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The Importance Of Good Bylaws

The Importance of Good Bylaws Black’s Law Dictionary (the classic and definitive “Webster’s” dictionary of the legal profession) defines “Bylaws” as: “Rules or administrative provisions adopted by an association for its internal governance.”

A nonprofit organization has two principal charter documents: the Articles of Incorporation, and the Bylaws. The organization is formed by the filing of the Articles with the Secretary of State, which can and often should contain certain specific provisions that are not required, but permitted by the Code, and further include specific limitations on the ability of the directors or members to amend those provisions. These provisions can serve to protect the original purposes and mission of the organization. The Bylaws (which are not filed with any public agency) should define, control and set the basic principles and manner by which the organization will be operated. If the Bylaws do not address certain matters of corporate operation, then the California Nonprofit Corporations Code imposes its rules and, in the absence of specific clarification in the Code, the rules of common law (court interpretation of corporate law), treatises on corporate law and, if all else fails, perhaps to Robert’s Rules of Order will govern. While the Corporations Code may be adequate for many routine operational matters, it may be too restrictive, or too lax, on others that the Organization’s founders or present Directors would rather be better, or differently, defined, addressed or treated. In the case of removal of directors, for example, or votes required to carry certain resolutions, it may be particularly important to have Bylaws that are much more restrictive than the Code’s requirement of only a simple majority of a quorum to pass a resolution.

The California Nonprofit Corporations Law requires a nonprofit corporation (referred to as the “organization” in this paper) to have directors and officers. The organization may also have members, who may or may not have certain voting rights, as set forth in the Bylaws. The organization’s board of directors (the “board”) is comprised of three or more individuals—preferably always an odd number to avoid stalemates in voting—called directors. Directors are responsible for overseeing, governing, and controlling the business of the organization. Directors are bound by duties of loyalty and duties of care to have sufficient knowledge about the organization’s finances and operations, to seek professional and other counsel as needed, and to make informed decisions, based upon reasonable business judgment and correct information, to govern the operation of the organization. Directors are to avoid conflicts of interest (discussed below). Officers (president, secretary and treasurer at a minimum, and others if provided for in the Bylaws or board resolution), have duties as described in the Bylaws or Nonprofit Corporation Code and report to the Board of Directors. An individual may be both a director and an officer unless the Bylaws provide otherwise.

An organization’s Bylaws should be the principal guide, the primer, or “rule book” by which the organization runs its overall corporate affairs. Questions such as “when and how often does the board meet?,” or “how and when do we elect directors?,” or “how is a meeting of the board to be run?,” or “how do we get rid of a board member who never comes to meetings?,” or “how do we change the Articles of Incorporation or Bylaws?,” or “who can serve on a committee, and what are the limitations on a committee’s power to make decisions that bind the organization?,” and many others, are questions that should be able to be answered by referring to the Bylaws. From time-to-time the Directors will adopt resolutions, or “policies,” that governing important matters, like the formation and adoption of budgets, the job description of the executive director if not set out in the Bylaws, key financial policies, and other important matters. Those policies, adopted as formal resolutions of the Board of Directors, may have the same force and effect as Bylaw provisions. However, Bylaws may also provide that changes cannot be made to certain Bylaw provisions without a supermajority, or even unanimous vote of all directors, whereas most Board resolutions can be easily overturned or modified by the vote of a simple majority of those directors present at a board meeting (provided a quorum—one more than half of the total serving—are present at that meeting and all directors had notice of the meeting).

The Bylaws do not address the day-to-day operations details that executive directors and/or other employees oversee, but the principles, frameworks and policies (in some cases) for the overall governance of the organization, how that structure is maintained; how many directors will serve at one time, what their qualifications are, what they are to do, when they meet, what they can delegate to others and what they cannot, what committees are authorized, how committees function and what power they have over what matters, how directors and committee members are held accountable, how members are selected, meet, vote and function (if the organization has members), and who the officers are and what their job descriptions are. The Bylaws often will contain key policies regarding conflict of issues policies and how those are to be handled, duties of loyalty, overall guiding financial policies, and international grant making policies if the organization makes grants to organizations or efforts outside the USA.

