Our first installment in this series discussed the advantages and disadvantages of a statutory merger, the main disadvantage being the assumption of all of the target nonprofit's known and unknown liabilities. One alternative the surviving nonprofit can use to protect itself from the target nonprofit's known and unknown liabilities is to structure the reorganization as a transfer of assets.
Under this alternative, the target nonprofit (or "transferor nonprofit") uses its assets to pay its known liabilities. The transferor nonprofit then transfers its remaining assets to the "surviving" nonprofit, or in this case, the transferee nonprofit. The transferor nonprofit then remains in existence.
The main advantage of this structure is that the transferee nonprofit should have no liability for the transferor's unknown liabilities unless the fraudulent transfer or transferee liability rules apply, in which case, the transferee nonprofit's liability should at least be limited to the fair market value of the assets transferred to it.
Another advantage to this structure is that the transferor nonprofit can continue to receive known and unknown gifts. If the transferor nonprofit dissolved after transferring its assets to the transferee nonprofit, any gifts left to the transferor nonprofit via a will or trust will not automatically transfer to the transferee nonprofit as a successor organization.
For example, assume your will leaves $50,000 to the transferor nonprofit to be used to feed the homeless in Philadelphia. Further assume that the transferee nonprofit feeds the homeless in New York City. While both nonprofits exist to help the homeless, their purposes are geographically distinct. Therefore, if the transferor nonprofit no longer exists, a court may direct that the $50,000 be given to a third nonprofit that assists the homeless in Philadelphia even though the transferee nonprofit is the transferor nonprofit's successor.
Based on the above example, there are clear advantages to retaining the transferor nonprofit post-asset transfer. But what are the disadvantages of this structure? Because a transfer of assets is distinct from a statutory merger, the transferor nonprofit's assets do not automatically transfer to the transferee nonprofit. Thus, it may be time-consuming and costly to transfer all of the transferor's nonprofit's assets, especially if the target entity holds real property (i.e., realty transfer tax issues and real property tax exemption issues).
Also, it may be time-consuming and costly if the transferor nonprofit has to transfer licenses and contracts to the transferee nonprofit. Additionally, because the transferor nonprofit continues to exist, there will likely be duplicative costs of running two organizations (e.g., insurance premiums, accounting fees). Finally, a creditor of the transferor nonprofit is more likely to commence a legal action against the transferor nonprofit if the transferor nonprofit remains in existence.
Both nonprofits will also need to give thought to who will serve as officers and directors of each entity after the reorganization. Will there be overlapping directors and officers? Will the transferee nonprofit have the ability to appoint and remove the transferor nonprofit's directors and officers? These considerations are important because overlap and/or control could increase the risk that a creditor of the transferor nonprofit will commence a legal action against the transferee nonprofit.
Check back soon for the next installment of this series, which will cover liquidating transfers of assets.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
