Considerations for Determining Whether Association Chapters Should Incorporate
January 6, 2020
Following are the general considerations regarding whether a chapter of a hypothetical trade or professional association ("Association") should incorporate or remain as an unincorporated association. Whether chapter incorporation is required by the Association is a different issue, of course.
Overview of Incorporation Considerations
Incorporation is the process of creating a legal entity under authority granted by a state. A corporation is a separate legal entity, with continuing existence independent of its officers, directors, stockholders, and members. An organization, whether incorporated or not, may be either a for-profit entity or a nonprofit organization. For-profit organizations typically are incorporated, issue stock to shareholders, and are taxable on net income. Nonprofit organizations have no specific "ownership" as such, but are generally controlled by members, who do not receive stock; all profits are "reinvested" in the organization. Only nonprofit organizations can be granted an exemption from federal income tax by the Internal Revenue Service ("IRS"), but incorporation is not required for an organization to be considered tax-exempt by the IRS. The decision as to whether a chapter of Association should incorporate is influenced by a number of considerations, as discussed below.
Specific Considerations for Incorporation
The following specific considerations are involved in determining whether or not to incorporate a chapter of Association:
1. Liability. Generally, the primary benefit of incorporation is the protection of individual officers, directors and members from personal liability when these individuals are conducting activities on behalf of the chapter. These individuals will generally not be personally liable for damages relating to chapter activities, including personal injury, property damage, or contractual liability, if the chapter is incorporated and as long as the individuals are acting reasonably, prudently and in good faith.
If the chapter is unincorporated, the officers, directors or members may be personally liable for any damages and other liabilities associated with chapter activities. This means that the exposed individual assets of the officers, directors and members could be seized to pay for damages associated with chapter activities, as well as to satisfy debts and other contractual obligations of the chapter (which are generally held to be the joint obligations of the members).
2. Insurance. Whether the chapter is incorporated or unincorporated, it can purchase insurance to cover many types of likely lawsuits against the chapter and its officers, directors or members. Obtaining insurance, however, is often more difficult for an unincorporated association. In certain circumstances, the insurance company may not be able to determine the precise authority for the organization and its operation. Incorporated organizations usually have better opportunities for obtaining desired insurance at more competitive rates.
3. Legal Actions. A corporation can sue and be sued in its corporate name, while an unincorporated chapter must appear in court in the name of participating individuals, such as officers, directors or members. This is important from the liability aspect, discussed above, but also from the viewpoint of a chapter having to file a lawsuit. For example, a chapter might wish to sue the owner of the meeting site where an assault on a chapter member occurred for negligence in failing to provide adequate lighting and security. An unincorporated chapter could not file a lawsuit in the name of the chapter; the officers, directors or members would be required to individually file a joint lawsuit against the meeting site owner. Not only is this cumbersome, but individuals are frequently reluctant to have their names associated with lawsuits. An incorporated chapter can use its own name in a legal action and is not required to bring its individual officers, directors or members into the lawsuit as parties.
4. Independence. A corporation has an existence of its own, independent from its officers, directors and members. A corporation is theoretically perpetual, although it can be dissolved. An unincorporated chapter has no separate legal existence. Its actions are only the joint actions of its members. Each time a member enters or leaves the chapter, the entity changes. For this reason, landlords and vendors are sometimes unwilling to enter into contracts with unincorporated associations, because the "entity" with which they are dealing is in a constant state of flux.
5. Established Guidance on Administration and Governance. A corporation is formed by filing articles of incorporation with a state government under the state's corporation laws. These laws give guidance to corporations on organizational structure, voting and other matters. Corporations are governed by a well-established body of statutory and case law. By contrast, unincorporated associations are not subject to any reliable and consistent set of rules concerning formation, administration and governance, which can create difficulties and uncertainty when questions in these areas arise.
6. Volunteer Protection Laws. State laws frequently offer protection from personal liability for officers and directors of nonprofit corporations whose own actions result in damages, as long as the individuals were acting in good faith and without willful misconduct. State laws sometimes do not offer similar protections to officers or directors of unincorporated associations.
7. Tax Liability. Liability of an incorporated association for federal or state income taxes is usually limited to corporate assets. In contrast, the members of an unincorporated association could be personally responsible for income taxes. If the unincorporated association had no assets that the taxing authority could attach, the taxing authority could attach the assets of the members to obtain payment of income taxes due.
Of course, most chapters of Association often will not incur any income tax liability because they generally will not earn annual revenues in excess of expenses. However, it must be noted that a "tax-exempt" organization is not exempt from all taxes. While a tax-exempt organization is exempt from federal and state taxes on income derived from activities substantially related to the organization's tax-exempt purposes, it is generally still subject to sales and use taxes, real estate taxes, personal property taxes, payroll taxes, unrelated business income taxes, and other state and local taxes. Even unintentional failure to pay certain taxes could impact personally on the members of an unincorporated chapter.
8. Intellectual Property Rights. Ownership of trademarks, copyrights and other intellectual property is vastly simpler if such ownership is held by a corporation, as opposed to a conglomerate of individuals who may fight over ownership rights in the property.
9. Dissolution. When a corporation formally dissolves, except in unusual circumstances, all liabilities of the corporation are released and there need be no concern about whether closure has occurred. By contrast, when an unincorporated association dissolves, there is no such formal legal closure, and certain liabilities may be asserted against former officers, directors and/or members of the association years later.
10. Merger. If a chapter at some future point desires to merge with another organization (e.g., another Association chapter), the merger process is safer and more well-defined if both entities are corporations, regardless of whether a true “merger” or “consolidation” is undertaken or if an asset transfer and dissolution is chosen.
11. Liability Protection for Association. As a legally separate and distinct entity, an incorporated chapter poses a lesser liability risk to Association; there is a smaller risk that the actions (or omissions) of the chapter would be imputed to Association. Of course, mere incorporation of a chapter does not completely immunize Association from all potential liability stemming from the chapter's activities.
12. Technical Requirements. A corporation must meet a number of technical requirements to obtain and maintain its corporate status. A corporation must also observe various organizational and operational requirements under state law. Articles of incorporation must be filed with the state to establish a corporation. In addition, annual board and membership meetings must be held, meeting minutes must be kept, and annual reports must be filed by corporations with the state of incorporation. Unincorporated organizations do not have the same technical requirements. Incorporation may also entail some costs, such as state fees for incorporating (e.g., $75 fee) and filing annual reports (e.g., $40 fee per year), legal fees for drafting or reviewing articles of incorporation and bylaws, and accounting fees for preparing annual tax filings. Most of these technical requirements for corporations, however, are relatively straightforward and involve only modest expense. Furthermore, some of these costs would likely be incurred whether or not the organization is incorporated (e.g., tax filings).
For the reasons set forth above, if it can be done without too much burden on chapter leaders, it is generally recommended that each Association chapter be incorporated. Whether such incorporation is mandated by Association is a more difficult issue. Of course, if not mandated by the Association, for each chapter, the benefits of incorporation must be weighed against the detriments. The paperwork and expense must be balanced against the protection from liability afforded directors, officers and members, as well as the other considerations discussed above. Each chapter should examine its own activities and issues to determine what is in its own best interests.
In most association chapter structures, chapters are required to adopt bylaws consistent with association's model chapter bylaws and to otherwise comply with the association’s qualification requirements for chapters. These requirements apply regardless of whether the chapter is incorporated.
For more information, contact the author at jtenenbaum@TenenbaumLegal.com.