The Bylaws are intended to be the “rule book” to which you can go for answers, when fundamental problems or questions arise regarding the overall governance of the organization, such as how to fill a vacancy on the board; what are the qualifications for board members or Executive Director; how can an errant director be removed (or can he or she?); what is (or years ago was) the organization’s principal purpose for existence, and how does that impact current decisions about proposed activities or opportunities before the Board); or what can we do to stop the majority of present directors from changing the organization’s course of direction significantly from the founder’s original mission?. Many disputes that arise are unhappily decided by application of general corporation law developed from years of litigation, or the Nonprofit Corporations Code, or worse yet, in court at great expense (and public embarrassment to the directors and organization—and chagrin of former or would-be funders). If complete, detailed, carefully thought out and crafted Bylaws had been adopted by the Directors, many of these problems could have been resolved, or never come up, by simply following that important charter document.

“Boilerplate Bylaws,” in the form obtained from Office Depot or a company specializing in incorporating companies, or a lawyer who has no additional information from his client, generally provide the barebones” basics of corporate operation: a section on directors (how many, how they are chosen, how long they serve (one year unless specified otherwise), when they meet, how to give notice of meetings); officers (president, secretary, treasurer and basic function); if the organizations is has voting members, how meetings are noticed, what business can be conducted at meetings, what voting rights members have); basic record-keeping provisions; how the Bylaws can be amended (what % vote of board or members); and other basic, general matters regarding finances, amendments to the Bylaws, and similar general directives.

The Corporations Code gives an organization’s members and/or Board considerable latitude as to what can be included in Bylaws. It is this latitude that permits the founders, or later, the directors if amending the Bylaws, to develop Bylaws that provide foundation, definition, limitations, policies, specific mission and purpose details, that serve to provide overall structure, boundaries, operational direction and stability to the organization.

To the extent that an organization takes the time to carefully consider many of the issues identified below, and incorporate applicable provisions into its Bylaws, you will not only have a more useful document for corporate governance, but one which more provides a consistent guide to directors, keeps the organization along the path deliberately chosen by the founders, and better assures a continuity of operation in line with the originally intended purposes, mission and values. When disagreements or questions arise concerning certain matters of governance, it is often very helpful to be able to go to the organization’s Bylaws for direction—a convenient way of steering the Board “back to the basics,” or away from one director’s ‘interesting’ (or troubling) idea that could lead the organization down an unwanted path.

Bylaws do not have to include anything beyond the basic “boilerplate.” To the extent that boilerplate Bylaws are relied upon, the articles and Bylaws may be changed by simple majority vote of a quorum of the members or board, for example, leaving a board or membership free to radically change the purposes, direction and mission of the organization with just a few votes.

Recent scandals in the public sector (Enron, Worldcom, Tyco) have led to the passage of the Sarbanes-Oxley Act, which primarily applies only to public (for profit) companies, but in some instances also apples to nonprofit organizations. Effective January 1, 2005 California adopted laws that require nonprofit organizations with annual gross receipts of $2 Million or more to observe similar financial, audit, separation of finance committees, auditors and directors, other duties, restrictions and accountability on nonprofit organizations, and, regardless of annual revenues, to observe strict guidelines regarding fund raising. A review of your organization’s financial policies and systems, and fund raising policies and practices, with legal and accounting counsel is strongly recommended.

I have listed a number of issues or matters below that deserve the careful consideration of the Board of Directors. Consultation about some or all of these matters with legal counsel specializing in nonprofit corporate organization and operation is strongly recommended, to the extent that these matters have not been reviewed by and discussed with counsel in the last year or so. The list is not exhaustive (nor particularly explanatory) of ‘all’ matters that should be seriously considered for inclusion in the organization’s Bylaws or in separate resolutions (policies) adopted by the directors. The list is not legal advice or opinion, and the fact that your organization’s Bylaws does not address an issue raised below does not necessarily imply that there is a “problem” or legal “defect” in its Bylaws. Use the list to raise issues and generate thoughtful discussion, and determine from there, with counsel, whether it is appropriate to amended the organization’s Bylaws.

