BILL ANALYSIS AB 1233 Page 1 Date of Hearing: May 12, 2009 ASSEMBLY COMMITTEE ON JUDICIARY Mike Feuer, Chair AB 1233 (Silva) - As Amended: May 6, 2009 PROPOSED CONSENT SUBJECT : NONPROFIT AND CONSUMER COOPERATIVE CORPORATIONS KEY ISSUE : SHOULD VARIOUS TECHNICAL AND CLARIFYING CHANGES BE MADE TO SECTIONS OF THE CORPORATIONS CODE PERTAINING TO NONPROFIT AND CONSUMER COOPERATIVE CORPORATIONS, SO THAT THOSE CORPORATIONS MAY HAVE MORE CERTAINTY IN THEIR OPERATIONS? FISCAL EFFECT : As currently in print this bill is keyed non-fiscal. SYNOPSIS This non-controversial bill, sponsored by the Business Law Section of the State Bar, seeks to make technical and clarifying changes to sections of the Corporations Code pertaining to nonprofit and consumer cooperative corporations, so that those corporations may carry out their operations with more certainty. This bill makes these changes to code concerning a wide range of topics affecting the organization and operation of these nonprofit corporations, including directors' rights, the authorized number of directors, quorum requirements, board committees, officer titles and board reliance on committees. The bill also seeks, among other things, to authorize streamlined merger and liquidation processes as well as default provisions in the case of third party approvals, and a procedure for reducing the size of the board of directors. This bill passed the Banking and Finance Committee by a 9-0 vote and has no known opposition. SUMMARY : Seeks to make technical, clarifying and non-controversial changes to various sections of the Corporations Code pertaining to the organization and operation of nonprofit and consumer cooperative corporations. Specifically, this bill : 1)Clarifies that a person who does not have authority to act as a member of the governing board is not a director, but if the AB 1233 Page 2 articles or bylaws designate that a natural person is a director or a member of the governing body because he or she occupies a certain position, then that person is a director for all purposes and shall have the same rights, including voting rights, as the other directors. 2)Provides that any requirement for approvals to be made by non-members or non-directors shall not apply if any of the following circumstances exist: a) The specified person or persons have died or ceased to exist. b) If the right of the specified person or persons to approve is in the capacity of an officer, trustee, or other status and the office, trust, or status has ceased to exist. c) If the corporation has specific proposal for amendment or repeal, and the corporation has provided written notice of that proposal, including a copy of the proposal, to the specified person or person at the most recent address for each of them, based on the corporation's records, and the corporation has not received written approval or nonapproval within the period specified in the notice, which shall not be less than 10 nor more than 30 days commencing at least 20 days after the notice has been provided. 3)Provides that where directors are authorized to hold office by virtue of designation by a specified designator, as provided by the articles or bylaws rather than by election, the entitlement to designate shall not apply if any of the following circumstances exist: a) The specified designator or designators have died or ceased to exist. b) If the entitlement of the specified designator or designators to designate is in the capacity of an officer, trustee, or other status, and the office, trust, or status has ceased to exist. 4)Authorizes the articles or bylaws to require the presence of one or more specified directors in order to constitute a AB 1233 Page 3 quorum of the board to transact business; 5)Allows the bylaws to provide for a method or formula for determining the number of directors on the board of directors. 6)Prohibits a committee exercising the authority of the board from including, as members, persons who are not directors; clarifies that each director of a nonprofit corporation has only one vote and no director may vote by proxy. 7)Authorizes the board to create other committees with nondirectors that do not exercise the authority of the board, and clarifies that board committees may only have directors as members. 8)Allows a corporation to use any of four titles (similar to "chairman of the board") to designate the individual who serves in this statutory officer role, and further allows a corporation to have a "treasurer or chief financial officer or both" in the interest of providing consistency in officer titles. 9)Authorizes a nonprofit corporation under certain circumstances, including when it is impossible to find a sufficient number of directors to constitute a quorum, to proceed with steps to voluntarily dissolve without requiring an election of more directors simply to accomplish that purpose. 10)Clarifies the types of committees can be relied upon by the board of directors for the purpose of delegating certain authorized functions to those committees. 