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Winding Down: A Risk Management Checklist

A wide range of options should be explored anytime a nonprofit faces serious operational challenges, financial shortfalls and other circumstances that make it impossible to continue normal operations. This Risk Management Checklist offers an overview of the process of dissolution (which is an action governed by state law) as well as a list of the issues that CEOs and board leaders should consider when planning to wind down the operations of a nonprofit.

Note: This checklist is not a substitute for legal advice from a competent attorney licensed in the state in which your nonprofit operates. Obtaining legal advice concerning your nonprofit’s specific circumstances is highly recommended if your organization is considering winding down, dissolution, filing for bankruptcy, or merger opportunities.

The IRS has posted information on the “Termination of an Exempt Organization,” at www.irs.gov/charities-non-profits/termination-of-an-exempt-organization

 “Winding Down” – Will it lead to dissolution? What are the other options?

One of the first steps that leaders must make is determining whether the nonprofit will be “dissolved” (legally cease to exist), placed in a “dormant” state (not operating, but retaining its corporate identity), or pursue reorganization through bankruptcy proceedings. For additional information on bankruptcy and dormancy, see the Appendix to this article.

For organizations that decide to dissolve, the liquidation and distribution of all remaining assets must be conducted in accordance with state law, the bylaws or articles of incorporation of the nonprofit, and a board-approved plan of dissolution. For example, in New York, if assets remain, the plan of dissolution must be approved by a court in the jurisdiction in which the nonprofit is located.

The board-approved “plan of dissolution” must be filed with the state so that the state can be satisfied that the nonprofit has paid all its debts and appropriately transferred any remaining assets. The plan generally explains in narrative format what liabilities, if any remain, or that all liabilities have been satisfied, and describes what assets remain, if any, or how they have been disposed of.

  • Ideally, assets are sold to satisfy debts or transferred and liabilities are satisfied during the winding down process so that when the organization is ready to file the Plan of Dissolution the board member(s) or officer(s) signing the certification of dissolution required by the state can certify that: “All assets of the organization have been transferred so that no assets remain…. and, “All debts and liabilities of the organization have been satisfied.”

Assets and Liabilities

Identifying assets and liabilities

  • In cases where an existing tax-exempt organization has made the determination to cease to exist in the future through dissolution proceedings, one of the first necessary steps will be to identify all assets and liabilities of the organization.

Disposition of assets

  • In order for a nonprofit organization to officially dissolve, the nonprofit must arrange for the transfer of any remaining assets to another tax-exempt entity (or to the US federal government). Assets may not be transferred (although they may be purchased at fair market value) to an individual entity or person because such a transfer would be a prohibited transaction under US tax law.
  • The obligation to transfer remaining assets to another nonprofit or the federal government is usually set forth in the “dissolution clause” of the entity’s articles of incorporation (or its corporate charter or “certificate of incorporation”).
  • When identifying assets, it may be helpful to look at the nonprofit’s past and most recent audited financial statements because they may provide a source for a list of assets, including those that have been fully depreciated but are still owned by the nonprofit. (On the other hand, don’t rely on such lists as the definitive list of assets, particularly if any of the assets listed have been discarded since the last audit report and are no longer owned by the nonprofit.)

Satisfying debts and liabilities

Before ceasing operations, the organization must also satisfy, to the extent possible, all its debts and liabilities.

  • The organization will continue to exist until all pending obligations have been met, so it should not conduct any new business during the winding down period that would obligate the nonprofit to continuing liabilities.
  • Someone should be tasked with identifying all outstanding liabilities/recurring obligations.
  • The board or a task force of the board/staff should determine whether all debts and obligations of the organization can be satisfied or how to satisfy those obligations to the fullest extent possible.
  • If cash on hand plus the proceeds from the sale of other assets are not expected to cover all liabilities and efforts to make arrangements with creditors have proven unsuccessful, then bankruptcy should be considered. Legal counsel should be engaged to assist with bankruptcy proceedings.
  • When identifying liabilities, don’t forget taxes (withholding taxes for final pay; unrelated business income taxes for final fiscal period; any outstanding state tax obligations or filings)
  • Communicate with the nonprofit’s creditors. If there are contingent liabilities notice of the impending dissolution should be given to each creditor. Consider publishing the notice in a newspaper of general circulation (but be comfortable with your message and have a press release in hand explaining the decision to close the nonprofit’s doors). Notice of dissolution may be required in order to trigger creditors’ obligations to file a claim. If no claim is filed and notice has been given, then depending on state law, the claim may be barred. If state law does not provide for a method of limiting contingent liabilities, or if the creditor is not correctly notified, the nonprofit may have left itself open to a claim from its creditors.

Issues to Consider When Winding Down

What will be the impact on the nonprofit’s programs?

Consider whether there are any programs that could be transferred to another nonprofit in the community.

