The Law of Charitable Status: Maintenance and Removal (Law Practitioner Series)

When there are disputes, the attorney general files suit in court as the representative of the public, which is the ultimate beneficiary of the assets. It is judges who then determine whether the purposes for which the nonprofit was established are impossible, obsolete, wasteful, or impractical to implement. This is what happens, for example, to a medical research foundation when the research succeeds and the disease is cured. Traditionally, only the charity's fiduciaries and the attorney general have legal standing to challenge the process.

In the case of insurance company conversions, an insurance commissioner or health department representative might be allowed to intervene as well. New York is not one of the four. Founded in the s, Empire was organized as a nonprofit company. It provided a safety net of sorts for poor New Yorkers who were unable to find health insurance elsewhere and, in return, received preferential financial treatment from the state until the mids.

Sloppy management, fraud charges, and high executive turnover rates made its prospects look grim McCue A CEO claimed in that unless relieved of its nonprofit status, Empire would be unable to compete, grow, and, ultimately, survive 3 Freudenheim ; Stocker Empire proposed, and the insurance department approved, a conversion transaction under which the proceeds of an initial public offering would be transferred to a new charity. The conversion legislation amended the state insurance laws, establishing a new nonprofit corporation with the statutorily defined purpose of managing a charitable asset fund containing 5 percent of the sale proceeds from the conversion.

The statute required the board to direct the proceeds from the public asset, under the direction of the director of the budget, to the tobacco control and insurance initiatives pool. The statute further required that the public asset be paid to hospitals, nursing homes, and other agencies for wage increases for health care employees. The statute assumed that if there was going to be a public stock offering, the asset value would be determined by a market sale. In August , five consumer and voluntary health organizations and five individual Empire subscribers brought an action against the company, its directors, the state, and individual government officials.

The suit sought a declaration that the conversion statute was unconstitutional, an injunction preventing the transfer of Empire's assets to the state, and an order directing that all conversion proceeds be transferred to a private charitable foundation impressed with Empire's former mission. The state retained the remaining shares. On that same day, a justice of the New York State Supreme Court the trial court ordered the state comptroller to hold the stock and cash in trust, pending the final determination of the suit. In February , the New York Supreme Court ruled on certain preliminary issues in the case, finding that some of the plaintiffs—the subscribers and consumer advocates, but not the social services organizations—had standing to challenge the statute.

In this case, the court recognized that the plaintiffs had a special interest in the corporation and that the attorney general was defending the statute rather than representing the public's interest in the charity. The court did not rule for the defendants, however, because it found that the alleged facts supported an additional, although unstated, claim.

Namely, the statute violates the state constitution because it is a private law applicable only to Empire and not to a class of similar entities. In May , the New York appellate court upheld the decision allowing the plaintiffs to go to trial on this private law issue. Empire's many corporate predecessors were organized and licensed under New York corporate, charities, and insurance statutes. In brief, Empire is governed by two statutes—New York Not-for-Profit Corporations Law and Insurance Law—that could have different implications for the disposition of conversion proceeds. First, as a New York nonprofit corporation, Empire was organized exclusively for nonbusiness, nonpecuniary purposes.

If a nonprofit corporation wishes to dispose of substantially all its assets, it must follow certain internal procedures in making that decision and then obtain permission from the state supreme court. In contrast, the new statute explicitly excused Empire from these procedural requirements. Empire also held an insurance license. As a nonprofit corporation Empire had a general obligation to pursue the company's charitable mission, but as an insurer it had a duty to operate for the benefit of its members, making the company more akin to a mutual than a public benefit corporation.

For example, insurers must follow several procedures, including notifying enrollees and obtaining permission before dissolving or discontinuing operations. After reviewing a restructuring plan proposed in , however, the insurance commissioner ruled that this prohibition did not apply to the transfer of Empire's assets to a for-profit company because assets of an equal value the sale proceeds would be used by an independent entity for nonprofit purposes.

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To legal practitioners and scholars of nonprofit law, Empire's conversion history seems odd. As noted earlier, conversions have been for centuries under the jurisdiction of the courts rather than the legislatures. Originally, the power to direct the disposition of charitable assets stemmed from the power of the king as parens patriae parent of the country. During the 16th century, the king delegated to the courts some of his power to exercise the cy pres doctrine to the courts of equity under the jurisdiction of the lord chancellor the presiding judge in all but two circumstances.

The Crown retained the power to exercise cy pres 1 when the gift was made to charity generally without designating a trustee, a circumstance that included gifts to nonexistent or defunct charities; and 2 when the object of the gift was illegal or void as contrary to public policy. The use of the Crown's retained power to alter the purposes of charitable property was known as the prerogative cy pres power. In no cases, however, did Parliament have any power to direct the disposition of charitable funds.

