December 2010 Board Talking Points: Furloughs: A Tool for Managing Personnel Expenses Furloughs are being used as a way to reduce salary costs without having to lay off employees or institute salary reductions. For example, to save money some organizations are closing their offices and furloughing their employees during the week between Christmas and New Years. When planning a furlough there are legal issues to consider, particularly with respect to exempt employees. 1 Questions: 1. What is a furlough? 2. Must all employees be furloughed or can only a segment of the workforce be subject to a furlough? 3. Are there special concerns when furloughing exempt employees? 4. Does advance notice of a furlough need to be given? 5. Will a furlough effect employee benefits? Answers: 1. What is a furlough? A furlough is an unpaid leave of absence during a defined, temporary period of time and can be voluntary or mandatory. Furloughs may be taken in full weeks, or on one or more days per week. An alternative to furloughs would be salary reductions but furloughs may be preferred because employees are given time off and base salaries are preserved so when economic conditions improve compensation levels are maintained. 2. Must all employees be furloughed or can only a segment of the workforce be subject to a furlough? It is possible to furlough only a portion of employees. As with selecting employees for a layoff, make sure that there is a sound business reason for choosing the departments and individual employees subject to the furlough. For example, if funding for one program is reduced, the decision might be made to furlough all the employees working in that program while the rest of the staff remains unaffected. Employees who believe they were chosen to participate in a selective furlough for discriminatory reasons may have a cause of action. Therefore, it is important to effectively communicate with staff about the reasons for the furlough and its implementation. 1 For purposes of this discussion, it is assumed that all employees are employees at will and not covered by a collective bargaining agreement or employment contract. If employees are covered by a collective bargaining agreement or employment contract that agreement must be reviewed when planning a furlough.
3. Are there special concerns when furloughing exempt employees? Federal and state laws impose mandatory minimum wage requirements and overtime requirements for most employees. Certain categories of employees are considered exempt from overtime requirements including executive staff and professionals. As long nonexempt hourly employees are continued to be paid their hourly wage (which must meet or exceed the minimum hourly wage) for the hours worked an employer can reduce an employee s hours at its discretion. Consider applying for the New York State Shared Work Program, which provides for partial unemployment insurance for full-time employees whose weekly hours have been reduced. 1 Reducing the hours and wages of salaried exempt employees, however, creates a more complicated situation. This is because under the Fair Labor Standards Act ( FLSA ), an exempt salaried employee must receive the same amount of compensation regardless of the amount of hours they work. This requirement is commonly known as the salary-basis test. To put it another way, an exempt employee s salary is not subject to reduction because of variation in the number of hours worked or in the quantity or quality of work performed during the pay period. This means that if an exempt employee performs any work - no matter how little - during the workweek, the full salary must be paid. Exempt employees can be furloughed without pay in week-long increments (for instance, one week per month for the next four months) without running afoul of the salary-basis test. 2 As long the employee performs no work for an entire week, there is no legal obligation to pay the employee for that week. During the furlough period, however, the performance of even a minimum amount of work, such as checking emails or receiving phone calls, could require payment of the employee s full weekly salary. For this reason it is critical to ensure that furloughed employees are not performing any work during the furlough period. At a minimum, employees should sign a statement that they will perform no work while on furlough. You should also consider disallowing email access or taking possession of company laptops or cell phones. Organizations may also be able to reduce an exempt employee s salary on a weekly basis if the salary reduction reflects a reduction in the normal scheduled work week. An example would be to reduce the employee s normally scheduled work week from 40-hours per week to 35-hours per week, and correspondingly reducing their salary by 12.5%. In order to maintain the employee s exempt status, the weekly salary cannot be reduced below $536.10. US Department of Labor regulations provide that making deductions from an exempt employee s salary due absences caused by the employer or by the employer s fluctuating business needs flunks the salary basis test. For this reason, the reduction in hours and wages should be made prospectively only, and should be made on a long-term basis. Frequently changing an employee s work schedule may result in a denial of exempt status. 1 For more information, see http://www.labor.state.ny.us/ui/dande/sharedwork1.shtm. 2 This is the least risky way of furloughing exempt employees, but will preclude exempt employees from participating in a Shared Work program, which requires that hours be reduced on a weekly basis by no more than 60%. Affected employees may still qualify for regular unemployment benefits for the week in which they are furloughed.
4. Does advance notice of a furlough need to be given? To best manage employee relations in a difficult situation, advance notice of the furlough should be given. Organizations that employ 50 or more people should consult with Lawyers Alliance attorneys well in advance of imposing mandatory furloughs or layoffs in order to determine if the federal and New York State Worker Adjustment and Retraining Notification Acts ( WARN Acts ) apply. Failing to comply with the WARN Acts can expose your organization to liability for back wages and lost benefits, as well as civil penalties. The federal and state WARN Acts require covered employers to give s written notice if at least 25 employees will experience certain types of employment losses, including a reduction in hours of more than 50% for each month of a six-month period or a layoff lasting more than six months. The state law requires 90 days written notice. 3 Notice must also be given to the affected employees representatives, the Department of Labor, and the Local Workforce Investment Board. The New York State WARN Act does not apply if the furlough or reduction in hours is carried out as part of a Shared Work plan through the NY Department of Labor, in which the employees receive unemployment benefits to partially compensate for their reduced wages. However, be aware that the WARN Act will apply if the wage reductions persist after the Shared Work program ends. There is also a limited exception to the notice requirement for unforeseeable business circumstances. An unforeseeable circumstance must have been not reasonably foreseeable when the ninety-day notice would have been required your organization s major funding source collapses suddenly and without warning, for instance. Even in these cases, however, employers are still required to provide as much notice as practicable. 5. Will a furlough affect employee benefits? Many employers benefits plans cover only full-time employees. For these organizations, reducing an employee s hours to less than full-time (e.g. 4/5ths FTE) will trigger a loss of benefits. To avoid this, you may consider amending the plans to include part-time employees. Loss of group health insurance due to a reduction in hours is considered a qualifying event under the Consolidated Omnibus Budget Reconciliation Act ( COBRA ), requiring affected employees to receive notice of their right to elect continuation coverage. Remember that employers participating in the New York State Shared Work Program may not reduce employee benefits. You should also review the effect that a reduction in hours may have on an employee s participation in other welfare plans, as well as your pension plan. Review your 3 The federal law, which covers employers with at least 100 employees, requires only 60 days written notice. However, employers must comply with the most stringent requirements of both statutes.
employment policies, such as vacation, to see whether a reduction in hours will affect employees on furlough. Contact Lawyers Alliance to speak with an attorney regarding your options and to ensure you meet all your legal obligations. This alert is meant to provide general information only, not legal advice. Please contact Judith Moldover at Lawyers Alliance for New York at (212) 219-1800 x 250 or visit our website www.lawyersalliance.org for further information.
Board Talking Point: Watching the Dollars A fundamental and critical responsibility of a nonprofit Board of Directors is to monitor the corporation s financial health. Many board members may feel they lack the expertise needed to effectively monitor finances and are not sure where to begin. However, Board members must overcome this fear and actively review financial information on a regular basis. Because each nonprofit organization has different funding streams and expenses, faces different financial issues and has different resources for financial management, each organization will choose a slightly different set of regular financial reports to prepare and analyze. And, over time as the organization s financial condition changes, the reports requested and reviewed will change. Questions: 1. What documents should the Board review regularly? 2. Should the Board review different documents or review documents more frequently when the organization s financial health is uncertain? 3. Who prepares the financial reports and who reviews them? 4. Is a nonprofit corporation required to have an audit or finance committee? What do these committees do? Answers: 1. What financial documents should the Board review regularly? The answer will depend on several factors, including the extent to which the organization is financially stable, the degree and extent to which the financial picture changes during the period, the availability of cash to meet financial obligations, the availability of staff or other professionals to prepare reports, etc. When designing your financial reporting schedule, consider including the following reports: Key Reports Whether your Board meets monthly or quarterly, below are some of the most important reports to consider. If your board does meet quarterly, these same reports should be reviewed monthly by fiscal staff, the Executive Director, and Treasurer. At minimum even small nonprofits should generate a Balance Sheet and Budget Variance Report every month. In addition, the Board should be actively involved in developing and should approve the organization s annual budget. Statement of Position (Balance Sheet) shows what the organizations owns (assets) and what it owes (liabilities) and if it has more assets than liabilities (net assets). This will help answer: What is our financial health? Can we pay our bills? What resources do we have in the short, medium, and long term?
