Winding Up and Dissolving a Nonprofit Corporation

This article discusses the basic steps to wind up and dissolve a nonprofit public benefit corporation under California law. Although this background is helpful, it is not a substitute for retaining competent counsel to assist with the analysis of alternatives and the preparation of the required resolutions, minutes, forms, notices and letters. This article does not cover mutual benefit corporations, private foundations, freestanding charitable trusts, political action committees or religious corporations, although there are many similarities.

The Role of the Attorney General

A key distinction from winding up and dissolving an ordinary corporation is that the Attorney General of the State of California (the "AG") must receive notice and may play a role in the ultimate disposition of assets. The AG considers public benefit corporations to hold assets in a charitable trust by their very nature, over which the AG has broad powers of supervision. California Government Code ("Gov't C.") Sections 12598 through 12599.7; Holt v. College of Osteopathic Physicians & Surgeons (1964) 61 Cal.2d 7590; People v. Cogswell (1896) 113 Cal. 129, 136. Certain filing requirements with the Secretary of State of California are triggered upon dissolution, as are certain tax reporting requirements

Merger Alternative

The option of merging with another nonprofit or for-profit business should be considered. A public benefit corporation may merge with any type of business entity, including a for-profit entity. California Corporations Code ("Corp. C.") § 6010(a). However, without the prior written consent of the AG, a public benefit corporation may only merge with another public benefit corporation (or a religious corporation or a foreign nonprofit corporation or an unincorporated association), the governing documents of which provide that its assets are irrevocably dedicated to charitable, religious, or public purposes. Corp. C. § 6010(a). For more information on the merger alternative, read here.

Considerations

If a dissolution is warranted, it should be planned and commenced promptly in order to avoid drifting into insolvency or wasting assets, which course of conduct could expose directors to liability. Corp. C. §§ 5232, 5233 & 5240.

The assets of a public benefit corporation may be sold for fair value, with the proceeds distributed to another public benefit or religious corporation, or donated directly to another public benefit or religious corporation, and the articles of incorporation can be amended to designate new recipients of the corporation's assets, subject to the powers of the AG, as applicable. Corp. C. § 5820.

An election to wind up and dissolve can be revoked at any time before a certificate of dissolution is filed with the Secretary of State. Corp. C. § 6612. Likewise, subject to the rights of any affected third parties, the board may abandon a sale at any time. Corp. C. § 5911(b).

Election to Wind Up and Dissolve

The corporation may elect to wind up and dissolve by approval of its board of directors as provided in its governing documents. Corp. C. § 5032 & 6610(a)(3). If the number of directors remaining in office is less than a quorum, the corporation may nevertheless elect to wind up and dissolve by unanimous consent of the remaining directors or majority vote of the remaining directors at a meeting held pursuant to a valid waiver of notice of the meeting. Corp. C. § 6610(c). Although approval of third parties may be required to amend the articles, there is no requirement that their consent to a dissolution must be obtained unless provided in the governing documents.

Powers and Duties of the Board

The process of winding up and dissolving commences upon the board's resolution. The board continues and has full power to wind up and settle the corporation's affairs. However, the corporation may only conduct activities necessary to wind up and dissolve. This includes all tasks necessary for an orderly winding down of operations, including phasing out services, but new activities should not be undertaken.

The board's powers are the same as prior to electing to dissolve, except that the board may "sell at public or private sale, exchange, convey or otherwise dispose of all or any part of the assets of the corporation for an amount deemed reasonable by the board." Specifically, the boards powers and duties in a dissolution are as follows:

The powers and duties of the directors (or other persons appointed by the court pursuant to Section 6515) and officers after commencement of a dissolution proceeding include, but are not limited to, the following acts in the name and on behalf of the corporation:

(a) To elect officers and to employ agents and attorneys to liquidate or wind up its affairs.

(b) To continue the conduct of the affairs of the corporation insofar as necessary for the disposal or winding up thereof.

