Tag: Nonprofit

Strategic Use of Arbitration Provisions in Nonprofits’ Contracts

In the nonprofit sector, organizations often face unique legal challenges that require efficient and cost-effective dispute resolution mechanisms. Arbitration provisions in contracts can offer nonprofits a strategic advantage by providing a streamlined process for resolving disputes. Below, we explore the benefits and strategic considerations for incorporating arbitration clauses in contracts, drawing on recent developments and case law.

Background and Legal Basis

Arbitration is increasingly favored in the business context for its efficiency, cost-effectiveness, and confidentiality. Unlike traditional litigation, arbitration generally allows parties to resolve disputes more quickly and with less expense, which is particularly beneficial for nonprofits operating on limited budgets. The process is also private, protecting sensitive information related to donors and beneficiaries, avoiding potential adverse publicity and reputational harm, and has less risk of unpredictability like a “run-away” jury verdict.

The Federal Arbitration Act (FAA), enacted in 1925, provides the foundational legal framework for arbitration in the United States. As a result, arbitration agreements involving interstate or foreign commerce are enforceable and binding. The FAA’s core principle is to support a national policy favoring arbitration, overcoming historical resistance in some areas.

The Uniform Arbitration Act and its revised version offer a model statute adopted by most states to ensure the enforceability of arbitration agreements, even in the face of state laws that may be hostile to arbitration.

Under these arbitration statutes, federal or state courts may be involved both before or after arbitration. First, the courts are empowered to order parties to arbitrate where an enforceable arbitration agreement exists. Second, the courts may conduct a substantially limited review of an arbitration award and may enter judgment on the award or, in some cases, vacate the award or order further arbitration proceedings.

Federal Court Jurisdiction

Most trial lawyers prefer federal courts. However, the FAA does not automatically confer federal court jurisdiction over arbitration matters. Federal court jurisdiction requires a federal question or diversity of citizenship between the parties. When one of the arbitrating parties is structured as an LLC or non-corporate entity, determining diversity can be complex because it is based on the citizenship of the individuals or corporations that ultimately own the entity, regardless of how many layers are in the ownership structure. Thus, as a practical matter, many arbitration matters are decided within state courts.

Arbitration Rules

There is no requirement that an arbitration agreement select an arbitration organization to administer the arbitration. Private arbitration, where the parties self-administer the matter, is possible but increasingly rare. Instead, there are two major arbitration organizations in the United States and many smaller ones. The two major organizations are the American Arbitration Association (AAA) and the Judicial Arbitration and Mediation Services (JAMS). Each organization has several sets of arbitration rules focused on the nature of the dispute. For example, there are rules for general commercial disputes, expedited cases, and larger, more complex matters. Selecting the applicable rules is an important consideration when drafting an arbitration provision.

Drafting Arbitration Clauses

When drafting arbitration clauses, clarity and precision are paramount; otherwise, you risk entering into litigation to interpret the clause. At the very least, the arbitration clause should cover the when, where, which, and how details of the arbitration process. Nonprofits should consider whether to use broad or narrow clauses. Broad clauses cover all disputes arising from or relating to the contract, while narrow clauses limit arbitration to specific issues. Sample clauses are available from the AAA and JAMS that provide templates for structuring effective arbitration agreements. These clauses should specify the rules governing arbitration, the number of arbitrators, and the location of proceedings, among other issues.

Deemed Arbitration Clauses

Courts have found other contractual clauses to be arbitration clauses and subjected them to the requirements for arbitration. For example, a real estate contract that included a procedure involving three experts to determine the actual square footage development potential of a property to be sold was deemed an arbitration clause. Thus, when the parties disagreed as to the determination by the experts, the court performed only the substantially limited review used to review arbitration awards, not a broader review that would allow reversal for mistakes or law or fact.