Statement of Activities (consolidated) showing budget to actual information (often called the Budget Variance Report). This will help answer: What has been our overall financial performance this month and to date? How are we doing against our budgeted projections? What s the reason or back story behind the larger variances (the differences between the budgeted and actual expenses?) Departmental Income and Expense Statement showing budget to actual information. Having income and expense information by department (including individual programs) or cost center is critical to getting a full understanding of the organization s financial health. This report will help answer: How are the programs and other cost centers performing? How are the pieces faring in addition to the whole? Is specific action called for, such as limiting expenses in certain areas or programs? If the organization has government funding, are there modifications that should be made to contract budgets? Should changes to foundation grant budgets be requested? Cash flow projections. Unless your organization has substantial reserves (a year or more of operating expenses in the bank), it is advisable to maintain cash flow projections for your fiscal year. This is especially critical for small organizations, groups struggling with financial uncertainty, and/or organizations with a significant percentage of government funding. Here the focus is strictly on actual cash coming into and leaving the organization. This report will help answer: At what points in the year will we most need cash? At what points in the year are we on steadier footing? Is it necessary to seek short term loans or take other steps (cut costs, for example) to manage cash flow? An executive summary of financial highlights, analysis, and concerns. This will help answer: Have there been any recent financial highlights? What are the key trends? Has the organization received any important grants? What key expenses were incurred? What are the explanations for key budget variances? Additional Reports Depending on your organization, you may also consider the following supplemental reports (likely on a quarterly basis): Fundraising Update (showing actuals vs. projections for donations and status reports on all foundation proposals). This will help answer: Are fundraising results on track? Are our cash flow projections for the next six months and beyond -- accurate?
Payroll tax reports Most Boards need not review payroll tax reports, but it is helpful to know that these important quarterly reports have been filed especially if the organization is administering payroll on its own. This will help answer: Have payroll tax reports been submitted on time and tax deposits been made? Fee-for-service report showing number of fee-paying clients and revenue against projections. The need for this report will depend on how big a part of your organization s revenue mix earned income is. If your organization depends significantly on Medicaid billings or some other source of earned income, this is a helpful supplemental report. This will help answer: Are we servicing approximately the same number and type of clients as we had anticipated? If not, what action or change is appropriate? How well are we collecting fees from clients? Do we need to improve or tighten up our collection procedures? Annual Reports Form 990 and CHAR 500. These are federal and state reporting forms that must be filed annually. This will help answer: Has the organization fulfilled its reporting responsibilities to federal and state governments? Has the organization engaged in any interested party transactions that should be reviewed by the Board? Audited financial statements for year. Statement of Activities, Statement of Position, Income Statement for each program. Aggregated financial statements with narrative showing key trends. This should help answer: What was our financial performance over the past year? How does it compare to the previous year? In what ways and for what reasons was performance different from the budget? What financial implications must be taken into account when planning the upcoming year? Can we satisfy our financial reporting requirements to funders? Management letter from the auditor. This should help answer: What changes should we implement related to the financial systems, internal controls, and financial planning? 2. Should the Board review different documents or review documents more frequently when the organization s financial health is uncertain? The Board of Directors must always take an active role in monitoring the organization s financial health. This is even truer during times of financial uncertainty. If the Board currently meets quarterly it would be appropriate to schedule monthly Board meeting to review financials or delegate that authority to a committee of the Board. These meetings can take place by conference call unless prohibited by the corporation s bylaws or certificate of incorporation. NPCL 708(c). Even if the Board does not formally meet monthly, the person overseeing the finances can circulate key financial reports such as the Balance Sheet, Budget Variance Report, and Cash Flow Projections. If the crisis is severe, the Board or a smaller group of board members (empowered by the full board) should schedule ongoing emergency meetings in between regular meetings. If the organization has a standing finance committee, it is natural to turn to this group for this purpose. This group can provide weekly or even daily assistance to the staff.
The Board should work closely with the organization s staff to determine what reports would be most informative and relatively easy to prepare. Some key reports to consider if your organization is struggling financially include: Cash flow projections. See above description. In times of financial crisis or uncertainly, this may be the most important report. Consider weekly cash flow projections if the staff or board are making cash-related decisions on a frequent basis (what bills to pay, for example). Accounts Receivables (AR) Aging Report. This report which shows what money is owed to you and how long it has been outstanding can be critical when an organization is faced with cash flow problems. It helps focus staff and board in their efforts to bring in funds. After reviewing the AR Aging Report, for example, a Board member may decide to call a donor about the status of a pledge, or staff may double up their follow-up efforts with a government funder behind on reimbursement. Accounts Payables (AP) Aging Report. This report shows which of the organization s bills are outstanding and for how long. When being in the unenviable position of choosing which bills to pay, this report provides important information. 3. Who prepares the financial reports and who should review them? In a small nonprofit the Board Treasurer or outside accountant/bookkeeper might work with the Executive Director to prepare the financial information for all in-house financial statements and the narrative with financial highlights to be presented to the Board. A Controller or Finance Director would prepare these reports in a larger organization. The Program Director, if you have one, would ordinarily prepare the quarterly feefor-service report. Similarly, the Director of Development would prepare the quarterly fundraising report. The Executive Director reviews all reports prior to presenting them to Board members to ensure that the financial information makes sense and can be translated into issues and opportunities facing the organization. In addition, key staff members such as program directors and the director of development should have the opportunity to review income and expense reports for the whole organization in addition to income and expense reports for their respective functions. The audit and management letter are addressed directly to the Board of Directors because of its oversight function. Typically, the auditor works with the finance staff to prepare federal and state reports and may be included at board meetings during which presentations are given. In order for a Board member to fulfill their fiduciary obligation to the corporation they must satisfy the duty of care. This means that Board members must act in good faith and use their common sense in reviewing the corporation s operations. Proper fiscal oversight is among the Board s most important functions. This means that Board members must attend meetings, must review the documents provide to them and must ask questions. To the extent that Board members do not feel comfortable reviewing financial documents and asking questions they need to seek out additional training. This can provided by an outside source or by a board colleague. 4. Is a nonprofit corporation required to have an audit or finance committee? What is the role of these committees?
