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Duty of Obedience in Charitable Organizations Evolution Research Paper

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Updated: Mar 6th, 2022

Introduction

It is observed that evolution of charitable organizations in terms of the fact that they inure for the benefit of the community, or the public good. Again it is seen that charitable organizations need to have office-bearers who are sincere and honest and committed to the welfare and betterment of the charitable organization. This, it is seen that the onus of superintendence, direction, and control of the activities of the charitable organization are also important considerations that need to be kept in mind.

The main objective of duty of obedience is to ensure and maintain that the performance of the trustee in so far as the usage of trust funds are concerned, are in line with the objectives assigned by the donors and need to conform with applied needs of beneficiaries, or for the public good. If this is not possible, it is incumbent upon the trustees to seek application of cy pres norms for the trust funds, in keeping with the best interests of beneficiaries, and according to the desire of donors.

The meaning of charitable trusts has evolved, signifying changing circumstances of the value systems that inure for public benefit. It is seen that a lot of laws also impinge upon the conduct of operations in charitable organizations. It is also seen that in the event of any discrimination on racial grounds, it is well within the powers to disallow tax exemptions to charitable agencies.

The course that this study would be taking would be first in terms of examining and analyzing the Traditional Application of Trust Model, after which the trending model of for-profits charitable institutions would be taken up.

Next, it is proposed to take up governance and regulation of net profit charitable organizations.

After which, the analysis and interpretations of the study would be taken up and finally the conclusion would recommend the best course of action that could possibly be taken regarding charitable organizations.

Traditional Application of Trust Model

First of all, it would be necessary to define the meaning of the term “duty of obedience” according to the norms of a charitable organization which means “an expectation that a board member remains obedient to the central purposes of the organization and respects all laws and legal regulations” governing it. 1Thus it is seen that the duty of obedience demands that the board members should be dedicated to the achievement of the company‘s mission. They are not supposed to act in such a manner that is not goal congruent, and it is also important that the endeavors need to be consistent with the missions of the unit.

Kurtz has emphasized that there are current needs for duty of obedience by the trustee towards the objectives of the charitable trust, besides that of loyalty and care. The Trustees are under covenant to carry out the terms and conditionality of the trustee in congruence with the deemed requirement of the trust donors. 2

Thus, it is necessary that trustees act in the best interests of the donors about monies at their disposal for common good and to meet the objectives of the trust.

It is seen that the main aspects about conformance with the board’s objectives would stem from the following:

  1. Communications systems: The communication system must be such that could motivate, inform and guide employees and also volunteer to work with media personnel.
  2. Evaluation: there must be manifest value to public, especially, in the case of non-profit trusts in which the public holds sustain stakes. It needs to have clear set of goals, Therefore, the evaluation process needs to take into account improvement in quality and also enforce accountability.
  3. Financial management needs to consider fiscal responsibilities and also issues of public trust that could address the areas that need to come under the purview of duty of obedience.
  4. Fundraising is a major aspect of the societal role in charitable or philanthropy and could act as a bridge between the donor and the beneficiary. Ethical considerations must be considered that could address these aspects of the business.
  5. The resources to fulfill the mission need to be considered, in the context of the duty of care, duty, and obedience in the carrying out of official duties by the administrative board members and sub staff.
  6. The ethical and legal issues need to be considered, especially in the context of the fact that the interests of donors and their influence over the unit need to be considered over a long time frame.
  7. It is necessary that to maintain equity and fair play, the board members must participate in overall plan processes to implement the monthly plans and programs of charitable organizations. 3

It is seen that although the duty of obedience may be rigid and narrow in its approach, its main feature lies in the fact that directors of non-profit agencies need to put the interests of their organization above their personal interests. This is because they have fiduciary duties towards their company which may not be compromised. 4

Again it is seen that good faith is incumbent in charitable organization business, and the duty of obedience is linked with that of duty of loyalty and charity.

It is now necessary to consider the aspects of where the non-profit charity systems are heading. It is seen that wider use of financial propriety is being emphasized in recent years, in terms of accountability and control over the chances of wrongdoing by the office bearers of charitable agencies. The

“law of nonprofit governance is moving toward a more corporate model of accountability—a model that emphasizes audits and other formal financial controls,1 and that focuses enforcement on financial wrongdoing and misuse of charitable funds by directors and managers.” 5

However, the government’s obsession with rigid financial controls may not always be relevant. It may give rise to misconceptions and illusions that the objectives in charitable organizations are to strengthen the bottom line. This may set dangerous precedents for structures needing board size and constitution or even the autonomy of directors may lose sight of their main goals, or the objectives these structures need to defend.

