Chapter 1: Corporations and Directors, What, Who, Why and How
Primer for directors of not-for-profit corporations (Rights, Duties and Practices)
President, Association Xpertise Inc.
What is a not-for-profit corporation?
Not-for-profit corporations (also called "non-share capital corporations") are different from for-profit corporations (also called "business corporations") in three fundamental ways:
- The not-for-profit corporation is composed of members, whereas the for-profit corporation is owned by shareholders. Footnote 1
- The members of a not-for-profit corporation cannot receive any financial (or pecuniary) gainFootnote 2 during the life of the corporation,Footnote 3 whereas a for-profit corporation may distribute profits to its shareholders in the form of dividends.
- The powers of a not-for-profit corporation are limited to what is written into its objects (purposes), whereas, typically, the for-profit corporation has no such limits.Footnote 4
The process of incorporation is also usually different for not-for-profit corporations, although this varies from jurisdiction to jurisdiction. Incorporating a for-profit entity is a routine matter of submitting the correct forms and payments. Saskatchewan provides for a similar process with respect to not-for-profit corporations. Incorporating a not-for-profit entity at the federal level and in most other jurisdictions, however, requires government review and approval. For instance, not-for-profit entities incorporating federally under the Canada Corporations Act must apply to the federal Minister of Industry to issue letters patent to the corporation.Footnote 5 The proposed bylaws of the corporation must accompany the application.
In various jurisdictions, additional approvals are required, or conditions must be met, for the incorporation of certain types of not-for-profit organizations and for those with certain specific words in their name.
A not-for-profit corporation that is an accreditation body, or sets industry standards, may require additional approvals.
A not-for-profit corporation that wants to use the term 'Canadian' must receive federal approval, and a corporation that wants to describe itself as an 'institute' or 'academy' usually has to obtain approval for the appropriate provincial education ministry.
A not-for-profit entity can incorporate either federally or provincially, depending on the scope of its stated purpose and proposed activities. Each jurisdiction has its own legislation for the incorporation of not-for-profit organizations, and its own approval process.
Advantages of incorporation
There are many advantages to incorporation. These include:
- A not-for-profit corporation has a legal status separate and distinct from its members. Members may come and go, but the corporation continues until it is dissolved or wound up.
- The not-for-profit corporation can enter into contracts, buy and sell property, etc.
- Individual members of a corporation are generally shielded from liability (see Chapters 2 and 3 for more on this).
- The formal corporate structure facilitates ongoing operations and decision-making.
- There may be increased credibility with the government, funders, and the public.
- The not-for-profit corporation has an enhanced ability, through its governing documents, to address membership status issues (e.g., removal for unpaid dues or death, and expulsion for disciplinary reasons).
Disadvantages of incorporation
There are some disadvantages to incorporation. The most commonly encountered is the paperwork and regulation entailed. This includes:
- Most jurisdictions require an annual corporate filing related to the location of the head office as well as director information.
- Some not-for-profit entities (excluding registered charities and smaller not-profit organizations) must file an annual information return with the Canada Customs and Revenue Agency.
- Incorporated not-for-profits (except registered charities) must file an annual corporate income tax return.
- Federal corporations incorporated under the Canada Corporations Act must get ministerial approval to change certain bylaws.Footnote 6
Other disadvantages include:
- There are some constraints placed on the type of activity that the group or entity may engage in.
- There is a need to devote time and resources to maintaining corporate structure that would otherwise go to carrying out the desired purposes or activities of the organization.
The not-for-profit board of directors
The not-for-profit corporation is governed by a board of directors. The size of the board is defined in the bylaws of the corporation (within parameters established by each jurisdiction). While the board, as a whole, has a great deal of authority and power, the individual director, when acting alone, has almost no power. The letters patent or articles of incorporation and the bylaws establish certain elements of the corporate governance structure.
Within this basic corporate structure, however, the board is typically responsible to appoint (whether directly or indirectly) board committees, officers, employees Footnote 7 and agents of the corporation to carry out day-to-day activities. In some cases, it may fall to the corporation's membership to elect particular officers, such as the president. A director will be entitled to exercise any authority associated with an office or position to which he or she is elected or appointed.
A director selected as chair of a standing committee will enjoy the rights and privileges accorded to that position.