New York nonprofits corporations are not required to have finance or audit committees. There are, however, situations in which having a finance or audit committee will make it easier for Board members to review reports in greater detail then the full Board is able too. 1 If a corporation wants to form a committee it should first review its bylaws and certificate of incorporation to see if the board is authorized to form a committee. NPCL 712(a). Finance and audit committees will be considered standing committees and must consist of three or more board members. Id. Finance Committee The finance committee is usually charged with overseeing the fiscal health of the organization including actively reviewing financial reports, developing fiscal policies and procedures and overseeing the budgeting process. Recruiting a finance committee can be difficult because few Board members believe they have the fiscal skills to perform the function. However, especially with larger boards where detailed discussions can be challenging, the finance committee serves an important function. Having a finance committee enables a smaller, dedicated group of Board members to review the financial reports in greater detail than the full board. To help the Board fulfill its oversight function, it is important for the Executive Director and the finance committee to present regular reports to the entire board in as clear and concise a manner as possible. These reports should include the financial reports given to the committee and there should be an opportunity for the Board to discuss the reports. Audit Committee The function of the audit committee is primarily to select the outside auditors, to meet with them at least once a year upon completion of the audit and to oversee any changes to financial procedure recommended by the auditors. The Treasurer will not usually chair the audit committee although they will be a member of the committee because, at least in part, the auditors are reviewing the work of the Treasurer. 2 About Community Resource Exchange For over 30 years, Community Resource Exchange (CRE) has worked to create a more just, equitable and livable city for all New Yorkers. We provide strategic advice and technical services every year to more than 300 community-based nonprofit organizations confronting social issues such as poverty and HIV/AIDs in low and moderate income neighborhoods. As one of the most established nonprofit management consulting providers of its kind, CRE provides its clients with information, guidance, resources for nonprofits, skill building and leadership training for Community Based Organizations to make New York City stronger - one community group at a time. For more information please contact: Lawyers Alliance: Linda Manley, Legal Director, at (212) 219-1800 ext. 239, or firstname.lastname@example.org. For information on CRE s financial management services, contact Louisa Hackett, Managing Director, at email@example.com or 212-894-3372 or Jeff Ballow, Senior Consultant, at firstname.lastname@example.org or 212-894-8047. 1 For more information on the role of the finance and audit committees and the role they play in corporate governance see Final Report from the Panel on the Nonprofit Sector http://www.nonprofitpanel.org/report/final/panel_final_report.pdf. 2 For information on the function of the audit committee and internal financial controls, see Internal Controls & Financial Accountability for Not-for-Profit Boards http://www.charitiesnys.com/pdfs/internal%20controls%20-%20final%20- %20Small%20Type.pdf.
Updated October 2010 Board Talking Points: Tapping Cash Reserves (Updated) As organizations struggle to fill funding gaps, they will be tempted to tap cash reserves to meet ongoing expenses. As long as those funds are unrestricted, it is within the discretion of the board to decide how to spend the corporation's cash reserves. When, however, a donor has given a restricted gift, the organization is bound to honor that restriction. Below are some questions a board should consider when deciding whether or not to tap cash reserves to fund ongoing expenses: 1. Does the organization have any assets that are restricted? 2. Are the funds part of an endowment fund? 3. Can a portion of the endowment fund, other then principal, be withdrawn to fund ongoing expenses? 4. Can we borrow money from the endowment fund? 5. What do we have to do if the value of the endowment fund falls below historic dollar value because of investment losses? Answers: 1. Does the organization have any assets that are restricted? A restricted asset is an asset that a donor directs to be used for a specific purpose. The gift restriction can be contained in the gift instrument, e.g. a letter, or the restriction could be implied from the organization's fundraising material. For example, the invitation to Do Right's annual fundraiser states, "all proceeds will benefit Do Right's scholarship program." In this instance, the profit from the fundraiser would be considered an asset restricted to benefit the scholarship program and could not be diverted to support Do Right's other charitable activities. If the invitation stated, "all proceeds will support Do Right's activities, including its scholarship program" the proceeds would not be restricted. A not for profit corporation's board of directors cannot use a restricted donation for a purpose other than for which the gift was received without the consent of either the donor or court approval. NPCL 513(b). A court may lift the restriction when it finds the restriction to be
"obsolete, inappropriate or impractical." NPCL 522(b) & 555(b). Restricted assets must be separately accounted for and the treasurer must make an annual report to the board regarding the use of restricted assets and any related income. NPCL 513(c). Therefore, any restricted assets should be identified in the organization's audited financial statements. 2. Are the funds part of an endowment fund? Assets that are restricted are not necessarily part of an endowment fund. An endowment fund is a fund that "is not wholly expendable by the corporation on a current basis under the specific terms of all applicable gift instruments." NPCL 102(a)(13). For gifts made prior to September 17, 2010, unless otherwise specified, donors intend their gift to the endowment fund will be invested and that any return on this investment will be available to the organization to spend on current program operations. NPCL 513(c). For gifts made after September 17, 2010, expenditures from endowment funds are governed by a standard of prudence explained below. Funds that the board has set aside in a "board restricted account" are not considered to be an endowment or restricted from an accounting perspective because the board has the authority to lift the restriction, as it had the authority to institute the restriction. Bjorlund et. al, New York Nonprofit Law and Practice, Lexis Nexis 2007 at 5-23. 3. Can a portion of the endowment fund be withdrawn to fund ongoing expenses? There are circumstances under which a board can expend a portion of endowment funds to cover ongoing costs. Effective September 17, 2010, New York enacted the New York Prudent Management of Institutional Funds Act (NYPMIFA) relating to the investment of funds and the expenditure of endowment funds. Under NYPMIFA, subject to donor intent, an organization can expended endowment funds if the board determines in good faith that the expenditure is prudent and consistent with the purpose for which the endowment fund was created. In making this determination, the Board should consider eight (8) factors: 1. Duration and preservation of the endowment fund; 2. The purposes of the institution and endowment fund; 3. General economic conditions; 4. The possible effect of inflation or deflation; 5. The expected total return from income and the appreciation of investments; 6. Other resources of the institution; 7. Where appropriate and circumstances would otherwise warrant, alternatives to expenditure of the endowment fund, giving due consideration to the effect such alternatives may have on the institution; and 8. The investment policy of the institution. NPCL 553(a). Every time a board authorizes expenditure from an endowment fund it needs to make a record (such as including the discussion in board minutes) describing the consideration given to each factor. Id.
For gifts made after September 17, 2010, an expenditure of more than seven (7) percent of the fair market value of the endowment fund within one (1) year will be presumed to be unwise or imprudent. This is called the rebuttable presumption of imprudence. Fair market value of the endowment fund is calculated on the basis of market value determined at least quarterly and averaged over a period of at least five years immediately preceding the year in which the appropriation for expenditure is made. NPCL 533(d). An expenditure of less then seven (7) percent within one year will not automatically be considered wise or prudent. NPCL 533(d)(2). If a nonprofit organization wants to apply the NYPMIFA expenditure rules to endowment funds received prior to September 17, 2010, it must provide donors with ninety (90) days written notice to the donor, if available, prior to withdrawing money from the endowment fund for the first time under the new standards. NPCL 553(e)(1). The donor has the option of requiring the organization to apply the prior law to their gift rather than NYPMIFA. A donor is available if the donor is: (i) a natural person and is living; or (ii) if not a natural person (e.g. a corporation or foundation) is in existence and conducting activities; and (iii) can be identified and located with reasonable efforts. NPCL 551(j). The notice must include a form to be used by the donor and must contain the following language: Attention Donor: Please check Box #1 or #2 below and return to the address shown above. #1 The institution may spend as much of my gift as may be prudent. #2 The institution may not spend below the original dollar value of my gift. If you check Box #1 above, the institution may spend as much of your endowment gift (including all or part of the original value of your gift) as may be prudent under the criteria set forth in Article 5-A of the Not-for-Profit Corporation Law (the Prudent Management of Funds Act). If you check Box #2 above, the institution may not spend below the original dollar value of your endowment gift but may spend the income and appreciation over the original dollar value if it is prudent to do so. The criteria for expenditure of endowment funds set forth in Article 5-A of the Not-for-Profit Corporation Law (the Prudent Management of Funds Act) will not apply to your gift. NPCL 553(e)(1). There are limited circumstances under which it is not necessary to give a donor notice prior to applying NYPMIFA. NPCL 553(e)(2). 4. Can we borrow money from the endowment fund? NYPMIFA does not directly address the question of whether or not funds can be borrowed from an endowment fund as opposed to being spent from an endowment fund. However,
borrowing funds could be considered an appropriation of the endowment fund and, therefore, the Board of Directors should follow the same steps as it would when approving an expenditure of endowment funds. NPCL 553(a). If an endowment fund s operation is governed by the prior law, a board could decide that it is prudent to borrow money from its endowment fund that will be repaid over time when the value of the fund is above its historic dollar value. NPCL 717(a). If, however, an invasion of the endowment fund would cause its value to fall below its historic dollar value that could be considered a breach of the directors and officers duty of care. Id. 5. What do we have to do if the value of the endowment fund falls below historic dollar value because of investment losses? NYPIMFA eliminates the need to be concerned about historic dollar value and instead places focus on whether an expenditure of endowment funds is prudent. If, however, the endowment fund continues to be governed by the prior law, the New York State Attorney General's office has concluded that a board cannot withdraw net appreciation from an endowment fund when that fund is at or below historic dollar value. A GUIDE FOR NEW YORK NOT-FOR-PROFIT CORPORATIONS CONSIDERING EXPENDITURE OF ENDOWMENT OR OTHER RESTRICTED FUNDS, www.charitiesnys.com at 2. Should the value of an endowment fund fall below historic dollar value a board may "prudently" decide not to spend any income from the fund regains its historic dollar value. Id. at 1. The Attorney General's office also encourages organizations to inflation adjust the historic dollar value of the endowment fund. For more information please contact Linda Manley, Legal Director, at (212) 219-1800 ext. 239, email@example.com.
