The Ability of the State Attorneys General to Remove Members of Non-Profit Boards | gnh2104 | July 30, 2011

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The Ability of the State Attorneys General to Remove Members of Non-Profit Boards

 

I.  Introduction:

Alberta Bair was the last descendent in a line of wealthy and prominent Montana citizens that began when her ancestor Charles M. Bair moved to the state as an employee of the Northern Pacific Railroad in the 1880’s.  By the early 1900’s Charles Bair had become one of the most successful businessmen in the state of Montana—using the railroad to ship tons (literally) of raw wool from his 300,000 head of sheep back to the eastern markets.[1]  Bair’s descendants kept his vast estate and ranch within the family and over the years acquired a fine historical collection, including the house itself.  Alberta Bair added to it with her collection of artwork, Indian artifacts and decorative furniture;[2]  she wanted to ensure that the history of her region continued to be studied and learned by generations to come.  Therefore, in the early 1990’s she established a charitable trust that would turn her estate into a museum and would disburse grants from her still considerable fortune to further the research and study of Montana in general, and her region of the state in particular.[3]  Alberta Bair died in 1993, and over subsequent years the board of trustees she had specified to watch over the trust disbursed grants but was less enthusiastic about the museum.[4]  In 2005, the board voted to close museum in the face of strong public support for keeping it open,[5] which included a resolution passed by the Montana state legislature.[6] 

The Attorney General of Montana filed suit against the board and demanded a variety of legal remedies, including a court order to re-open the museum.  The Attorney General argued that closing the museum was an act “hostile” to the particular purpose of the trust, so the court could step in and contravene its actions.[7]  But perhaps most dramatically, the Attorney General demanded that the board of trustees be removed wholesale, to be replaced by trustees who were not hostile to the trust’s purpose.[8] 

 Situations like Alberta’s raise interesting questions.  On a basic level, why is it the state Attorney General who oversees nonprofits?  More specifically, what exactly is the nature and extent of a state Attorney General’s removal power over nonprofit boards?  Where does this power come from, in what ways has it been used, and how should this power be assessed as a policy matter? 

Section II of this Note will look at the background of the power of state Attorneys General over nonprofit groups within their respective states.  It will set the stage with a basic explanation of the scope of  power and parens patraie authority Attorneys General exercise over state issues.  The basic reasons why Attorneys General have control over nonprofits within their state will be laid out, and the statutory authority over nonprofit boards that a number of states have given their Attorneys General will be outlined.  Section III will look at a few specific examples of Attorneys’ General use, or attempted use, of their power to remove nonprofit board members.  In doing so, this Note will consider the legal underpinnings of their actions as well as practical and political purposes and effects.  Finally, section IV will explore legal and policy controversies surrounding the power of a state Attorney General over nonprofits and their boards.  It will explore issues of public trust as opposed to private corporations, problems with determining performance of nonprofits and the intentions of trusts, as well as legal reasons for and against Attorney General control over nonprofit boards.  Ultimately this Note will argue that there are sound legal and policy reasons for state Attorneys General to be able to effect removal of nonprofit boards.  

 

II.  The background for state Attorney General authority over nonprofits and examples of board removal attempts. 

The power of state Attorneys General over nonprofits derives from both statutory and common law sources.  This section will explore the ancient common law basis for Attorney General authority generally, as well as its application to nonprofit.  Although there is very little common law that speaks directly to the ability of an Attorney General to remove nonprofit board members, this section will briefly address the case law that does exist.  The second part of the section will provide examples of several jurisdictions that have given specific statutory authority for an Attorney General to sue for the removal of board members.  The final subsection will provide examples in which state Attorneys General have invoked both common law and statutory authority to remove board members.  These examples will also inform the policy considerations discussed in later sections. 

 

A.  COMMON LAW AUTHORITY FOR STATE ATTORNEYS GENERAL POWERS OF ENFORCEMENT OVER CHARITABLE TRUSTS. 

Section A will first address the broad common law power that Attorneys General have within their states and over nonprofits, and then specifically consider the common law powers concerning the ability of Attorneys General to remove nonprofit board members. 

 

1.  COMMON LAW ORIGINS OF ATTORNEY GENERAL POWER    OVER NONPROFITS

Any analysis of the power of state Attorneys General over charitable trusts and nonprofits must begin with the general common law authority granted to almost all Attorneys General in the United States, authority that has its roots in English common law.  The modern state Attorney General descends from an office of attorney general established under the English crown before the United States or its original colonies were founded. Although that office was established to serve the legal needs of the king, it also held some decision-making power in its own right.  When the colonies adopted the office of Attorney general they combined those traditional powers with a divided executive structure.  The new state Attorneys General retained their traditional discretion and combined it with a new independent grant of power as elected officials in their own right, increasing their ability to make decisions about the public interest of a state’s citizens. [9] 