  • Identify strategic partners for possible transfer of those programs.
  • Determine when to open lines of communication with potential partners.

Identify fragile clients/consumers who will be most at risk when programs cease and consider what steps may be taken to mitigate their risks. If the nonprofit delivers professional services, such as counseling, the leaders of the nonprofit should be aware of the applicability of any professional code of ethics on the topic of “client abandonment.”

Identify whether there are any programs funded by restricted funds where the funding will NOT be completely expended by the anticipated date of closure.

  • Contact the funding source as soon as appropriate to determine whether the funds need to be returned, or
  • Determine whether it would be appropriate to request that the funds be re-purposed in the process of winding down to fulfill, or most closely honor, donor intent. Ask the donor.

What steps need to be taken to address winding down of the nonprofit’s finances?

  • An important first step in winding down finances may be to collect any amounts owed to the nonprofit.
  • Where money is due to vendors, it may be possible to negotiate less than full payment. If discussions with vendors disclose that the nonprofit is winding down operations, be prepared for that information to gain a wider audience.
  • Consider the appropriate timing of consolidating and then closing financial accounts, including bank and brokerage accounts. Determine who is authorized to take the identified steps and establish a timetable.

Board governance during the winding down period

There is generally great angst among board members who want to support the organization at this critical time, and loyal members may also express anger that the organization is closing its doors.

  • Some may have been present at the organization’s founding or be so closely aligned with the organization that they believe their own reputation is inextricably linked to the nonprofit’s and that dissolution equates to failure.
  • It is especially important for board members to remember their duty of loyalty to the organization and to make decisions in the best interests of the organization.

By the time the decision to close the nonprofit’s doors is made, several board members may have resigned.

  • State law determines the minimum number of board members for a nonprofit organization (it is generally two or three; a small minority of states require only one person to comprise the board of a nonprofit corporation.)
  • Be mindful of the minimum number of board members required. If appropriate, and at the appropriate time, all board members except the minimum number may resign during the winding down period.
  • It is a violation of a board member’s legal duty of care to the nonprofit to resign if his/her resignation would leave fewer than the minimum number of board members in place.

Making the determination of who stays and who leaves is an important decision for the nonprofit during this sensitive period.

  • Those remaining will have to ensure that all required terminal (never heard this word in this context) filings are completed with the state and the IRS, and that correspondence with stakeholders, insurance carriers, and possibly vendors is handled professionally.
  • The winding down process may require several months—those who remain may be involved in the nonprofit’s closure off and on for several months after the nonprofit ceases day-to-day operations.

Communications with Stakeholders

Strategize and prepare a message to stakeholders about the winding down process.

  • Someone should be tasked with identifying who should be notified and when, as well as what the communication should say.
  • Board members and employees should be notified first. They will want to know “when” and “why.” Answers to these two critical questions should be prepared in advance.
  • Prepare a press release that can be provided in response to any press inquiries and make sure it is ready as soon as employees are notified. Employees are often the source of contact with the media.
  • Communicate with consultants, vendors, funding sources, corporate sponsors, individual donors etc. Similarly, these stakeholders will want to know “when” “why” and what was done to avoid the final step of closing the nonprofit’s doors.
  • Donors will require special messaging to assure them that their gifts have been and are being used in furtherance of the mission. 

Staff and Volunteers

Advance notice of termination may be required.

  • While generally the employment-at-will doctrine does not require advance notice of termination, larger nonprofits need to be aware that a federal law requires advance notification when a nonprofit is closing its doors. The federal Worker Adjustment and Retraining Notification Act, (The WARN Act) 29 USC § 2 101 et seq. (www.dol.gov/compliance/laws/comp-warn.htm) requires employers of more than 100 employees to provide at least 60 days notice prior to closing a site where 50 or more employees will lose their employment during a period of 30 days.
  • The WARN Act doesn’t require severance pay. However, several states have their own WARN Acts, and some do require severance payments.

The following states have their own version of the WARN Act: (Please note that this list is as up-to-date as we can make it, however, NRMC encourages you to research the law of your own state and makes no promises that this list is fully inclusive of all state laws impacting closure of operations.)