Conclusion

For nonprofits, arbitration provisions offer a strategic tool for managing disputes efficiently and confidentially. However, nonprofits should carefully draft effective arbitration clauses that align with their operational needs and legal obligations. Thoughtful consideration of the scope, rules, and procedural requirements will ensure that arbitration serves as a valuable mechanism for dispute resolution.

© 2024 ArentFox Schiff LLP
For more news on Arbitration Provisions, visit the NLR ADR, Arbitration, & Mediation section.

2020 Vision: Protecting Your Hospital’s Tax-Exempt Status

The manner in which medical services are being provided to patients is rapidly changing. Procedures that used to be performed in hospitals and required overnight stays are now being performed at outpatient clinics. Similarly, technological advances have decentralized hospital administration and the way in which treatment is provided. This should not come as a surprise to anyone that has any level of familiarity with the health care system, which includes just about anyone who goes to a doctor on a regular basis.

It should also come as no surprise that the law often lags behind technological advances and is often in a state of playing “catch up.” This trend is readily apparent when it comes to the property tax exemption for Wisconsin hospitals. The good news is that the courts are now taking the advances in hospital care into account when affirming eligibility for property tax exemption, particularly as to clinics and outpatient facilities. That said, hospitals must be vigilant in obtaining and maintaining their exemption.

This Legal Update offers guidance for Wisconsin nonprofit hospitals that may be filing tax exemption applications for calendar year 2020. Later in this Legal Update, we briefly discuss recent developments at the federal level involving hospital exemptions under § 501(c)(3) of the Internal Revenue Code.

Property Tax Exemption for Nonprofit Hospitals

In Wisconsin, all property is subject to taxation unless it is explicitly deemed exempt by statute. The Wisconsin Statutes provide that the following type of property is exempt:

(4m) NONPROFIT HOSPITALS. (a) Real property owned and used and personal property used exclusively for the purposes of any hospital of 10 beds or more devoted primarily to the diagnosis, treatment or care of the sick, injured, or disabled…. This exemption does not apply to property used … as a doctor’s office.

(Wis. Stat. § 70.11(4m)). The legislative intent behind this exemption is to encourage not-for-profit hospitals to provide care for the sick.

Applications for property tax exemption must be filed by March 1. This includes exemption applications for newly constructed property as well as for existing and previously non-exempt property whose use has changed in a way that now makes it eligible for exemption. The property owner bears the burden of proving that the property is exempt and the Wisconsin courts interpret the statutory exemptions narrowly. Hospitals should start analyzing and preparing their exemption applications well in advance of the filing deadline.

All real property is assessed based on its “fair market value” as of January 1 of each year. The Wisconsin Property Assessment Manual (“WPAM”) makes it clear that in the case of partially completed improvements, the assessor must value the improvements as they exist on the assessment date. Accordingly, hospitals with facilities currently under construction need to document the state of building as of January 1, 2020. Key documentation may include photographs and time-lapse construction progress videos. Assessors typically conduct an on-site inspection when there have been significant construction changes, and may also request additional documentation such as construction contracts and blueprints.

Assessors frequently utilize the cost approach when valuing new construction. One way to assess value for an under-construction project is to look at construction draws. This method has the appeal of simplicity but does not always produce accurate results. For example, if there have been construction draws of $12 million as of January 1 on a $30 million dollar project, an assessor might be inclined to give the property a fair market value of $12 million as of that date. It is entirely possible, however, that $1 million of that work was done on grading, soil stabilization, or other site development work that adds no value to the building from a “fair market value” perspective. Accordingly, the owner should be armed with knowledge of the actual condition of the building, including statements from the project manager, showing the value of what is “in the ground” as of the assessment date.

