by Thomas E. Rutledge
The 2015 Kentucky General Assembly approved the adoption of the Kentucky Uniform Unincorporated Nonprofit Association Act. This new law is important in that, with this new statute, there is for the first time in Kentucky an analytic paradigm and body of default law by which such organizations may be assessed. Prior to this enactment, Kentucky has lacked such a body of law even as unincorporated nonprofit associations have been organized and operated. Further, for the first time it will be possible for the participants in an unincorporated nonprofit association organized in Kentucky to enjoy the benefits of limited liability.
The Kentucky Uniform Unincorporated Nonprofit Association Act is largely a default statute, setting forth rules as to particular matters that are applicable absent contrary agreement with respect to the topic. In light of their expected informality there are minimal requirements that the agreement be reduced to a writing.
An important defined term used in the law of unincorporated nonprofit associations “UNPA” is the “governing principles.” Roughly equivalent to a partnership’s partnership agreement or an LLC’s operating agreement, and including the “established practices,” the governing principles are the agreements of the members as to the purpose and operation of the association. The governing principles may be oral, written or arise from a course of conduct. The association, the members and the managers are bound by the governing principles.
Formation, Purpose & Powers; the Certificate of Association
An unincorporated nonprofit association is a default structure; it exists if its definition is met. There is no requirement of an intent to form an unincorporated nonprofit association. In fact there is not even a requirement that the participants in the venture be consciously aware of the possibility of forming an unincorporated nonprofit association.
An unincorporated nonprofit association is considered to be an entity distinct from its members and managers, and enjoys perpetual duration while being vested with all powers of an individual necessary or convenient to carrying out its purpose. While limited for profit activities are permitted, the proceeds thereof must be applied to the nonprofit purpose.
Name Requirements, Annual Report
The name requirements for a UNPA are set forth in the Kentucky Business Entity Filing Act KRS. ch. 14A and are dependent in part upon whether the UNPA has filed a certificate of association. Regardless of whether a certificate is filed, a UNPA may not include in its name any of “incorporated,” “corporation,” “Inc.,” “Corp.,” “company,” “partnership” or “cooperative.” If a certificate of association is filed, the name of the NPUA must include either “Limited” or “Ltd.” Further, that real name as set forth on the certificate of association must be distinguishable from any name of record with the Secretary of State. Absent filing a certificate of association the name distinguishability standard is not applicable, but the UNPA’s name should not include “Limited” or “Ltd.” in its name as doing so would be misleading. The assumed name statute has been revised to define the real name of a NPUA and to allow a NPUA to file an assumed name.
The application of the rules governing annual reports to UNPAs is dependent upon whether or not the particular UNPA has filed a certificate of association. If no certificate of association is filed then no annual report is required. Conversely, if a certificate of association has been filed, an annual report is required.
An UNPA, subject to distinctions based upon whether or not a particular UNPA has or has not filed a certificate of association, is subject to the Assumed Name Statute.
Liability for Association Debts & Obligations; Limited Liability
Initially, the members and other participants in an unincorporated nonprofit association are each liable for its debt and obligations. While the Uniform Act, by fiat, reversed the rule and afforded limited liability ab initio, this policy has not been carried forward in Kentucky. Rather, under the Kentucky Act limited liability is available if and only if the association makes a filing with the Secretary of State. By means of this filing, the public is put on notice that the participants in the association enjoy limited liability, and that those extending credit to it may look only to its assets for recovery.
The filing by which limited liability is elected is a certificate of association. The certificate of association must set forth:
The filing fee for a certificate of association is $15.00.
In accordance to the law governing other forms of business organizations, the grant of limited liability effected by the filing of a certificate of association will not protect an individual from liability for their own negligence, wrongful acts or misconduct.
In the absence of a certificate of association, in any suit brought against the association, the judgment rendered thereon will not be binding upon a member ab initio unless that member was named as a party therein. There are, however, a series of provisions pursuant to which, even in the absence of certificate of association, the members may, consequent to their personal liability for the debts and obligations of the association, be required to satisfy that judgment.