August 2010 Board Talking Points: Charging Fees for Program Services As nonprofits seek to generate revenue to preserve programs, many are considering new fundraising strategies, including whether to charge for the goods and services they provide. Program service fees can constitute an additional revenue source for many nonprofits, particularly in times where reliance on charitable giving has become an ever increasing challenge. Diversified funding streams can be vital to an organization s success and financial health. Below are frequently asked questions about charging for nonprofit services. Questions: 1. Are tax-exempt organizations allowed to charge a fee for service? 2. Can we use a sliding scale to charge for program services? 3. Can we keep services free of charge, but ask for a suggested donation? 4. Are there other limitations for nonprofits to consider when contemplating charging fees for services? Answers: 1. Are tax-exempt organizations allowed to charge a fee for service? Yes, generally, it is permissible for tax-exempt, nonprofit organizations to engage in activities that generate revenues. Charging a fee for program services or goods is quite common. For example, an organization may charge a fee for participants to attend a workshop, charge tuition for an after-school program, or charge for the purchase of books or materials. The question is whether the revenue from the fee-for-service activity is tax-exempt, or whether the activity generating the fee subjects to the organization to taxation, as Unrelated Business Income Tax (UBIT). In order to avoid UBIT, the feegenerating activity must be related to, or further, your organization s exempt purpose. The IRS has stated that an activity is unrelated to an organization s exempt purpose if there is no connection to the exercise or performance of charitable, educational, or other purpose or functions constituting the basis for an organization s tax exemption. Internal Revenue Code, 513(a). The need to raise funds or using the profits from an unrelated activity to fund your organization s programs does not qualify as furthering exempt purposes. For more information on whether an activity is taxable as UBIT and how much UBIT is permissible without jeopardizing an organization s tax-exempt status, see IRS Publication 598 "Tax on Unrelated Business Income of Exempt Organizations," available at www.irs.gov/pub/irs-pdf/p598.pdf. 2. Can we use a sliding scale to charge for program services? Yes, absent any restrictions in your organization s funding contracts, using a sliding scale is permissible. A sliding scale is a fee structure that bases the amount of fee charged for program services
or goods on a particular participant s ability to pay. To ensure proper accountability and fairness, the Board should develop a policy that sets forth eligibility standards, including what documentation is acceptable to prove a participant meets such standards. If the requested documentation contains personally identifying information such as social security numbers then the organization will have to develop a procedure for protecting this information. The sliding scale policy should be reviewed frequently and available upon inquiry so as to avoid any claims of favoritism or unequal application of the sliding scale. 3. Can we keep services free of charge but ask for a voluntary donation to participate? Yes, if your organization wishes to keep program services free of charge, it may instead ask for a suggested or voluntary donation to help the organization cover the costs of the program. This may incentivize participants to give to the program even if it is difficult financially to do so. Be careful to ensure the donation is truly voluntary, and the services are available even if the participant does not make a contribution. Whether a suggested donation fee structure is appropriate depends largely on the nature of the program, as well as the population the organization serves. Remember that any donations made to the organization are subject to the IRS rules on deductibility and documentation of contributions. If a donor receives services in exchange for a charitable contribution, there may be a limit on how much of that contribution is tax deductible. Organizations must provide a written disclosure to donors who give more than $75, partly as a contribution and partly for goods and services provided by the organization. For more information on these rules, see IRS Publication 526 Charitable Contributions, available at www.irs.gov/pub/irs-pdf/p526.pdf and Publication 1771, Charitable Contributions: Substantiation and Disclosure Requirements, available at www.irs.gov/pub/irspdf/p1771.pdf. 4. Are there other limitations for nonprofits to consider when contemplating charging fees for services? Your organization should review your funding contracts and award letters, including public and private funding agreements to ensure that charging a fee for services is permissible and not prohibited or limited by an agreement. Moreover, it may not be clear whether your organization s activities are related to, or further, your exempt purposes. Classifying program activities can often be a challenge. Consult Lawyers Alliance or legal counsel if you have questions about the classification of your organization s fee-generating activities. Lastly, organizations should be aware that the IRS may deny recognition of tax-exemption to an organization on the grounds that the financial support of the organization is entirely fee-based, whether or not the activities from which the fees derive relate to the organization s exempt purpose. The IRS has often used the absence of a varied and broad fundraising program as a basis to deny tax-exemption. When an organization is entirely or substantially dependent on fee-for-service revenue, the IRS may raise questions of undue commerciality and inquire whether charging fees for program services significantly detracts from the organization s charitable purpose. While this would be an issue for relatively few organizations, Boards should be aware that revenues based entirely or substantially on fee-for-service income have the potential to affect an organization s exempt classification. This alert is meant to provide general information only, not legal advice. Please contact Lindsey Jones, Staff Attorney, at (212) 219-1800 ext.228, firstname.lastname@example.org or visit our website www.lawyersalliance.org for further information.
July 2010 Board Talking Points: Accepting Loans from Board and Staff Members With funding from New York State being held up and no end in sight, cash flow at many nonprofit organizations is getting tight. Moreover, because contracts with New York State for the fiscal year that began April 1, 2010 have not yet been registered, some traditional avenues of bridge financing are not available. To meet payroll and other emergency expenses, nonprofit Board and staff members may be considering making loans to the organization to be repaid when monies from the State begin flowing again. Before accepting a loan from a Board or staff member, the organization should consider the information below. Questions: 1. Is it allowable for individuals to loan money to the nonprofit organization on whose board they serve? 2. Is it allowable for staff members to loan money to the nonprofit organization that employs them? 3. How is it determined that the loan is in the best interest of the corporation? 4. Does the Board of Directors need to vote on accepting the loan? 5. If the Board or staff members decide to forgive the loan, can they take a tax deduction? Answers: 1. Is it allowable for individuals to loan money to the nonprofit organization on whose board they serve? Yes, it is allowable for board members to loan money to the nonprofit organization on whose board they serve. However, because this is a transaction between a person with a fiduciary duty to the organization (i.e. the board member) and the organization, there is the appearance of a conflict of interest. Whenever a situation or transaction might benefit (either directly or indirectly) the personal interests of a director (for example, establishing terms for the loan or deciding when loan repayment will occur), there will exist a conflict of interest. The organization must review its conflict of interest policy to determine what steps need to be taken to determine that the loan is in the best interest of the corporation and to approve the terms of the loan. 2. Is it allowable for staff members to loan money to the nonprofit organization that employs them? Yes, it is generally allowable for staff members to loan money to the nonprofit organization that employs them. The organization should review its personnel policies to make sure that accepting the loan is not prohibited by the policies. If the staff member is an individual in a position of substantial authority (for example, the Executive Director or Chief Financial Officer) then they will have a fiduciary duty to the organization, and as with the loan from the board member, there is a potential conflict of interest. The organization must review its conflict of interest policy to determine that the loan is in the best interest of the corporation and to approve the terms of the loan.