A director serving as a member of a special committee mandated to take a particular action on behalf of the corporation will be entitled to participate in, and vote on, deliberations considering the matter.
For-profit and not-for-profit directors share a legal responsibility to act in the best interests of the corporation. However, the stakeholders in not-for-profit corporations do not share the pecuniary interest that binds together those involved with a for-profit corporation. Having volunteer board members, and often volunteers carrying out the corporation's operations, means the dynamics of governing a not-for-profit corporation differ markedly from those of a for-profit entity. In some jurisdictions thought has been given to enacting statutes that would empower not-for-profit directors to consider stakeholders or community interests in their decision-making; however, this approach has generally been rejected.
In for-profit corporations it is assumed that those with an interest in the entity can and will be satisfied with economic compensation - either through distribution of income over time or through purchase of their share(s). No such straightforward mechanism exists in not-for-profit corporations. Not-for-profit corporations pursue purposes that are less tangible and therefore hard to quantify. This makes it much more difficult to measure the performance of the corporation and of the directors. Recognizing this, not-for-profit directors should always try to be closely attuned to the views and interests of the members of their corporation and other stakeholders.
Failure to do so is apt to result in one or both of two outcomes: either the members of the corporation will lose their commitment to the corporation and/or different factions promoting their own agendas will develop within the corporation. When this happens, the smooth operation of the organization is hampered, or in extreme circumstances, the existence of the corporation is at risk.
Most provinces, and most U.S. jurisdictions, classify not-for-profit entities by type for purposes of incorporation. There is, however, no classification of not-for-profit entities within the Canada Corporations Act.
Some provinces use a two-category system. While the dividing point may be similar in these provinces, the terminology and approach vary. In Saskatchewan, the Not-for-profit Corporations Act,1995 uses a two-part classification scheme: charitable organizations and membership organizations. In this system, all organizations that do not qualify as charities are categorized as membership organizations. Organizations can qualify as charitable either through registration with the Canada Customs and Revenue Agency or by meeting other criteria set out in the Act.
In Ontario, although there is no distinction in corporations law, not-for-profit corporations can be either charitable or non-charitable under the Charities Accounting Act.Footnote 8 Charitable corporations are subject to the jurisdiction of Ontario's Office of the Public Guardian and Trustee. The Charities Accounting Act covers "[a]ny corporation incorporated for a religious, educational, charitable or public purpose".Footnote 9
In Québec, no distinction is made between the types of not-for-profit corporations incorporated under Part III of the Companies Act, and there is no equivalent of the Ontario Charities Accounting Act to distinguish between charitable and non-charitable corporations. However, corporations that want to solicit public donations are obliged to include certain restrictions in their letters patent.
The most common classification system in the U.S. contains three categories: mutual benefit organizations (organizations which primarily serve the interests of their members); public benefit organizations (which includes charities that are not religious organizations); and, religious organizations.
For governance purposes, it is most useful to distinguish between two principal categories of organizations.
- Public benefit not-for-profit corporations carry on activities that are primarily for the benefit of the public. Their revenue sources may include public and corporate donations, government grants, contract funding, and fee-for-service programs or activities. A public benefit not-for profit corporation may, but will not necessarily, be registered under the IncomeTax Act. These organizations are at times referred to as 'charities', regardless of whether or not they are registered with the Canada Customs and Revenue Agency, and regardless of whether they meet the common law requirement that they be exclusively charitable (i.e., not engage in non-charitable work).
- Mutual benefit not-for-profit corporations carry on activities that are primarily for the benefit of their members. They are typically supported by their members through fees and fee-for-service programs or activities, but may also receive other revenues such as government project funding. Examples of mutual benefit corporations are trade associations, professional societies, golf clubs, social clubs, etc.
Directors of public benefit organizations generally must take into account the interests of a broader range of stakeholders in their decision making than directors of mutual benefit organizations.
All not-for-profit corporations have members. With many mutual benefit not-for-profit corporations, membership criteria can be defined through a clear common interest, often related to service provision. With public benefit corporations, the common interest may be vaguer or very broadly stated. It follows from this that in public benefit organizations it will often be subject to debate who should be eligible for member-ship and whether there should be different categories of membership. In some public benefit organizations, membership is limited to a relatively small number of people - e.g., currently serving directors. Where the membership base is small, eligibility of non-members to serve as directors may be an important issue for public benefit corporations, and have a significant impact on the organization's ability to renew itself.