Suits By or Against an UNPA
An UNPA may sue or be sued in its own name. Suit against an UNPA that has filed a statement of association and thereby designated a registered agent may be initiated by service on the registered agent. Where no registered agent is designated, service may be completed as otherwise provided by law. The capacity to sue or be sued in its own name is a common characteristic of business organizations. This capacity extends to suits by a member or manager against the UNPA or a UNPA suit against a member or manager. If an UNPA has filed a statement of association and thereby elected limited liability for its members and other constituents, a member or manager is not a proper party to the action simply by reason of their status as a member or manager. This provision is not uniform and has no equivalent in the Uniform Unincorporated Nonprofit Association Act.
Even where the UNPA has not filed a statement of association and thereby elected limited liability, a judgment against the association is not enforceable against a member or manager therof unless and until certain conditions have been satisfied. A creditor may include as parties to the action some or all of the members or managers, and conceivably be awarded a judgment against them coincident with the receipt of a judgment against the association. In that instance, the judgment against the member or manager may be immediately enforced and need not wait upon a determination that the association is unable to satisfy the judgment. A change in the membership or management of an UNPA will not abate a pending action by or against it.
If the UNPA has filed a certificate of association, the proper venue for an action against the association is the county in which the principal place of business is maintained or, if the principal place of business is not in Kentucky, the county in which the registered office is located. Where the UNPA has not filed a certificate of association, the rules applicable to general partnerships are adopted to determine proper venue.
Every organization must have two or more members; there is no such thing as a single member UNPA. Absent filing a certificate of association the members are personally liable for the association’s debts and obligations.
A member of a UNPA is not by reason of that status an agent of the association. Except as may be otherwise provided in the governing principles, members vote on a per-capita basis with a majority vote controlling. Unless delegated in the governing principles to the managers, there is expressly reserved to the members the right to vote on certain matters. There is left to the governing principles rules as to notice, quorum and other procedural rules for member meetings. While a member is not, consequent to that status, in a fiduciary relationship with either the UNPA or any other member thereof, each member is bound by an obligation of good faith and fair dealing.
A person becomes a member in an UNPA in accordance with its governing principles or, in the absence of governing principles as to admission of members, by a vote of a majority of the incumbent members. On those same terms a member may be suspended, dismissed or expelled from the association. None of resignation, suspension, dismissal or termination of a member will relieve that person of unsatisfied obligations to the association. A member may resign at any term unless the governing principles impose limitations upon the right to resign. Unless a contrary rule is set forth in the governing principles, a member’s interest in the association is not transferrable.
Every UNPA is required to be managed by “managers” who have the authority to make all decisions on the association’s behalf except those reserved to the members. Managers are selected by a majority of the members, and there is no requirement that a manager be a member. If the members do not elect or otherwise designate managers, then every member is as well a manager. Each manager has an equal vote, and the managers act by a majority. Each of these rules may be altered in the governing principles.
Pursuant to a non-uniform provision, rules as to notice, quorum and other procedural requirements for manager meetings shall be set by the governing principles.
Managers owe to the association fiduciary duties of care and loyalty. The statutory formula for the duties of care and loyalty owed to the association by the managers is unique as contrasted to the formulas employed in others of Kentucky’s business entity statute. For that reason it is crucial that the focus be upon the words employed; loose analogy to the laws of other organizations is not proper.
The fiduciary duty standard, which is not identified as being subject to modification in the governing principles, obligates each manager to manage in good faith, in the manner honestly believed to be in the best interest of the association, and on an informed basis. Reliance upon the opinions and information provided by others is conditionally appropriate. A related party transaction, which would otherwise violate the duty of loyalty, may be approved or ratified after full disclosure by a majority of the disinterested members. The governing principles may limit the exposure of a manager to liability for breach of the fiduciary standards provided the failure does not fall within certain prescribed conduct.
Inspection of Books and Records
Members in their capacity as members, and managers as managers, have the right to inspect association books and records. It bears noting that there is no requirement that any particular records be maintained by the association. Ergo, the right of inspection applies to what records have been maintained. The right of inspection is collared by the requirement of a proper purpose and a limitation to information “material to the member’s or manager’s rights and duties under the governing principles.” The Kentucky Act is not uniform as to the right of the association to limit access to and use of association information. Essentially, where the uniform act would defer to the association to unilaterally impose limitations on access to and use of information, the Kentucky Act looks to the governing principles for such limitations, and unless set forth in written governing principles asserted to by the member or manager seeking inspection, the association bears the burden of showing the reasonableness thereof. While former members and managers are afforded inspection rights, it is difficult how they satisfy the requirement that the books and records sought are “material to the member’s or manager’s rights and duties under the governing principles.”