The cases in which gifts were given for illegal purposes were those for the support of religions other than the Church of England. In some reported cases, the king exercised the cy pres power by confiscating these gifts. In most instances, however, the Crown ordered that the gift be used for a legal charitable object. Over time, in what some viewed as a usurpation of the king's power, the chancellors expanded their judicial power to save outright general gifts to charity when there was no trustee. The chancellors exercised this prerogative power in the king's name.

It was not until that the court's cy pres powers were clearly delineated as judicial and prerogative cy pres. By that time, the provisions banning superstitious uses had been repealed, thereby effectively voiding the king's power to direct the disposition of gifts for illegal, charitable purposes. Although the court was empowered to apply the cy pres doctrine in all instances, the rulings made clear that the court was exercising two distinct powers. One power stemmed from its delegated jurisdiction, and the other, from an exercise of the king's retained powers.

In the United States, the state legislatures are considered to be the inheritors of many of the powers of the English kings. Rather, legislative authority over charities whose purposes no longer serve contemporary needs generally pertains to regulating the extent of the cy pres doctrine and framing rules by which courts apply the doctrine. Only a handful of American opinions have dealt with the prerogative cy pres power of the legislature. None is from New York. The most important is a series of 19th-century cases involving the Church of the Latter-Day Saints the Mormon Church in the Utah territory for a historical survey, see Gordon These cases, discussed in more detail later, held that the Congress retained the prerogative cy pres power at least in regard to the territories.

In the few cases dealing with the prerogative cy pres power in the states, it was flatly rejected in almost all. The Massachusetts Supreme Judicial Court, for example, responding to a question posed by the state senate in , ruled that the legislature had no power to terminate, change, or control the disposition of charitable funds. According to the court,. The power of the courts of equity to administer charitable trusts cy pres is so firmly established and so frequently resorted to, that the authority of the Legislature with respect to the disposition of charitable trust funds has not been much mooted.

In England, the state never appropriated charitable funds for its own purposes, except for a few cases in which the charitable purposes were illegal. One of the first reported cases involving prerogative cy pres was decided in The king's power was applied to a gift to a schismatic sect opposed by James I, and the funds were diverted to more acceptable religious uses Jones ; Sheridan and Delany In other words, they were directed to another charity.

Throughout the 17th and 18th centuries, this pattern was followed, with the exception of a few cases in which funds reverted to heirs or, though the records remain unclear, were forfeited to the Crown for its own use. The question of the proper disposition of funds subject to prerogative cy pres was settled in the Gaynor Jones case, decided in a series of rulings between and Therefore, only in the rare occasions when a charitable purpose was illegal did the Crown direct the property to itself.

And even then, the practice was short-lived. The Mormon Church cases are similar to the earliest English cases in their approval of the government's seizure and transfer of substantial funds from illegal and disfavored religious uses to state-sanctioned uses. Two statutes formed the basis of the Mormon Church controversy. Second, in , Congress amended the previous act by, among other things, ordering the U.

Three years later, the U. Supreme Court upheld the act, ruling that Congress could lawfully seize church property because its supreme power over the territories included the ability to repeal a corporate charter and dissolve a corporation it had created. The Court also held that the state has power over charitable property when a charitable corporation is dissolved and no donor or founder can be identified that would be entitled to its real estate. Under such circumstances, the Court stated,. The government or sovereign authority, as the chief and common guardian of the state, either through its judicial tribunals or otherwise , necessarily had the disposition of the funds of such corporation to be exercised, however, with due regard to the objects and purposes of the charitable uses to which the property was originally devoted, so far as they are lawful, and not repugnant to public policy [italics added].

Comparing the federal, legislative powers with those of the English king, the Court concluded that some cases, such as those in which the purposes of a gift are declared void, are beyond the judiciary's jurisdiction. The legislature held the same parens patriae authority as the king, with the exception of limitations imposed by the Constitution. If it should be conceded that a case like the present transcends the ordinary jurisdiction of the court of chancery, and requires for its determination the interposition of the parens patriae of the state, it may then be contended that, in this country, there is no royal person to act as parens patriae , and to give direction for the application of charities which cannot be administered by the court.

It is true we have no such chief magistrate. But here the legislature is the parens patriae , and, unless restrained by constitutional limitations, possesses all the powers in this regard which the sovereign possesses in England. Finally, the Court distinguished the U. Here, the legislative power was to be exercised only for the benefit of the people. Congress and the U.

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Supreme Court later eliminated the need for the distinctions between judicial and prerogative powers outlined in the cases. It restored the personal property to the control of the church's president:.