(c) To carry out contracts and collect, pay, compromise and settle debts and claims for or against the corporation.

(d) To defend suits brought against the corporation.

(e) To sue, in the name of the corporation, for all sums due or owing to the corporation or to recover any of its property.

(f) To collect any amounts remaining unpaid on memberships or to recover unlawful distributions.

(g) Subject to the provisions of Section 5142, to sell at public or private sale, exchange, convey or otherwise dispose of all or any part of the assets of the corporation for an amount deemed reasonable by the board without compliance with the provisions of Section 5911, and to execute bills of sale and deeds of conveyance in the name of the corporation.

(h) In general, to make contracts and to do any and all things in the name of the corporation which may be proper or convenient for the purposes of winding up, settling and liquidating the affairs of the corporation.

Corp. C. § 6710. Nevertheless, to the extent applicable, assets remain subject to restrictions upon charitable trusts.

Sale of Assets

Subject to the terms of any express charitable trusts affecting the corporation's assets, the corporation may sell or otherwise dispose of all or substantially all of its assets. Corp. C. § 5911. It is important to determine whether and to what extend the assets are impressed with charitable trusts.

The sale or disposition of all or substantially all of the assets requires approval of the board. Corp. C. § 5911(a)(1). A sale or disposition outside of the usual course of business must be approved by any persons specified in the articles of incorporation. Corp. C. § 5911(a)(2). Although approval may be obtained after the transaction (Corp. C. § 5911(a)(2)), it is best to proceed carefully pursuant to proper authority. The AG carries out a heightened review process when assets are sold to a for-profit entity. See the AG's Sales of Charitable Assets to For-Profit Entities - Review Protocol.

An instrument conveying the corporation's property can include a certificate by the corporate secretary attesting that the transaction was properly noticed. This is prima facie evidence of authorization and conclusive in favor of any food faith purchaser without notice of any trust restrictions or failure to comply with restrictions. Corp. C. §§ 5912, 7912 & 9632.

Notice to Attorney General

The corporation must give written notice to the AG at least 20 days before it sells or disposes of all or substantially all of its assets outside of the ordinary course of business, unless the AG has given a written waiver of notice of the particular transaction. Corp. C. § 5913. If no action by the AG is sought, the notice should include a statement that the documents are delivered only to provide the notice required by the statute. The notice should include:

(1) A letter signed by an attorney for the corporation or a director describing and stating the material facts of the proposed transaction (11 California Code of Regulations ("CCR") Section 999.1(c));

(2) A copy of the board's resolution or minutes discussing or otherwise authorizing the proposed transaction;

(3) A copy of the corporation's current financial statement;

(4) A copy of the corporation's articles of incorporation and bylaws if not already on file with the Registrar of Charitable Trusts;

(5) A copy of the articles of incorporation of any other corporation that is a party to the proposed transaction; and

(6) On request of the AG, independent appraisals or other evidence that the sale price and terms are fair to the corporation.

The notice should be submitted to the nearest AG's office. 11 CCR § 999.1(a). The notice is deemed filed when it is received, not when it is mailed. Id. A request for waiver will be granted or denied within 30 days after filing. It is best to give notice well before the 20-day deadline as the AG's written response can serve as proof of timely notice or waiver of notice.

Special Requirements of Health Facilities

There are additional notice and approval requirements (Corp. C. §§ 5914-5925) for "health facilities" as defined in the California Health and Safety Code Section 1250, which defines a "health facility" in general to be:

[A]ny facility, place, or building that is organized, maintained, and operated for the diagnosis, care, prevention, and treatment of human illness, physical or mental, including convalescence and rehabilitation and including care during and after pregnancy, or for any one or more of these purposes, for one or more persons, to which the persons are admitted for a 24-hour stay or longer....

This definition appears not to apply to facilities licensed as a Residential Care Facility for the Elderly under Health and Safety Code Section 1569, et seq. unless the facilities meet the definition of a "health facility" for other reasons.