It is often seen that social impacts are far superior to financial accountability. This is concerning such kind of financial control and adoption of a business model which, in the long run, may do more harm than good to the institution. If smaller firms are required to submit to rigors of business accountability as required by large well-diversified charitable organizations, they may incur costs far beyond their capacities. This may not be in sync with the non-profit-making objective that forms the core of such charitable activity. The paucity of government funds need not be a valid excuse for such organizations to lose sight of their focus on public benefits and the need to be socially relevant and useful,

“The doctrine of obedience “derives from trust law [under which] a director (trustee) must administer the corporation’s assets (trust) in a manner faithful to the expressed wishes of the creator and donors, who rely on those express purposes when making their contributions.”26 Strict trust law parallelisms would also impose “a trust on a charitable corporation’s unrestricted gifts… for those charitable purposes outlined in its articles of incorporation (and perhaps those manifested in its operations) at the time such gifts were received.” 6

NY Stock Exchange President Richard Grasso

The Courts are sometimes skeptical about upholding violations regarding the duty of obedience. A recent case of NY Stock Exchange President Richard Grasso is an instance of the pointer in which while the doctrine was referred to but not made prejudicial to him. The shift seems to be towards care, and not necessarily of loyalty. Over the years the shift has been from one of traditional value maintenance to the current need for protection of assets, or from protectionism to maintenance of objectives as was witnessed in the following case.

Manhattan Eye, Ear and Throat Hospital’s (MEETH)

Manhattan Eye, Ear and Throat Hospital’s (MEETH) petition to sell its assets. The Courts held that the decision to sell its assets was not in line with its objectives and was thus summarily rejected. Although the agreement would not have produced enough consideration for the assets, thus lending grounds for its disposal, the ground for disallowing sale of MEETH assets was based on the tenet that this would not meet the primary need of the charitable nature of its operations.

“Attorney General Spitzer today cited a State Supreme Court decision blocking plans for the sale and eventual closure of the Manhattan Eye, Ear & Throat Hospital, and (MEETH).

In a decision issued on December 3, Justice Bernard J. Fried upheld the Attorney General’s contention that MEETH’s Board of Directors failed to promote the hospital’s corporate mission.” 7

Duty of obedience gives way to fidelity

It is seen that over the years, the law seems to be changing from the narrow and straitjacketed notion of obedience to a broader framework of fidelity towards the commitment of directors in the attainment and maintenance of the charitable trust’s goals and objectives.

“Fidelity creates a legal norm explicitly connected to the charitable mission that also accommodates considerable flexibility and discretion for nonprofit boards” and “an obligation of fidelity is necessary to distinguish nonprofit directors from business directors, signals the importance of charitable mission for nonprofit organizations, distinguishes charities from social-entrepreneurial businesses, and requires subordination of non-charitable goals.” 8

It could also be seen that dynamism and major changes need to be instituted in the mission statement and charter documents of charitable organizations so that the narrow perception of ethereal obedience, sometimes subjective and incapable of being rendered justice in large broad-based organizations, give way to a more concrete and broad-based system of corporate fidelity by the directors and members of the governing body of charities to make their functioning more transparent, useful to the public and also, in line with the stated objectives of the charitable trust covenant.

In re Multiple Sclerosis Service Organization of New York, Inc

This fact was explained in the case of In re Multiple Sclerosis Service Organization of New York, Inc., in which the courts distinguished between the activities of the trust and the purpose of the trust. It is believed that the cy pres aspects need to be paramount. 9

Cy Pres norms

It is seen that the Court attached much value to the doctrine of cy pres, wherein, if the matter of trust cannot be met, due to dissolution, closure or lack of clarity in how the ultimate benefit passed on, or beneficiaries would be, it would need to be determined by the Court as to how these could be achieved. In this case the Courts reached the following conclusions:

  1. Donatives purpose is important to factor in arriving at the proper recipient of funds
  2. Non-specific grants would be deemed to be used for general corporate purposes
  3. The actual activities need to be assessed since cy pres norms have to be considered. The recipient should carry on similar activities as the dissolving trust carried out.
  4. The recommendation of the governing board of the organization and the reasons for that recommendation, as discussed above, should be given substantial deference, given the emphasis in the N-PCL on the critical importance of board management of not-for-profit corporations, both with respect to dissolution and in general. 10

Thus, it is seen that cy pres is an important aspect that governs the functioning of non-profit charitable organizations and in the event of the need to distribute unallocated funds, equitable and as near to rules also have to be maintained. If a donor A bequeath funds to B as charity, B being a charitable organization, in the event B is dissolved or fails to meet the criteria of the grant, then the Courts would have to pass on the grant to other institutions, who carry out similar activities as B did.