While it is important that new exemption applications document value as of January 1, the most important piece of the application involves documentation of exempt use. Recent litigation has focused on whether outpatient clinics or satellite hospital facilities are being used as a “doctor’s office,” which may disqualify the facility from exemption. The Wisconsin courts have identified the following list of factors that must be considered and evaluated when determining whether real property is used as an exempt hospital or as a doctor’s office:

  1. Do physicians own or lease the facility or equipment or are they hospital owned?
  2. Do physicians at the facility receive “variable compensation,” that is, compensation based on their productivity?
  3. Do physicians at the facility employ or supervise non-physician staff, or receive extra compensation for such duties?
  4. Does the facility and hospital generate separate billing statements or use separate billing software?
  5. Do the physicians in the facility have office space in the facility?
  6. Does the facility provide care on an outpatient, as opposed to inpatient, basis?
  7. Is the facility only open during regular business hours during which time the physicians generally see patients by appointment or is there 24/7 urgent care?

It should also be noted that the exemption for a nonprofit hospital is not an all-or-nothing proposition—partial exemptions are permitted. For example, in a seminal case interpreting the breadth of the nonprofit hospital exemption, Covenant Healthcare System, Inc. v. City of Wauwatosa, the Wisconsin Supreme Court upheld Covenant Healthcare System’s application for an exemption for 3 out of 5 floors in an outpatient clinic. The other floors did not fall within the criteria for the hospital exemption because they were doctors’ offices, among other reasons.

Another use-related issue involves the exempt status of vacant space in newly constructed hospital facilities. The WPAM acknowledges that “hospitals often construct oversize additions to anticipate technological and industrial changes and to reduce the unit cost of construction.” Assessors will generally treat this space as exempt so long as it meets the following conditions:

  • The hospital is exempt.
  • The space is attached to an existing hospital.
  • The projected use of the space is declared in the board minutes, in the general building plans, and in the blueprints and is consistent with exempt hospital use.
  • The building specifications and actual construction-to-date include features appropriate for hospital space.
  • The owner annually declares by affidavit that the space will be used as hospital space that would normally be exempt.

Hospitals intending to seek exemption for vacant space in new construction should ensure that they have appropriate documentation for these elements as of January 1.

Wisconsin law states that property tax exemption claims are strictly construed in favor of taxability. Given today’s climate of tight budgets, assessors are understandably conservative in their exemption determinations as they try to protect their tax base. Vigilance and thorough preparation are the keys to obtaining exemption under § 70.11(4m). Hospitals that are planning to file an exemption application by March 1 of this coming year, particularly for property that might have been taxable in the past as a physician clinic, should begin preparing their exemption applications no later than January 1 with an eye on these requirements.

Finally, note that owners of property exempt under sec. 70.11, Wis. Stats., are required to file a Tax Exemption Report form with the municipal clerk in each even-numbered year. Reports are due March 31, 2020.

Federal Tax Exemption under IRC § 501(c)(3)

Hospitals claiming exemption under IRC § 501(c)(3) have been under the microscope for the past several years; judging from events in 2019, that pattern will continue in 2020.

Senator Charles Grassley (R-Iowa) is back at the helm of the Senate Finance Committee and is once again pushing for increased transparency and oversight, including hospital adherence to community benefit requirements. In February 2019, Senator Grassley asked that IRS Commissioner Charles Rettig provide a briefing on the scope of IRS audits of tax-exempt hospitals on matters including charity care, financial assistance, and billing and collection policies. Senator Grassley called into question hospital compliance with the standards set by Congress and made it clear that he expects IRS enforcement to include all of the tools in its toolbox, including denial of exempt status. He specifically asked for details on how many hospitals have been found to be out of compliance with § 501(c)(3) requirements and how the IRS is dealing with noncompliant hospitals. In October of this year, Senator Grassley wrote to the University of Virginia Health System regarding a news report that the System’s financial assistance and debt-collection practices did not comply with its obligations as a tax-exempt entity, as well as regarding possible issues on overcharging.

Nonprofit hospitals and health systems can expect increasing scrutiny on Schedule H of Form 990. Past analyses of Schedule H reporting have found inaccuracies and inconsistencies in reporting of community benefits and financial assistance policies, including how financial assistance policies are publicized – these areas should receive particular attention when preparing 990 forms in the coming year. Form 990 is due on the 15th day of the 5th month following the end of the organization’s taxable year. Hospitals and health systems with September 30 fiscal years will need to file their 990 forms by February 15, while organizations on a calendar year have a due date of May 15.