Property; Statement of Authority
An UNPA may hold in its name real, personal and intangible property. With respect to real property, the UNPA may file a “statement of authority” by which there is made of public record the capacity of a person to, on its behalf, affect a transfer of the real property. Filed with the title records of the county clerk where the transfer would be recorded, a statement of authority is conclusive as to the authority of the person executing the transfer on the association’s behalf as to a grantee without notice of a limitation on the authority who gives value. A statute of authority has a maximum term of five years.
There is no requirement of a statute of authority to transfer real property held in the name of an UNPA. Rather, it is an optional mechanism by which to avoid questions as to the capacity of the person signing on behalf of the UNPA. A grantee with those concerns, or a title insurer seeking to avoid those questions, may insist that a statute of authority be filed prior to the property transfer.
An unincorporated nonprofit association may not pay dividends or make other distributions to its members except to a limited degree upon dissolution. Still, without violating the limits against dividends/distributions, an unincorporated nonprofit association may pay reasonable compensation, reimburse expenses, confer benefits on its members consistent with its nonprofit purpose, or repay a capital contribution or repurchase a membership if doing so is authorized by the governing principle. In the event of an improper distribution, a member may bring a derivative action.
An UNPA has the capacity, but not the obligation, to indemnify its members and managers from debts, obligations or liabilities incurred on behalf of the association provided that the person seeking indemnification has, in the case of a member who is not a manager, acted in good faith or, in the case of a manager, discharged their fiduciary obligations. In a rare application of the statute of fraud in the statute, the right to indemnification may be broadened or limited in the governing principles, provided the broadening or limitation is in record form.
An unincorporated nonprofit association may be dissolved:
Consistent with the law governing other business organizations, an unincorporated nonprofit association continues its existence after dissolution. Upon dissolution, the debts and obligations of the association are to be satisfied, assets held subject to trust or requiring return to the donor are to be conveyed in accordance therewith with the remaining assets distributed to other persons with similar nonprofit purposes, to the members or as directed by the appropriate court.
It should be noted that, unlike most other business organization statutes, the Unincorporated Nonprofit Association Act does not afford a mechanism by which known creditors of an association may be notified of its dissolution and afforded a limited period of time in which to tender claims. Likewise, the Unincorporated Nonprofit Association Act does not provide a mechanism for, by means of publication, providing notice to unknown creditors. Consequence of these omissions, it will often be difficult to determine, on behalf of a nonprofit unincorporated association, that all creditor claims, to the extent of association assets, have been satisfied. The absence of these provisions of the uniform act is curious in that they are standard provisions in other uniform unincorporated entity laws.
The uniform act provides for mergers between UNPAs and as well with other organizational forms. These provisions have not been carried forward into the Kentucky enactment. As such, until such time as Kentucky adopts a comprehensive “junction box” act governing all organic transactions and entity forms, unincorporated nonprofit associations lack the capacity to enter into a merger.
Relationship to Other Law; Uniformity
Principles of law and equity supplement the Act. It is important to recognize that an UNPA is its own freestanding body of law. It is not directed or otherwise indicated that the law of partnerships, corporations (whether for-profit or not-for-profit), limited liability companies (whether or for-profit or not-for-profit) or any other body of organizational law shall serve as the “gap filler” when either the agreement as to a particular venture or the unincorporated nonprofit association act are silent. Rather, when the statute and the private ordering of a particular association ar silent there should be referenced general principles of law and equity.
If another statute governs a particular form of UNPA, to the extent of an inconsistency with this act, the other act will control.
It is directed that the act be construed to promote uniformity among the states that have adopted the act. Similar provisions appear in other of Kentucky’s adoption of uniform acts, it needs to be appreciated that this dictate extends only so far as the Kentucky enactment of the statute is consistent with the uniform act. Where the statutory language employed in Kentucky departs from the language employed in the uniform act, uniformity is obviously not the intended result, and cases and commentary from other states are of diminished or no value as interpretive aids.
Expressly not considered herein are questions involving federal and state income taxation of an UNPA. These issues are at minimum challenging in that, ab initio, an UNPA is not a “corporation” falling within section 501 of the Internal Revenue Code. While the Kentucky Unincorporated Nonprofit Association Act does set forth a default organizational paradigm for these often informal organizations, these tax complexities may caution against the intentional utilization of this form by persons who are not otherwise well versed in the tax consequences of this form.