What Is A Nonprofit “Mutual Benefit” Corporation?
California nonprofit mutual benefit corporations are a type of nonprofit corporation organized to serve the "mutual" interests of their members. A mutual benefit corporation is distinct from "general public benefit" corporations, which are organizations like hospitals and public charities that advance a social or community purpose for the benefit of the general public rather than a certain group of people or organizations . Several types of nonprofits in California are mutual benefit corporations, including business, professional, and trade associations, cooperatives, chambers of commerce, veterans’ organizations, labor organizations, and homeowners’ associations. The Corporation Code applies specifically to certain types of mutual benefit corporations to set their class rights, and additional laws may be relevant to others. For example, the Food and Agriculture Code, Section 14302, specifies the law that governs agricultural cooperatives.
The Governing Law For Mutual Benefit Corporations
As mentioned above, nonprofit mutual benefit corporations in California are incorporated under the Nonprofit Mutual Benefit Corporation Law of the California Corporations Code (Section 7110, et seq.), and are governed by the general provisions for nonprofits (General Nonprofit Corporation Law; Section 5000, et.seq.). In implementing its governing provisions, nonprofit mutual benefit corporations are required to act pursuant to statutory provisions under the California Nonprofit Corporations Code and California Common Law that regulates all types of corporations. Nonprofit mutual benefit corporations must follow the rules, principles and requirements that apply to both public charities and private foundations, which can result in laws that can conflict with each other. Unless otherwise prohibited by the articles of incorporation or bylaws, members of mutual benefit corporations may be organized to hold membership in any or all such classes and on such terms and conditions as are specified and established in the articles of incorporation (Section 7310). Mutual benefit corporations are organized to render services and to establish and maintain normal business operations commensurate with their class of membership (e.g. a professional or trade organization) and operate on a nonprofit basis. These are the basic legal matters that must be addressed under the law with regard to the formation of a nonprofit mutual benefit corporation in California.
Requirements For Formation
Until the 1998 California Nonprofit Corporation Law ("NPC") was enacted, the only available form of nonprofit corporation was a nonprofit public benefit corporation. The NPC was enacted on July 1, 1992 to replace the prior laws of nonprofit public benefit corporations. The NPC was amended in 1994 to make it easier for groups desiring to form a social club, cooperative association or a nonprofit mutual benefit corporation. These organizations sometimes do not qualify for tax-exempt status if they are organized as a public benefit corporation.
The NPC authorizes the formation of a nonprofit mutual benefit corporation, including a nonprofit public benefit corporation, nonprofit mutual benefit corporation, nonprofit religious corporation, and nonprofit cooperative corporation, but does not apply to business corporations. A nonprofit mutual benefit corporation is a voluntary association that is incorporated for the mutual benefit of its members, and usually is formed to further social, recreational, and other noncommercial purposes. Members receive limited control over and interest in the corporation. Each member has one vote and may be a stockholder, bondholder, or neither. However, the members of a nonprofit mutual benefit corporation are entitled to participate in the activities of the corporation in good faith and without unreasonable restraint. The members have a statutory right to inspect the corporate books and demand that the Roll of Members be maintained. By statute, the assets of the nonprofit mutual benefit corporation are subject to a statutory trust in favor of members, creditors, and dissenting members.
The filing of articles of incorporation is the first official step in forming the corporation. A professional may help prepare the corporation’s articles of incorporation. A corporation: (1) should have express and specific provisions in the articles of incorporation and bylaws; (2) may include any lawful purpose in the articles of incorporation, such as operating a business other than the nonprofit mutual benefit corporation; and (3) cannot issue stock but can issue certificates evidencing membership. The articles of incorporation are required to state the purpose of the corporation. The corporation also must keep certain minutes for the principal office and for each branch office. Additional special provisions may be in the articles of incorporation.
The articles of incorporation should state: The articles must be filed with the Secretary of State in Sacramento, California. The Secretary of State’s office stamps a copy of the articles that is filed with it by the date it was received. The Secretary of State rejects filings of incomplete articles of incorporation.
Board Structure And Governance
The board of directors of a California nonprofit mutual benefit corporation (a "mutual benefit corp.") has the authority to manage the activity and affairs of the corporation, subject to the members’ rights under law or in the articles or bylaws. Corporations Code section 7210. The board has full authority, rights and powers granted in the articles and bylaws, all without shareholder approval.
The number of directors may be fixed by the articles or bylaws. Corporations Code section 7220. A member of the board can act if the member is present at the meeting or if the member’s action is consented to in writing or by electronic transmission. A regular meeting of the board of directors must be held at least annually at a time and place designated by the board. Corporations Code section 7211. Meetings of the board are conducted by the president of the corporation, unless otherwise provided in the articles or bylaws. The board can act without a meeting if all members of the board consent in writing or by electronic transmission.