This broad grant of authority to act on behalf of the citizens of a state is embodied in the concept of the parens patriae duty and authority of a state Attorney General.[10]  As ex rel. Shevin suggests, it was this parens patriae power that was vested in each state after its transfer from the crown to the American colonies as a result of the revolution.  The Supreme Court has held that, “[j]urisdiction is also supported by the States' interest as parens patriae. A State is not permitted to enter a controversy as a nominal party in order to forward the claims of individual citizens. But it may act as the representative of its citizens in original actions where the injury alleged affects the general population of a State in a substantial way” (citations omitted). [11]   Parens patriae is a remarkably broad grant of power to Attorneys General, one that allows them to bring suits against parties ranging from violators of consumer rights to tobacco companies to irresponsible polluters.  While the extent of the power has been controversial at times, it is also widely acknowledged as traditional and settled.[12]  The full common law authority to act “as the representative of its citizens where the injury alleged affects the general population of the state” is presumed to exist unless specific legislative injunction denies it.[13]  

This general parens patriae power forms the basis under which modern Attorneys General regulate charitable trusts and nonprofit corporations.  The settled law is quite clear that one of the duties of state Attorneys General is the monitoring and regulation of charitable trusts and nonprofits to make sure trustees carry out the duties assigned to them by the charter or incorporating documents.  “The public benefits arising from the charitable trust justify the selection of some public official for its enforcement. Since the Attorney General protects the rights of the people of the state, he has been chosen as the protector, supervisor, and enforcer of charitable trusts, both in England and in the several states.”[14]  In addition:

    Because of the public interest necessarily involved in a charitable trust or gift to charity and essential to its legal classification as a charity, it generally is recognized that the Attorney General, in his or her capacity as a representative of the state and of the public, is the, or at least a, proper party to institute and maintain proceedings for the enforcement of such a gift or trust.  The powers, duties, and functions of the Attorney General in these respects is provided for by statute in some states, but it generally has been held that even in the absence of statute, he or she has the power to enforce charitable trusts as a common-law incident of the office, and there is also authority to the effect that he has this common-law power although he has also been given the same power by statute.[15] 
 

While the language above speaks specifically about charitable trusts, the same law applies to non-profit corporations—indeed, much of the law for charitable trusts and nonprofit corporations overlaps fairly closely.[16]  Although charitable trust law is deeply rooted in English common law, with nonprofit law a more recent branch of that legal field, the law for both is very similar. [17] In some commentary sections the second restatement on trusts says, “Ordinarily the principles and rules applicable to charitable trusts are applicable to charitable corporations.”[18]  For the purposes of analyzing Attorney General oversight, charitable trusts and nonprofits are basically interchangeable, although in recent years there has been some separation as nonprofits are more likely to be compared to their for-profit counterparts when rules of law are being worked out in courtrooms and legislatures. 

In cases such as the Alberta Bair trust, mentioned above, the trust’s general public purpose is clear—a museum can benefit any citizen of Montana, and could bring in people from out of state who could contribute to the local economy—and so the reason for an Attorney General’s oversight role is easy to identify.  Many nonprofits and charitable trusts are set up to benefit a fairly specific group, yet those too are subject to the same state oversight.  Why the state regulation?  The answer is, in part, that all nonprofits are tax-exempt organizations and as such all the citizens of the state are essentially supporting them for the value of the taxes they do not pay.[19]  Moreover, the rule against perpetuities is relaxed for charitable trusts and non-profits, allowing them to collect and maintain wealth in ways the rest of a state’s residents may not.[20]  These are the basic policy justifications for Attorney General oversight of all nonprofit corporations and charitable trusts. 

  

2.  THE COMMON LAW POWER OF ATTORNEYS GENERAL TO    REMOVE NONPROFIT BOARD MEMBERS.

There is little common law that speaks directly to the question of whether state Attorneys General, in the absence of explicit statutory language, can sue for the removal of trustees.  A pair of cases are somewhat on point. In a Supreme Court case from 1890, the Court explored the history of charitable trust law and noted that, “In England, the court of chancery is the ordinary tribunal to which this class of cases is delegated, and there are comparatively few which it is not competent to administer. Where there is a failure of trustees, it can appoint new ones…”[21]  Thus the common law authority for courts to remove trustees definitely exists in England, or did at one time, but only California seems to have explicitly followed this path.  A California appeals court case, speaking of nonprofit corporations, states: “It is true that our courts possess the equitable power to remove directors independent of any statutory authorization.”[22]  This was an expansion on a California Supreme Court holding which had applied that principle to for-profit corporations.  That California Supreme Court opinion explicitly referred to the old English common law authority in its opinion.  This explicit common law grant of power to California courts (and thus to Attorneys General seeking to remove trustees) does not appear to exist in other United States jurisdictions. 

B.  THE STATUTORY AUTHORITY FOR STATE ATTORNEYS GENERAL POWER OF REMOVAL OVER TRUSTEE BOARDS.

Many states have laws on the books that allow state Attorneys General to remove trustees.  These include North Dakota,[23] Montana[24] and Nebraska[25].  Each of these laws is found under the nonprofit corporation section of their respective state’s statutes.  Their language is fairly explicit.  North Dakota’s reads:  “The district court of the county in which the principal executive office of a corporation is located may remove any director of the corporation from office in a proceeding commenced either by the corporation, its members holding at least ten percent of the voting power of any class of shares, or the attorney general [under specified circumstances].”[26]  Nebraska’s law states: “The district court of the county where a corporation's principal office (or, if none in this state, its registered office) is located may remove any director of the corporation from office in a proceeding commenced either by the corporation, its members holding at least ten percent of the voting power of any class, or the Attorney General in the case of a public benefit corporation [under specified circumstances].”[27] 

