Guide-for-Nonprofit-Organizations-Bankruptcy-Issues-FINAL-with-ads

question that is not easily answered. Notable nonprofits, such as Helping Hand in California,have survived internal financial scandals by restructuring through Chapter 11 and survivedthese events with little impact on the support it received from its major institutional donors,reportedly because the organization chose to be open and frank about the crisis it faced and itsplans for emerging from the fire.A nonprofit generally cannot use endowed funds and other restricted donations to satisfycreditors’ claims. In liquidation, such funds must be returned to the donor unless the donoragrees otherwise. Partially restricted funds, which are funds that have been donated to andretained by the nonprofit with the understanding that such funds will be used for certainpurposes but without a formal endowment structure, are generally accessible to creditors andmay be tapped to pay creditor claims in connection with insolvency or bankruptcy.In addition to debts owed to vendors and other creditors, a board should include a nonprofit’stax obligations and other legal obligations such as existing judgments against the entity. Theboard should also include the nonprofit’s potential liability for any alleged fraud,embezzlement, or misuse of restricted funds within the entity. This might lead the board to ananalysis of the adequacy of the nonprofit’s insurance coverage for such events. Additionally, aboard should consider any continuing obligations pursuant to contracts and leases, as anonprofit may be able to modify or cap such obligations through the Bankruptcy Code.Realizing Value if there is Value to RealizeOnce a board evaluates its financial status, it needs to formulate a plan on realizing the value ofthose assets to satisfy debts and the feasibility of continued operations. The plan to restructurethe nonprofit’s assets and liabilities may include a partial sale of assets or sale of operations.For example, if a nonprofit falls behind on tax liabilities, and owns its office building, the boardmay consider selling the property and switching to renting space in order to satisfy that debt.Note that this is a viable option only to the extent that the nonprofit has equity in its holdings.A board of a section 501(c)(3) entity should take care in these situations to maintain tax-exemptstatus, which requires paying ―unrelated business income tax‖ on income unrelated to theentity’s mission. Do not assume that the entity’s tax-exempt status is a shield against capitalgains tax on the sale of an investment asset or the taxes normally levied against the sale ofpersonal or real property. The organization will want a tax professional to advise on that issuebefore undertaking these one-time transactions as part of a larger restructuring.The board may consider merging with another organization in an attempt to form aneconomically stronger entity, or explore other joint venture or partnership options. Whilemergers can prove to be more complicated than a sale of operations, the choice between the saleof operations and a merger in the nonprofit sector may be more driven by regulatory orlicensing concerns than would be typical in the for-profit sector. In some cases, a straight sale orbankruptcy sale may not be a practical option because of the risk (or certainty) of loss of a keylicense or regulatory status. The board will need to consider, and will need professional counselregarding, the tax, regulatory, and licensing impact of each of these options.8