11)Allows a nonprofit religious corporation that is a private foundation to meet intermediate requirements for tax exempt status under federal law without obligating the corporation to include specified language in its governing instrument. 12)Clarifies that as long as a nonprofit medical association maintains a liability insurance policy that is applicable to a particular claim, then the directors and officers shall enjoy limited liability, as specified. 13)Authorizes a one-step merger process for nonprofit unincorporated associations to merge with nonprofit or AB 1233 Page 4 consumer cooperative corporations. EXISTING LAW , the Nonprofit Corporation Law, regulates the organization and operation of nonprofit public benefit corporations, nonprofit mutual benefit corporations, and nonprofit religious corporations, as defined. (Division 2 of Title 1 of the Corporations Code, commencing with Section 5000.) In addition, existing law, the Consumer Cooperative Corporation Law, regulates the organization and operation of consumer cooperative corporations, as defined. (Part 2 of Division 3 of Title 1 of the Corporations Code, commencing with Section 12200. All further references are to sections of the Corporations Code, unless otherwise noted.) Specifically, existing law: 1)Defines "directors" as a natural person, designated in the articles or bylaws or elected by the incorporators, as well as natural persons designated, elected or appointed by any other name or title to act as members of the governing body of the corporation. (Section 5047.) 2)Authorizes the articles of incorporation and bylaws of nonprofit corporations and consumer cooperatives to contain certain provisions, including, but not limited to, a provision requiring that an amendment or repeal of those articles or bylaws be approved in writing by a specified person or persons other than the board. (Section 5132 (c).) Also authorizes the articles or bylaws to provide for the designation or selection of directors by a specified person or persons rather than by election by a member or members and similarly to authorize a specified person or persons to remove a designated or selected director. (Section 5220.) 3)Specifies that a majority of the number of directors, authorized in the articles or bylaws, constitutes a quorum for the transaction of business of a nonprofit corporation or a consumer cooperative corporation. (Sections 5211, 7211, 9211, and 12351.) 4)Authorizes a board of a nonprofit corporation or a consumer cooperative to form one or more committees consisting of 2 or more directors to serve at the pleasure of the board and provides that these committees have the authority of the board. (Sections 5210, 7210, 9210, and 12350.) 5)Requires a nonprofit corporation or consumer cooperative to AB 1233 Page 5 have a chairman or a president or both, a secretary, a chief financial officer, and other officers as provided in the bylaws or determined by the board. (Sections 5213, 7213, 9213, and 12353.) 6)Authorizes a nonprofit corporation or consumer cooperative to elect to voluntarily wind up and dissolve by approval of a majority of the members, as defined, or by approval of the board and approval of the members, as defined. (Section 6610.) 7)Provides that certain public benefit corporations deemed to be private foundations, as defined, are subject to Federal Internal Revenue Code requirements. (Section 5260.) 8)Prohibits a cause of action for monetary damages from arising against any director or officer of a nonprofit corporation or a nonprofit medical association, who serves without compensation, on account of any specified negligent act or omission if the nonprofit corporation or nonprofit medical association has a general liability insurance policy in a specified amount that is in force both at the time of the injury and at the time the claim is made. (Section 24001.5.) 9)Authorizes an unincorporated association to merge into a specified corporation, limited partnership, general partnership, or limited liability company. (Section 5063.5 & 12242.5.) COMMENTS : This non-controversial bill, sponsored by the Business Law Section of the California State Bar, seeks to clarify and improve the application of existing Corporations Code sections for the benefit of nonprofit and consumer cooperative corporations. These code sections concern a wide range of topics affecting the organization and operation of these corporations, including directors' rights, the authorized number of directors, quorum, board committees, officer titles and board reliance on committees. This bill also seeks to authorize streamlined merger and liquidation processes, default provisions in the case of third party approvals, and procedures for board reductions, among other things. The Bill Clarifies the Role of "Designators "to Designate Directors in Specified Situations . The bill seeks to clarify the role and authority of so-called "designators" when the AB 1233 Page 6 articles or bylaws call for the designation of directors rather than