Conclusion

Nonprofit hospitals remain under attack regarding their tax-exempt status. It is extremely important—now more than ever—for administrators to have a familiarity with the law and the criteria necessary to maintain their exemptions into the future. Proper planning heading into 2020 is an important key to that success.

©2019 von Briesen & Roper, s.c

For more on hospital administration, please see the National Law Review Health Law & Managed Care page.

New York Nonprofit Revitalization Act Rollout Challenges

Proskauer

As the July 1, 2014 compliance date of the New York Nonprofit Revitalization Act of 2013 (the “Revitalization Act”) quickly approaches, many charities operating in New York are confronting some difficult rollout challenges. While parts of the Revitalization Act are clear and welcomed (such as new rules that broaden the use of electronic communications and eliminate the need for supermajority board approvals of routine property transactions), other new requirements are puzzling to many of these charities’ officers and directors. Indeed, as we counsel our clients, we are finding that certain new Revitalization Act rules that concern board operations are causing some charities, in particular family foundations and corporate foundations, to wonder whether operating through corporations formed in New York is desirable.

The charities that seem to be facing the hardest issues are foundations with small boards, and with directors that either directly and appropriately exert substantial influence over foundation operations (such as in a family foundation), or are employed by the businesses that have founded and fund these charities to do their good works.

We are finding that many, but not all, of the requirements causing concern are tied to vague drafting in the Revitalization Act. The good news is that we have also identified what we believe are reasonable interpretations of the law that align with workable solutions for many clients.

This client alert notes just a few of the more pressing Revitalization Act issues, as well as relevant potential solutions, as they appear to us today. We will be highlighting other aspects of the Revitalization Act rollout over the coming year. We stress that the New York State Attorney General’s Charities Bureau may issue clarifying Revitalization Act guidance, and it is also possible that follow-up legislation may address some of these issues. Importantly, it is possible that this guidance or future legislation will not support our interpretations, although we hope that it does. Stay tuned.

Three Independent Directors

The Revitalization Act will require many charities to identify at least three individuals that satisfy detailed requirements of “independence” to serve as directors and oversee specified audit and financial reporting activities. (Three are needed because that is the fewest number of directors required by New York law to perform delegated board-level functions.) For many family foundations, corporate foundations, and labor/management charities – with small boards that are typically composed of individuals tied in some way to the charity or related entities – this requirement has created concern. This concern may be heightened when membership on the board has been finely balanced to achieve acceptable approaches to shared governance.

Most important for these charities to keep in mind is that the requirement is limited to charities that raise or “solicit” funding from the general public. However, some of these charities, in their annual charities filing with the New York Attorney General, may have been filing as soliciting charities even though they do not actually solicit funding. We suggest that such charities consider amending their filing status and we urge that any change in filing status in response to the Revitalization Act be made in consultation with corporate and tax counsel, closely assessing individualized factors and risks. For example, part of the analysis may be to examine whether the charity has been filing its annual Form 990 with the Internal Revenue Service (“IRS”) as a “public charity” (based on “public support” concepts of the IRS that differ from the New York concepts of “solicitation”). While we do not believe that the New York charitable solicitation concepts match the IRS concepts, tailored assessments should be made with both New York charitable solicitation laws and U.S. federal tax laws in mind.

For those charities that do solicit within the meaning of New York law, and whose small boards are populated by individuals employed by related entities, it will be worthwhile to take a hard look, again guided by counsel, at the kind of control exerted by a charity’s affiliated corporate entities over the charity. Under the Revitalization Act, whether that employment disqualifies a director as “independent” will depend on whether the particular corporate or other entity that employs the director “controls” or is “under common control with” the charity. Notably, the Revitalization Act does not define “control.”

