August 12, 2004 | Read Time: 13 minutes
IN THE TRENCHES
By Rebecca Gardyn
Hoping to raise money, a human-services charity in Massachusetts sponsored a canoe race several years ago
on the Charles River. During the festivities, some of the participants drank alcohol, and their craft collided with another, causing a man in the other canoe to fall into the water and nearly drown. The charity assumed that the waterfront restaurant that played host to the event would have the proper liability coverage — but the venue did not, and so the charity was held liable. Although the charity narrowly avoided a lawsuit, it lost money because the accident forced the cancellation of the fund-raising event, says Jeffrey Hurwit, a lawyer in Newton, Mass., who specializes in counseling philanthropic organizations and who advised the human-services group, which he prefers not to name.
Although this mishap occurred nearly 10 years ago, he says, it stands out in his mind as a prime example of the headaches that can result when a charity fails to protect itself from risks and keep its legal affairs in order. “If they would’ve just stopped to think about this event’s potential liability risks, and bought some insurance to cover those possibilities, this could’ve easily been avoided,” he says.
Doing charitable work does not provide immunity to nonprofit organizations that fail to obey the law. It is easy for smaller charities in particular to end up in legal trouble due to ignorance of their own needs and a failure to educate their staff members and volunteers about some legal and ethical basics.
“Nonprofit budgets often do not accommodate hiring experienced accounting, legal, or tax professionals to guide them through the legal and regulatory minefields,” says Jeffrey Power, a lawyer in Grand Rapids, Mich. “These nonprofits rely instead on advice from inexpert volunteers and the staff of other nonprofits. Furthermore, small and midsized nonprofits staff may be overburdened and unspecialized. Predictably, things slip through the cracks.”
In an effort to fill in some of those cracks, several lawyers from around the country who frequently or exclusively counsel nonprofit organizations describe some of the most common types of legal trouble their clients face — and how best to avoid those pitfalls. To protect a charity’s integrity and bank account, the lawyers say, follow these tips:
Read the fine print. One of the most common mistakes that nonprofit organizations make is failing to read, understand, and negotiate contract terms, says Paula Cozzi Goedert, a lawyer in Chicago. Few people are willing to spend hours carefully reading lengthy and confusing contracts, she notes, but what compounds the issue is that many nonprofit organizations mistakenly believe that “standard” contracts are nonnegotiable.
In addition, Ms. Goedert says, charity workers tend to be a little too trusting of the parties they deal with, often assuming that, because people are pleasant to work with, the terms of contracts will be fair.
“By giving in to these tendencies, nonprofits ignore some harsh facts,” she says. “First, the nice people they are dealing with may be salespeople who will have no role in fulfilling the contract. Or they may quit or be fired. Or the company may be sold.”
Almost every contract is negotiable, says Ms. Goedert. Of course, a charity’s ability to bargain will depend on how much leverage it has in the relationship. If the company or other party wants the deal, she says, it will be willing to negotiate reasonable terms, but if it thinks or has been told “the organization has selected you for this project,” the party has little incentive to budge on contract changes.
“Failing to read and understand contracts is like playing Russian roulette,” says Ms. Goedert. Although it is likely that a contract will be fulfilled without problems, she says, disaster could strike if something unexpected occurs. She describes a current nonprofit client of hers that entered into a contract with a printing company without really understanding its terms. It turns out that the vendor is not performing well, but the contract can only be ended under very narrow circumstances, and a low standard of quality is not one of them. “The vendor has significant resources, and has threatened to sue if the nonprofit stops paying,” Ms. Goedert says. “This could have been avoided with a fair set of termination provisions included in the contract.”
Get sufficient insurance coverage. Many charities are so dedicated to their missions and programs that they fail to pay attention to some basic administrative needs, such as protecting themselves against liability risks, says Mr. Hurwit.
Mr. Hurwit, a former assistant attorney general in the public-charities division of the Massachusetts Attorney General’s Office, says clients often to come to him without knowing what types of insurance they have or what is covered by their policies. And a lack of budgeting for insurance expenses is a very common problem, he adds: “Charities will get grants to cover their program costs, but they forget that they will need additional funding to insure those programs.”
