October 23, 2007 | Read Time: 5 minutes
The San Francisco Superior Court has awarded Network for Good — an organization that collects online gifts for charities nationwide — more than $4.7-million in damages in its lawsuit against the United Way of the Bay Area that stemmed from the 2003 collapse of PipeVine, a donation-processing organization set up by the United Way.
The United Way of the Bay Area maintains that it has done nothing wrong and is not responsible for the losses Network for Good suffered when PipeVine imploded.
Nonprofit legal experts say the decision shows the care charities need to take when setting up additional corporate entities.
The decision by the court was preliminary. Both sides have two weeks from the date the ruling was issued, October 19, to file objections, something the United Way says it plans to do. The court will then issue a final ruling after reviewing the comments.
Network for Good, a nonprofit organization in Bethesda, Md., had a contract *with PipeVine to process the donations made through its site. After PipeVine folded, Network for Good used its own money to make good on $2.4-million in contributions that PipeVine had collected but not distributed to the charities for which they had been intended.
The court determined that Network for Good was entitled to damages based on nine of the 15 legal charges it brought against the United Way, including two counts of breach of contract, fraud and deceit, breach of fiduciary duty, and unjust enrichment.
“Because the evidence demonstrates UWBA’s significant role in the events leading up to that collapse, it would be inequitable to allow UWBA to escape responsibility for such conduct,” Robert L. Dondero, judge of the Superior Court, wrote in his decision.
The court, however, said it found insufficient evidence to award punitive damages that Network for Good had sought.
‘Alter Egos’
In the early 1990s, the United Way of the Bay Area formed a subsidiary, United Nonprofit Operations, to process pledges to that United Way, as well as pledges made by employees at national companies, such as Bank of America and Clorox, during on-the-job fund-raising drives.
On July 1, 2000, United Way of the Bay Area spun off United Nonprofit Operations as a separate entity, renaming it PipeVine. PipeVine continued to process donations for the United Way of the Bay Area and other customers — including Network for Good — until it ceased operations on June 2, 2003, without distributing $17.7-million in charitable contributions it had collected.
The court concluded that the continuing effects of not having enough start-up capital was the primary reason PipeVine failed.
Judge Dondero found that rather than acting as separate corporate entities, United Way of the Bay Area and PipeVine were “alter egos.” In the decision, the judge wrote that many factors in the case supported that conclusion, including the commingling of assets, the sharing of officers and legal and accounting services, and the diversion of employees and assets from one entity to the other at critical times during PipeVine’s operation.
But the key factor supporting the “alter ego” conclusion, he wrote, was the United Way of the Bay Area’s failure to put adequate assets into PipeVine at the point when it attempted to spin off the venture.
The court found that the United Way of the Bay Area did not provide PipeVine with the money necessary to cover the liabilities that were assigned to the new entity and that the United Way adjusted its financial statements — and those of PipeVine — “to conceal the fact that UWBA owed $4.7-million to PipeVine upon its separation from UWBA.”
“This forced PipeVine to use new donor donations to pay old liabilities to designated charities and its operating expenses from ‘day one’ of its operation as an ‘independent’ company,” wrote Judge Dondero.
The United Way of the Bay Area strongly disagrees with the court’s conclusion that it was the “alter ego” of PipeVine and its findings that United Way did not provide the new venture with the assets it needed to be successful, says Bob Phelps, a San Francisco lawyer who represents the United Way. It also disputes the court’s finding that it owed PipeVine $4.7-million at the time of separation.
As the United Way considered the possibility of spinning off PipeVine, there was a “tremendous” amount of discussion about PipeVine’s finances as a stand-alone entity, says Mr. Phelps. Much of that planning was done in conjunction with the employees who would be running it, he says.
“They certainly had no incentive to set up their new business in an undercapitalized form,” he says, “and we didn’t have any incentive to do that, either, because we were looking to them in the future as a very important vendor.”
Mr. Phelps also says PipeVine had not distributed $9.4-million in United Way donations to their intended charity recipients, compared with only $2.4-million in donations made through Network for Good.
“Far from being unjustly enriched, we feel like we were actually more harmed by the closure of PipeVine than was Network for Good or anyone else,” says Mr. Phelps.
The facts of the case suggest otherwise, says James P. Joseph,a Washington lawyer who represents Network for Good.
“Did they set up PipeVine with the intent that it would fail? Well, no, probably not,” says Mr. Joseph. “But did they set it up so that it started life 50 feet in the ditch? Yes, and they could never get themselves out of the ditch.”
Case Study
Legal experts say the case provides a valuable lesson for nonprofit organizations not to take lightly the process of setting up additional corporate entities.
Sarah Duniway, a Minneapolis lawyer who specializes in nonprofit issues, says that when she works with a charity that is spinning off a subsidiary, she sometimes feels like she’s being “overly nitpicky” when insisting that the entities hold separate board meetings, keep separate books, and have separate bank accounts.
While these types of matters were secondary to the question of undercapitalization in the court’s ruling, she says, they were still factors.
At the same time, Ms. Duniway says that she hopes the decision won’t scare nonprofit organizations away from creating separate entities.
“I don’t think this is a lesson of, ‘Oh, nonprofits can never set up a subsidiary,’” she says. “It’s clear there still are ways you can do it right. It just doesn’t look like that was the scenario here.”
The preliminary decision in Network for Good v. United Way of the Bay Area may be found on the San Francisco Superior Court’s Web site by searching the case number 04-436186.