“In Alco Gravure, Inc. V. Knapp Foundation 1985), the New York Court of Appeals held that the quasi cy pres standard would be applied to any change in the manner of administration of not-for-profit assets, citing the provisions of the N-PCL addressing restricted gifts and dissolution.” 11

In other words, if the trust objectives have been realized, or if conditions have come to pass that render it impossible, or difficult to realize trust objectives, it would become necessary for diversion of funds, or cy pres application of the funds to inure for the public good and for protecting the interest of beneficiaries. 12 The concept of obedience would fail to meet standards, in so far as it fails to translate the stated objectives of trust into action.

The trending use of for-profit corporate law

The main aspects with regard to for-profit corporate law in the US context would be about taxation aspects under Section 501(c (1) of the Internal Revenue Services. It is to be seen that even for-profit charitable organizations could claim tax exemptions or deductions based on the kind and level of activities that they perform or the charitable services that inure for the public good.

Therefore, the main aspects that need to be considered are not whether the trust seeks profits or not, but the kind of activities and work that they do, to promote their objectives of public service and also to work in sync with the predetermined laws and legal requirements of the laws of the state governing charities.

In as far as charities are concerned it is seen that different laws operate in different states and it would thus be difficult to seek broad-based laws that govern US charities as a whole.

However Section 501 (c) (1) states certain stipulations that need to be carried out. They are as follows:

  1. It should be made up fully of exempt purpose items and no portion of its earnings should benefit private shareholders and individuals.
  2. It should not attempt to influence laws for any of its activities and should not have any kind of political agenda or affiliations.
  3. In the event any excess benefit transactions are carried out, to profit any individual who may wield influence over it, surtax must be charged and paid as laid down by the law. 13 Again it is seen that in most cases, it would not be allowable for officers or office bearers to be provided salaries for their work contribution to for-profit charity. Even the amount of honorarium, etc that is being provided should be in line with the norms and should be duly audited by professional accountants who may also need to provide detailed reports regarding the functional aspects of the business.

Governance and Regulation of Net profit in Charitable Organizations

A high degree of accountability and responsibility must be sustained in the organization. The Board members need to ensure that all activities undertaken by the charity are for the benefit of the public and not for individual gains. They need to be very clear about their duties, obligations responsibilities and privileges, whatever is assigned to them through the Charter of incorporation and for day–to–day functioning of the unit. “For example, individual board members may be held responsible for the failure to remit payroll taxes, unless they can demonstrate that there were reasonable controls in place that were usurped.” 14

While considering the regulation of net profits in charitable organizations it is necessary that both for-profit and non-profit need to maintain accounts and submit returns to respective IRS. However, it is seen that as a normal rule, non-profit charities do not issue stock or declare dividends. Thus the raising of capital and the payment of dividends to stakeholders form part of the regulatory aspects in charity business. Again it is also necessary that profits need to be plowed back into the business so that the corpus for the stakeholders of the charity is widened and every attempt is taken to provide benefits to the public, as is the primary objective of all kinds of charity, whether public or private in the US context. Thus, audit and maintenance of transparent accounts, holding of annual meetings and other formalities of joint-stock companies are also applicable to charity, although the level of restrictive trade prices is lowered. However, it is seen that the surplus funds need to be in the business itself and cannot be reinvested for profits in most cases.

Another aspect of recent origin is the use of charitable institutions for financing global terrorists’ activities. Following the September 11, 2001, terrorist attacks, the US government has closed down 3 of the 5 largest international Muslim humanitarian agencies and frozen nearly $8 million assets of these institutions.

Again it is also seen that under Executive Order 13224, the US has designated 12 charitable organizations as having links with Al Qaeda, and similar terrorists’ outfits. “The FATF Special Recommendation VIII on Terrorist Financing commits all member nations to ensure that nonprofit organizations cannot be misused by financiers of terrorism. The United States is co-chairing the FATF Terrorist Financing Working Group that has recently produced an international best practices paper on how to protect charities from abuse or infiltration by terrorists and their supporters.” 15

The charitable trusts cold act as a good decoy for movements of funds, especially among countries sponsoring and abetting terrorism on their soil and therefore, the US administration is of the unqualified view that these kinds of transactions have to be stopped completed.

