Written by David L. Sevalrud
As we discussed in Part One of our series on the Roles and Duties of Directors in a Combination of Non-Profits and Charities, a Non-Profit’s (“NFP”) Board of Directors (the “Board”) is responsible for informing itself of both the material risks as well as the material advantages of any combination involving the non-profit organization.
Some of the material risks that a NFP Board will want to understand and manage during a proposed combination transaction include: protecting the confidential information, intellectual property, key employees/officers and donors of an organization from use and disclosure by the other organization should the proposed combination transaction not be completed; utilizing representations, warranties, indemnities, and the delivery of a senior officer’s certificate upon closing of the transaction; being diligent to avoid and manage conflicts of interest that are both actual and perceived; and managing the potential for any directors’ personal liability in carrying out the Board’s duties. If the organization is a registered charity, the Directors will also need to understand if there is any risk to the registered charitable status of the resulting organization.
Entering into a non-disclosure agreement (“NDA”) at the beginning of the combination process is essential for risk management of the proposed transaction. This is especially so in the event of a combination transaction being explored but not completed.
If a NDA is entered into, the directors of both (or all, as applicable) NFP organizations should ensure that all parties involved, including advisors, are aware of the obligations of non-use, non-disclosure and non-solicitation of the information being exchanged. The NDA should include provisions on some of the following key issues:
- Confidential information: A prohibition on the use and disclosure of any confidential information by the party that receives confidential information about the other party during the combination process. For example, if a donor becomes aware of the financial distress of a NFP they support because the other organization disclosed such information without restriction, the donor could stop giving to the distressed NFP or choose to give to another organization.
- Non-Solicitation: This includes non-solicitation of donors of the NFP and key employees and officers of each organization.
- For example, if a proposed combination does not occur and the two NFPs have similar objectives (and no restriction on the use or disclosure of each others’ confidential information), the other organization may contact donors they were not aware of before the combination process commenced.
- During the due diligence process, each NFP organization will also become familiar with the other’s senior officers and key employees. Non-solicitation provisions in a NDA can help to protect a NFP from the loss of such key officers and/or employees if the combination is not completed.
- Intellectual property protection: In some cases, IP rights may also need to be protected in a NDA.
Representations, Warranties and Indemnities
A final agreement to enter into a NFP combination (“Combination Agreement”) may contain limited representations and warranties and related indemnities.
However, these provisions are of limited value because once the combination is completed the resulting entity will either be liable for the obligations of the prior organizations or will own all the material assets of the prior organizations. As such, a remedy against the former organizations may not have any value. This is one reason why it is important to ensure that (1) a thorough due diligence is conducted, and (2) the directors are comfortable the other organization has fully disclosed all material risks.
Upon closing the combination transaction, a senior officer of a NFP may need to deliver an officer’s certificate to the other side stating that the representations and warranties in the Combination Agreement are true. The certificate is usually provided by the officer in his or her capacity as an officer of the NFP and not in his/her personal capacity. Although not a guarantee, this certificate provides an additional layer of reassurance to the other party.
Conflicts of Interest
The NFP Board must maintain its independence at all times during a proposed combination transaction. The Board must avoid all conflicts of interest as it works to ensure an appropriate and credible process is followed in making an informed decision. Sometimes it is not enough to avoid a conflict of interest, and the Board must also take steps to avoid the perception of any conflict of interest.
Directors also need to manage the risk of personal liability. The Board’s risk management plan in this regard can therefore include: retaining legal advisors regarding how to discharge director’s duties; obtaining director and officer liability insurance; offering director indemnities (which will generally only be available for larger organizations and should be considered where appropriate); and ensuring a reasonable process has been followed by the Board in determining what is in the best interests of the organization.
Carscallen LLP’s Charities and Not-For-Profit Organizations Expertise
Carscallen LLP’s team of experienced corporate and commercial lawyers have advised a range of NFPs with legal advice tailored to the field of charity and non-profit organizations. Our lawyers can assist with such issues as structuring, organization and governance of NFPs, as well as advising on regulations and compliance issues for NFPs.
Whatever the legal issue, Carscallen LLP’s Charities and Not-For-Profit Organizations team can help guide your organization through a complex legal landscape. If you have any questions about directors’ roles and duties in a NFP combination, or any other legal questions for our team, please contact us.
*This update is intended for general information only on the subject matter and is not to be taken as legal advice.