Other states have statutory language broad enough to allow an interpretation giving Attorneys General that power.  Minnesota’s reads: “Upon the application of the attorney general the district court is vested with jurisdiction to restrain, enjoin, and redress violations of sections 309.50 to 309.61. The court may make any necessary order or judgment including, but not limited to, injunctions, restitution, appointment of a receiver for the defendant or the defendant's assets, suspension of the defendant's registration, awards of reasonable attorney fees, and costs of investigation and litigation, and may award to the state civil penalties up to $25,000 for each violation of sections 309.50 to 309.61 [detailing the regulation of charitable trusts].” [28]   In many ways this type of statute is the most interesting for the purposes of analysis.  It could be read to allow for Attorney General power of removal, but because it does not say so explicitly the law invites judges to consider policy arguments that might or might not support allowing Attorneys General to sue for the removal of trustees.  In fact, Minnesota Courts have assumed that the statute confers on the court the power to remove board members.  In one case addressing an Attorney General’s request to remove board members a Minnesota court decided against the removal, but only because it decided the Attorney General had a poor factual case.  The court clearly believed that it was within its power to remove the board members had the Attorney General prevailed on the facts.[29] 

 

C. RECENT INSTANCES OF ATTEMPTED COURT ORDERED TRUSTEE REMOVALS

This section will look at four different instances of court ordered trustee removals.  These examples will be instructive as later sections look at the policy implications of this Attorney General power. 

   

1.  NORTH DAKOTA 

Darold Larson ran several nonprofit corporations with the ostensible purpose of providing religious and family care services to North Dakota families.  The Attorney General sued Larson for numerous violations of the state’s consumer credit counseling laws and the state’s Nonprofit Corporation Act, including commingling client funds with other moneys and making illegal loans of corporate funds to a corporation director.  The trial court found Larson and his nonprofits—Family Life Services (FLS) and Help and Caring Ministries (HCM)—guilty of many of the accused violations.  The court ordered Larson and other members of the board removed for a period of years and reconstituted the board with new members.[30] 

On appeal the Supreme Court of North Dakota struck down the reconstitution of the board on first amendment grounds.  The court held that allowing the Attorney General to appoint the directors of what was a largely religious organization implicated the constitutional separation of church and state.  Instead they directed that FLS and HCM simply be dissolved, a remedy explicitly provided for in the statutes. 

Thus the state supreme court largely sidestepped the issues of the case most relevant to this Note, but, in dicta, the court did uphold the trial court’s power to remove Larson.  The statutes that governed nonprofit corporations were slightly different at the time the case was considered.  They did not explicitly provide for the removal of officers in the event of convicted lawbreaking (only for dissolution of the nonprofit).[31]  However, in an earlier case having to do with for-profit corporations the North Dakota Supreme Court held that where a statute provided only for the extreme remedy of dissolution of a corporation for some violation, a court could use its equitable powers to enforce a lesser punishment where appropriate.[32]  In Heitkamp, the state supreme court chose to extend this logic to nonprofits and allow for the lesser punishment of trustee removal where the statute only provided for dissolution.[33] 

Although the modern statute (see supra section II) has rendered this opinion moot, its logic could be instructive for other state courts dealing with a similar legal regime.  Where the laws explicitly contemplate only dissolution but other remedies might be more appropriate or fair, courts could use North Dakota’s lesser punishment precedent as a guide. 

 

2.  MONTANA 

The background of the Montana lawsuit is discussed above (supra part I: Introduction).  The Montana Attorney General’s office has a stance of considerable deference toward nonprofit and charities boards and the work they do.  Although they receive charity governance complaints weekly (at minimum), they encourage the parties to seek a resolution to their problem within the organization, recognizing that boards and trustees “are much closer to the particular charitable mission” and better situated to decide what is best for their organization.[34]  The Montana Attorney general’s office believes that it is “not our place to micromanage charitable assets.”[35] They only step in when the most basic fiduciary duties of a board have been abandoned: obedience, care, or loyalty.  In their judgment the Bair case represented an unusual situation in which all three obligations had been violated, and they filed suit. 

The office of the Montana Attorney General believed that the lawyers and trustees were deeply mistaken as to the intent of the charitable trust, but did not view the violation as malicious.[36]  Nonetheless, they decided the removal of at least some of the trustees was necessary and appropriate.  The trustees had made abundantly clear through their actions that they simply were not interested in running a museum—they only wanted to carry out the disbursement of grant money (a duty they had performed without fault).  The Attorney General’s office felt that it made more sense to install board members who wanted to carry out the terms of the trust, as opposed to continually policing members who did not.[37]

In an opinion handed down on April 29th of this year the court sided with the Attorney General of Montana, holding that the board had breached its fiduciary duty to maintain a well-functioning museum and ordering a new board put in place.  In enforcing the board turnover the court was careful not to override any terms of the trust agreement, instead ordering the trust to invoke clauses already in the agreement that cumulatively had the effect of creating new board membership.[38] Although the Attorney General’s office had textual support for the power to remove the board of trustees, the main legal argument in the case was a complicated battle surrounding the meaning of the trust document, the precise standards of conduct the board should be held to and whether or not those standards were violated.[39]  These questions concerning standard of review—at what point Attorneys General can step in and request removal—are important to a policy analysis of the removal power.  In the Bair case, the court did find that the board had breached their fiduciary duty, but also decided that there was no bad faith motive on the part of the board.[40]  While the statutory scheme in that case allowed the board to be removed in such an instance, a scheme in which boards could only be removed after a finding of bad faith would curtail the removal power.  