Conflicts Policy Quagmire

Although the Revitalization Act is clear that the requirement for independent-director oversight of auditing and financial matters is limited to “soliciting” charities, the law is less clear about whether independent director oversight also applies to the law’s requirements on conflicts policies.

Essentially, the Revitalization Act codifies the widespread practice already adopted by many charities – many motivated by the IRS Form 990 conflicts policy checkbox – to have a written conflicts policy. It also requires oversight of adoption, implementation, and compliance with the conflicts policy by the Board or the audit committee. Certain provisions of the Revitalization Act can be read as requiring these oversight functions to be handled by independent directors only. While our interpretation is not free from doubt, we believe that to the extent there is an obligation to have independent directors oversee conflicts policy administration, a close and reasonable reading of the Revitalization Act supports the interpretation that such requirement is also confined to soliciting charities. If not, many private foundations will be forced to make drastic board changes for conflicts policy oversight, while permitted to use directors that do not satisfy independence criteria for what is generally viewed as the critical audit oversight function – a seemingly absurd result.

Charities with conflicts policies based on the IRS form are probably already aware that they will need to amend those policies to satisfy Revitalization Act requirements, since the IRS form does not track all of the components of a conflicts policy required by the Revitalization Act. As these policies are drafted, special attention should be paid to the annual conflicts questionnaire required by the Revitalization Act. Many charities already distribute an IRS Form 990 annual questionnaire to directors, officers and key employees. Revitalization Act questionnaires will now be covering some, but not all, of the same territory. To avoid bombarding individuals with duplicative annual forms, consideration should be given as to whether to use a single questionnaire that reasonably covers both IRS and Revitalization Act requirements.

Approval of Director, Officer, and Key Employee Compensation

The Revitalization Act imposes significant new requirements concerning related-party transactions. Among other things, the Revitalization Act imposes a new requirement to “contemporaneously document in writing the basis for the board or authorized committee’s approval” of a related party transaction, “including its consideration of any alternative transactions.” The Revitalization Act also provides the Attorney General with enhanced enforcement authority to void, rescind, seek restitution, and remove directors in connection with a transaction that is not properly approved or that was not reasonable or in the best interests of the corporation at the time the transaction was approved.

Because the Revitalization Act broadly defines a “related party transaction” as “any transaction, agreement, or any other arrangement in which a related party [including a director, officer or key employee] of the corporation has a financial interest and in which the corporation or any affiliate of the corporation is a participant,” there is some question as to whether compensation arrangements with directors, officers, and key employees are related party transactions. While the matter is not free from doubt, we believe that there is a reasonable basis for considering these compensation arrangements to be regulated in a manner distinct from related party transactions under the Revitalization Act. Clarification on this issue, however, would be helpful.

In addition, the Revitalization Act appears to define all directors as “related parties,” and prohibit all related parties from participating in deliberations and voting pertaining to related party transactions, without specifically distinguishing between directors who have an interest in the particular transaction and those who do not. Guidance clarifying that the Revitalization Act will not be construed or enforced in such an impracticable manner would be helpful.

Also, certain ambiguous language in the Revitalization Act can be read as expressly prohibiting any director from being present at or participating in any board deliberations or vote concerning director compensation, while apparently requiring director approval of the compensation. While we believe that such a reading of the Revitalization Act would be unreasonable and contrary to principles of statutory construction, clarifying guidance would help avoid uncertainty on an important governance issue. In the interim, boards may wish to approve director compensation arrangements prior to July 1.

Extraterritorial Application of Revitalization Act

Finally, some commentators have raised concerns that certain provisions of the Revitalization Act relating to board composition and operation may be applicable to charitable organizations formed outside of New York, such as Delaware non-stock corporations. We have not found this to be a reasonable interpretation of the Revitalization Act. Again, however, clarifying guidance would be welcome.

Article By:

Jacob I. Friedman
Edward S. Kornreich
Amanda H Nussbaum
Richard J Zall
Herschel Goldfield
Ellen H Moskowitz
Of:
Proskauer Rose LLP