election. Importantly, the bill does not change existing law concerning the rights of members, directors, boards of directors and/or other persons or entities to designate or select directors. Section 5220(d) allows for designation of the directors by a third party ("designator") entity or individual rather than election by members. However, internal changes and turnover at an institution with authority to designate a director may result in no response at all when requests are made for appointment of a replacement director. In some cases, the designating entity may have dissolved or merged, or an individual with designating authority is dead, in poor health, or otherwise incapable of responding to a request for designation of a replacement director. In those situations, failure to designate a replacement director can have the effect of preventing the corporation from conducting its business in the ordinary course of events. The bill revises Sections 5220(d) & 5222(f), 7220(d) & 7222(f), and 12360(d) & 12362(h) with respect to "designators." These three pairs of code provisions are structurally similar to each other. In each case, the last sentence of the subdivision (starting with "After this death?") has been deleted because if a designator no longer exists, the ordinary statutory election procedure for directors should apply to that directorship once the incumbent's term expires and a vacancy arises. Required Approvals by Nonmembers or Nondirectors . Part 2 of the Nonprofit Corporation Law in two specified circumstances requires approval of certain changes to the articles or bylaws to be made by specified persons who are not members nor directors of the corporation. First, Section 5132(c)(4) allows the articles of incorporation to provide that amendment or repeal of the articles of incorporation or bylaws must be approved by a specified person or persons other than the board or the members. Second, Section 5150(d) allows for the bylaws to provide that amendment of the bylaws must be approved by a specified person or persons other than the board or the members. A problem arises where the specified person is unavailable to fulfill his or her prescribed role to approve those changes. In those situations, failure to provide for a replacement person AB 1233 Page 7 who has the authority to make the approval can have the unwanted effect of preventing the corporation from conducting its business in the ordinary course of events. This bill proposes a default solution to address this problem if drafters of articles or bylaws do not. In such a situation the authority defaults to the members or, if no members, to the directors. Section 5222(f), relating to removals of directors, is also amended to mesh with Section 5220(d) as amended. Sections 7132(c)(5), 7150(d), 7220(d) and 7222(f) in the Nonprofit Mutual Benefit Corporation Law and Sections 12330(d), 12360(d) and 12362(g) in the Consumer Cooperative Corporation Law are amended similarly. Section 9132(c)(4) in the Nonprofit Religious Corporation Law is amended to correspond with Section 5132(c)(4); there is no Religious Corporation Law provision similar to Sections 5150(d) or 5220(d). Clarification of Directors' Rights : According to the sponsor, many nonprofit corporations utilize titles, including the word "director", although such persons are not part of the governing body of the corporation as specified in Corporation Code Sections 5047 and 12233. AB 1233 would amend the definition of "director" in Sections 5047 and 12233 to clarify that (1) persons who have a title suggesting they are directors (e.g., "honorary directors," "directors emeritus," "advisory directors") but who have not been designated, elected or appointed to act as members of the corporation's governing body and vote on actions or decisions taken by it on behalf of the corporation are not directors for purposes of the code, and (2) persons who become directors by reason of having a particular status or holding a specified position ("ex officio directors") are directors for all purposes. This would eliminate common misperceptions and confusion about the ability of a nonprofit or consumer cooperative corporation to have nonvoting directors and about the voting rights of "ex officio" directors. Method of Determining the Authorized Number of Directors : According to the sponsor, nonprofit corporations sometimes wish to determine the size of the board of directors by a formula tied to specific objective factors. The Corporations Code currently provides that the bylaws may fix the number of authorized directors within a range specified by them, or the board may determine the number of directors within that range by resolution. However, there is no provision clearly permitting the number of directors to be determined by a formula set forth AB 1233 Page 8 in the bylaws. AB 1233 would amend Sections 5151, 7151, 9151 and 12331 to allow the bylaws to provide for a method of determining the number of directors. Quorum; One Director One Vote; No Proxy Voting by Directors : According to the sponsor, nonprofit corporations may wish to ensure that certain board actions may not be taken without the presence, at the meeting where such action is taken, of certain directors or constituencies who are on or represented on the board. Sections 5211(a)(7), 7211(a)(7), 9211(a)(7), and 12351(a)(7) do not expressly provide that the requisite quorum must include certain specified directors. This practice is relatively common and expressly permitted in some other states. The bill would state that the articles or bylaws may specify that certain directors must be present for a quorum to exist, as long as that does not prevent efficient decision-making for the corporation when those directors die or the person or persons authorized to appoint or elect them died or ceased to exist. In addition, Sections 5211(a)(7), 7211(a)(7), 9211(a)(7), and 12351(a)(7) refer to the authorized number of directors as stated in the articles or bylaws. In many cases, the bylaws provide for a range of directors (for example from three to nine) and the authorized number is set by the board in a resolution. AB 1233 adds the language "or pursuant to" before the articles or bylaws to clarify that the authorized number may be the number authorized by resolution and not the highest end of a range in the articles or bylaws. Constituents of nonprofit corporations sometimes wish to permit certain directors to possess more than one vote. However, that is inconsistent with the Corporations Code and a director's fiduciary duties. While existing law indicates that an action or decision taken by a board of directors is determined by a headcount of directors present rather than a vote cast by them, that subtlety is not always clearly recognized by volunteers trying to manage the affairs of a nonprofit corporation. In addition, although the code does not expressly forbid a director from participating in a decision by proxy, this restriction should be made clear as such volunteers may not recognize the risk of that being inconsistent with fiduciary duties. AB 1233 adds a new subdivision (c) to Sections 5211, 7211, 9211 AB 1233 Page 9 and 12351 to state that each director has only one vote and no director may vote by proxy. Contrast Between Board Committees and Advisory Committees : Sections 5212(a), 7212(a), 9212(a), and 12352(a) list restrictions on the authority of board committees, including "the approval of any action for which this part also requires approval of the members ? or approval of a majority of all members." This restriction applies to actions the law states require approval by members as defined in Sections 5034 and 5033 (and Sections 12224 and 12223), regardless of whether the corporation has or does not have members. To prevent confusion in these situations, AB 1233 would add language clarifying that the restriction applies regardless of whether the corporation has members. According to the sponsor, it is common practice for bylaws to provide for the creation of both "board" committees - committees comprised entirely of directors, to whom the board of directors may delegate its authority, except as provided- and "advisory" committees - committees that may be partially or wholly comprised of non-directors, and which advise the board or board committees or implement their decisions, but do not hold the authority of the board. AB 1233 amends Sections 5212(b), 7212(b), 9212(b), and 12352(b) to clarify that board committees may only have directors as members but that other committees with non-director members may be created as long as they do not exercise the authority of the board. Consistent Nomenclature for Officers: "Chairman of the Board" and "Chief Financial Officer" : Section 5213(a) of the California Corporations Code currently sets forth the required officers for a nonprofit public benefit corporation, requiring that the corporation have a "chairman of the board or a president or both." It also requires that the corporation have a "chief financial officer" and a secretary. The same requirements apply to mutual benefit corporations (Section 7213(a)), religious corporations (Section 9213(a)), and consumer cooperative corporations (Section 12353(a)). For nonprofit corporations in existence on December 31, 1979, which are currently subject to the transition rule of Section 9916, and consumer cooperative corporations subject to Section 12694, the "treasurer" is deemed to be the "chief financial officer." AB 1233 Page 10 Section 5062 defines an officers' certificate as a document signed and verified by the chairman of the board or president (or any vice president), and the secretary, chief financial officer or treasurer (or any assistant secretary or treasurer). This definition applies to public benefit, mutual benefit and religious corporations. The same definition is found in section 12241 for consumer cooperative corporations. The language of the current law allows the titles of "other officers" to be at the board's discretion, but does not expressly allow the board to change