At the very minimum, all organizations need a basic general liability policy, to cover basic “slip and fall” type injuries that may occur among staff members, volunteers, or visitors, says Mr. Hurwit. Then, charities also need to be sure that managers are covered under a directors-and-officers policy, which protects the organization’s leaders and trustees from personal liability when lawsuits are brought against a charity. This type of insurance is increasingly becoming more important for nonprofit organizations to carry, especially given the fact that allegations of unfair employment practices have become more common, says Mr. Hurwit. “More and more often, directors are being sued for a variety of employee grievances, from unfair dismissal to sexual harassment, so it is important to be covered for these issues as well,” Mr. Hurwit says. “Even if such claims are eventually dismissed, the organization will need resources to defend itself.”
In addition, he says, organizations need to also buy liability policies to cover other potential situations that may arise from the charity’s programs and events. A common mistake that many nonprofit administrators make, he says, is to renew the same policies year after year, without assessing current liability risks. “Organizations need to sit back and say ‘for our particular programs, or for this particular event, what are the most easily predictable ways in which someone might get hurt? ‘” he says. After a charity consults with its insurance agent, Mr. Hurwit says, it should add whatever amendments are necessary to its policies to cover its current needs.
Even when a charity is properly covered, Mr. Hurwit still recommends trying to negotiate so that liability is distinctly spelled out. “Surprisingly often, contracts do not specify who will be responsible if things go wrong, and rather than negotiate, nonprofits will unnecessarily assume all of the liability,” he says. “I always make sure my clients’ contracts state clearly that the other entity will indemnify us, or hold us harmless. Then I make sure we get a copy of the vendor’s insurance policy showing that they cover the particular issue we’re worried about.”
Respect copyrights. A lack of understanding of intellectual property and copyright law is another common legal pitfall charities face, says Fred Frawley, a lawyer in Portland, Me., who not only counsels nonprofit groups but also sits on several nonprofit boards.
Every piece of intellectual property — each written, audio, and visual expression of an idea — is owned by someone, he explains. When charities hire freelance writers or independent consultants or use volunteers to help them develop articles, brochures, and training manuals and other materials, they often don’t realize that just because they commission such things to be created, it does not necessarily mean that they fully own the final products and can republish them whenever they want without the author’s permission.
“Generally, an employer only owns the copyright to a creative work produced by an employee during the scope of their employment,” he says. “But if a volunteer or an independent contractor generates the work, or even an employee working overtime, the person who created it owns the copyright.”
The only exception to this scenario would be if an explicit written agreement had been made between the creator and the organization at the start of the project, stating that upon completion and payment, the organization owns all rights to the work. That is why Mr. Frawley says it is important for organizations that commission creative works to have all contractors sign what are known as “work for hire” contracts. Those agreements give total ownership of a piece of commissioned work to the organization that bought it, says Mr. Frawley. (A sample work-for-hire contract is available on the Web site of the University of Texas.)
Securing copyrights for commissioned work, says Mr. Frawley, is also important for another reason: because that work could be a source of income in the future.
“The training materials and course material that you create as part of your mission statement might be attractive to other nonprofit organizations in another geographic area or field,” he notes. Once ownership of any document has been secured, he also suggests putting a copyright notice on the first page. While this is not legally required, he says, it can serve as an added protection.
Charities also get into trouble in this area by “borrowing” copyrighted material, or portions of such material, without obtaining permission, says Ms. Goedert. “People inaccurately assume that when works are published, they fall into the public domain,” she says. “People sometimes take copy from Web sites, add to it, and submit it for publication by their nonprofit. Claims of copyright infringement often arise from this kind of unauthorized taking.”
Even changing some of the content does not make the work original, she notes. If it is derived from the original work, it is still covered by the original author’s copyright. Ms. Goedert recalls a booklet she recently reviewed that was prepared by one of her nonprofit clients.
“It contained some terrific drawings of buildings, so I called the staffer and asked who did the drawings,” she recalls. “He told me that he copied them from another book, but added some new elements. He had no idea that permission was required from the publisher of the book, the copyright holder, before the revised drawings could be used.”
