Michigan residents who live in condo/homeowner/cooperative associations and fair-minded lawyers who have ties or dealings with nonprofit corporations were recently dealt a serious blow by lawmakers. Significant changes were made to the Michigan Nonprofit Corporation Act (the “Act”) during a lame-duck session of the Legislature. Although some changes can be viewed as positive, as a general matter, the changes have a negative impact.
One of the most troubling changes is the addition of Section 122(3) to the Act, which provides: “The uniform fraudulent transfer act … does not apply to distributions permitted under this act.” The uniform fraudulent transfer act is designed to prevent debtors from defrauding creditors by transferring assets to a third party without getting “reasonably equivalent value” in exchange.
In other words, it prevents a company from giving away its assets so that it would become impossible to collect a judgment against it. This is bad policy because it makes it easier for nonprofits (including charitable nonprofits) to defraud others. This seems to be confirmed by the newly added Section 753, which states that a nonprofit may “dispose of all, or substantially all, of its property and assets … in a transaction that is not in the usual and regular course of its business, on any terms and conditions and for any consideration.”
Therefore, the nonprofit can transfer all of its assets for no justifiable reason and receive virtually nothing in exchange. The Act still requires member approval for such an action, but the Board has the right to determine that “special circumstances” exist to avoid membership approval. Fundamentally, what possible legitimate reasons are there for allowing any company to do this, let alone nonprofits which are intended to be established for the greater good?
The revisions to Section 209 also allow a corporation to unduly protect its directors — not just the uncompensated but also the compensated — from liability for virtually any sort of conduct other than, principally, crimes and intentional infliction of harm. The changes delete what used to be a gross negligence exception, whereby directors were not shielded from actions that were grossly negligent.
Our lawmakers saw fit to make sure there are no remedies for citizens when directors are grossly negligent. That type of exemption is legally outrageous given the settled law regarding directors’ and officers’ fiduciary duties and duty of care. In fact, directors may be immune from liability for any act or omission other than conduct which amounts to “intentional infliction of harm on the corporation, its shareholders, or members.” This is a very high standard, particularly considering that a director’s wrongdoings can inflict harm on the association or charity without having the intent to inflict harm.
While there is a logical reason for protecting volunteer directors who might otherwise be reluctant to serve, there is no reason to protect compensated nonprofit directors more than compensated profitcorporation directors. Who benefits from this — seemingly no one other than malicious and/or negligent directors (and, collaterally, insurance companies which avoid having to pay claims). Prior protections in the Act were adequate.
Even worse, Subsection 2 of Section 209 arguably automatically foists these new provisions on nonprofit corporations that already have a limitation on director liability in their Articles of Incorporation. This is despite the fact that existing limitations in Articles are typically more limited and more reasonable than what the amended Act provides, which may saddle nonprofits with these new provisions whether they want them or not.
Alternatively, it may force nonprofits to incur legal fees and go through the difficult process of amending association documents in order to enact amendments so that the new provisions are not automatically forced on them.
Even if the changes are not automatically imposed on the nonprofit corporation, directors and officers are now further insulated because, under Section 541, in discharging their duties because a director or officer is entitled to rely on information, opinions, reports, or statements, including financial statements and financial data, if they are prepared or presented by another director, officer, or employee of the nonprofit corporation, so long as the director or officer “reasonably believes [the other director or officer] to be reliable and competent in the matters presented.”
It makes sense for directors and officers to rely on the advice of third party legal counsel, accountants, engineers, or other professionals, but now they can rely on each other so long as they reasonably believe the information to be reliable and competent.
This can have a direct impact on directors who also provide services to the nonprofit. Directors should not perform services for the nonprofit. Dual-role directors must not only provide full disclosure to the rest of the directors, but exclude themselves from the decision-making process where the dual-role interests may be affected.
The Act, however, does not mandate exclusion in a conflict situation, and now, theoretically, the Board can rely on the so-called expertise of the director who already has some self-interest in performing services for the association.
In the area of condominium development, the limited liability provisions are even more problematic. Developers initially establish the condominium association as a nonprofit corporation. Developers appoint the initial board of directors – obviously only those who are friendly and/or affiliated with the developer.
The developer’s appointees remain in control of the board of directors and of the corporation until the “transitional control date,” which occurs when at least half of the condominium units in the project are sold, a process which can take years. During this time, there exists a setup and circumstance where the developer will protect its interests vis-à-vis the nonprofit association that the developer has set up.
Now, with the new provisions in the Act, the fox will really be watching the henhouse. It would seem to give them license to mismanage the corporation and otherwise fail to exercise sound business judgment with impunity. When the turnover of power to the owners of the condominiums is made, the owners will have a much more difficult time holding developers and their designees on the Board accountable for mistakes and mismanagement.
The amendments to Section 408 also permit directors to be elected without a meeting of the members or shareholders under a specified ballot process, making it potentially easier for incumbent directors to remain in power without debate and without nominations for opposition following that debate.
Indeed, the amendments refer to “any action the shareholders or members are required or permitted to take at an annual or special meeting,” not just election of directors, so this provision may be subject to abuse.
The revisions also permit the addressing and passing of certain matters at membership meetings without prior notice and conducting “membership” meetings without notice. In addition, under Section 209, “other persons” (i.e., those other than the duly elected directors) are authorized to exercise corporate powers or manage the business and affairs of the corporation.
The same section generally relieves elected directors of their responsibilities to the extent of the delegation, yet still insulates such other persons to the extent the elected directors would also be protected. These are people who potentially have no stake in the community — yet they could be entrusted with managing the affairs of the community, and generally with impunity.
The new law also makes derivative actions harder to file. Under the new Section 491a, et. seq., there is an automatic 90-day pre-suit waiting period, along with provisions providing for dismissal of the lawsuit at early stages when certain combinations of the existing directors think the lawsuit should be dismissed.
It has now become more difficult to bring these suits, particularly for those who are already disadvantaged because the board of directors has attorneys and community funds at its disposal.
The law may have been intended to improve efficiency in the operation of nonprofits, but it goes too far, resulting in consequences that are harmful to the public and the members and shareholders of nonprofit corporations, particularly those living in neighborhoods governed by community associations.
By Robert M. Meisner, The Meisner Law Group, P.C.
This article reprinted with permission from Michigan Lawyers Weekly.