The issue of licenses and permits to do business is also intrinsic for charitable organizations, including registration and the filing of particulars of directors, shareholders and other office-bearers. It is also necessary that proper performance appraisal of for-profit organizations and the method in which their surplus has been used also need to be available to concerned departments. Filing of Annual Audited Accounts and other statutory details need to be made to ensure that there are good controls and monitoring of the way trust funds are being utilized by profit agencies.

It is also necessary that directors of charities need to exercise due care and judgment not only in the affairs of the trust but also in their level of commitment and dedication to it.

“Nonprofit directors and officers have three fiduciary duties under current law: the duty of care, the duty of loyalty, and the duty of obedience. If directors do not exercise these duties, they may be personally liable for their actions.” 16

Charity trusts are banned from indulging in political activities

It is further seen that any kind of political activities by charities are categorically banned and if indulged in. may affect their tax exemption status. Charities must also take care in trying to influence public opinion or legislation, because no substantial part of an NPO’s activities may be lobbying [IRC section 501(c) (3)].17

Again, it is also seen that “The IRS may revoke the organization’s exempt status if any amount of political activity is conducted.” 18

Further the directors or authorities of charities cannot make speeches that would show the unit in a bad light, or seek to demoralize the present staff or workforce.

When considering political campaigning, it could be said that candidates could make speeches at charitable events, but this should meet the norms laid down under IRS News 2004-79. “Charities should be careful that their efforts to educate voters comply with the Internal Revenue Code requirements concerning political campaign activities.” 19

Factors that would disqualify charitable organizations from tax benefits

Thus it is seen that the reports provided by the IRS inspectors would be crucial in deciding the case of whether exemption status needs to be continued to be given to the charity. Some of the major issues could lie in the following:

  1. When any kind of discrimination is shown in managing of work staff and outsiders in terms of racial or other kinds of prejudices.
  2. Excess benefit has been received which has either not been accounted for, or has inured for the personal benefit of the directors, or promoters and not for the charity as such.
  3. Indulging in political activities or lobbying that is emphatically prohibited by the bylaws and charter of the charity or by Section 501 (c) of IRS Code.
  4. Any other kind of activity that transgresses the spirit and objective of the charity, or is such that the deciding authority or Court decides would be detrimental to the interests of the objectives and goals of the charity and the Court feels that it is a fact that aspects that inure for public benefit have been compromised.

Under such circumstances, when Governmental regulation and enforcement of laws in the workings of such charity needs to be enforced it could lead to actions against the directors of such charity, and also temporary or permanent suspension of tax-free status, with penalties and fines that may be deemed necessary from time to time.

However, it is also well within the ambit of the charity to appeal against the orders and prove remedial measures that its Board thinks necessary considering the circumstances of the case and the fact that the Board feels that the charity has been victimized or is innocent of alleged wrongdoings or breach of rules.

Conclusions

It is seen that over the years of its fruitful and yeoman service rendered by charities in the United States, the priorities have not shifted from one of utilitarian based on the duty of obedience to one of commercialization, based upon integrity and allegiance of the directors of charities. The narrow and straitjacketed view of obedience has now embraced a wider aspect of fidelity, which also includes the right kind of strategic decision making and policy adherence that marks charity off from others of its ilk.

The fundamental premise is that stakeholders and directors of charities need to now take a broad-based approach on the administrative and accounting systems prevalent in their charities and lay more stress and emphasis on the preventive and pro-active aspects of its running, keeping in consonance with the fundamental rubric of its creation and also eschew actions that could be deemed as lowering the standards and ethical values that are so necessary and virtually important in the matter of governing charity trust affairs.

It is necessary for the directors to draw up short, medium and long term planning that could possibly take charity along the right path of progression and distinction and also eschew parochial and vested interests, which in the long run could even vitiate the very fabric of its existence and sustenance in the United States of America

Again, it is also necessary that with the changing times the value systems surrounding charities also need to undergo sea changes. Not only the objectives

of the charity need to be more deeply etched across the performance of these functionaries but it is also necessary that the objectives of the grantor or donor also need to be met. In the first instance, the Board must understand the motive and intentions behind granting such charity, for tax purposes, or for any other reason, including advancement of learning, art or culture for alleviating poverty or to aid handicapped people, etc.

In the context of the ambitions of the donor, it is necessary for the Board, within the specified timeframe, to take necessary steps for the best use of such trust funds, keeping the best interests and objectives of the trust in mind. It is also necessary, in order to avoid future litigation, to use the grant or donations, according to the wishes of the donor and for the specific purpose assigned by him.

