Nonprofit organizations are always seeking monies to carry out their purposes. Fees for services, membership dues, donations, grants, planned giving – all are contributors to the bottom line. Events are also popular and one item that frequently is raised is the raffle. One director suggests a raffle, saying she knows where she can get some great prizes donated. Everybody loves raffles, she says. Most of the other directors jump on board. One director raises the question – aren’t there legal problems with holding a raffle? Some directors quickly assert that everyone holds raffles so it must be okay. They should not jump so quickly. There are requirements that must be met to hold a raffle legally and in ways that will not jeopardize the nonprofit’s tax-exempt status or cause it to owe taxes.

North Carolina nonprofits must look to two sources of law when considering holding a raffle – North Carolina law and federal tax law. In North Carolina and under federal law, raffles are a form of gambling, or gaming. In North Carolina, they are generally unlawful. By statute, however, North Carolina nonprofits are permitted to hold up to two raffles per year. A raffle is defined as a game in which the prize is won by random drawing of the name or number of one or more persons purchasing chances. What about door prizes? Purchasing a ticket for a dinner or some event, such as a concert or other entertainment, at which door prizes are given out counts as a raffle.

The maximum cash prize or fair market value of non-cash items per raffle is $125,000 and the total value of all prizes offered in a calendar year – whether cash or non-cash – is $125,000. If real estate is offered as a raffle prize, the total appraised value of all real estate prizes offered in a calendar year may not exceed $500,000.

Back to those paid dinners with door prizes or any event at which a raffle is held: in North Carolina, raffles may not be held or conducted in rooms where alcohol is being served or consumed. That does not mean that there may not be alcohol served or consumed anywhere on the premises where the raffle is held. It means only that none of the factors that comprise the raffle may occur in the room or rooms where alcohol is sold or consumed. For example, participants may not wander into the room to hear the raffle drawing results with drink in hand nor may they purchase or receive tickets at the cash or open bar set up for the event.

North Carolina law requires that no less than 90% of the raffle’s net proceeds must be used by the nonprofit for charitable, religious, educational, civic or other nonprofit purposes. None of the raffle proceeds may be used to pay anyone to conduct the raffle or to rent space where the tickets are received or sold or the drawing conducted. Raffles may not be held in conjunction with bingo.

Under federal tax law, gaming is generally not considered a charitable activity. Conducting gaming as an insubstantial part of a 501(c)(3) organization’s activities will not ordinarily jeopardize its tax-exempt status. What is insubstantial? There is no bright-line answer. The Internal Revenue Service will consider all the facts and circumstances, including a review of all the monies raised by and spent on the gaming activity by the tax-exempt organization and the time and other resources devoted to it, in making a determination of whether gaming constitutes a substantial part of the nonprofit’s activities.

Even if the nonprofit’s gaming activities are insubstantial and its tax-exempt status is not threatened, it may be subject to tax on unrelated business income. Generally, there are three conditions that must be satisfied for an activity, such as gaming, to be classified as an unrelated trade or business that may generate unrelated business taxable income. Two of the three conditions are nearly always satisfied with regard to gaming. The first is the activity must be a trade or business. Gaming is considered a trade or business if it generates revenue. The second – the activity is not substantially related to the nonprofit’s exempt purpose – is satisfied with regard to all 501(c)(3) and many other tax-exempt organizations. Gaming is not a charitable activity.

The last condition provides more leeway, or an exception, to classifying a nonprofit’s gaming as unrelated trade or business. Gaming must be carried on regularly. It must be conducted with a frequency and continuity similar to comparable activities carried on by for-profit organizations and pursued in a similar manner. Gaming activities, such as raffles, that occur only occasionally or sporadically do not meet this last condition. What is occasional? A raffle held at an annual fundraiser is not regular. Raffles held weekly are.

