CHARITABLE ORGANIZATIONS-SELF-DEALING

May 9th, 2018 by Rieders Travis in Miscellaneous

Commonwealth v. New Foundation, Inc., et al., No. 36 M.D. 2014 (Pa. Cmwlth. March 1, 2018) Pellegrini, S.J.   The Commonwealth, through its Attorney General, brought an action as parens patriae against New Foundations, Inc. (New Foundations), Firetree, Ltd. (Firetree), and Orange Stones Company (Orange Stone) (collectively, Charities). Each was created as a charitable nonprofit with different but related charitable purposes. New Foundations was incorporated to provide services to families and children, with special emphasis on providing services to fragile infants and children. Firetree was incorporated to provide food and shelter to disadvantaged people. Orange Stone was incorporated to provide housing, care and treatment to halfway house residents. Each provides those services pursuant to contracts with federal, state and local government agencies.

The Commonwealth has filed a Motion for Summary Judgment which is primarily based on its claim of illegal self-dealing by the Individual Defendants with the Charities. It contends that because of that self-dealing, the Individual Defendants should be surcharged and held jointly and severally liable for a total of $25,530,742 based on approximately 26 transactions, which they contend were illegal self-dealing.

The Charities and Individual Defendants have filed a Motion for Partial Summary Judgment contending that the evidence shows that they are upholding their mission and serving the public good in accordance with typical nonprofit practices and in compliance with Pennsylvania law.

The duty of loyalty requires that corporate directors devote themselves to corporate affairs with a view to promote the common interests and not only their own, and that they cannot directly or indirectly utilize their position to obtain any personal profit or advantage. Anchel v. Shea, 762 A.2d 346 (Pa. Super. 2000).

Factors that determine whether actions of a board fall outside the business judgment rule are whether the board was disinterested, whether it was assisted by counsel, whether it prepared a written report, whether it was independent, whether it conducted an adequate investigation, and whether it rationally believed its decision was in the best interests of the corporation – i.e., acted in good faith. 

By requiring that “excess income” only be used for the lawful activities of the nonprofit provision, the duty of obedience requires that the director’s decisions to expend funds substantively further the purpose for which the nonprofit was organized and not to any of its members, directors or officers of the corporation.

Under the above provisions of the Law, the Individual Directors would not be liable if the transactions at issue here and the relationship and the material facts are disclosed as well as if the transactions were fair and reasonable at the time it was authorized.

A director of a nonprofit charitable corporation does not have the equivalent obligation of a trustee but the director, when exercising his or her fiduciary duties, must take into consideration what is “in the best interests” of the corporation. This includes acting with due care, including reasonable inquiry, skill and diligence as a person of ordinary prudence would use under similar circumstances. The director must also take into consideration that the primary purpose is to advance the charitable purposes of the corporation.

In support of their respective motions, the parties have submitted hundreds of exhibits, consisting of thousands of pages of documents, together with expert reports. In reviewing those documents, the parties appear to disagree as to what each document signifies, whether the transaction was fair at the time it was entered, and there is virtually no discussion of whether the board of directors or members were fully informed of the self-dealing transactions and whether it was authorized by the disinterested board of directors or approved by the members “in good faith.” 15 Pa.C.S. § 5728(a)(3).

Accordingly, the Commonwealth’s Motion for Summary Judgment and the Charities and Individual Defendants’ Motion for Partial Summary Judgment are denied.