  • California [Cal. Lab. Code § 1400 et seq. (https://www.dir.ca.gov/dlse/cal-warnact.html)]
  • District of Columbia [D.C. § 44 -1003.11. (http://www.nolo.com/legal-encyclopedia/district-columbia-layoff-plant-closing-laws.html)]
  • Hawaii [Chapter 394 B, Hawaii Rev. Stat. (https://labor.hawaii.gov/wdd/files/2012/12/Plant-Closing-Handbook-Printable-Version-Revised-121912.pdf)]
  • Illinois [820 ILCS 65 /1 et seq. and 3 0 LICS 76 0/15. (https://www.illinois.gov/dceo/WorkforceDevelopment/warn/Pages/default.aspx)]
  • Maine [Me. Rev. Stat. Title 26 Ch 7, § 625 -B (http://www.nolo.com/legal-encyclopedia/layoff-plant-closing-laws-maine-employees.html)]
  • Maryland [Md. Code Ann. Lab. & Empl. §§ 11-201(c),  11-302-304. (http://www.nolo.com/legal-encyclopedia/maryland-layoff-laws.html)]
  • Massachusetts [Mass. Gen. L. c. 151A § 7 1B (http://www.mass.gov/lwd/employment-services/business-services/rapid-response/worker-adjustment-and-retraining-act-warn.html)]
  • Minnesota [Minn. Stat. Annot. § 116L.976 (www.revisor.leg.state.mn.us/stats/116L/976 .html)]
  • New Hampshire [New Hampshire Rev. Stat. Annot. 282 -A:45-a (https://www.nhes.nh.gov/services/employers/compliance.htm)]
  • New Jersey [N.J.S.A. 34:21 et seq.( http://lwd.dol.state.nj.us/labor/lwdhome/warn/njwarn.html)]
  • New York  https://labor.ny.gov/workforcenypartners/warn/warnportal.shtm
  • Ohio [Ohio Rev. Code § 4141.28 http://codes.ohio.gov/orc/41)]
  • South Carolina [S.C. Code Ann. § 4 1-1-40 (http://www.nolo.com/legal-encyclopedia/south-carolina-layoff-laws.html)]
  • Tennessee [Tenn. Code Ann. §§ 5 0-1-601 through 5 0-1-604 (https://www.tn.gov/workforce/article/warn-notices)
  • Wisconsin [Wis. Stat. § 109.07 (https://dwd.wisconsin.gov/dislocatedworker/employer/tools/notice/wbcml_overview.htm)

 

  • Staff will be concerned about the loss of their income and their benefits. Staff need to know how their health insurance will be impacted, how to obtain information about their potential eligibility for unemployment compensation, and the impact of their separation of employment on their participation in other employee benefits such as 403B plans and pension plans if applicable.
  • It is best practice to the extent possible to tell all staff/volunteers at the same time. Generally holding a “town hall meeting” to explain what is happening, (focusing on why and how it will impact them) as well as to answer questions is advisable. Ideally, the CEO and Chair of the board will stand side-by-side communicating the news.
  • Know whether your nonprofit has a policy or practice of providing severance pay and in what circumstances and determine whether several pay liability will be triggered for some or all employees in the current circumstances.
  • Consider whether asking some employees to resign/retire with a separation agreement that includes a release is advisable. The agreement will require the nonprofit to pay severance pay, but the advantage is that the employees accepting the agreement will be barred from bringing a lawsuit for wrongful termination against the nonprofit. All such agreements should be arranged only with guidance from a competent employment lawyer familiar with the laws of your state.
  • Consider the nonprofit’s policies for accrued but unused vacation, sick and personal leave time. Do the nonprofit’s policies provide for carryover of unused time year to year? If so, don’t neglect to take into consideration the liability that will be triggered by the separation of employment of all staff as a result of unused but accrued paid leave time.

Health Insurance

COBRA (or the state law equivalent for workplaces with fewer than 20 employees) will require the nonprofit to provide various notices to employees about how their separation of employment will impact their right to continuation benefits. Know in advance what the obligations of the nonprofit will be going forward and plan accordingly.

Intellectual Property

Consider what the disposition will be of any intellectual property owned by the nonprofit, including publications, the results of research and other significant work product.

  • The ownership of intellectual property may be transferred to another nonprofit or sold for fair market value.

Website  

When considering winding down contractual relationships consider the timing of shutting down the nonprofit’s website(s), and also making sure that access to “stale” sites is limited. However, it may be advisable to maintain a copy of the nonprofit’s website in an archival venue for at least two-six years after the close of business, in the event that it could be helpful to refer back to the site’s content for legal defense purposes. (Six years is the statute of limitations for breach of contract in some states. A chart showing statutes of limitations in all 50 states is available from NOLO Press, here: www.nolo.com/legal-encyclopedia/statute-of-limitations-state-laws-chart-29941.html)

Other Contracts

In order to prepare to terminate ongoing contracts, read the contracts to determine what is required in connection with notice of termination (e.g., how many days or months’ notice is required by the contract to cancel/terminate) and what are the penalties if the notice provisions is not followed?

Consider the following:

  • Leases, including leases for office equipment
  • Website hosting, software, and other technology contracts
  • Future special events/venue contracts
  • Various contracts with professional services providers and other vendors
  • Commercial insurance policies

Document Retention/Storage

Decide where significant documents will be stored for what period of time and where and who will have custody, post-dissolution.