A number of the issues listed below are more commonly (and in some counsel’s or directors’ opinions, more properly) addressed in written policies adopted by the Board, briefly addressed in the Bylaws and expanded further by separate board policies or resolutions. Since the Bylaws provide both an education to new and existing directors about the organization’s governance that is more easily gleaned in one document than in a loosely-maintained set of policies adopted over a number of years and often included in (buried!) pages of board minutes, inclusion in the Bylaws (perhaps supplemented-expanded in board-adopted policies) may be a good idea. Also, to the extent that Bylaws are protected from amendment by supermajority vote restrictions, many of these matters, if set forth in hard-to-change Bylaws, help define, guide, fix and maintain consistency in governance over many years, and preserve and protect the organization’s original mission. Further, certain matters, like duties of loyalty, and conflict of interest, self-dealing, are matters that are not well understood by volunteer directors, who may not take their duties nearly as seriously as they should if not educated by a concise document—the Bylaws—that clearly state the organization’s standards, and the corporations law, on the subject.

1. Are the organization’s principal (or specific) purpose(s), “mission,” “core values,” and “objectives” (at least specific purpose or “mission”) set forth in the Bylaws? Should one or more of those items be (that is, would defining mission, values, purpose (perhaps already briefly, though not necessarily, stated in Articles in Incorporation) help define the organization better to third parties, to potential large donors or their counsel, or help “stay the course” and keep the Board from wandering into tangents? If the Organization has not adopted a “mission statement” or “core values” or “objectives,” (buzz words to ‘strategic planners’),

2. Measuring Effectiveness. Should the Bylaws contain provisions (guidance) on how the effectiveness of the Board, and the Organization, is to be measured? Monitoring or measuring provisions or policies, or some kind of accountability measures? Therefore all difficult to define and adhere to and consistently apply, but even if generally stated, such provisions may provide helpful and consistent guidelines for analyzing existing programs, considering new proposals, and so forth. Coupled with #1 above, and if bolstered by a supermajority-only Bylaw amendment provision, a combination of #1 and #2 in the Bylaws can provide considerable stability and guidance to successive boards in “steering the course” straight and consistently with the original intent of the organization’s founders.

3. For religious organizations, do the Bylaws contain a statement of faith (like the Apostles’ or Nicene Creed, or similar faith statements) that give clear definition to what the organization wants its board (and members if any) to believe and adhere to, and to express through the organization’s activities? If not, new Director’s in later years, with different views on faith, religion and practice can significantly reduce the focus or mission of the organization.

2. What percentage vote of the Board (or members) is required to amend the Bylaws? Is it a simple majority of all directors (or all members)? Is it a simple majority of a quorum (one more than one-half) of the board (or members) presents at the time of the vote (which could be just 26% of the total, for example)? Should the Bylaws, or portions of the Bylaws, be subject to a supermajority vote (of ALL directors or ALL members, or of just a quorum), so that key provisions (like mission, values, vote required to amend, etc.) cannot be easily changed by board member?

3. Do the Bylaws define the qualifications or functions of Board members? How are prospective directors nominated? What are the selection criteria? Is there a search and nominate committee? What is a director is expected to do (in addition to attending board meetings: e.g. fund raise)? What “mix” of Board expertise, personality or strength should they exhibit (e.g. always include one CPA, one lawyer, one fund raiser, one high-profile person, etc.)?

4. Size of the board, frequency of meetings, can be key to an organization’s success, and better set in Bylaws than in board resolutions from time to time that tend to be taken less seriously. Large (9+) boards become difficult to convene and manage. Small boards (less than 5) may become too “inbred”, lack independent thinking and not provide effective leadership.

5. Means of participation of board members: do the Bylaws provide for meetings by conference call? By instant messaging? By email? For approval of resolutions by email or instant messaging (i.e. without a “hard signature” from the director)?