The letters patent (articles of incorporation) or the bylaws of a not-for-profit corporation may provide for some special categories of directors. The most common are "ex officio", "honourary", and "public" directors.
Ex officio directors
Ex officio board members are defined in most basic procedural texts, such as Robert's Rules of Order.Footnote 10 They are individuals who qualify as board members because they hold an office, such as the presidency of the organization or of another - usually affiliated or related - group or organization. They may also qualify because they hold a certain public office.
An ex officio member of the board generally has the same rights as other directors, but may or may not have the right to vote. This should be specified in the governing documents of the corporation. It is not uncommon for a not-for-profit corporation's bylaws to state that the executive director serves as an ex officio board member, typically with no right to vote. This ensures the executive director has input into board decisions. Since he or she does not have a vote, this prevents a situation where the executive director is charged with implementing a decision he or she voted against at the board level.
Where the director may be considered to be acting as a trustee, such as in a registered charity or public benefit corporation, an executive director serving as an ex officio board member may be subject to challenge. This is because, under trust law (and under statutory law in Ontario), he or she may be obligated to serve without pay. A salaried executive director could be seen as being paid when performing his or her role as an ex officio board member. The law is unclear on this point, so - particularly in Ontario - public benefit corporations should avoid the practice of designating executive directors (or other paid staff) as ex officio board members. Alternative means for assuring executive director participation in board meetings should be sought.Footnote 11
Regardless of whether or not they have voting rights, ex officio board members have the same legal duties and responsibilities as regular directors.Footnote 12 Where an ex officio director does not have a vote, he or she takes on liability without the opportunity to oppose a board decision or register a dissent. In these circumstances, where possible, provision should be made to provide such a director with indemnity and/or insurance protection. (See chapter 6 for a detailed discussion of indemnification and insurance.) As well, it should be noted that except where a conflict of interest arises, the ex officio director will be entitled to be present during any in camera discussions of the board.
Generally, the bylaws should also specify that the ex officio director serves as long as, and only as long as, the individual occupies the office in question.
A not-for-profit corporation wishes to ensure representation from a related organization on its board, so it provides for ex officio membership of that organization's president on its board in its governing documents. That president will sit as a full member of the board, and will be obligated to act in the best interest of the not-for-profit corporation. He or she will be fully liable for any board decision, unless he or she has registered a dissent or withdrawn from the decision based on a conflict of interest.
A not-for-profit corporation appoints its executive director as an ex officio member of the board. The bylaws provide that he or she may participate in board discussions, but is not entitled to vote. He or she will be fully liable for any board decision, and the board will be unable to exclude him or her from in camera board deliberations except where a conflict of interest arises.
Honourary Directors or Officers
Where the not-for-profit corporation makes a practice of naming honourary directors or officers, its governing documents should make provision for these positions, including their method of appointment. As with ex officio directors, the not-for-profit corporation's governing documents should specify whether honourary directors enjoy voting rights. If they do not have voting rights, honourary directors may attend meetings and take part in discussions, but may not make motions or vote.
Although commonplace, the practice of naming honourary directors or officers needs to be approached with caution. This is not to dispute the need to recognize long or distinguished service, or the value of enlisting a prominent individual in the organization as an avenue for using their name for promotional or fundraising purposes. However, by deeming such individuals as honourary directors or officers, there is a risk that they will be held liable for board decisions in which they do not fully participate. As with ex officio directors, the inability of such individuals to vote may not preclude them being held liable, and may preclude their being excluded from in camera proceedings.
There is little case law dealing with this issue, so it cannot be said with certainty when, or if, a person serving in such a capacity would be liable. An alternative is to find another title or way of designating the individual that will make it apparent to third parties that he or she is not, or is no longer, an active decision maker within the organization. An individual may, for instance, be called an honourary advisor or patron.
Some not-for-profit corporations are required to have one or more board members appointed to represent the public. This is common in professional societies that have a role in protecting the public interest as well as the interests of their members. These directors are not members of the organization. However, they have all the rights and responsibilities of regular directors, except that they are not required to fulfill any membership obligations, such as payment of dues.