 

3.  NEW HAMPSHIRE

Howard Sargent was one of New Hampshire’s pre-eminent archeologists.  In addition to work he did around the country and the world, he excavated over 66 sites in New Hampshire during his career, covering over 12,000 years of prehistoric life.[41]  At his death in 1993 he had acquired around 1 million pieces, but he died suddenly and left no will.[42]  To properly utilize and share with New Hampshire citizens the vast store of historical artifacts Sargent had acquired, friends and associates set up a nonprofit organization to start a museum.  The trust document stated that: “[t]he General purpose shall be to promote, through educational exhibits, events, and fundraising activities, the establishment and maintenance of The Sargent Museum.”[43]  The nonprofit took some initial steps, including acquiring a building in Manchester, NH, but made little progress after that. 

In 2005, the New Hampshire Attorney General’s office instituted an action to remove the board of trustees, dissolve the charitable trust, and appoint a receiver to decide the fate of Sargent’s collection.[44]  This was not a case of active wrongdoing or misinterpretation of a trust document; instead the board appeared to be completely nonfunctioning.  Almost nothing had been done since the acquisition of the building—all 900 boxes of artifacts remained unsorted, and the building was had not been worked on despite a $30,000 grant from the state of New Hampshire for renovations.[45]  In compliance with New Hampshire state law the trust document required there to be at least five members on the board of trustees.  At the time the Attorney General’s petition was filed only three board members remained.[46]  When called to appear before the court, one did not remember that he was a trustee, another did not appear, and the last seemed relieved to have someone else willing to take over the project.[47]  The judge sided with the state and turned the assets over to a receiver nominated by the Attorney General’s office and confirmed by the court.[48]  Finding a proper placement for the artifacts took a while, but they recently found a home with another New Hampshire archeological museum, allowing the collection to stay in the state.[49] 

This was probably an ideal use of the Attorney General’s regulatory power.  A nonprofit entity controlling an educational resource valuable to the state had become nonfunctional, and no other individual or group had the power or ability to force a change.  Here the New Hampshire Attorney General’s office unlocked resources that had been lost to neglect, and ultimately gave citizens of the state access to a part of their historical heritage that they had earlier been supporting without any benefit to themselves as the public. 

4.  MINNESOTA

Attorney General Mike Hatch of Minnesota dove into a legal battle with higher stakes and a higher profile than anything contemplated in Montana, North Dakota or New Hampshire.  Prior to 2001 Allina/Medica was a nonprofit corporation that served as the second largest health care provider in the state of Minnesota with 1.3 million members and a billion dollars in assets.  Over 10,000 employers subscribe to Medica plans and 15,000 physicians are part of its network.[50] 

In 2001 Allina/Medica found itself in dire financial straits and was hit hard with allegations of rampant corruption and fraud.  An audit report from the United States Department of Health and Human Services had detailed “graphic findings of waste and abuse.”[51]  The report garnered national attention, and Attorney General Hatch stepped in and conducted an extensive investigation that resulted in a six volume report of the problems within the corporation.  In this initial stage Hatch’s legal power to ask for the removal of board members as a remedy was not put to the test.   Instead he threatened to put Allina under receivership which would remove liability protection from the individual board members.  The threat was enough to convince the entire board to step down, and under a consent agreement the company was split up, with Medica spinning off as a separate nonprofit entity solely focused on healthcare (Medica kept the entire healthcare portfolio).[52]  

Hatch convinced some of the top civic leaders in Minnesota to become the new board of Medica, including a former justice of the Minnesota Supreme Court and a wealthy Minnesota-based CEO.[53]  The new board was to clean up the operation and report to Hatch to ensure they were performing properly.  In the final opinion on the case, the judge stated that this “2001 intervention by Hatch was lauded by witnesses in this trial as an example of a partnership by government and business at its best.”[54] 

Somewhere between 2001 and 2005 this partnership crumbled rather emphatically.  In 2005 Hatch brought a new case to court, this time against the board that he himself had appointed, accusing them of engaging in behavior similar to that which had brought down the Allina board four years earlier.  In this new case the Attorney General did try to create removal of the board as a legal remedy available to a court.  As shown above, the language of the Minnesota statute is broad enough to allow for such a reading if a judge were so inclined: when dealing with a violation, “The court may make any necessary order or judgment including, but not limited to…”[55]