6. Proxies. The Nonprofit Corporations Law permits directors and members to vote by proxy, unless the Bylaws provide otherwise. Does the organization want to prevent the use of proxies—at least in certain circumstances, to make it more difficult for one or more persons to control blocks of votes to ‘get their way,’ particularly when it comes to amending the articles or Bylaws, changing certain significant policies, firing a pastor or other key employee, buying or selling the organization’s building, taking on significant debt load, and other issues of significant impact to the organization?

7. Do the Bylaws identify specific powers that directors can only exercise upon supermajority votes of the directors (quorum, or total board?)? (E.g. acquisition of real property, incurring debt in excess of $XXX, selling off property, engaging in certain activities, or hiring certain employees (if the organization is a membership organization).

8. Term of Service. Does a director serve for one, or two, or three years? Do the Bylaws provide for staggered terms and staggered voting, to maintain continuity on the Board? Can a director serve an unlimited number of successive terms? Must a director step down for a specified number of years, and then can return as director again after that?

9. Removal of a Director. How may a director be removed? What is the process for removal? Must it be “for cause,” only, and are those “causes” specified? Only mutual benefit and religious nonprofits may remove directors “without cause,” and public benefit nonprofits (nonprofit, non-religious, public charities) may not remove directors except under very limited circumstances.

10. Do the Bylaws place restrictions on interested (“disqualified”) persons serving as directors? Or receiving compensation if serving as a director or officer? Or receiving certain other benefits (conflict of interest issues tied to “disqualified person” tax issues) from the organization?

11. Compensation of Directors: Do the Bylaws address the issue of compensation to directors (acceptable, not acceptable, not acceptable if the director is a “disqualified person”)?

12. Expense Reimbursement: Do the Bylaws address the matter of reimbursing directors for out-of-pocket expenses incurred in attending a board meeting?

13. Contracts: Do the Bylaws address the matter of contracts for services or products between the organization and directors and officers, or their related parties (family members, entities they own or control? Mutual and public benefit corporations are subject to specific rules in the Nonprofit Corporations Law regarding these matters, but religious corporations are not (but that does not mean that accountability and careful consideration should not be given). [See §§5233, 7233, 9243 of the Nonprofit Corporations Code, and §§5234, 7233(b) and 9244]

14. Loans to Directors and Officers: Permissible or not? Under what circumstances? For what purposes? Are loans to Directors of officers legal? [See §§5236, 7235 of the Nonprofit Corporations Law—there is no prohibition or limitation on loans to directors or officers of religious corporations—but be very careful, since donors may not like what they see or hear about, and create significant problems by filing complaints to the State Attorney General fiduciary duties may outweigh a perceived “license” in the absence of a Code restriction].

15. Conflict of Interest Policies: Do the Bylaws contain a conflict of interest policy, and how direct or perceived conflicts must be addressed by a director or committee member, and who has the power to vote on a matter? Does the organization require its directors, officers and key employees to sign conflict of interest letters each year, and/or sign addendums each year disclosing all actual and potential conflicts?

16. Duty of Loyalty: Do the Bylaws define what directors’ duties of loyalty are? This may be important to state in the Bylaws if, for no other reason, so a director reading the Bylaws for the first time learns, or for the ninth time is reminded, what his or her duties of loyalty are, and what breach of those duties can mean.

17. Committees: Do the Bylaws define what committees may be established, who can serve on them, accountability to the Board, and establish powers and limits?

18. Audits, Audit Committees, Who can, who must, and who cannot be on the audit committee? What protections are in place to ensure that that the audit committee is independent of the finance committee, and that auditors are independent from tax and accounting service providers to ensure independence and oversight? Who in the organization must sign (certify under penalty of perjury) the organization’s 990 and 199 (law requires the signer certify that the form is accurate, complete, filed on time), and what duties (levels of) inquiry, inspection and understanding are (and should be) required to ensure compliance? What additional matters of financial systems, operations, oversight, independence, and accountability should be considered, and set forth in written policies adopted and enforced by the board of directors?

19. Are policies regarding private inurnment, excessive personal benefit and self-dealing addressed in the Bylaws? (Similar to conflict of interest issues).