Knowing the mandate
To be effective in their role, directors and prospective directors must know and understand why the organization exists and whom it serves. It is equally important for the board of directors to periodically re-visit this mandate to determine its ongoing relevance and the organization's commitment to it.
Although there is much a well-governed organization can do to help a new board member become familiar with the organization and its man-date, inevitably most of the onus is on the member himself or herself to get up-to-speed. New directors should recognize that they may not get much direction beyond the opportunity to review the corporation's governing documents - and that those may or may not reflect the not-for-profit corporation's current operations - and determine how the gaps in their knowledge can best be filled. Investing time outside of a board meeting to talk to staff, other board members or former board members, can both increase the new member's effectiveness and mean board meeting time is used more efficiently. (For more on director development and orientation, see to Chapter 8.)
The Drucker Foundation's Self-AssessmentTool identifies five key questions that can assist not-for-profit directors in sizing up their organization:
What is our mission?
Who is our customer?
What does the customer value?
What are our results?
What is our plan?
The first three questions address the board's need to understand and re-visit its mandate. Question four looks at the organization's effectiveness in delivering on its mandate. Question five turns the board's attention to developing a plan to better deliver on the mandate.
It is also important for directors and prospective directors to understand the corporation's mandate so that they can determine whether their motivation for serving on the board is compatible with it.
In addition, the purpose of the organization, as articulated in the mission and vision, will determine why the corporation enjoys not-for profit status, why members join the organization, and why the public and other funders support the organization financially.
Corporate governance documents
In The Guide to Better Meetings for Directors of Non-Profit Organizations, Eli Mina describes three sets of governing documents that provide the framework for how not-for-profit entities operate:
- Laws of the land: The statute under which your organization is incorporated…
- Bylaws (or Constitution and Bylaws)…
- Meeting Procedures or Book on Rules of Order…Footnote 13
The incorporation statute takes precedence. Where it is silent or provides for alternatives, the bylaws apply. Where both the statute and bylaws are silent, the book on rules of order applies, if the corporation's bylaws identify such a document. Robert's Rules of Order is typically used as the default authority where the bylaws do not specify another document. In Québec, Procédure des assembleés deliberantes, by Victor Morin, is the commonly used reference.
Two additional governance documents often exist in not-for-profit corporations. In some organizations, the bylaws or organizational practice may pro-vide for 'codes' or 'regulations' spelling out practices for members . The process for amending such documents will vary from organization to organization and may entail input and decision making by members, the board and/or staff. Also in many organizations, specific decisions of the board are compiled in a 'governance' or 'policy' manual. This sets out appropriate practice without referring to discrete matters in every instance. The order of precedence, in both cases, would be after bylaws.
Not infrequently, organizations will act in a way that is at odds with their governing documents - with the consequent implications for liability. A statutory and bylaws review (also referred to as a compliance audit) can be invaluable in ensuring that responsibilities and requirements are being met. A key issue for many not-for-profit corporations is maintaining institutional memory. High turnover among board members and staff can mean that an organization revisits a matter that has already been decided, or acts inconsistently over time. Revisiting a matter usually entails wasted effort, and acting inconsistently over time is apt to alienate clients or other stakeholders. Any steps that can be taken to simplify or facilitate tracking of governance practice or decisions are worthwhile.
All not-for profit directors are potentially accountable to someone or some entity, often to multiple parties. This accountability can take many forms: annual general meetings where members can vote to replace directors they have lost confidence in or make changes to governance documents that affect the board; administrative or judicial penalties imposed owing to regulatory non-compliance; reporting requirements to funders; and, court actions mounted by dissatisfied stakeholders. While directors often focus on their legal liabilities, they also need to be mindful of their obligations to stakeholders who might not have or take legal recourse. Very infrequently legal duties will be at cross purposes with stakeholder interest, and in these rare instances, legal responsibility must take precedence. In other cases, the most skillful directors will recognize and accommodate stakeholder needs whenever possible, and thus ensure the long term health of their organization.
The accountability of directors of public benefit not-for-profit corporations is similar to that of mutual benefit directors. Typically, directors of public benefit corporations will have more constituencies to take into account than their mutual benefit counter-parts. A stakeholder map can be a useful tool to help directors track their accountability when there are multiple constituencies involved with the organization.