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Supreme Court ordered Utah to issue a new decree so as to avoid the perception that the courts and not Congress had directed the outcome. Thus Congress, and not the court, determined the use of all the seized property. We described these Mormon Church cases to provide historical background as well as to indicate the limits of the prerogative power. Although the cases represent an application of the prerogative cy pres power in the United States, there are several reasons why they offer only limited support for the power of the New York legislature to take Empire's assets.

Most important, the prerogative power was applicable in those cases because the purposes of the charity violated public policy, a reason that does not exist in the Empire case. In addition, according to the majority opinion in the cases, Congress's power to rescind the church's charter stemmed from its sovereign authority over the territories. This was unusual because the exercise of inherent powers was usually reserved for the state legislatures.

Given their historical context, however, state legislatures should be reluctant to rely on the Mormon cases as good authority for exercising inherent power to claim charitable funds. The use of the prerogative cy pres power over Mormon assets in the territories was part of an effort to suppress the Mormon Church and the beliefs of its members through methods such as denying them voting rights see Cleveland , —3.

Finally, as discussed earlier, in those cases in which the states considered the prerogative cy pres , they found it to be a doctrine not appropriately inherited by the state legislatures. The third unusual aspect of the Empire case is that the attorney general did not exercise his power to protect charitable funds as representative of the public interest but, rather, took the position of the insurance commissioner in arguing for the validity of the statute approving the conversion. A state attorney general has many duties, and it is not unusual for them to conflict. Conflicts commonly occur, for example, when a state revenue department challenges the deductibility under the state tax laws of a charitable gift and the attorney general must choose whether to represent the state department of revenue or fulfill his role as protector of charitable funds.

In this case, New York law requires the courts to give notice to the attorney general of any case involving a constitutional challenge to a statute and authorizes him to appear in the case to uphold the statute. In any case in which an attorney general chooses to appear as an adversary to charitable interests, a strict interpretation of the rule giving him exclusive standing effectively ensures that the public interest will be defeated.

The Conversion Process

The court in the Empire case recognized this difficulty when it granted standing to plaintiffs representing the public to be heard, thus allowing the suit to go forward. Another anomaly in the Empire situation should be noted. In the lower court hearings, the attorney general not only supported the constitutionality of the statute authorizing Empire's conversion, but he also opposed giving standing to the plaintiffs to argue against the propriety of the conversion legislation.

It is questionable whether this was a necessary component of his defense of the statute—particularly since, as noted, if standing were refused, there would be no way in which a court would hear the case for preserving the charitable assets. In short, one must wonder whether such zeal is appropriate in light of his role in preserving charitable funds. There are a number of bases on which it can be argued that the Empire statute violates the Constitution.

It was for this reason that the New York Supreme Court ruled that the legislation may have violated a New York constitutional provision prohibiting special legislation—private bills granting exclusive privileges to individual people and corporations—and gave the plaintiffs an opportunity to present this argument to it.

A second concern is whether the New York legislation violates the contracts clause of the U. Constitution, which forbids states from passing a law that retroactively impairs the obligation of contracts. The basis for the argument is that the legislation improperly interferes with property interests arising from Empire's incorporation as a nonprofit corporation. After this case was decided, it became customary for corporations to be established under general enabling statutes in which the legislature reserved the right to amend charters, thereby limiting the holding in the case.

The Empire conversion may also be distinguished from the facts in the Dartmouth College case, and therefore the New York legislature may not be constrained by its holding. Empire's directors chose to convert to for-profit form. Consequently, their actions could be characterized as voluntary. The legal objection to this position, however, is that the directors of Empire had no power to accept the conditions set by the legislature.

As directors of a charity they could abandon their charitable mission only when authorized to do so by the courts in a cy pres proceeding. In other words, their action exceeded their powers and, therefore, had no legal effect. A third constitutional objection is that the legislation may violate the takings clause of the Fifth Amendment, which forbids the government's taking private property for public use without just compensation. Empire's directors had initially hoped to convert and establish a new, private, nonprofit charity, but that choice was removed by the legislature Cowan and McKinley The directors wished above all else to convert, and in New York, the price of conversion was turning the funds over to the state.

One recent case may support the claim that the Empire statute was an impermissible taking. The foundation, funded by Commonwealth-Edison when it earned large profits from the sale of some power plants in the late s, was established to support energy efficiency and environmental projects. There is some dispute about whether the foundation's establishment, the result of a compromise between the parties, was entirely voluntary or a quid pro quo for permission to sell the power plants.

In upholding the lower court's decision, the U. Court of Appeals found that. Illinois [c]annot lawfully amend its corporation law to confiscate the assets of all corporations incorporated … in Illinois by virtue of that law. In some respects, the case against the validity of the Empire legislation is stronger than that against the Illinois legislation.

