New York Changes Sole Member Rule

Effective July 1, the New York State legislature has modified a key provision of the Not-for-Profit Corporation Law (NPCL) regarding the ability of New York non-profits to establish a sole member structure.  This change may require immediate adjustment to legal structures by affected non-profits.

First, some background.  Article 6 of the NPCL allows New York corporations to establish one or more classes of members. In the case of charitable corporations, members are optional.  Members have certain rights with respect to the corporation as established by law.  The core right of members is to elect the Board.  Members also have the right to approve certain corporate actions such as mergers or dissolutions.   

Prototypically, membership rights are granted to a broad group of the organization’s constituents.  Non-profit organizations sometimes also grant a sole membership interest to a single individual or entity to provide such persons with control rights.  For example, large affiliated groups of non-profit organizations often are structured by granting a membership interest to a “parent” organization in a group of affiliated non-profit corporations.

As relevant here, founders of non-profit organizations, including private foundations, frequently utilize membership interests to grant control to their founder.  This allows the founder to personally elect the board and to control fundamental corporate transactions.  That will change under the new law.  

Effective July 1, Section 601 of the non-profit corporation law is amended to set the minimum number of members that are natural persons at three.  This limits the ability of the founder in the above scenario to maintain control, upending what may have been some very careful planning.

The new law does not describe whether the three members must have equal rights.  The NPCL allows classes of members to have different sets of rights so long as all the classes of members, together, have all voting rights required under the NPCL.  Query whether one class of member could hold the right to appoint and remove the Board and the others could have a suite of rights that the founding member is willing to share with others, for example, approval rights over certain fundamental transactions that are unlikely to ever be on the table (but which the members could approve if they so desired). 

In addition, there are no requirements related to who the three members must be.  Accordingly, it seems that a founder could have his or her spouse and adult children serve as the other members, thereby effectively maintaining informal control (so long as the donor remains on good terms with his or her family). 

Significantly, the rules allow an exception for membership by single entities as long as the entity is “owned or controlled by” at least three persons.  This allows the continued use of the group structure that is currently utilized by affiliated non-profit organizations.   

The legislative history is scantly.  There is only a brief description in the sponsor memo which states that the purpose is to address a “significant loophole” in the NPCL and states that the new law “will prevent abuse by individuals who may try to use a charitable non-profit for his or her own private interest.”

The law appears to apply to both existing and newly formed corporations.  Persons forming new entities that desire to control in this manner may wish to consider forming under the law of another state, such as Delaware, and qualifying in New York.  New York does not (and could not) apply this rule to foreign corporations.  For existing corporations, analysis will need to be conducted about how to approach the July 1 deadline.

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