To Be or Not to Be ... Incorporated

I was recently surprised, and to be honest, somewhat embarrassed, to learn a professional organization I thought I knew well was legally structured as an ‘Unincorporated Association’ as opposed to a Non-Profit Corporation.

Initially, I have to admit I didn’t know what that meant. In all my board and related governance training, the focus has been on corporate governance of all types: non-profit, for profit, family businesses, private companies, and government crowns, boards and agencies.

These organizations were either legally established by articles of incorporation or by government statute. Always.

Although I am based in Canada and have earned director certification within the context of a Canadian legal system, I do know there are similar legal structures, sometimes under different names, to protect owners, members and boards from legal liability in the USA, the UK, Australia, New Zealand, Ireland, Mexico, and other countries as noted by the Global Network of Director Institutes (GNDI). (Check out DirectorPrep’s link to GNDI institutes here.)

As we like to say around the hallways of DirectorPrep, “Stay Curious.” I was curious to know why a multi-million-dollar professional association governed by a board of directors, with significant real estate assets and an investment portfolio, would be legally structured as an unincorporated association, as it may have been when it was originally established years ago.

While I don’t have an answer yet, I think it could be a good idea to ask relevant questions at the next meeting of the Governance and HR Committee, where I serve as an external member with subject matter expertise. My embarrassment continues…

First, a little background from this past week. I reached out to an outstanding lawyer in the field, Florence Carey, who specializes in charities and non-profits. Our conversation was supplemented by online research from other legal firms. All the reference material and links that I came across can be found at the end of this blog post.


Disclaimer - I am not a lawyer and the words below are my own. Input from sources was interpreted by me and should not be taken as legal advice. Always contact your own legal advisor for professional counsel.



What is an ‘Unincorporated Association’?

An unincorporated association is a group of people who come together for a common purpose (unless the purpose is profit) and intend to create a legally binding relationship among themselves.

Unincorporated associations are cheap and easy to form, requiring a bare minimum of formalities to bring them into existence (and can even be formed without their members realizing it).

They are also extremely flexible, with examples ranging from tiny associations of just a few people to national organizations with thousands of members. Plus, there are no statutory filing obligations.

From a legal perspective, the most significant feature of such associations is that they are unincorporated. That means they are generally not able, in their own name, to own property, to enter into contracts, and to commit or defend themselves against a wrong in tort.

However, a solid set of governing documents, such as a constitution or bylaws, can delegate appropriate authority to enter into contracts, and so on. For example, I’ve seen a constitutional/bylaws document for an unincorporated association that delegates such authority to the board of directors, who can then further delegate the authority to management.

While the set up and lack of regular filings does sound simpler and less bureaucratic, there is a downside risk related to the legal liability that remains with the individual members who came together in the first place to advance a good cause.

By contrast, legal incorporation provides a corporate shield for individual members. In the event of litigation, there is complete clarity as to the entity that is being sued ─ the corporation, not the individual members.

Not being incorporated means there is no legal entity standing between the members and the lawsuit. A good lawyer could determine which members have the most assets and might sue those individuals directly. Incorporation would limit the liability to the assets owned by the corporation itself.

Despite this risk, board directors of an unincorporated association may feel comfort since they are able to purchase director’s liability insurance for themselves. However, there would still be potential for significant liability against the association’s members.

That’s because an unincorporated association is not legally separate from the individuals who run the association. As a result, the people carrying out the association’s activities would be personally liable for the acts and liabilities of the association. This means that everyone’s personal assets would be exposed to the creditors of the association once the association’s insurance and assets are exhausted.

While an unincorporated association is a flexible structure, if the entity is carrying on business or other activities that could give rise to future liabilities, I’ve been advised it’s a good idea to consider incorporating to limit the liability of the organization to its own assets and not those of the individual members.

 

Bylaw Best Practices

As mentioned, an organization that decides to continue its legal status as an unincorporated association should have a well-drafted set of bylaws or a constitution to facilitate how decisions are made (governance). Since, legally, an unincorporated association is nothing more than a group of members, it’s important to know exactly who those members are and how they make decisions.

Legal firm Miller Thomson LLP suggests the following elements, at minimum, for the bylaws or constitution of an unincorporated association. Notice how similar these elements are to a fully incorporated non-profit or charity? I can’t help wonder… why not finish the job?

  1. The purposes of the organization.
  2. The classes of membership and conditions of membership.
  3. The membership dues payable (if any).
  4. If membership dues are payable, the consequences of non-payment.
  5. The circumstances in which membership will be terminated.
  6. Member discipline procedures, including grounds for expulsion, the relevant notice periods and the appeal process, if any.
  7. The requisite notice for meetings of members.
  8. Whether there will be a board in place to make decisions in the interim between members’ meetings and the scope of its power.
  9. A provision dealing with how the bylaws may be amended or how fundamental decisions may be effected.

Miller Thomson LLP further concludes: “Although flexible in structure and low in cost, unincorporated associations have many drawbacks that can be avoided easily by incorporation. For a small association, such as a community book club, incorporation is likely more trouble than its worth. However, an association that is anticipated to grow and hold property or other assets (even membership dues) should consider incorporating earlier rather than later.”

“Any organization, whether incorporated or not, is advised to have well-drafted constating documents to enable it to run smoothly and efficiently.”


Why does it matter to the savvy director?

A group of people might get together to do something worthwhile. They might not even think of themselves as a legal entity at all. Once they get to the point of owning assets or incurring liabilities, that’s often when the leadership of the organization decides to formalize.

The savvy director can help minimize risk by asking good questions regarding the pros and cons of the existing legal structure and the liability risks that go with it. Can the board identify what those liabilities might be and how they could be mitigated? At a certain point, the most efficient way to mitigate the risk is through incorporation.

Ideally, you would want to know the organization’s legal structure before joining a board so you can get a handle on the potential risks of an unforeseen event that could impact the viability of the organization.

 

Your Takeaways

As a savvy director, your job includes learning and understanding these details. An effective orientation or onboarding process should ensure that you are able to:

  • Know and understand the ‘ground zero document’ that underpins the organization, and help to ensure that other directors understand it to the same level.
  • Inform yourself about the risks inherent in that document ─ regulation, legislation, statute ─ whatever establishes the organization as an entity.
  • Know how to read and understand the organization’s financial statements.
  • Access and refer to any applicable legislation, regulation, or other documents.
  • Know whether the organization owns assets – land, building, etc. – and in whose name.


Acknowledgments

I would like to thank Florence Carey, a lawyer specializing in charities and not-for-profits for her knowledge in answering my questions. You can find out more about Florence from her LinkedIn Profile.

 

Resources

 

Leave a comment below to get in on the conversation.

Thank you.
Scott

Scott Baldwin is a certified corporate director (ICD.D) and co-founder of DirectorPrep.com – an online hub with hundreds of guideline questions and resources to help prepare for your next board meeting.

 

Share Your Insight: As a new director on a board, what could you do if you were unsure of the organization’s legal structure?

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