the title given to the "chairman of the board." Many corporations prefer to use a gender-neutral term for this officer, such as "chair of the board" or "chairperson of the board," or to grant the alternative title of "chairwoman of the board" when the person holding this office is female. In recent years, the Secretary of State's office has rejected officers' certificates signed under a title that does not exactly match the statutory text ("chairman of the board"). AB 1233 would add Sections 5039.5 and 12228.5, and amend Sections 5213(a), 7213(a), 9213(a) and 12353(a) to state that a corporation may use any of these four titles to designate the individual who serves in this statutory officer role. The "chief financial officer" is a named and required office in Section 5213(a), 7213(a), 9213(a), and 12353(a), but a "treasurer" is not. This language is inconsistent with the treatment of the office of "president" and role of "chief executive officer" in the same code section. This language also causes confusion because many nonprofit corporations have both a "treasurer" and a "chief financial officer," where the treasurer is a board officer and the chief financial officer is an executive staff member. To provide consistency in officer titles in a manner that conforms with many corporations' existing practices, this bill would permit a corporation to have a "treasurer or a chief financial officer or both." These sections and the transition rule in section 9916 would also be changed to note that unless otherwise provided in the corporation's articles or bylaws, the treasurer will fulfill the role of "chief financial officer" if there is no separate chief financial officer. Reducing the Size of the Board : According to the sponsor, a AB 1233 Page 11 nonprofit corporation occasionally will be engaged in a board dispute whereby the board wishes to reduce the size of the board, and the director occupying the seat that will be terminated looks to the language "until a successor has been elected and qualified" in Section 5220(b) as evidence that unless that director is actually removed from the board, the director continues to serve. Section 5222(c) further states that any reduction of the authorized number of directors does not remove any director prior to the expiration of that director's term of office. To remedy this problem, AB 1233 amends Sections 5220(b) and 5222(c) to state that this is the case unless the director has been removed from office. The corresponding sections in the Religious, Mutual Benefit and Consumer Cooperative Corporation Law, i.e., Sections 7220(b), 7222(c), 9220(c), 9222(c), 12360(b), and 12362(d) would also be amended. Board Reliance on Committees. Under Sections 5210, 7210, 9210, and 12350, the board may delegate the management of the activities of the corporation to anyone, although it retains ultimate responsibility. Under Sections 5212, 7212, 9212, and 12352, the board may delegate board authority, within specified limits, to committees of the board composed only of two or more directors. Under subsection (b)(3) of Sections 5231, 7231, 9241, and 12371, in discharging their fiduciary duties, directors may rely on "information, opinions, reports or statements prepared or presented by" a "committee of the board upon which the director does not serve," as to matters within its designated authority. It is assumed in practice the only committee on which a director may rely is a committee that complies with Section 5212 (and its parallel sections), but Section 5231(b)(3) does not expressly provide this limitation. The proposed amendment to Sections 5231(b)(3), 7231(b)(3), 9241(b)(3), and 12371(b)(3) clarifies what committees can be relied upon by substituting the ambiguous phrase, "committee of the board," with a description of committees composed entirely of directors. AB 1233 also widens the reliance category to include advisory committees composed of (i) those with fiduciary duties to the corporation (e.g., officers and employees), (ii) those with relevant professional expertise (e.g., attorneys and accountants), and (iii) directors. Voluntary Dissolution When No Quorum of Directors Exists. AB 1233 Page 12 Section 6610 currently requires "approval of the board" for voluntary dissolution of a nonprofit public benefit corporation if there are no members and in certain other situations. Similar rules apply to mutual benefit and religious corporations in Sections 8610 and 9680 and to consumer cooperative corporations in Section 12630. By the time corporations find it appropriate to dissolve, it is often impossible to find a sufficient number of directors to make up the quorum necessary for that approval. Although Section 5224 of the Code (and similar provisions in Sections 7224, 9224 and 12364) would allow the remaining directors to elect new directors to create a quorum in order to make this election, it can be difficult to find directors willing to join a board for the limited purpose of dissolving and winding up the corporation. This technical