Keep track of paperwork and deadlines. Another increasingly frequent and serious pitfall that charities face is the failure to comply with continuous reporting and remittance requirements under federal, state, and local laws, says Mr. Power. Although most nonprofit groups are exempt from federal income taxation, most must nevertheless submit information about their finances each year to the Internal Revenue Service and file some sort of annual report with a state regulatory agency, he says. But, he says, small charities, especially those that lack the continued assistance of a professional accountant, often fail to stay on top of these tasks and face fees for their delinquency.
Indeed, Jacob Friedman, a New York lawyer who specializes in tax law and nonprofit organizations, has witnessed his clients suffer these consequences firsthand. “One organization I worked with failed to file their Form 990 for many years and faced penalties of $10,000 per missed return,” he says. “Another failed to properly answer certain items on the form, such as the amount of benefits received by the executive director.”
Although it may not be necessary or feasible for every charity to hire a lawyer or accountant, Mr. Power acknowledges, every nonprofit group should be working from an annual calendar and checklist to make certain that all required filings are made and that deadlines are not missed.
Charities also get into trouble by misclassifying their workers, says Mr. Power. Before a nonprofit group hires help and pays for services, it needs to always consider the proper status of those workers — will they be considered employees or independent contractors? “Nearly every audit of a nonprofit now includes an IRS review of whether the nonprofit properly classified its workers for employment-tax purposes,” he says. “Many nonprofits misclassify workers and as a result subject themselves to substantial taxes and penalties.”
If a nonprofit classifies its workers as employees, then it must comply with numerous federal, state, and local registration and reporting requirements for those workers, he says. He suggests that organizations that have difficulty determining the proper status of a worker submit IRS Form SS-8, “Determination of Worker Status.” Small charities, especially those with little payroll experience, may be overwhelmed by these responsibilities, so Mr. Power also recommends hiring an outside human-resources service to handle them whenever possible.
Keep compensation reasonable. Payment of excessive compensation to people who are connected to a charity’s staff, such as members of employees’ or trustees’ families, is a problem that David Ulich, a Los Angeles lawyer, frequently sees in his practice. “It is not unusual for family foundations to come to me and ask if they can put their daughter on the payroll at $75,000 per year,” he says. “When I ask what the daughter will be doing, the answer is not clear.” It’s not that such compensation itself is illegal, he says, but the amount of compensation needs to be “reasonable” in relation to the services provided. (This issue is especially important for charities to heed these days, as the IRS is currently asking groups that pay their chief executives more than $1-million annually to justify those salaries. For more information, see this recent Chronicle article.)
But what is “reasonable”? Mr. Power offers the following definition: “Compensation is deemed reasonable only if it is an amount that would ordinarily be paid for like services by like enterprises under similar circumstances.”
He adds that nonprofit groups can assume that compensation is reasonable if it passes this three-part test: If it is approved by the nonprofit board or by a committee composed entirely of individuals who do not have a conflict of interest with respect to the arrangement; if the board or committee obtains and relies upon appropriate data that compares compensation paid to others doing a similar job before making its decision; and if the governing body or committee adequately and concurrently documents the basis for its decision.
“Nonprofits need to take the steps necessary to obtain this presumption of reasonableness,” says Mr. Power. “Nonprofit managers who knowingly and willfully participate in so-called ‘excess benefits transactions’ are personally subject to an excise tax penalizing such behavior.”
Asking the Right Questions
Overall, charities that hope to stay out of legal trouble need to take the time — and spend the money, if necessary — to educate their employees and trustees about the possible consequences of their actions and inaction, says Ms. Goedert. “Even a passing familiarity with a particular legal issue will cause a staff member or volunteer to raise the right questions and get the right help,” she says.
And for those organizations that claim they cannot afford to pay for training or professional advice, she evinces little sympathy: “I don’t believe that nonprofits are without resources to retain legal assistance. Truly needy nonprofits can get free help from local bar associations or [law] school legal clinics.” Even a few hours a year with a knowledgeable professional can make a huge difference, she says. “Failing to get legal advice costs more in the long run because it is always more costly to solve a problem after it has occurred than to prevent the problem upfront.”
What do you consider to be the most common pitfalls that small charities face in protecting themselves against legal trouble? Give your opinion in the Share Your Brainstorms online forum.