Although the appellate court decided that the specific terms of the ICECF incorporation did not make it public, unlike Empire, ICECF was specifically chartered by the state, and state officials held some control over the foundation through its power to appoint, though not to remove, trustees.

By contrast, Empire is a creation of New York law only by virtue of its incorporation under the general nonprofit and insurance statutes. To the extent that the decision by Empire's directors to convert did not exceed their authority, the decision could be characterized as voluntary. Therefore, the money transfer would better be described as giving to the government than as taking from the charity. But even if the directors gave the proceeds to the government voluntarily, the legislation could still be considered an impermissible taking if a court found that the price of the conversion—95 percent of the proceeds—was too high.

Requiring that Empire turn over almost all the proceeds to the state for the privilege of converting could be considered sufficiently coercive or such an intrusion into private property rights as to be an unconstitutional condition see generally Epstein ; Sullivan Many important policy implications raised by the Empire case have nothing to do with the behavior of English kings in the s, and these modern-day considerations have drawn substantial attention elsewhere see, e.

Commentators have correctly wondered whether Governor Pataki's closed-door deal with the hospitals and union regarding the conversion proceeds was a legitimate way of conducting health policy. With budget deficits estimated in the billions, the governor has encouraged other insurers to convert Cowan and McKinley Using one-time infusions of conversion proceeds to fix structural budget shortfalls has, and should, give pause to New Yorkers.

The purchase of durable medical equipment for home use, or mobility enhancing equipment, when made pursuant to a prescription and when such devices or equipment are for use by a human being. Tangible personal property used in air, noise or water pollution control facilities by holders of pollution control certificates. Tangible personal property to be resold in the form received. Tangible personal property used or consumed in commercial fishing. Gas, water, steam, and electricity delivered through pipes, conduits, or wires and sold by a public utility or, if applicable, a municipal gas utility.

Bulk water for residential use. Tangible personal property incorporated into an energy conversion facility, solid waste energy conversion facility, or a thermal efficiency improvement facility by holders of the appropriate certificate. Telecommunications service to call centers. No longer an exemption of the sale of , WATS, or private communications services. Sales of property for used directly in agricultural production. Property used in the preparation of eggs for sale.

Sale and installation of agricultural land tile. Sale and construction of portable grain bins to farmers. Sales to persons licensed to conduct a food service operation of tangible personal property primarily used directly: Ships or vessels or rail rolling stock used in interstate or foreign commerce and material used for repairing, altering, or propelling them. Material, machinery, equipment and other items used in packaging property for sale by a manufacturer or retailer.

Building and construction material sold to contractors for incorporation into real property of federal, state, or local governments; religious and charitable institutions; a sports facility under section Building and construction materials sold to construction contractors or persons engaged in the business of horticulture or producing livestock for incorporation into a horticulture or livestock structure.

Property manufactured in Ohio and immediately shipped outside the state for use in the retail business, if sold by the manufacturer to the retailer and shipped in vehicles owned by the retailer. Material incorporated as part of tangible personal property produced for sale by manufacturing, assembling, processing, or refining. Tangible personal property used or consumed in a manufacturing operation. Sales where the purpose of the consumer is to use or consume the things transferred in making retail sales and consisting of newspaper inserts, catalogues, coupons, flyers, gift certificates, or other advertising material which prices and describes tangible personal property offered for retail sale.

Sales to direct marketing vendors of preliminary materials such as photographs, artwork, and typesetting that will be used in printing advertising material; of printed matter that offers free merchandise or chances to win sweepstakes prizes and that is mailed to potential customers with advertising material described in section To use tangible personal property to perform a service listed in division B 3 of section Parts and services used in repairing and maintaining aircraft with fractional share ownership private aircraft whose ownership is shared by a group of people.

Sales of investment metal bullion and investment coins. Effective January 1, Sales of a digital audio work electronically transferred for delivery through use of a machine, such as a juke box, that does all of the following: Effective October 1, This list of exemptions is merely an abbreviation of the law.

The Common Law Power of the Legislature: Insurer Conversions and Charitable Funds

The statutes and rules concerning sales tax exemptions are very long and complicated. Also there are hundreds of court decisions which affect the application of these exemptions. If you have any questions regarding a particular situation, please contact the Department of Taxation. State Agencies Online Services. Ohio Department of Taxation.

Effective October 1, "Direct use" exemptions: Material used or consumed directly in mining, farming, agriculture, horticulture, floriculture, or used in the production of and exploration for crude oil and natural gas. Motor vehicles titled and registered to operate on the highways generally do not qualify for exemption. Tangible personal property used directly in rendering a public utility service.