Board members are subject to certain duties under law. In general, the duty of care requires that a director act, in good faith, in a manner such director believes to be in the best interests of the corporation…and with such care, including reasonable inquiry, as an ordinarily prudent person would use under similar circumstances. If a director fails to act in this fashion, the director would have breached his or her duty of care.
The duty of loyalty requires that the director act without personal conflict of interest. The director must act in the interests and for the benefit of the corporation, even when such action is against the director’s personal interest. A director would breach his or her duty of loyalty if the director (directly or indirectly) derives a personal profit from any transaction to which the corporation is a party.
The duty of obedience requires that the director be loyal and commit the corporation to purposes and goals that are legal and within the scope of the corporation’s mission.
If a director acts in good faith and in the best interests of the corporation, the court would allow the director to exercise a broader range of judgment without interference, but the powers of the directors are subject to the superior control of the members. Corporations Code section 7210. Directors of a mutual benefit corporation can also be removed without cause by members having the right to elect such director(s). However, such removal must be without prejudice to the rights of the director under any contract. Corporations Code section 7222.
In addition to the board of directors, officers are also subject to certain legal requirements. For example, an officer would also have a fiduciary duty to the mutual benefit corporation. In addition, no single individual can hold both the offices of president and secretary of the corporation. Corporations Code section 7213. The sole member of the board can appoint one or more officers, a president or a secretary. Officers can be individuals or corporations. Corporations Code section 7232. An officer of a mutual benefit corporation cannot serve as the sole member of the board of directors.
Complying With Reporting and Compliance Rules
Compliance and Reporting Obligations: Mutual Benefit Corporations
As a categorical matter, California nonprofit mutual benefit corporations are required to file with the California Secretary of State various periodic reports and documents. These obligations include:
- Initial Statement of Information. Within 90 days after receiving its certificate of incorporation, a corporation must file an initial Statement of Information with the Secretary of State containing the name and address of its initial agent for service of process, the street address of its principal office in the state, the names and addresses of its three directors, and the authorized number of directors (Cal. Corp. Code Section 2100(a)).
- Periodic Statement of Information. After filing its Initial Statement of Information, a corporation must file a Periodic Statement of Information within 90 days after the corporation files its initial Statement of Information following a corporate name change, and thereafter as follows:
- Statement of Information by Election. Directors, officers and members having election powers, if any, must file a Statement of Information listing their names and business addresses at least 90 days before a regular, or even-numbered year, special, or odd-numbered year, member meeting (Cal. Corp. Code Section 7512).
- Registered Agent Statement. As described above, California registered agent corporations cannot accept a registered agent appointment from more than a certain number of California corporations during a calendar year (Cal. Corp. Code Section 17901). Each corporate registered agent must submit a Report of Change of Agent for each corporation it serves as the registered agent (Cal. Corp. Code Section 17905.1). Where a California nonprofit mutual benefit corporation is served with process through an agent for service of process other than the Secretary of State , the nonprofit mutual corporation must register such location with the Secretary of State by filing an online form, and paying the appropriate fee (Cal. Corp. Code Section 5341).
- Corporate Tax Filings. Many mutual benefit corporations are subject to filing tax returns with the Internal Revenue Service and the Franchise Tax Board. Although most nonprofit mutual corporations, other than those that are private foundations or that demonstrate insignificant activities, may be exempted from payment of tax by the IRS under Section 501(c)(4), they nevertheless are required to file annual IRS returns, unless they are not otherwise required to file. The California Franchise Tax Board may assess penalties against nonprofit mutual benefit corporations that fail to file California franchise tax returns, but generally a mutual benefit corporation is not otherwise subject to California franchise tax.
In addition to the above compliance and reporting issues required to be filed with the California Secretary of State and other taxing authorities, California nonprofit mutual benefit corporations should consider including in their bylaws and restated articles of incorporation certain other matters, such as:
* Unrelated business income, from which members may of course derive small financial benefits, could jeopardize qualification for exemption from federal income tax. Although routine incidental business activity of a mutual benefit corporation is not treated as unrelated business income (IRS Revenue Ruling 2004-38), the scope of this exemption is not always clear. If the mutual benefit corporation engages in business activity that produces a high percentage of unrelated business income, special care should be taken to ensure that all income-producing activities are related to the positive furtherance of its tax-exempt purposes.