As well, it should be noted that public benefit corporations frequently have to meet higher regulatory requirements, either through the Canada Customs and Revenue Agency or provincial legislation. In some instances, these regulatory requirements effectively replace the role of the beneficiaries in ensuring that public benefit organizations act appropriately; however, in other cases, the beneficiaries also have recourse to the courts to enforce their interest.
Note Regarding Jurisdiction
Incorporation of an entity, either federally or provincially, does not automatically give that jurisdiction authority over the corporation's operations (other than its compliance with the requirements of the corporations statute); rather, the authority over the operations is determined by what level of government has jurisdiction over the activities in question (e.g., a nationally incorporated educational institution falls under provincial jurisdiction with respect to its operations; the activities of an airport authority fall under federal jurisdiction no matter where it is incorporated).
Jurisdiction of the federal government
Aside from statutes governing incorporation and corporate regulation, the federal government's jurisdiction over the not-for-profit sector is manifested most extensively in the Income Tax Act. This jurisdiction is exercised both in the determination of non-profit status and of status as a registered charity. The basis of this involvement is the federal power over direct and indirect taxation. (Chapter 7 addresses the taxation status of not-for-profit entities in greater detail.)
Depending on the purposes and activities engaged in by the organization, the federal government may also have regulatory jurisdiction - for instance, port authorities are subject to regulation by the federal Department of Transport.
In addition, the federal government shares jurisdiction with provincial governments regarding sales and consumption taxes, and consequently has a say in how that aspect of the taxation system is applied to not-for-profit entities. In some cases, not-for-profit corporations are eligible for a preferential GST rate.
Federal regulation of such areas as trade and commerce and privacy also gives it jurisdiction over certain aspects of the activity of not-for-profit corporations. Finally, federal spending can give it authority over some not-for-profit work.
Jurisdiction of provincial governments
Aside from statutes governing incorporation and corporate regulation, provincial governments have considerable jurisdiction with respect to the not-for-profit sector. Some examples include:
- Supervision of charities. The Office of the Public Guardian and Trustee in Ontario supervises most public benefit organizations - i.e., corporations incorporated for a religious, charitable or public purpose - operating in Ontario regardless of where they are incorporated, and whether or not they have been registered with the Canada Customs and Revenue Agency.
- Fundraising. The Alberta government has legislative measures in place to monitor and control fundraising activities. Manitoba also has legislation dealing with registration of fundraising organizations.
- Gaming and lotteries. Whether through charity bingos, casinos or raffles, or provincial government funding from gaming or lotteries, this represents a huge area under provincial jurisdiction affecting not-for-profit entities.
- Professions. Education is a provincial responsibility. Such matters as the tax deductibility of education fees, professional self-regulation, and the right to grant a protected designation or certification are all matters addressed provincially.
- Property taxation. Various provinces (acting directly or through their municipalities) either exempt certain not-for-profit entities from property taxes or provide lower assessment rates, depending on the type of organization.
- Taxation. In Québec, provincial legislation provides for a distinct taxation regime - which roughly parallels the federal system - that contemplates exemption of non-profit organizations and registration of charitable organizations. It also establishes a distinct system of sales and consumption taxes.
- Language. In Québec, the Charter of the Frenchlanguage and the Act respecting the legal publicityof sole proprietorships, partnerships, and legalpersons requires and regulates the use of the French language for the names of not-for-profit corporations as well as their contracts, signs, posters, leaflets, brochures, etc.
- Registration. All not-for-profit corporations carrying out activity in Québec must register and subsequently file an annual declaration in conformity with the Act respecting the legal publicity ofsole proprietorships, partnerships and legal persons. The Act provides for fines for the corporations and its directors for non-compliance.
- Funding. Health care, for instance, is a provincial responsibility. Provincial governments provide funding related to health care delivery, education, etc.
- Regulation. Provincial governments have jurisdiction over many of the activities most commonly undertaken by not-for-profit entities through their constitutional authority over property and civil rights.
- Freedom of Information and Privacy. Some provincial governments have implemented legislation that focuses on the freedom of information and privacy.
Jurisdiction of the courts
Other than enforcement of legislation, there are at least three notable areas where various courts have jurisdiction over not-for-profit corporations:
- having inherent power to supervise the activity of organizations to ensure their proceedings accord with the requirements of procedural fairness;
- determining whether the purposes and activities of an organization are charitable, and therefore whether it is eligible for status as a federal or Québec registered charity; and
- where an organization is a charity, having inherent power to supervise treatment of the assets of the organization as trust property.