State Law Process of Dissolution 

  1. State law requirements: The dissolution process must be conducted in accordance with the regulations of the state in which the organization was incorporated. Review the state law. The state generally provides a form to be filed called the “certificate of dissolution” that should be reviewed. Usually, the state requires certification (signature and date) by one or two officers of the corporation on the dissolution form. Signatures may need to be witnessed or notarized. An initial “notice of election to dissolve” may be required to be signed by the president and secretary and filed with the Secretary of State in some states. This step is not required in all states.
  2. Published Notice. Some states require a notice to be published in a newspaper of general circulation in order to complete the dissolution process.
  3. Board Action: Review the nonprofit’s bylaws and articles of incorporation for guidance on the steps necessary to obtain board approval for dissolution. The bylaws may require a majority or a supermajority vote to dissolve the corporation. (If the corporation has members, a vote of the members may be required.) The remaining board of directors[1] should convene a final meeting, where a quorum is needed. Notice of the meeting should be provided in accordance with the bylaws or a waiver of notice signed by all board members attending the meeting. vote to distribute the remaining assets to another nonprofit with a similar mission (or whichever organization is identified in the nonprofit’s bylaws or articles of incorporation, if any are specified).
  • One board member may be authorized in the final meeting to handle all affairs, such as the final IRS filing, after the corporation has been officially dissolved. Alternately, a staff member, usually the CEO, may be compensated, as approved as part of the plan of dissolution, to handle the final winding down steps, as needed, after the official closure of the organization.
  1. Approval of a Plan of Dissolution: a formal document, in most states referred to as a plan of dissolution, should be drafted that explains how the assets have been distributed and how the liabilities have been addressed. If all assets are distributed and all liabilities addressed then the plan can state: “All liabilities and debts have been satisfied and the assets of the organization have been transferred to XYZ organization. There are no remaining assets.”
  2. Filing the Certificate of Dissolution: The state should provide explicit directions for filing corporate dissolution forms. Look on the web site of the Secretary of State or whichever state department handles business filings. There is generally a fee for filing dissolution forms. Be sure to follow directions carefully and enclose (or bring with you if you are filing in person) an extra copy of the certificate of dissolution for the state to return to you as proof that the dissolution was filed.

 

Final Step: Notify the State and the IRS

After the State has accepted (“filed”) the dissolution:

  1. Notify the other state departments, such as the state Department of taxation and the department responsible for charitable registration/solicitation by sending a letter enclosing the certificate of dissolution (as stamped “filed” and dated by the State)
  2. Notify the IRS by filing the IRS 990/990 EZ (and 990-T as applicable) for the final fiscal year of operations and sending a letter enclosing the certificate of dissolution (as stamped “filed” and dated by the State) to EO Customer Account Services:

Internal Revenue Service

TE/GE Customer Account Services

P.O. Box 2508

Cincinnati, OH 45201

When filing the final Form 990/990 EZ after the conclusion of the organization’s fiscal year, check the Final Return box in the header areas on page 1 of the return.

 

Resources

“10 Things Nonprofits Should Consider Before Electing to Dissolve,” by Gene Takagi, Erin Bradrick and Michele Berger, NEO Law Group, http://www.nonprofitlawblog.com/10-things-nonprofits-should-consider-before-electing-to-dissolve/

“Nonprofit Decline and Dissolution Project Report: Going Out of Business – Why, When & How to Do It Gracefully,” Fieldstone Alliance, http://seachangecap.org/wp-content/uploads/2015/09/Nonprofit-Decline-and-Dissolution-Project-Report.pdf

“The Partnership Matrix,” La Piana Consulting, http://lapiana.org/insights-for-the-sector/insights/collaboration-and-strategic-restructuring/partnership-matrix

Navigating a Nonprofit Corporation Through Bankruptcy, Nonprofit Quarterly, https://nonprofitquarterly.org/2014/04/29/nonprofit-corporation-navigating-through-bankruptcy/

A Guide for Nonprofit Organizations: Bankruptcy Issues, The Law Project, https://static1.squarespace.com/static/5871061e6b8f5b2a8ede8ff5/t/592f2f6c86e6c052a88c2e45/1496264559919/Guide-for-Nonprofit-Organizations-Bankruptcy-Issues.pdf

“Reviving a ‘Dormant’ Public Charity, Tate & Tryon, https://static1.squarespace.com/static/5871061e6b8f5b2a8ede8ff5/t/592f2f6c86e6c052a88c2e45/1496264559919/Guide-for-Nonprofit-Organizations-Bankruptcy-Issues.pdf

 

[1] In the winding down process, some but not all board members may resign, however, enough board members should remain to carry on the necessary obligations of the organization. State law will determine the minimum number of board members for the operations of a nonprofit corporation. In most states, it is one, two, or three board members.