3. How is it determined that the loan is in the best interest of the corporation? Accepting the loan will be considered in the best interest of the organization if the loan proceeds are needed to fund programming and the terms of the loan are the same or better than the organization would receive from an unrelated party. It is important that there is a promissory note or loan agreement that establishes the terms of loan: (i) the amount of the loan; (ii) the interest rate; (iii) the term of the loan; and (iv) how the loan will be repaid. The organization should review its conflict of interest policy to see if it includes a process for researching fair market value of a transaction. For example, the organization could research the terms and cost of securing a loan in the same amount from a traditional lender. The Internal Revenue Service provides a sample conflict of interest policy that can offer guidance if the organization does not have its own. http://www.irs.gov/instructions/i1023/ar03.html. Typically, the conflict of interest policy will require that: 1) The conflict must be disclosed to the Board in writing; 2) The interested person must be excluded from any discussions by the Board of the transaction, unless responding to a request for information; and 3) The interested person must be excluded from the vote of the Board on any matter in which he or she has a conflict of interest. Disclosure of conflicts and any action taken in response to the conflict, including noting the procedures followed in accordance with the organization s conflict of interest policy, should be recorded in detail in the Board meeting minutes. 4. Does the Board of Directors need to vote on accepting the loan? Yes, the Board of Directors should approve the acceptance of a loan from a member of the Board of Directors or a staff member. This will help evidence the fact that the financial transaction between the organization and its Board or staff member is legitimate. Additionally, under the New York Not-for-Profit Corporation Law (NPCL), an interested party transaction may be voidable by the corporation if: (i) there is no evidence that the transaction is fair and reasonable to the corporation; (ii) the conflict is not disclosed in good faith or known to the Board; and (iii) the transaction is not properly approved by a vote of the Board without counting the interested person s vote. Depending on the facts, a director or officer who fails to make proper disclosures may be subject to a charge of breach of the duty of loyalty by the Attorney General. 5. If the Board or staff members decide to forgive the loan, can they take a tax deduction? A Board or staff member can choose to forgive a debt and take a charitable deduction for the amount forgiven if there is valid evidence of an enforceable loan. For example: A board member loans money to a nonprofit organization that the organization cannot repay. For the board member to forgive the loan and take a charitable deduction for the amount forgiven, there must be a promissory note or loan agreement evidencing the obligation of the organization to repay the board member. For more information please contact Linda Manley, Legal Director, at (212) 219-1800 ext. 239, email@example.com.
June 2010 Impact of State Budget Stalemate on New York Nonprofits With the New York State s budget three months late and weekly extender bills being passed to keep State government operating, New York nonprofits that contract with the State of New York wonder whether or not they are going to get paid on their contracts. It is anticipated that a budget will be adopted before June 30th but nonprofits need to be vocal advocates for critical government programs. Organizations need to monitor State budget developments since continued funding for human service programs is still in doubt. Questions: 1. Is the State of New York required to reimburse contractors for expenses incurred on contracts after April 1, 2010? 2. Is the State required to make timely payments on its contracts? 3. If an organization takes a loan to cover expenses while it awaits reimbursement can those interest expenses be reimbursed as an expense of the State contract? 4. If a contractor continues to perform and ultimately the funds are not appropriated by the State or the terms of the contract are modified will the contractor be able recoup their expenses? 5. Can the State require a contractor to provide the same level of programming while reducing funding? 6. If an organization temporarily ceases programs funded by the State while it awaits payment can the State terminate the contract? 7. How can nonprofits participate in advocacy efforts to ensure timely payment? Answers: 1. Is the State of New York required to reimburse contractors for expenses incurred on contracts after April 1, 2010? In order for the State of New York to be bound by a contract, that contract must be a fully executed contract meaning that is signed by both the state agency and the nonprofit and approved by State Comptroller. State Finance Law 179q. If an organization has been awarded a contract that is to take effect on April 1, 2010 but it is not yet registered or if an organization has been awarded a contract that is subject to annual renewal and the renewal provisions have not been triggered by the State then that agreement is not yet binding on the State. If an organization has a multiyear contract that is validly registered then that agreement continues in effect. The State s obligation to pay is further limited to those funds which have been appropriated. State Finance Law 40.
2. Is the State required to make timely payment on its contracts? There is a State law requiring timely payment on contracts. However, this provision does not apply when funds for payment have not been appropriated. State Finance Law 179f(2)(v). If funds have been appropriated and the State is delayed in making timely contractual payments contractors are entitled to interest payments. State Finance Law 179(a). While a state agency can request that a contractor waive its right to receive an interest payment the contractor is under no obligation to honor that request. 3. If an organization takes a loan to cover expenses while it awaits reimbursement can those interest expenses be reimbursed as an expense of the State contract? There are circumstances under which interest payments can be reimbursed by the State. In order for the interest payments to be reimbursable, the loan must be taken to cover expenses under a State contract and the State Agency awarding the contract must authorize the interest payments. 179. 4. If a contractor continues to perform and ultimately the funds are not appropriated by the State or the terms of the contract are modified will the contractor be able recoup their expenses? Whether or not the organization operating under a multiyear contract will be able to recoup costs incurred under a contract after April 1, 2010, to the date that the organization receives notice of the contract modification will depend on the terms of the individual contract and whether the funds to pay the expenses have been appropriated. Organizations that continue to operate according to contractual terms during this period of uncertainty run a risk that some of the expenses will not ultimately be reimbursed. 5. Can the State require a contractor to provide the same level of programming while reducing funding? The ability of a contractor to modify contract deliverables will turn in part on the status of the contract (ie whether or not it is fully executed) and the nature of the services to be delivered. Certainly to the extent that a contractor receives a budget cut they should engage in negotiation with the State agency regarding modifications to budget deliverables. 6. If an organization temporarily ceases programs funded by the State while it awaits payment can the State terminate the contract? New York State contracts typically contain provisions that enable the State to terminate the agreement in the event that the contractor is not performing contracted services. They do not typically contain a provision that excuses performance by the contractor in the event that the State fails to make payments due under the contract. Therefore, an organization that temporarily ceases programs while it awaits payment from the State runs the risk that the State will terminate the contract. -2-
7. How can nonprofits participate in advocacy efforts to ensure timely payment? The Human Services Council of NYC (HSC) is coordinating advocacy efforts around the issue of late payments. You can assist in these efforts by providing them with information about the problems you are facing because of late payments. To participate in HSC s advocacy efforts, organizations must be members of HSC. If you are not yet a member, you can find membership information on their website www.humanservicescouncil.org. To successfully advocate for solutions, HSC needs information from providers. Please provide the following: specific examples of services in jeopardy with details on where they are located and what the status and timeframe of your contract is detailed information on how late payments have been and how much funding you should be receiving monthly examples of actions you are considering or have taken to deal with cash flow problems laying off staff, taking out loans, etc. State agency responses to your inquiries regarding payments suggestions for solutions that would be helpful to you in the short or long term information on whether or not you may be willing to participate in a lawsuit Please provide this information to Michelle Jackson, Policy Analyst at (212) 836-1588 / firstname.lastname@example.org. -3-
May 2010 Board Talking Points: Lobbying In an era when the need for services is growing, nonprofit organizations across New York City are facing uncertainty with respect to funding from New York City and New York State agencies. Both the State and the City are facing the very real possibility of making drastic cuts to projected funding for nonprofit organizations, and these cuts are likely to have a severe impact on the ability of these organizations to provide vital services. In response to the proposed budget cuts, many nonprofit organizations are taking action. From busing senior citizens from senior centers to Albany to protesting at City Hall, these organizations are informing legislators about the harsh consequences these cuts will have on their ability to provide services, and seeking to prevent the interruption of fundamental services. Whether your organization is already actively engaged in the budget making arena or considering joining in due to the looming threat of budget cuts, below is a summary of the regulatory regime that may have an impact on your advocacy efforts. Questions: 1. Are 501(C)(3) organizations allowed to lobby? 2. Is fighting for budget restoration considered lobbying? 3. Beyond the IRS, are there other lobbying regulations that New York nonprofits must comply with? 4. What counts as lobbying? 5. What is grassroots lobbying? 6. How can I maximize my volunteers? Answers: 1 1. Are 501(C)(3) organizations allowed to lobby? A 501(c)(3) organization is permitted under the Internal Revenue Code to engage in limited lobbying activity, but cannot engage in substantial part lobbying. While what constitutes a substantial part is a facts and circumstances test and is not well defined, most 501(c)(3) organizations can make an election under 501(h) of the Internal Revenue Code that allows them to understand exactly how much money they are permitted to spend on lobbying. The amount varies depending on the size of the organization, but is in no case greater than 20% of the annual operating expenses for the organization, and no more than $1,000,000. Within this permissible lobbying limit, a smaller cap is set on grassroots lobbying (see below). This total cap on the 1 The information below is directed toward nonprofit organizations with tax-exempt status under 501(c)(3) of the Internal Revenue Code. If your organization is not exempt under 501(c)(3), please contact Lawyers Alliance for information applicable to your organization.
