Unincorporated Nonprofit Association: What It Is, The Benefits and The Disadvantages
Increasingly, I’ve seen articles about the innovative things happening in the social enterprise and nonprofit sectors; spin-off paradigms for funding, updated accountability standards and the creative application of missions. All of which run counter to the trending misconception that in order to facilitate change “new” things have to be created. When in reality, most of the tools already exist but deeper analysis, and a better understanding, is needed to implement them in out of the box ways. I’ve seen this come up with no other issue more than organization structure.
By way of example, there’s been an increasing defection from the traditional nonprofit model in favor of smaller, more agile and community centric organizations. For these organizations, their small size and specific scope probably warrants something different than the traditional corporate structure.
One current option is the unincorporated nonprofit association. What this is, some of its benefits and some of the drawbacks are discussed below. Note, as with most things I discuss the laws, benefits, and drawbacks will differ from state to state. For ease (actually my ease since I live here :/) I’ll primarily talk about associations as defined and regulated in Texas.
What Is It?
In Texas, an unincorporated nonprofit association is defined as, “a group of three or more members joined by mutual consent for a common, nonprofit purpose.” This definition is generally the same for other states that recognize the entity, with only the group changing (with it typically being two).
In Texas, as in most states, unincorporated associations are governed by a code. They are not, just by being created, tax-exempt but can file for federal tax exemption just like a corporation or LLC. As I mentioned above unincorporated associations are typically used where an organization doesn’t intend on maintaining large operations, will have a limited number of transactions and will not be processing or receiving alot of donations. An example of this may be a neighborhood audobon or booster club; where activities are fairly confined, the scope is small and the amount of donations received will be fairly limited.
It should be noted there are states that allow for unincorporated associations that do not have a charitable purpose.
Benefit: Fewer Formalities
The formalities associated with unincorporated associations are far fewer than those of nonprofit corporations; both in terms of start-up and operations. Unincorporated Associations may draft a formation agreement (such as Articles of Association and Bylaws) and file them with the state but both tend to be discretionary. This is unlike the corporation, where a certificate of formation must be drafted and filed with the state in order for the organization to be created. Also:
- The annual meetings and filings required of a corporation generally do no apply to unincorporated associations;
- A board doesn’t have to be maintained; and
- There aren’t strict requirements as to how meetings are held and when notices must be sent out.
Note the number of formalities for an unincorporated association change when it seeks federal tax exemption. Those rules and regulations require that exempt organization’s run more like a corporation, with most flexibility being lost.
Benefit: Protection and Separate Liability
Unincorporated associations are treated as a separate legal entity. This means they can sue or be sued, enter into contracts, hold real property, and most importantly, its officers, Directors and members (if applicable) aren’t personally responsible for its contractual debts or legal liabilities (note this largely depends on the facts, with there being exceptions for “bad behavior”.)
Disadvantage: Little Control
The flexibility of an unincorporated association can also work against it. For example, that formation documents don’t have to drafted or filed with the state, and a formal board isn’t required, makes policing mission hard. This lack of formality might also lead members to come and go at will, making legacy preservation and succession planning tougher with the possibility of mission creep more prevalent.
Also, unlike corporations, the statutes addressing unincorporated associations don’t specifically allow for perpetuity (i.e. that the organization will last forever) which makes it appear is if they are limited in time. For those founders that want to address a specific purpose, and ensure the organization sticks to that purpose for years to come, an unincorporated nonprofit association may not be the way to go.
Disadvantage: Questionable Statutory Protection
In lieu of the dramatic rise in litigation, and to encourage volunteerism, local and federal governments have enacted a sub-set of laws to protect volunteers. Commonly, these either shield volunteers from the civil liability of an organization or allow for officers and board members to be indemnified for costs associated with a law-suit against the organization (as an aside, indemnification is where the organization steps in and pays the costs incurred by a board member defending themselves in a lawsuit against the organization. You’ll often find language in by-laws addressing how the indemnity will work but statute’s generally provide a default base-line right). The problem is, these statutes tend to use language that ties these protections to corporations. Which means it is questionable as to whether such protections extend to unincorporated association’s as well. One way to protect against some of this, at least with regard to indemnity, would be for the organization to include the right in its formation documents. But even in that case, the way in which the provision might be interpreted is still a wildcard.
The codification of unincorporated associations in the U.S. is comparatively recent. Which means there is little to no case law on them, i.e. little direction on how the organization is supposed to conduct itself based on court cases. The impact of this is compounded if a state’s statutes aren’t very specific or comprehensive; the problem being these statutes are generally the last resort for guidance where an organization might have failed to address a concept in its policies or documentation. Members must also bear in mind that not every state recognizes unincorporated associations. So if an organization operates outside of the US, or in a state without a statute recognizing this type of structure, there may be issues with which state’s law applies to the organization, i.e. what rules apply, if litigation occurs. This can create a real problem where an organization operates based upon the understanding its states law’s will apply to it should problems arise. Directors and officers might also end up personally responsible for the debts and obligations of the organization as they would be treated more like a partnership.
Similarities Between Unincorporated Nonprofit Associations and Corporations
There are alot of similarities between corporations and unincorporated associations. For example, Texas statute requires that correct books and records be maintained by unincorporated associations much like a corporation. Its books and records are also subject to being audited by a governmental entity.
Also, as I mentioned before if an association is looking to gain its tax-exemption status then, for the purposes of exemption, it will be treated much like a corporation. That means things such as filing requirements, annual reporting, prohibitions against private inurement, lobbying, etc will be the same.
Bear in mind, if the foregoing has you thinking that an unincorporated association model might not fit that doesn’t necessarily mean that a corporation model is right. There are all types of other creative models (fiscal sponsorship) that exist or it may even be a matter of choosing another formation structure like an LLC.Posted by Erin | 3 comments