Conflicting or mixed accountability
Directors should always be aware that they may be accountable to different parties. By-and-large it should be possible to reconcile the responsibility owed to these various constituencies. When they cannot do so, directors should seek legal advice and make decisions based on a full understanding of the implications.
If the organization is on the verge of insolvency and is offered funding for a project that is apparently beyond the scope of its objects or purposes, the directors need to seek legal advice to assure themselves that the proposed work is within their mandate, or to determine how to bring it within their mandate, should they decide to do so.
Recommended practices for not-for-profit boards of directors
The Panel on Accountability and Governance in the Voluntary Sector,Footnote 14 chaired by Ed Broadbent, identified eight tasks required of the boards of charities and public-benefit not-for-profitsFootnote 15 to further developeffective governance:
- steering toward the mission and guiding strategic planning;
- being transparent, including communicating to members, stakeholders and the public and making information available upon request;
- developing appropriate structures;
- ensuring the board understands its role and avoids conflicts of interest;
- maintaining fiscal responsibility;
- ensuring that an effective management team is in place and overseeing its activities;
- implementing assessment and control systems; and,
- planning for the succession and diversity of the board.
The tasks highlighted in this list could be elaborated on at length. Here the list is offered merely as a starting point to indicate the issues that directors need to consider. Each organization should look at its own circumstances to determine the particular areas it should focus on, and what, if any, additional elements need to be added to the list for their purposes.
Sample Questions For Prospective or Current Directors to Ask the Organization
- Is the organization incorporated and, if so, in what jurisdiction and under what legislation?
- Is the corporation primarily for the mutual benefit of its members, or is it primarily for public benefit?
- What is the mission of the organization and when was it last reviewed?
- Who are the members of the corporation?
- Who does the corporation serve - the members or some other constituency?
- To whom are we, as directors, accountable?
Sample Questions For Prospective or Current Directors to Ask Themselves
- Am I committed to the mission of the organization?
- Can I contribute the time necessary to be an effective board member?
- Am I comfortable with the approach and tone of the organization's fundraising efforts?
- Can I contribute financial support consistent with the organization's expectations of board members and with my own means and priorities?
- Can I place the organization's purposes and interests above my own professional and personal interests when making decisions as a board member?
|Subject||To Be Conducted By||How Often||Comment|
1. A review of the letters patent (articles of incorporation)
Full board (possibly with assistance from advisor and/or counsel)
Annually, or as frequently as is appropriate given the length of board terms and the board turnover rate
Is there any deviation between the organization's mission statement, and the purpose as defined in the letters patent or articles of incorporation? Has the organization complied with corporate filing requirements?
2. A compliance review of the bylaws
One of: the full board/ executive committee/bylaw committee (possibly with assistance from advisor and/or counsel)
Annually, or as frequently as is appropriate given the length of board terms and the board turnover rate
Do the bylaws comply with current corporate and tax laws as they apply to not-for-profit corporations? Has the organization changed, or is it considering change, necessitating amendment of the bylaws? Do the bylaws contain the purpose of the organization and, if so, is it consistent with the purpose and/or mission described elsewhere?
3. A best practice review of the bylaws
Full board and/or executive director (possibly with assistance from advisor and/or counsel)
Do the bylaws represent existing best practice? Are amendments or updates to the bylaws needed? Are there any unnecessary bylaws, given the corporation's current size and state? Are there logical gaps in the bylaws that should be addressed?
4. An electoral process review of the bylaws
Executive director and/or the nominating committee
Annually, in advance of the nomination and election process
What are the milestones that must be met in the nomination and election process (e.g., the timeline)? Does the number of directors comply with the bylaws? Does the nomination and election process comply with the bylaws?
5. A review of the mission statement
Full board and the executive director
The questions in the Mandate section of this chapter (see pg. 7) should be answered to ensure that the mission statement is still relevant.
6. A review of the governance approach used by the organization
Full board with input from members
Every two years; more frequently if board turnover is high
Is the board the right size? Is it doing the right job (see Broadbent recommended practices in this Chapter)? Does the organization have good governance, and how could it be improved?
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