step should not be necessary before dissolving. AB 1233 would revise the requirement for board approval of a voluntary dissolution under Section 6610, by adding a new Subsection 6610(c). Under subsection (c), if the corporation would be permitted to dissolve by approval of the board, but the number of directors then in office is less than a quorum, an action by the board to elect to dissolve could be taken by the same vote as would be required under Section 5224 for the election of additional directors (that is, by a unanimous consent of all remaining directors, a vote of a majority of the remaining directors at a meeting, or the approval of the sole remaining director). Furthermore, after such an election to dissolve, any actions by the board during the period of winding up and dissolving, including an election to revoke the dissolution, would also require only the same vote that was required for the dissolution. AB 1233 eliminates the need for a board that is less than a quorum to recruit and elect more board members to operate the corporation during this period. Corresponding changes would be made to Sections 8610, 9680, and 12630 to apply the same rules to mutual benefit corporations, religious corporations and consumer cooperative corporations. Allowing Religious Corporations to More Easily Satisfy IRS Requirements. A private foundation is not tax exempt under federal law unless its governing instrument contains special provisions in addition to those required of all other organizations holding tax-exempt status under Internal Revenue AB 1233 Page 13 Code Section 501(c)(3). A private foundation's governing instrument is considered to satisfy this requirement if applicable state law obligates it: (i) to act or refrain from acting so as not to subject the foundation to the taxes imposed on prohibited transactions, or (ii) to treat the mandatory provisions as contained in the foundation's governing instrument. Currently, Corporations Code Section 5260 allows a public benefit corporation that is a private foundation as described in that section to satisfy the IRS requirement without including this language in its governing instrument. AB 1233 creates a new Section 9260 which makes the provisions of Section 5260 applicable to religious corporations. Limitation of Personal Liability for Directors and Officers of Nonprofit Medical Associations. Sections 5047.5 and 24001.5 of the Corporations Code provide a limitation of personal liability for officers and directors of nonprofit medical associations. Both sections apply only if the nonprofit association maintains a "general liability" insurance policy that is in force both at the time of injury and at the time that the claim is made. According to the sponsor, "general liability" insurance policies often do not cover employment-related or other claims that are brought against directors and officers. These claims frequently are covered by director's and officer's liability policies or employment practices liability policies. In practice, it is often unnecessary to condition the limitation on liability on whether the insurance policy was in force both at the time of injury and at the time of claim, as long as the policy is applicable to the claim. This bill removes these two conditions, thus enabling nonprofit medical associations to assure their directors and officers that the statute provides the type of limitation on liability that the Legislature intended. Streamlining the Merger Process for Unincorporated Nonprofit Associations . Under existing law, unincorporated nonprofit associations may not merge into nonprofit or consumer cooperative corporations due to the exclusion of nonprofit associations from the definition of "other business entity" in Corporation Code Sections 5063.5 and 12242.5. As a consequence, such mergers presently occur in a two-step process: the nonprofit association is first incorporated and then the merger is consummated. AB 1233 Page 14 To authorize a one-step merger process for nonprofit unincorporated associations and streamline their merger with nonprofit or consumer cooperative corporations, it is recommended that Sections 5063.5 and 12242.5 be amended to delete "other than a nonprofit association" so that all unincorporated associations are included in the definition of "other business entity." This bill would also remove the restriction which limits unincorporated associations to one-way mergers "into" a corporation, limited or general partnership, or limited liability company under Corporations Code Section 18360. The bill would replace the word "into" with the word "with", which is used in other sections of the Corporations Code to permit two-way mergers by for-profit corporations, nonprofit corporations, partnerships and limited liability companies. REGISTERED SUPPORT / OPPOSITION : Support Nonprofit and Unincorporated Organizations Committee, Business Law Section of the State Bar of California (sponsor) Opposition None on file Analysis Prepared by : Anthony Lew / JUD. / (916) 319-2334