20. Removal, Discipline, Expulsion, Reinstatement of Members. If the organization is a membership organization, do the Bylaws provide a fair and reasonable mechanism for removing, disciplining, expelling, and/or reinstating a member? Are there stated causes for the removal of a member (or director)? If not, or if the Board has not adopted and consistently applied policies for these matters, be very careful how the organization goes about such a process! Current policies and Bylaws provisions should be reviewed by counsel to ensure that whistler-blower (#21 below) and/or other laws are not violated by existing provisions, or do contain provisions or provide too much latitude for such procedures that may expose the organization to liability that could more likely be avoided if tailored to current law.

21. Whistler-Blower Provisions. Do the Bylaws define a formal process for dealing with employee complaints or reports of alleged illegal activities in the organization? While more typically spelled out in board policies, this can be addressed in the Bylaws, and gives the organization and Board a more formal, serious statement of policy that follows the current law against retaliation against “whistle-blowers.

22. Document Maintenance and Destruction: This issue is more typically addressed in Board-adopted policies, but may be wise to state in Bylaws as a matter of education for and clear statement of the “rule of law” to, Directors, officers and others in the organization. What are the organization’s policies and with respect to destruction of unnecessary and outdated documents and files? What files must be kept, and for how long? How are electronic files and voice mail maintained? What back-up procedures, check-ups re system reliability, and document retention in the event of litigation or IRS or other audit, are in place to guide the board’s Executive director and employer?

23. Privacy Issues. Do the Bylaws (more likely Board-adopted policies on this one) address how the organization is to comply with new privacy regulations, particularly with regard to donors’ information (credit card numbers, social security numbers, and other identifications that new laws require special protections for and treatment of). This is a very important new area of the law to taken very seriously.

24. International Grant-Making Policies. For organizations making grants to individuals and/or organizations outside the USA, do the Bylaws contain provisions detailing the manner in which such grants can be made, control and oversight safeguards, and other provisions required by applicable revenue rulings? Such policies are imperative if foreign grants are made, and while can be covered in Board-adopted policies, are also well-stated in the Bylaws as a matter of education to directors, and stressing the importance of maintaining oversight and control.

25. International (or national) Micro-Business Controls. If your Organization makes grants to individuals or organizations outside the USA that do not have IRS-exemption letters (most will not), do the Bylaws (or Board policies) set forth guidelines governing the manner in which the organization will make micro-business loans, the selection process, documentation, supervision, and control vis-à-vis the organization’s stated purposes (and bases upon which the IRS granted tax exempt status)? IRS Regulations and Revenue Rulings require written foreign grant-making policies that include several clearly delineated elements.

24. Encroachments, Controls, Limitations of Religious Freedom. For religious organizations, the Bush administration’s emphasis on faith-based NGO’s providing services to the public sector may add considerable limitations on, or application of Federal anti-discrimination laws (employment, facilities access and use, expression) to, the ability of the organization to express and carry out its religious purposes. Further, recent aggressive ACLU activities throughout the country regarding religious organizations access to and use of public facilities for ‘religious’ purposes are narrowing the freedom of religious organizations to carry out their purposes in ways, or in the places, formerly available to them. This places pressure on these organizations to modify, or water down, or abandon, their religious purposes or expression of those if public grants are to be received, or public facilities used. Religious organizations will want to give careful consideration to the extent to which they prohibit deviation from the organization’s original religious purposes and mission by limiting the ability of directors or members to amend the organization’s Bylaws, even if this results in public funds or public facilities unavailable to the organization.

A number employment-related matters not mentioned above are tremendously important to every nonprofit Organization, but are not typically addressed in the Bylaws. However, in these days of rapidly changing laws regarding harassment, whistle-blowing, and other employee matters your Organization should seriously consider whether such matters should be in the Bylaws to state the Organization’s clear policies concerning these matters (or at the very least adopting Board resolutions that cover these matters and appending those resolutions/policies to the Bylaws for easy review.

Most financial policies are generally not covered in Bylaws, but should be in writing, adopted by the Board of Directors, and regularly reviewed and used.

Many other issues can be raised, and many additional questions within issues noted above. As the laws continues to rapidly change, you are strongly advised to regularly seek legal counsel experienced in representing nonprofit organizations regarding these and related issues.

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