North Carolina nonprofits are limited by state law, as noted above, to two raffles per year. Therefore, nonprofits complying with this limitation should not be deemed to be engaged in an unrelated trade or business for federal tax purposes, as they are not regularly carrying on gaming activities. A North Carolina nonprofit that generates a substantial portion of its revenues from its two raffles per year may find itself, however, stripped of its tax-exempt status if the Internal Revenue Service concludes that the nonprofit’s gaming activities are substantial.

Exempt organizations must also be aware of the IRS reporting and withholding requirements that apply to raffles. The exempt organization must report raffle prizes to the IRS on Form W-2G if the amount of the winnings paid to the winner (less, at the organization’s option, the amount paid by the winner for the chance to win the prize) is $600 or more and at least 300 times the amount of the wager. If the winnings are more than $5,000, the organization must withhold 25% from the winnings and report the amount to the IRS. Failure to withhold correctly may result in the exempt organization’s being liable for the tax. If the raffle prize is a noncash prize, the winner must pay the organization 25% of the fair market value of the prize, less the amount of the wager. An award of cash to cover the tax is also subject to tax.

Raffles remain a popular and oftentimes effective means of fundraising for a nonprofit. They are not, however, without their own risk and nonprofits that hold raffles without understanding and complying with the law may themselves be engaged in gambling.

— Melanie S. Tuttle

Many nonprofit boards have executive committees. Under North Carolina law, these committees may be charged with exercising the authority of the board. If your board has an executive committee, you might want to consider exactly what authority that committee has, what authority it exercises, and what responsibilities, and possible liability, you have as a board member and not a member of the executive committee.

Despite statutory permission to delegate to an executive committee broad power, no committee has unfettered discretion to do whatever it chooses on behalf of the board. For example, the creation of a committee must be approved by at least a majority of all the directors on the board. Only the full board has the authority to delegate its authority to a subgroup of the board. An executive committee may not create a board committee and delegate authority or power to it.

Further, no committee of a North Carolina nonprofit board, including an executive committee, may do any of the following: authorize distributions; recommend to members or approve dissolution, merger or the sale, pledge or transfer of all or substantially the nonprofit’s assets; elect, appoint or remove directors, or fill vacancies on the board or on any of its committees; or adopt, amend or repeal the nonprofit’s articles of incorporation or bylaws.

Given those limitations, are there other restrictions on executive committee authority that might be merited?

North Carolina nonprofit law not only permits creation of committees with broad board authority but also provides that the creation of the committee, delegation of authority to it, and action by the committee do not relieve the other directors of their statutory standards of conduct. The non-committee members remain obligated to act in good faith, with due care and in a manner reasonably believed to be in the best interests of the corporation. How does one reconcile the right to broadly delegate authority with the retention of possible liability for failure to meet these standards? To what extent may directors rely on the executive committee members?

The statute gives one answer: A director may rely on a board committee of which he or she is not a member if the director reasonably believes the committee merits confidence. But, what does it take to merit confidence?

In many cases, it makes sense to delegate responsibility to a smaller group of directors with special expertise in the relevant area. For example, including directors with solid knowledge of accounting and finance on the board’s audit and finance committees is prudent. It is reasonable for a director whose strengths lie elsewhere to place reliance on the more financially literate directors. Individuals with human resources experience are natural choices for personnel or compensation committees.

The executive committee, however, generally does not rely on any particular expertise or skills. On many boards, the executive committee serves as a “mini-board,” addressing matters that may, and should, be handled by the full board.

There are appropriate purposes for an executive committee. It may serve to set the agenda for full board meetings. It may also act as liaison between the board and staff, permitting the executive director a sounding board before matters are brought to all the directors. The executive committee may also act in truly urgent situations where timing is such that the full board cannot be convened on short notice and act effectively on the matter. Beyond that, there is real question as to what purpose the executive committee serves. It should not be a substitute for full board oversight of the nonprofit organization.