This time, however, Hatch seemed to have overstepped his authority.  Judge Zimmerman’s opinion, after praising Hatch for his earlier work, strongly condemned him for the suit he brought against his own handpicked board.  The judge goes through every allegation of misconduct heard at trial and finds each one baseless.  “There was no evidence at trial that any of these board members did anything wrong, other than the allegation that they should not have remained board members….There was no or scant evidence offered—though many rhetorical flourishes by the Attorney General in his trial testimony—to back up the State’s claims of board mismanagement, of improper executive pay raises, failure to address ‘serious and abundant service quality problems,’ or take timely action to select a chief executive officer.”[56]  Although Attorney General Hatch originally sued on issues of deceit and misconduct, the judge notes that, “[a]fter publicly attacking their integrity, the state finally concedes in its written closing argument that they are good people who did a good job, and abandons claims of misconduct.”[57]  Judge Zimmerman soundly criticized the Attorney General for dragging the board members’ names through the mud with no cause: “At the end of the day, good people were unfairly accused.  After a fair and impartial trial, their good name is restored to them.”[58] 

In order to successfully sue the board, Hatch would have had to show that they had breached their fiduciary duty to the corporation.  In Minnesota this duty means in part that a director has to “act in good faith, with honest in fact, with loyalty, in the best interests of the corporation, and with the care of an ordinary, prudent person under similar circumstances.”  [59]  Significantly, the Minnesota Supreme Court has ruled that nonprofit directors are subject to the same business judgment rule deference that for-profit directors receive.  They may use rational, good faith “business judgment” and are not subject to “second-guessing” by courts or regulatory agencies when they do.[60]   Because Judge Zimmerman ruled that Hatch had not come close to proving the board had crossed the line of sound business judgment, the judge never got to the question of whether a court possessed the power to remove nonprofit officers. 

It is unclear what motivated Attorney General Hatch to bring the suit against his own board, but the two suits seem to provide a good illustration of the best and worst that Attorneys General can achieve with the power of removal.  In 2001 Hatch stepped in and made sure that the healthcare insurance of a significant percentage of his state’s citizens remained solvent and honestly run.  Later, for reasons unknown, Hatch seemed to abuse his potential power and got in the way of a now effectively run nonprofit organization. 

 

III.  Policy considerations: arguments for and against Attorney General power of board member removal. 

To determine the policy questions unique to the removal of nonprofit board members and charitable trustees, one needs to recognize how removal might be different from the already well-established powers of regulation that state Attorneys General have over nonprofits and charitable trusts. 

 

A.  POLICY QUESTIONS PERTAINING TO THE GENERAL REGULATION OF NONPROFITS.

This section will first set out both sides of the basic controversy over Attorney General regulation of nonprofits.  After looking at these policy issues, the section will first investigate the issue of standards—what standards nonprofits should be held to, and what exactly Attorneys General would need to prove in court before they could take action against a nonprofit.  Finally, the section will briefly look at some ideas and proposals for changing nonprofit regulation. 

The power of Attorneys General to regulate nonprofits is sometimes controversial.  The basic debate on the two sides breaks down fairly predictably.  Proponents of strong Attorney General oversight point out that nonprofit corporations and charitable trusts are fundamentally different from other instances where trustees or directors have a fiduciary duty to some type of beneficiary.[61]  In the case of a for-profit corporation, that beneficiary is a stockholder and stockholders have shown they can be trusted to enforce their own monetary interests with shareholder lawsuits whenever they deem necessary.[62]  Nonprofit corporations, on the other hand, often do not have such a clear cut beneficiary—the benefit that is derived by the public from the charitable activity may be too generalized to actually give any particular person standing to sue since they could not show a particularized injury.  This makes Attorney General oversight power, the power to sue on behalf of the public, necessary so that some party has the ability to enforce director and trustee fiduciary duties in nonprofits.[63] 

Others object to strong Attorney General oversight, saying the elective office makes it inevitably too political.  These scholars argue that this type of oversight will put burdens on nonprofits that they do not deserve and should not bear as they face scrutiny that stems not from legitimate legal concerns, but from mere political expediency on the part of a powerful public official.[64]  For them a prime example of this behavior would be Attorney General Mike Hatch’s suit against his own handpicked board—a suit that was ultimately found to be without evidence. 

Proponents of Attorney General oversight might reply that Hatch’s earlier efforts against Medica were essential to the well-being of many of Minnesota’s citizens.  No other individual, public or private, was in a position to effect the broad-based turnaround that occurred as a result of the original legal action.  Moreover, the power of an Attorney General is rarely immediate, but rather is filtered through the courts which serve as a definite legal check.  It is only a court, not Mike Hatch, who uproots nonprofit boards, and only then if Hatch has proven his case. 

Some of the recent debates around Attorney General oversight and nonprofits center around what standards nonprofit corporations and charitable trusts should be held to—exactly what do Mike Hatch and his ilk have to prove.  Along with the interpretation of the language of the trust, this is the primary legal issue in the Bair case in Montana.  The most basic traditional formulation of a trustee’s duty is that he act in good faith with reasonable care and skill, and not be negligent.[65]  Ordinary negligence would result in personal liability of the trustee.[66]  More recent innovations have been changing that standard in some jurisdictions. 