Again, it is also necessary that in case no specifics have been delineated, it needs to be shared by the bylaws of the charity and also the decision of the governing body of the charity.

It is seen that charities do serve a very important position in society, especially in the poverty-stricken and backward segment of American society. Their plight could be alleviated through the judicious and sincere use of charity and other benefits, especially in healthcare, education, employment, etc.

However, maximum responsibility would lie upon the board of directors and others to decide how best and optimally trust funds could be used for the betterment of societal needs and aspirations. Should actions of office bearers of trust funds fall short of desired goals and objectives, it is necessary to seek remedial measures to ensure the protection of interests of beneficiaries in line with the motives of donors.

References

  1. Claudia L, Kelley, “Advising nonprofit organizations.” All Business.
  2. “Charities may not engage in political campaign activities.” Internal Revenue Service: United States Department of the Treasury.
  3. Cuomo, Andrew M, “Media centre: court blocks sales of Manhattan hospital.” Office of the Attorney General.
  4. “Exemption requirements.” Internal Revenue Service: United States Department of the Treasury.
  5. Fremont-Smith, Marion R. “.” Harvard University Press. Web.
  6. “Grassroots governance: governance and the non-profit sector: transparency and accountability.” Certified General Accounts Name Your Needs CGA.
  7. Mann, Pamela A. “Operating the New York not for profit organization: how to make structural changes.”
  8. “Principles & practices guide: for nonprofit excellence in Michigan.” M N A: Michigan Nonprofit Association.
  9. Sugin, Linda. “Resisting the corporatization of nonprofit governance: transforming obedience into fidelity; abstract.” SSRN: Social Science Research Network.
  10. Sugin, Linda. “Resisting the corporatization of nonprofit governance: transforming obedience into fidelity.”
  11. Sugin, Linda. “Resisting the corporatization of nonprofit governance: transforming obedience into fidelity: reflection on the conference.”
  12. Sugin, Linda. “Resisting the corporatization of nonprofit governance: transforming obedience into fidelity: Fordham law review: trust law defines obedience.
  13. “Topic paper and articles: board glossary: duty of obedience.” Board Source: Building Effective Nonprofit Boards.
  14. “Terrorist organizations, freezing of assets: protecting charities from terrorists abuse.” Espionage Information.

Footnotes

  1. “Topic paper and articles: board glossary: duty of obedience.” Board Source: Building Effective Nonprofit Boards.
  2. Fremont-Smith, Marion R. “Governing nonprofit orgnizations: federal and state law and regulation.” Harvard University Press.
  3. “Principles & practices guide: for nonprofit excellence in Michigan.” M N A: Michigan Nonprofit Association.
  4. Sugin, Linda. “Resisting the corporatization of nonprofit governance: transforming obedience into fidelity.”
  5. Sugin, Linda. “Resisting the corporatization of nonprofit governance: transforming obedience into fidelity: reflection on the conference.”
  6. Sugin, Linda. “Resisting the corporatization of nonprofit governance: transforming obedience into fidelity: Fordham law review: trust law defines obedience.
  7. Cuomo, Andrew M, “Media centre: court blocks sales of Manhattan hospital.” Office of the Attorney General.
  8. Sugin, Linda. “Resisting the corporatization of nonprofit governance: transforming obedience into fidelity; abstract.” SSRN: Social Science Research Network.
  9. Mann, Pamela A. “Operating the New York not for profit organization: how to make structural changes.”
  10. Mann, Pamela A. “Operating the New York not for profit organization: how to make structural changes.”
  11. Mann, Pamela A. “Operating the New York not for profit organization: how to make structural changes.”
  12. Fremont-Smith, Marion R. “Governing nonprofit orgnizations: federal and state law and regulation.” Harvard University Press
  13. “Exemption requirements.” Internal Revenue Service: United States Department of the Treasury.
  14. “Grassroots governance: governance and the non-profit sector: transparency and accountability.” Certified General Accounts Name Your Needs CGA.
  15. “Terrorist organizations, freezing of assets: protecting charities from terrorists abuse.” Espionage Information.
  16. Claudia L, Kelley, “Advising nonprofit organizations.” All Business.
  17. Claudia L, Kelley, “Advising nonprofit organizations.” All Business.
  18. Claudia L, Kelley, “Advising nonprofit organizations.” All Business.
  19. “Charities may not engage in political campaign activities.” Internal Revenue Service: United States Department of the Treasury.
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