amount spent on lobbying would include any budget-related lobbying your organization does as well as any other kind of legislative advocacy. 2. Is fighting for budget restoration considered lobbying? Because the budget is a piece of legislation that is enacted by the legislative body, advocating for changes, additions or restorations falls under the definition of lobbying. This is true for both the New York City and the New York State budgets. 3. Beyond the IRS, are there other lobbying regulations that New York nonprofits must comply with? In addition to the IRS limit on how much lobbying a 501(c)(3) organization can do, both New York City and New York State regulate lobbying activity that takes place within their respective jurisdictions. Unlike the IRS, neither NYC nor NYS limit how much you can spend on lobbying. Instead, these entities require that you report lobbying activity if your organization exceeds specified thresholds. For NYS, the threshold amount is $5,000 in expenditures for lobbying activity at the state or municipal level. For NYC, the threshold is $2,000, and covers only New York City lobbying activity. The financial cost for most organizations consists primarily of paid staff time, but may include other expenditures on lobbying activity. If your organization does not spend enough money on lobbying to exceed either of these thresholds, you may continue to lobby but need not report your lobbying activity. If you think your organization is close to meeting or exceeds the thresholds, please contact Lawyers Alliance for more information about the reporting requirements. 4. What counts as lobbying? As mentioned above, asking legislators to restore budget cuts or make changes to the budget prior to passage of the budget into law will count as lobbying. Under both the NYC and NYS lobbying regulations, lobbying is defined as attempting to influence legislation. This can be done directly, by staff members speaking with city or state legislators, or indirectly, by asking members or volunteers to contact legislators (called grassroots lobbying). The definition of legislation is relatively broad. In addition to measures passed by City Council or the Mayor (or the state legislature or Governor), any rule or regulation having the force and effect of law by state or city agencies is considered legislation. Activities that are considered attempting to influence legislation include contacting legislators or administrators directly, organization advocacy days, testifying at public hearings (unless you have been invited in writing by the legislative body to testify), and all activities in preparation for lobbying. 5. What is grassroots lobbying? Grassroots lobbying, or indirect lobbying, is encouraging others to lobby. For example, you may ask members or recipients of your newsletter to call or write to legislators, or ask them to join in on an advocacy day at City Hall. For an activity to count as grassroots lobbying, there must be a
call to action, or an implicit or explicit request that people contact legislators. The compensated time used to prepare a grassroots communication will count towards the lobbying thresholds, and the amount you spend on grassroots communications is subject to limits if your organization takes the 501(h) election. 6. How can I maximize my volunteers? Time spent by volunteers to advocate or lobbying on behalf of an exempt organization is not counted towards the organization s thresholds for reporting of lobbying activity, and (unless the volunteer is a board member) is not reportable even if you exceed the thresholds and are required to report your lobbying activity. For more information please contact Elizabeth Perez, Staff Attorney, at (212) 219-1800 ext. 232, email@example.com.
April 2010 Board Talking Points: Loan Repayment Challenges Organizations may have taken on debt when the economy was stronger and it had realistically projected enough income to repay the debt. However, as cash constraints grow, the funds that were thought to be available for debt service may have disappeared. Defaulting on loan obligations can have serious consequences for a nonprofit and should be avoided, if at all possible. Here are some strategies for meeting loan obligations. Questions: 1. How do we determine our loan repayment obligations? 2. What does it mean to refinance a loan? 3. Should we be in contact with our bank about repayment challenges? 4. What are the consequences of defaulting on a loan? 5. Can a loan be converted to a charitable contribution? Answers: 1. How do we determine what our loan repayment obligations are? Payment terms for any loan should be contained in the loan documents. The monthly payment maybe fixed or variable depending on the type of loan. A term loan at a fixed interest rate will have set monthly payments while a term loan with a variable interest rate will have fluctuating monthly payment and the lender will have to provide notices of change. At the end of a term loan, it is possible that a balloon payment will be due to the lender. The balloon payment relates to the principal amount of the loan that has not been repaid. At the time the loan was taken out a balloon payment may have been appealing because it lowered the amount of the monthly payment. The monthly payment on a line of credit will also fluctuate depending on the outstanding balance. 2. What does it mean to refinance a loan? Refinancing is when a borrower uses money from a new loan to pay off an existing debt obligation or when the provisions of an existing loan are changed. When refinancing, the organization will need to go through an underwriting process to ascertain the financial strength of the enterprise. Refinancing may be appealing under several circumstances: The existing loan has a higher interest rate than is now available. The remaining time to pay the existing loan is shorter and, therefore, the monthly interest payments are higher than they would be if repayment of the loan could be made over a longer period.
The organization has more than one loan, and bringing all the existing loans into one loan agreement would help to control costs and make the debt easier to manage. The ability to consolidate may be limited by the total debt exposure a lender can have with a single organization. There is a balloon payment due at the end of the existing loan that the organization cannot pay in a lump sum. Although refinancing might lower the monthly payment, it is not always preferable because: If the time to repay the loan is lengthened, even if the interest rate or monthly payment is lowered, the total amount of interest paid over time may be greater. Lenders usually charge fees when making or changing the terms of a loan and the cost of those fees may outweigh any savings. In order to receive better loan terms, borrowers might be required to pledge additional collateral. Given the pressure in the credit markets, some lenders have tightened lending criteria. 3. Should we be in contact with our bank about repayment challenges? It is always advisable to be in contact with the loan officer if the organization anticipates difficulty in meeting its loan obligations. For the borrower to preserve its relationship with the lender and for the lender to maximize its return on the loan the parties need clear communications and to share accurate information. A default occurs when the borrower fails to meet an obligation established by the loan agreement. The most common serious default is failing to make a payment on time but other events of default include: Breach of certain material representations or covenants. The loan document contains representations and covenants made by the borrower that describe its business and finances at the time of the loan. Some loans contain ongoing covenants, for example, to retain a certain amount of cash reserves. If one of these representations or covenants was incorrect when made or if an ongoing covenant becomes incorrect during the term of the loan, then the lender maybe able to call a default. Before an event of default can be called (for something other than nonpayment), the default must be considered material (i.e., poses a substantial threat to the lender) and the time to cure (fix the problem) has passed. Cross-default. A cross-default clause is when a loan agreement states a default under another agreement will cause a default under the loan agreement. For example, the borrower has a line of credit and a term loan. The term loan states that an event of default is a failure to make a payment on the line of credit. If the borrower fails to make a payment on the line of credit, the lender on the line of credit and the lender on the term loan maybe able to call an event of default. Insolvency related events. A filing of a bankruptcy petition will be an event of default. However, some loan agreements will make steps short of filing for bankruptcy including: failure to pay debts as they become due and taking steps to wind-down the organization, events of default.