Most notably, as seen in the Minnesota Medica case, a few courts have moved toward instituting corporate governance standards for nonprofits.  Specifically, at the urging of scholars who believe nonprofits need more leeway to compete in the marketplace, some courts have allowed nonprofit directors to be subject only to the business judgment rule.[67]  This is a considerably looser standard than that traditionally applied to nonprofits and charitable trusts.  “The rule precludes courts from second-guessing directors' decisions as long as they are rational, not self-interested, and made in good faith on an informed basis.”[68]  Unlike the traditional standard that punished ordinary negligence, the for-profit business judgment rule only punishes gross negligence.[69]  This has the effect of removing a considerable amount of Attorney General oversight power because of the greater legal leeway allowed to nonprofit directors and charitable trustees.  They can only intervene after more significant damage has been wrought.  Given that many Attorneys’ General offices do not have adequate staff to closely monitor nonprofit corporations in the first place, as well as the fact that no shareholders’ lawsuits lurk to discourage malfeasance, this lessening of the ability of an Attorney General to intervene would arguably reduce the Attorney General power below any effectual level.[70]  If the move toward deregulation that dominated the 1980’s and ‘90’s also took some nonprofits into a realm of nearly unchecked discretion, the more recent impetus toward greater accountability in corporate governance embodied most dramatically in the Sarbanes-Oxley Act has also spilled over into nonprofit and charitable trust governance.[71]  The main thrust is toward creating structures that will enforce accountability on the part of directors and trustees, including more mandatory auditing requirements.[72]  There have also been theories floated that would broaden the definition of “relators,” those individuals who can sue a nonprofit, thus broadening the nonprofit’s accountability.[73]  Additionally, some are interested in having the federal government step in and take a more active role in the regulation of nonprofits.[74]  The Senate Finance Committee and Congress’s Joint Committee on Taxation have both issued reports encouraging greater federal oversight of nonprofits.[75]  Since all nonprofit organizations are tax exempt under federal law, the reports advocated the use of the IRS as an enforcement mechanism—if the organizations were acting improperly, the IRS could use its ability to determine tax-exempt status as leverage.[76]  Additionally, the reports propose allowing certain suits against nonprofits that are currently only allowed in state courts to proceed in federal court as well.[77] 

 

B.  POLICY QUESTIONS PERTAINING SPECIFICALLY TO THE POWER OF REMOVAL OVER NONPROFIT BOARDS.

This section will look first at the arguments against Attorney General power of removal, then at counter-arguments in favor of the removal power. 

How, if at all, does the power of an Attorney General to remove members of a board differ from the more general policy considerations of the Attorneys’ General power over nonprofits and charitable trusts?  There are some arguments that removing board members and putting in court appointed replacements is far more intrusive than normal Attorney General oversight, which brings up new concerns.  First, there are considerable reputational costs to the individuals involved in the charitable work if they are singled out by the Attorney General of their state for malfeasance and fired.  These individuals have chosen to give their time to a cause that is not-for-profit, and will not (generally) earn them much money.  They are in a real sense donating their time and expertise to the community.  As an AAG familiar with these issues has said, “[O]ne thing I've learned in charity law is that people invest a lot of themselves in the charities they serve, and even when there's not a dime of personal profit at issue they take their position—and challenges to it—personally.  That's a good thing until problems arise.” [78] They may be businesspeople more accustomed to operating under the business judgment rule as opposed to the (still much more common) traditional rules governing charitable trusts.  One might argue that the threat of Attorney General power of removal—which could come down on them based on rules they are not as familiar with—is too strong a disincentive to do charitable work and charities will lose talented people who would otherwise work for them.  

Second, the ability to remove board members or entire boards and appoint new ones potentially gives the Attorney General extraordinary access to the actual operations of a charity that goes beyond mere punishment for wrongdoing.  An Attorney General could appoint people whom he could trust to do certain things that he may desire, or even install them on a quietly quid pro quo basis.  If there are certain nonprofits that are high-profile or very important to livelihood of a state, this might provide a strong incentive to overzealously investigate them and ultimately give an Attorney General’s office greater control with handpicked board members or board.  And even if these overly incentivized investigations reveal nothing, they can impose serious deadweight costs on both sides.

Finally, some might argue that a new regime of for-profit corporation style regulation in nonprofit governance, if it is indeed coming, will provide enough accountability without this power of the Attorney General.  Indeed, the very purpose of many of these new regulations is to lessen the burden on Attorneys General and provide alternate means of enforcing fiduciary duties. 

Each of these arguments has a strong answer, and cumulatively they demonstrate that this removal power of state Attorneys General is one that deserves, at the least, to remain in those jurisdictions where it exists. 

In the first case, while there may be some small loss of people on the margin who fear the reputational costs of removal, this effect would be minimal.  People desiring to do service on nonprofit boards will understand that working for a nonprofit or charitable trust is simply a different type of duty than that owed to corporate businesses.  Those who would legitimately fear beforehand that they might be removed for failing to abide by the special fiduciary duties of a nonprofit board are probably people who are not suited to a nonprofit board anyway.  Most importantly, the value of reinforcing the notion that nonprofits are a public service and carry with them a special public responsibility outweighs any minimal economic cost that might come from losing some prospective (probably ill-suited) board member. 

The realities of mostly overstretched, underfunded modern state Attorneys General offices,[79] should mitigate fears of the overzealous politicians looking to put a controlling hand in important nonprofits.  Most devote fewer resources for charitable enforcement than is needed to carry out legally mandated enforcement duties. [80] Given the lack of resources the removal power appropriately helps tip the balance of power a little bit back towards Attorneys General.  While cases surely exist when meddling with a nonprofit will provide political gain, the courts remain to provide a check on the actions of the Attorney General.  In addition, it is perfectly appropriate for the role of an Attorney General to go beyond punishment for wrongdoing.  The Attorney General often occupies an organizational and advisory role in state and business affairs, as Hatch did quite properly in his first suit against Medica. 

