to a state or local government, for a public purpose.”