Material adverse change default. The provision enables the lender to call an event of default when there is a significant negative change in the borrower s business or financial condition. While these clauses can be very broad, and therefore hard to enforce, an example might be the termination of a significant government contract. Be prepared when calling the lender to comply with requests for additional information that it is seeking to ascertain the organization s financial position including: (i) most recent audited financial statements; (ii) most recent unaudited (internal) financial statements; and (iii) any other additional information the lender may deem necessary for further analysis. Also think about what adjustments the organization needs to the payment schedule or loan agreement in order to avoid additional defaults. Depending on how the lender operates, responsibility for monitoring the loan and amending the loan agreement may shift from the branch loan officer to the loan workout group. 4. What are the consequences of defaulting on a loan? There are several possible consequences of a loan default depending on the terms of the loan agreement. If the loan is a revolving line of credit, the lender can refuse to extend the borrower additional credit. With either a term loan or a revolving line of credit, the lender may have the ability to increase the interest rate charged on the loan by charging a default interest rate and/or to accelerate the loan which means the lender has the right to demand the entire outstanding balance be paid immediately. If the loan is a secured loan, the lender can sue the borrower for default and take possession of the collateral. Also, if the loan is guaranteed, the lender may have the right to collect the debt from the guarantor. Defaulting on a loan will have a negative impact on the organization s ability to reestablish credit in the future. 5. Can a loan be converted to a charitable contribution? Loans made by foundations and individuals at their discretion may be forgiven and taken as a charitable deduction for the amount forgiven if there is valid evidence of an enforceable loan. For example: A board member loans money to a nonprofit organization that the organization cannot repay. In order for the board member to forgive the loan and take a charitable deduction for the amount forgiven there must be a promissory note or loan agreement evidencing the obligation of the organization to repay the board member. 1 Commercial lenders, Community Development Financial Institutions (CDFIs) and credit unions do not convert debt to charitable contributions. When an organization uses debt forgiveness as a strategy, it is not viewed positively by commercial lenders and may be a factor in the organization s ability to reestablish a normal borrowing relationship with banking institutions. This alert is meant to provide general information only, not legal advice. Lawyers Alliance and the Nonprofit Finance Fund can help boards with questions about securing a loan. For more information please contact: Lawyers Alliance: Linda Manley, Legal Director, at (212) 219-1800 ext. 239, or firstname.lastname@example.org. NFF: Emily Guthman, Associate Director, New York Program, at (212) 868-6710, or Emily.Guthman@nffusa.org 1 A loan from a board member to a nonprofit organization is an interested party transaction and the organization must adhere to its conflict of interest policy when approving the loan.
March 2010 Board Talking Points: Is a Loan Part of the Solution? It is not unusual for nonprofit organizations to struggle with cash flow or to have a year in which contributed and earned revenue fails to meet projections. Securing a loan could help to alleviate cash flow pressures or to cover a deficit. Securing a loan, however, could help mask a fundamental problem in the organization s financial health that jeopardizes the organization s long-term viability. A loan is only part of the solution if there is a realistic plan for repayment including interest expenses. Questions: 1. When is it appropriate to seek a loan? 2. What are the different types of loan products that are available? 3. What are the most significant provisions of the loan documents? 4. What documents should we gather before applying for a loan? 5. What is the role of the Board in approving a loan? 6. Are board members or staff personally liable for repayment of the loan? 7. Are there resources for nonprofit loans? Answers: 1. When is it appropriate to seek a loan? A loan can be an important tool in managing a healthy organization s cash needs. Loans can help ease cash flow constraints, bridge the time between when expenses are incurred and reimbursement is received, or fund long-term capital or programmatic expansion. A loan, however, is not the answer to cover ongoing operating deficits that cannot realistically be cured. Loans are for cash flow problems; not cash problems. Before deciding to apply for a loan, the board and staff must determine why the loan is needed and how that loan can be repaid. Any calculations of the cost of loan repayment must include the interest expense. An organization may seek out a loan because of the following: Asset Support Seasonal Needs Cash Timing Gaps Related to Funding Day-to-Day Operating Cash Needs Acquisition of Asset Acquisition Construction Facility Renovations Equipment Purchase Organization is Losing Money Financing Growth Capital Financing Ongoing Operating Deficits (Red Flag)
What are the different types of loan products that are available? Loan products for nonprofit organizations generally fall under two categories: working capital loans or facility loans. Working Capital Loans: short-term financing for short-term needs Line of Credit Bridge Loan Growth-Related Loans Equipment Loans Facility Loans: long-term financing for long-term needs Acquisition/Renovation o Term Loan/Mortgage o New Markets Tax Credit o Bonds o Construction/Renovation/Leasehold Improvements Bridge Loans o Capital Campaign o Government Contract A term loan is made for a predetermined principal amount, with a set maturity date and either a fixed or variable interest rate. A short-term loan has a maturity date of less than one year and is typically used as working capital. A long-term loan has a longer maturity date and is typically used to purchase or improve facilities. With a line of credit the bank establishes a maximum loan balance that the customer will be permitted to borrow. Unlike a term loan, in which there is a one-time draw, the customer can draw down on the line of credit at any time during the term of the loan up to the maximum allowed. One of the advantages of a line of credit is that interest is only charged on the outstanding balance. With a revolving line of credit the bank establishes a maximum loan balance that the customer will be permitted to borrow, but the customer is allowed to draw on the funds again after they are repaid. Lines of credit are used for asset support and are repaid from general operating cash. When used properly, there are frequent advances and repayments as opposed to one large drawdown shortly after closing Loans can be either secured or unsecured. A secured loan is backed by a pledge of collateral that a lender can seize in the event that the borrower fails to repay the loan. An unsecured loan is backed only by the borrower s promise to repay the loan. 2. What are the most significant provisions of the loan documents? Principal: Term: Interest Rate: Amortization: This is the amount of money that will be forwarded to the organization upon loan closing and the amount the organization will be required to pay, including interest, at the end of the term of the loan. This is the length of loan. This is the percentage of interest that will be charged over the term of the loan, which can be either a fixed or a variable rate. The schedule of payments to be made in repaying a debt. The longer the amortization schedule, the lower the monthly payment.
Closing Costs: The fees that the lender will collect to cover the costs in originating the loan. These fees are usually subtracted from loan proceeds at closing. Events of Default: The circumstances under which either party can say that the other breached their agreement and end the contract. If the lender calls an event of default against the borrower, typically they can require the full amount of the loan to be repaid immediately. Guaranty: Sometimes, a lender will require that a third party, e.g., a corporate affiliate or an officer or director, promise to repay the loan amount if the borrower defaults. 3. What documents should we gather before applying for a loan? A lender will not extend credit to a nonprofit organization based on their mission alone. Financial institutions will need to be convinced of an organization s fiscal soundness and its ability to repay the loan. Lenders will require potential borrowers to complete a loan application and provide supporting documentation including: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) Loan request explaining the use of loan proceeds; Description of collateral; Balance sheets for the last three years; Profit and loss statements for the last three years; Audited financial statements for the last three years; Cash flow projections; Account receivables and payables aging; Certificate of Incorporation; and Determination letter. Other documents that may be requested include: organizational information, such as annual report and brochure, list of board of directors, key staff and major funders; as well as project-related information (for facility loans), including scope of work, project budget, pro forma for operations after project completion, and copies of lease, contract of sale, construction contract, architect s agreement. 4. What is the role of the Board in approving the loan? Prior to a loan closing a lender may require a board resolution approving the terms of the loan. Often the lender will supply a form of resolution for the Board s consideration. Even if the lender does not require Board approval, committing the nonprofit organization to the repayment of a loan is a significant commitment of corporate resources and should be discussed and approved by the Board. 5. Are board members or staff personally liable for repayment of the loan? As a general rule, the voluntary members of a nonprofit board of directors are not personally liable for the debts of the corporation. There are two significant exceptions to that rule that potentially apply when discussing loan agreements. First, a board member who personally guarantees the loan will be personally liable to the lender on that guarantee. Second, if the decision to accept the loan constitutes gross negligence or was intended to cause harm to the lender, then the officers and directors who approved that can be held personally liable. For example, if a Board of Directors was to approve the terms of a loan knowing the corporation did not have the resources to repay the loan there is potential personal liability for those Board members that approved the terms.