As for the concern that this considerable grant of power to Attorneys General is becoming outmoded and redundant, the new regime has not yet arrived.  If anything, the influence of the deregulation years still retains a stronger imprint on the law than the more recent move toward insuring the integrity nonprofit boards.  There may come a time when innovative new ways of checking the discretionary power of nonprofit boards and enforcing fiduciary duties will render old forms obsolete, but that largely remains a vision for the future.  For now, the offices of the state Attorneys General remain the front line of defense against nonprofit boards and charitable trustees who might abuse their duties.  And those are not just duties toward their intended beneficiaries, they are duties to the whole public that supports and encourages the existence of nonprofits.  Granting an elected officer the tools to steer and right these vessels for the public interest is sound policy.

IV.  Conclusion:

Given the current regulatory structure, with its lack of any type of comprehensive, or even very attentive, regulation of nonprofits, it is important that tools for regulation not be decreased.  Even if concerns remain over the level of power that Attorneys General retain over nonprofits, a middle-way fix is better than eliminating the power altogether.  One possibility would be to change the burden that must be met before boards or board members can be removed.  For example, instead of merely finding that fiduciary duties have been breached, state laws could require a finding that boards acted in bad faith. 

Congress has demonstrated bipartisan concern over the current state of nonprofit regulation, and many observers worry about widespread abuse of nonprofit status.[81]  If Congress does enact major reforms, some may argue that it would be appropriate for the nonprofit regulatory power of Attorneys General to curtailed, perhaps even drastically.  If nonprofits can be worthwhile and important additions to a community, there is no need for them to labor under excessive and possibly repetitive regulation.  But Congress has not acted to change nonprofit laws, and the offices of state Attorneys General are still relatively unfocussed on the problems of nonprofit regulation, generally stepping in after there is a public outcry over mismanagement.  As the state of the law stands now, state Attorneys General need all the possible tools at their disposal.  Even if they remain largely unused, the threat of more intrusive regulation may cause some nonprofits to act with greater care.  In the end, this remains an important policy tool, one that cannot be abandoned until the country has a more effective system of nonprofit oversight. 

Footnotes


1. http://visitmt.com/whatsnew/features/charlesbairfamilymuseum.htm

2. Brief of Appellant at 9-10, In Re Bair Family Trust, No. DA 06-0586 (Mont. Sup. Ct. Dec. 22, 2007).

3. Id. at 10.

4. Id. at 10, 20-29.

5. Id. at 29

6. Id. at 20.

7. Id. at 36-37, 59.

8. Id. at 59.

9. The United States Court of Appeals for the Fifth Circuit provides a good historical explanation:
    “The office of attorney general is older than the United States and older than the State of Florida. As chief legal representative of the king, the common law attorney general was clearly subject to the wishes of the crown, but, even in those times, the office was also a repository of power and discretion; the volume and variety of legal matters involving the crown and the public interest made such limited independence a practical necessity. Transposition of the institution to this country, where governmental initiative was diffused among the officers of the executive branch and the many individuals comprising the legislative branch, could only broaden this area of the attorney general's discretion.
    As a result, the attorneys general of our states have enjoyed a significant degree of autonomy. Their duties and powers typically are not exhaustively defined by either constitution or statute but include all those exercised at common law. There is and has been no doubt that the legislature may deprive the attorney general of specific powers; but in the absence of such legislative action, he typically may exercise all such authority as the public interest requires. And the attorney general has wide discretion in making the determination as to the public interest.” Florida ex rel. Shevin v. Exxon Corp., 526 F.2d 266, 268-9 (5th Cir. 1976).

10. County of Oneida v. Oneida Indian Nation, 470 U.S. 226, 262 n. 11 (1985) (“In fact, the idea that the State should protect persons suffering from disabilities who had no other lawful protector probably arose at equity where the Chancery Courts exercised the prerogatives of the King as parens patriae.”). 11. Maryland v. Louisiana, 451 U.S. 725, 737 (1981).

12. Mark Sidel, The Struggle for Hershey: Community Accountability and the Law in Modern American Philanthropy, 65 U. PITT. L. REV. 1, 2 (2003)

13. 7 AM. JUR. 2D Attorney General § 6.

14. G.G. BOGERT & G.T. BOGERT, THE LAW OF TRUSTS AND ESTATES § 441

15. 7 AM. JUR. 2D Charities § 136.

16. James J. Fishman, The Development of Nonprofit Corporation Law and an Agenda for Reform, 34 EMORY L.J. 617, 650 (1985).

17. Correspondence with Anthony Johnstone, AAG in the Montana AG’s office.

18. Restat 2d of Trusts, § 348, comment f. The areas that do not overlap mostly have to do with technical ways in which property is held and transferred, issues I will not be dealing with in this Note. Fishman, supra note 16 at 651-3.

19. Ilana H. Eisenstein, The Case for Consideration of Public Interest in Administration of Charitable Trusts, 151 U. PA. L. REV. 1747, 1760 (2003).