Membership Requirements
Membership rights and responsibilities within a California nonprofit mutual benefit corporation depend on the class of membership authorized by the articles of incorporation and bylaws of each mutual benefit corporation. Corporations Code Section 7321, subdivision (a) states: Each member of a mutual benefit corporation (other than an incorporated association) shall have the following rights: (1) To vote on the disposition of all or substantially all of the assets of the corporation. (2) To vote on any plan of reorganization adopted under Sections 6010 and 6011. (3) To vote on the dissolution of the corporation. (4) To vote on the admission of members to the corporation, unless otherwise provided in the articles. (5) To select a governing board of the corporation, if any, unless the articles otherwise provide. (6) To vote on all matters submitted to the members.
Corporate membership is significantly different than individual membership. Unlike an individual, a corporate entity does not have all of the same rights as an individual with respect to voting and attendance at corporate meetings. With a few exceptions, the rights are generally governed by the terms of the corporation’s articles and bylaws.
Dissolution Requirements
Pursuant to the California Corporations Code sections governing the dissolution of mutual benefit corporations not organized for pecuniary gain, a corporation may dissolve by a majority vote of the board of directors followed by three-fourths (3/4) of the members. CAL. CORP. CODE § 18100. If the corporation was created as a mutual benefit cooperative corporation, the written consent of all the members is required to dissolve. CAL. CORP. CODE § 19100. In order to dissolve, a mutual benefit corporation must, if any item of property not held in trust will be distributed within 60 days after dissolution or final liquidation, notify the attorney general of the distribution. CAL. CORP. CODE § 5912.
In two cases involving the Corporation as a plaintiff, the California Court of Appeals has held that, if a corporation has not been dissolved under the applicable laws, the director plaintiffs lack standing to commence an action or defend an action on behalf of the corporation. Redlands Care, Inc. v. Rice (2009) 172 Cal.App.4th 1261, 1272-1275; Holly Park Owner’s Ass’n v. City of San Diego (1988) 202 Cal.App.3d 300, 305.
As to the distribution of a mutual benefit corporation’s assets upon dissolution, California law provides that, if the corporation holds any money and other personal property exceeding $50,000.00, other than money and other personal property distributed in kind to members, or real property, and any unpaid claims against the corporation have not be fully paid, the assets shall be applied to pay those claims before making any distribution to members. CAL. CORP. CODE § 6016(e). The governing law as to the distribution of assets by a dissolved corporation depends upon the type of corporation involved. CAL. CORP. CODE §§ 6810-6822.
Section 6810 specifically applies to non-profit, mutual benefit public benefit (e.g., charitable) corporations and provides for the distribution of assets upon dissolution. CAL. CORP. CODE § 6810. Under this section, on dissolution or final liquidation of a public benefit corporation, after all its debts, liabilities and obligations have been paid and discharged or adequate provision made therefor, the remaining property and assets of the corporation shall be distributed as provided in its articles or bylaws, or, if not provided therein, as determined by a majority of the directors and with the approval of the superior court, or in the absence of any such provision, to the State of California for public use. CAL. CORP. CODE § 6820.
Guidance – A Case Study
Examples are hypothetical, but they are not uncommon in the California nonprofit mutual benefit corporation law. The following are real examples (although names and certain details have been changed to protect confidentiality), and track how an organization was formed and operated over the years.
Example 1: Art Services Company – California Dealer
A national company dealing in art and art services determines that a state exists which offers favorable tax incentives for individuals and other entities seeking to either a) buy art, or b) buy services associated with exhibiting art. The company decides to establish an organization in California to encourage such purchases, and it seeks out a tax attorney to assist in the formation of the organization.
The attorney sets up the company as a California nonprofit mutual benefit corporation, limited to California residents. The company has very few rights and responsibilities, and the Articles of Incorporation identify the tax benefit. As a result , the organization pays virtually no taxes.
Example 2: Home Owner’s Association
A group of homeowners in a neighborhood learn from a neighbor down the street that their homes are all at risk for a widespread pest issue. The group meets to inform all of the families of the issue, and to discuss a possible collective action to address the problem. After further conversations, the group formally organizes as a nonprofit mutual benefit corporation, and adopts bylaws to govern it going forward.
The group collects membership dues from each resident in the neighborhood, maintains records, holds regular meetings, and elects officers each year. The group obtains advice from a pest control specialist, who has agreed to provide free advice in exchange for the good publicity it provides.
The group’s entire purpose is to maintain and improve the value of the homes in the neighborhood, and in recent years, the organization has purchased a neighborhood wall and a common area swimming pool, which is open to all members of the community. All of these activities are possible, because all residents signed up as members of the organization, which is subject to rules, and must elect officers annually just like a business corporation.