Distribution

Plans to control the ultimate distribution of assets should be made prior to completion of the corporation's dissolution. The AG's prime concern is the purpose and use to which the assets will be dedicated after distribution. Assets subject to restrictions under the articles of incorporation, the bylaws or a trust must be distributed for a use that is consistent with the restrictions. Corp. C. § 6716; Estate of Zahn (1971) 16 Cal.App.3d 106. Moreover, assets of a nonprofit corporation that is exempt from taxation under Internal Revenue Code 501(c)(3) must be dedicated to the purposes for which the exemption was given

The AG's waiver of objections is necessary to distribute certain assets of a public benefit corporation, or the distribution may be made pursuant to a court decree. Corp. C. § 6716(c); 11 CCR 999.1-999.8. The corporation itself has no vested right to designate the recipients. In re Veterans' Indus., Inc. (1970) 8 Cal. App.3d 902. The AG will often request to review copies of the tax exempt determination letter for each recipient, the minutes authorizing the distribution and other information. The AG's waiver of objections must be attached to the certificate of dissolution to be filed with the Secretary of State.

As a practical matter, the AG should waive any objection unless the corporation proposes to distribute assets for a purpose not contemplated by the language of its articles. If the AG objects to the proposed distribution, there is an opportunity to obtain court approval of a distribution outside of the articles under the doctrine of cy pres. Cy pres is a French phrase translated "as near as," and in American law it means: "The equitable doctrine under which a court reforms a written instrument with a gift to charity as closely to the donor's intention as possible, so that the gift does not fail." Black's Law Dictionary (9th ed. 2009), cy pres.

Dissolution Procedure

Dissolution is accomplished by taking the following steps:

  1. The board adopts resolutions to wind up and dissolve;
  2. A certificate of election to wind up and dissolve is filed with the Secretary of State (this step is not necessary if all directors vote to dissolve) (Corp. C. § 6611(c);
  3. Notice to the AG is given;
  4. Notice to creditors is given;
  5. The corporation winds up operations, pays or provides for liabilities and distributes assets (see the requirements for AG or court approval of distributions above);
  6. The corporation files a certificate of dissolution with the Secretary of State, signed and verified by a majority of directors (the AG's waiver of objections must be attached, and it must state that the final tax returns have or will be filed);
  7. If assets are held in a charitable trust, notice is given to the Registrar of Charitable Trusts; and
  8. Final IRS Form 990 (with Schedule N) and FTB Form 199 tax returns are filed.

Providing for Claims

The debts of the corporation must be provided for. There is a streamlined notice and claim procedure available to nonprofits in order to clear up any unknown or doubtful claims. Specifically, the corporation notifies all potential creditors that can be identified, following which creditors will have 120 days to submit a proof of claim. A creditor who fails to submit a claim or whose claim is rejected and fails to initiate a proceeding to enforce the claim within 90 days will be forever barred. Corp. C. § 6618.

Taxes

The final Form 990 return must be filed four months and 15 days after the date of the organization's termination. The corporation must also file Schedule N, which includes:

  1. A description of the assets and any transaction fee, the date of distribution, the fair market value of the assets and information about the recipients of the assets;
  1. A disclosure of whether an officer, director, trustee or key employee is or is expected to be involved in the successor entity; and
  1. A certified copy of the articles of dissolution or merger, resolutions and plans of liquidation or merger.

Unless otherwise exempt, the corporation must also file Form 199 with the Franchise Tax Board. California Revenue & Taxation Code § 23332.

Post-Dissolution Activities

The existence of a nonprofit corporation continues for certain limited purposes after dissolution. Specifically, the corporation may continue to wind up it affairs, file final tax returns and handle administrative matters. The corporation may also continue as plaintiff or defendant in any pre-existing litigation, and it may bring new actions necessary to wind up. Corp. C. § 6720. The AG and third parties may sue the dissolved corporation as a nominal defendant in order to recover any improper distributions from third parties. Corp. C. § 6721.

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