20. Fishman, supra note 16, at 650.

21. Late Corp. of Church of Jesus Christ v. United States, 136 U.S. 1, 51 (1890).

22. American Center for Education, Inc. v. Cavnar, 80 Cal. App. 3d 476, 499 (Cal.App. 1978).

23. N.D. CENT. CODE, § 10-33-37 (2007).

24. MONT. CODE ANN., § 72-34-506 (2005).

25. NEB. REV. STAT. ANN. § 21-1977 (LexisNexis 2007).

26. N.D. CENT. CODE, § 10-33-37 (2007).

27. NEB. REV. STAT. ANN. § 21-1977 (LexisNexis 2007).

28. MINN. STAT. § 309.57 (2007).

29. Hatch v. Medica, No. MC 01-004100, slip op. at 1, note 1 (Hennepin County Ct. August 16, 2005), available at http://news.minnesota.publicradio.org/features/2005/08/18_stawickie_medicaruling/ruling.pdf.

30. State ex rel. Heitkamp v. Family Life Servs., 2000 ND 166, P1-P4 (2000).

31. Id. at P50.

32. Balvik v. Sylvester, 411 N.W.2d 383, 388 (Sup. Ct. ND 1987).

33. Heitkamp, 2000 ND at P50.

34. From correspondence with Anthony Johnstone, AAG in Montana AG’s office.

35. Id.

36. Id.

37. Id.

38. In re Charles M. Bair Family Trust, 2008 MT 144 (2008).

39. See Brief of Appellant, In Re Bair Family Trust, supra note 2.

40. In re Bair, 2008 MT 144 at 169.

41. Chelsea Conaboy, Archeologist’s Cache Passes to Museum, CONCORD MONITOR, April 18, 2008. available at: http://www.cmonitor.com/apps/pbcs.dll/article?AID=/20080418/FRONTPAGE/804180361&template=single

42. Id.

43. Petition for the Removal of the Board and Appointment of a Receiver, New Hampshire v. The Sargent Museum, New Hampshire Probate Court, June 20, 2005.

44. Id.

45. Correspondence with Michael Delucia, AAG in the New Hampshire AG’s office. 46. Petition for the Removal of the Board and Appointment of a Receiver, New Hampshire v. The Sargent Museum, New Hampshire Probate Court, June 20, 2005.

47. Correspondence with Michael Delucia, AAG in the New Hampshire AG’s office

48. The Attorney General’s office chose a lawyer who had been involved in other charities cases and was known to the court as an appropriate person to organize the transition of the assets. Id.

49. Chelsea Conaboy, Archeologist’s Cache Passes to Museum, CONCORD MONITOR, April 18, 2008.

50. Hatch v. Medica, No. MC 01-004100, slip op. at 1, note 1 (Hennepin County Ct. August 16, 2005), available at http://news.minnesota.publicradio.org/features/2005/08/18_stawickie_medicaruling/ruling.pdf.

51. Id. at 3.

52. http://news.minnesota.publicradio.org/features/2005/08/18_stawickie_medicaruling/

53. Hatch v. Medica at 3-5.

54. Id. at 2

55. MINN. STAT. § 309.57 (2007).

56. Hatch v. Medica at 35.

57. Id. at 33.

58. Id. at 49-50.

59. Shepherd of theValley Lutheran Church of Hastings v. Hope Lutheran Church of Hastings, 626 N.W.2d 436, 442 (Minn. Ct. App. 2004).

60. Janssen v. Best & Flanagan, 662 N.W.2d 876, 882-883 (Minn. 2003).

61. Fishman, supra note 16, at 676

62. Id. at 677

63. Id. at 677

64. Sidel, supra note 12, at 2-3.

65. 15 AM. JUR. 2D Charities § 93.

66. Id.

67. Denise Ping Lee, The Business Judgment Rule: Should it Protect Nonprofit Directors?, 103 COLUM. L. REV. 925, 927 (2003).

68. Id. at 927.

69. Id. at 927.

70. Id. at 935.

71. Marion R. Fremont-Smith, Approaching Nonprofit Law: The Search For Greater Accountability of Nonprofit Organizations: Recent Legal Developments and Proposals for Change, 76 FORDHAM L. REV. 609 (2007).

72. Dana Brakman Reiser, Who Guards the Guardians?: Monitoring and Enforcement of Charity Governance: There Ought to be a Law: The Disclosure focus of Recent Legislative Proposals for Nonprofit Reform, 80 CHI.-KENT. L. REV. 559, 592 (2005).

73. Fishman, supra note 16, at 671.

74. Fremont-Smith, supra note 72, at 609-610

75. Id. at 632, 633.

76. Id. at 632, 633

77. Id. at 634, 635.

78. Correspondence with Anthony Johnstone, AAG in Montana AG’s office.

79. Lee, supra note 68, at 935.

80. Pamela A. Mann, The Attorney General’s Regulatory Authority, in NONPROFIT GOVERNANCE AND MANAGEMENT, 393, 398 (Victor Futter ed., 2002).

81. Fremont-Smith, supra note 72, at 633.
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June 25, 2013

David Scherr

2008-05-01

attorney general non-profits

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