6. Are there resources for nonprofit loans? Contact Nonprofit Finance Fund for additional information on your specific needs and viability as a borrower. Be prepared to share: Short- and long-term plans for the organization Evidence of reporting and processes in place to measure progress against budget and ability to course correct Funding commitments / contracts for next 12 months (at minimum) Multiple scenarios for potential reductions or loss in funding Nonprofit Finance Fund is headquartered in New York City, with offices in seven locations: New York Region and National Headquarters Nonprofit Finance Fund 70 West 36th Street Eleventh Floor New York, NY 10018 Phone 212.868.6710 Fax 212.268.8653 E-mail NY@nffusa.org Greater Philadelphia Nonprofit Finance Fund 1608 Walnut Street, Suite 703 Philadelphia, PA 19103 Phone 215.546.9426 Fax 215.546.9427 E-mail Philadelphia@nffusa.org New England Nonprofit Finance Fund 89 South Street Suite 402 Boston, MA 02111 Phone 617.204.9772 Fax 617.204.9773 E-mail NE@nffusa.org Washington, DC-MD-VA Nonprofit Finance Fund 1801 K Street, NW Suite M-100 Washington, DC 20006 Phone 202.778.1192 Fax 202.778.1196 E-mail DC@nffusa.org New Jersey Nonprofit Finance Fund 59 Lincoln Park Suite 350 Newark, NJ 07102 Phone 973.642.2500 Fax 973.642.2520 E-mail NJ@nffusa.org Midwest Nonprofit Finance Fund 645 Griswold Street Suite 2202 Detroit, MI 48226 Phone 313.965.9145 Fax 313.965.9148 E-mail Detroit@nffusa.org West Coast Nonprofit Finance Fund 760 Market Street, Suite 333 San Francisco, CA 94102 Phone 415.255.4849 Fax 415.576.1090 E-mail SF@nffusa.org E-mail LA@nffusa.org (For Los Angeles Program) This alert is meant to provide general information only, not legal advice. Lawyers Alliance and the Nonprofit Finance Fund can help boards with questions about securing a loan. For more information please contact: Lawyers Alliance: Linda Manley, Legal Director, at (212) 219-1800 ext. 239, or email@example.com. NFF: Emily Guthman, Associate Director, New York Program, at (212) 868-6710, or Emily.Guthman@nffusa.org
February 2010 Board Taking Points: Use of Independent Contractors In an effort to contain payroll expenses employers turn to consultants and independent contractors. Employers believe that the use of independent contractors saves them money on payroll taxes, benefits and gives them a more flexible workplace. Unfortunately, employers do not accurately classify workers as independent contractors and expose the organization to potential liabilities. Questions: 1. What is the difference between an employee and an independent contractor? 2. How do we know if a worker is properly classified as an independent contractor? 3. Does having a written agreement that states the worker is an independent contractor end the analysis? 4. What is the risk if we misclassify a worker as an independent contractor rather than an employee? 5. If we decide that we need to classify a worker as an employee, does that mean we have to offer them benefits? Answers: 1. What is the difference between an employee and an independent contractor? An employee is a worker that the organization controls and for whom the organization withholds income taxes and pays unemployment, Social Security, and Medicare taxes. Control in this context means establishing what work will be done and how it is done. An employee will receive a W-2 statement each January that reports the worker s annual earnings. Generally speaking, an independent contractor controls the when, where and how of his or her work and employers do not have to withhold or pay any taxes on payments to the contractor. See IRS Publication 15-A. The organization must issue a 1099 to an independent contractor that receives $600 or more in payments annually. 2. How do we know if a worker is properly classified as an independent contractor? The determination of whether a worker is properly classified as an independent contractor or an employee will depend heavily on the facts and circumstances surrounding his or her work. The Internal Revenue Service (IRS) has developed a three-prong test (with several subcategories) to guide this analysis. The three prime factors are: (1) behavioral control; (2) financial control; and (3) type of relationship. The factors indicating the degree of control and the degree of independence will be weighed most heavily. If the organization requires the worker to be onsite in their offices at specific times, provides the equipment or materials needed to complete the work and provides instruction, the worker is likely to be considered an employee. It is important to remember that the mere fact that the individual works part time or on a temporary
basis does not automatically mean that the individual is an independent contractor. See page 6 of Publication 15-A. New York State uses a similar analysis for determining a worker s status under New York State Law. Example: Do Right retains Sally to work as a grant writer for $20 per hour. Do Right requires Sally to be in the office Monday, Wednesday, Friday from 9-12 and provides Sally with a computer, telephone. Each week, Do Right s Executive Director reviews Sally s work plan with her and helps to prioritize her work. Sally is properly classified as an employee. Do Right retains Sally to work as a grant writer and pays her $5,000 for each completed report or proposal. Do Right s Executive Director contacts Sally when she has an appropriate project, describes the project and sets a due date for a draft. Sally works offsite and is free to decline the work if she cannot meet the deadline. Sally is properly classified as an independent contractor. 3. Does having a written agreement that states the worker is an independent contractor end the analysis? Unfortunately, a written contract stating that the worker is an independent contractor is only one of the factors that the IRS or New York State considers when examining the type of relationship. The other factors examined as part of this analysis are: (i) whether the worker receives any benefits; (ii) the permanency of the relationship and (iii) whether the worker s role is integral to the organization. 4. What is the risk if we misclassify worker as an independent contractor rather than an employee? If an employer misclassifies a worker as an independent contractor rather than an employee without a reasonable basis the employer will be liable for back Federal and State withholding taxes as well as penalties and interest, and penalties for failure to provide statutory benefits such as workers compensation coverage. This misclassification is most often discovered when the worker is terminated and applies for unemployment. The Department of Labor will determine that unemployment insurance had not been paid for that worker and has the option of then auditing the entire organization to determine if they are correctly classifying employees. 5. If we decide that we need to classify a worker as an employee does that mean we have to offer the worker benefits? No, not all workers within the same organization need to be offered the same employee benefits. Under some circumstances, it is legal to provide benefits for some categories of employees but not for others. It is common for many employers to exclude part-time employees (for instance, those working fewer than 20 hours per week) from their benefits plans. You should seek advice on this subject from both a qualified benefits advisor and an attorney who specializes in benefits law. This alert is meant to provide general information only, not legal advice. Please contact Legal Director Linda Manley at 212-219-1800 ext. 239, firstname.lastname@example.org, or visit our website www.lawyersalliance.org for further information.
January 2010 Board Talking Points: Renegotiating Vendor Agreements To bring a budget into balance there are two options: raise revenue or reduce expenses. Most nonprofits have more control over their expenses than they do their revenue and should, therefore, be reviewing their agreements with outside vendors to identify opportunities for cost-savings. Questions regarding reviewing agreements with outside vendors: 1. Where do we begin? 2. What should we look for when reviewing these agreements? 3. How can we lower our vendor costs? 4. How do we identify reputable vendors who are willing to work with nonprofit organizations? Below are answers to these questions: 1. Where do we begin? Remember, a contract is a voluntary agreement between two or more parties that creates an obligation to do, or not to do, a particular thing. Contractual terms can usually be modified with both parties consent. Contracts probably govern most of the organization s day-to-day operations and will include: government funding contracts, grant agreements, employment and independent contractor agreements, leases and vendor or service agreements. Begin by gathering all of the organization s employee benefits and vendor and service agreements. Some examples include contracts relating to: (i) health insurance; (ii) 403(b) plans; (iii) bank accounts; (iv) corporate credit cards; (v) communications carriers (e.g., phone, internet); (vi) equipment rental; and (vii) facilities maintenance (e.g., snow removal, cleaning service). Many of these relationships are governed by agreements that were executed at the outset of the arrangement (for example, when the organization opened its credit card account) and, therefore, it is difficult to locate the written agreement or all the amendments. If that is the case, request a copy from the service provider.