If you serve on a board with an executive committee, you would be wise to make sure that the executive committee’s authority is limited to the purposes described above and that it reports to the full board the actions it has taken, if any, between board meetings. In this way, the executive committee may merit your confidence and you, while retaining authority to address important oversight and transactional matters, may adhere to the standards of conduct required of you as a director.

If your board has an executive committee that persists in taking actions that are appropriate for the entire board and no true emergency exists, consider whether your board is too large or whether you want to continue to serve on the board. Risking liability without having the ability to fulfill your duties as a director is foolish.

Directors should hold their fellow directors accountable and ensure that the full set of skills present on the board is brought to bear in governing the organization. No subset of directors should have more authority to act and deliberate than others. Unlike the animals on Orwell’s farm, no directors are more equal than others.

— Melanie Tuttle

There exists much confusion as to what it means that North Carolina is a right-to-work state. I have had clients tell me that employers can require them to sign non-compete agreements because North Carolina is a right-to-work state. I have also been told that employers cannot fire employees in North Carolina because it is a right-to-work state or that they can fire them because it is a right-to-work state. Others have asserted that employees are required by law to give two weeks’ notice before quitting, again because it is a right-to-work state. None of these is true.

Why so much confusion, even among many lawyers? The answer lies in the misunderstanding of two very different employment concepts: right-to-work and employment-at-will. Oftentimes, people use the term “right-to-work” when they mean “at-will.” At-will employment refers to the right of both employees and employers to terminate the employment relationship with or without cause or notice or both. Contrast this concept with “right-to-work,” which means an employer may neither require nor prohibit an employee from becoming or remaining a member of a labor union as a condition of employment or continued employment. Employers also may not compel employees to pay dues or fees to labor unions. The policy is grounded in the belief that the right to live includes the right to work.

Rarely do employers have trouble understanding “right-to-work” once the concept is explained. “At-will” employment poses greater issues. First, the ability to terminate an employee for any or no reason is not without constraint. The reason, if one exists, must not be an illegal one. Statutes prohibit discrimination on the basis of sex, race, national origin, religion, disability, age, veteran-status, and genetic information.  Local ordinances may prohibit discrimination based on sexual orientation or family status. Terminating an employee because of his or her possessing one or more of these protected characteristics is unlawful notwithstanding the at-will nature of the employment relationship. The termination is also unlawful if against public policy. An example of a termination that is against public policy is firing an employee for his or her refusing to violate the law when asked to do so, such as by lying under oath on the employer’s behalf or falsifying records.

Second, employers often try to restrict an employee’s ability to quit without giving notice. The “at-will” concept works both ways – both the employer and the employee may terminate the employment relationship with or without cause or notice.  There is no law that requires employees to give two weeks’ or a month’s notice before leaving. An employer may request such notice as a courtesy to permit transitioning and training, and may condition payment of accrued but unused vacation on receipt of such notice. But, the employer may not require the employee to provide the notice and work through the notice period. It is not only North Carolina’s policy of “at-will” employment that mandates this result but also the Thirteenth Amendment’s prohibition against involuntary servitude.

Third, many employers put too much stock in probationary periods, stating that employment may be terminated for any reason during the first say 90 days of employment and suggesting that the employee’s position is secure after successfully completing the probationary period. The laws against wrongful discharge, meaning termination for unlawful reasons (i.e., those that are discriminatory or against public policy), apply throughout the entire duration of the employment relationship, including during probationary periods. There is no period during which an employer may terminate an employee for unlawful reasons. Employers who state or suggest that continued employment is assured following the probationary period run the risk of jeopardizing their ability to rely on the benefits to them of “at-will” employment. They may be creating contracts of employment.

No employee in North Carolina is required to do anything simply because of North Carolina’s being a right-to-work state. If an employer suggests that an employee must by law agree not to compete or give notice before quitting, the employer is misspeaking. The employer may well desire these things for good business reasons, and an employee may be willing to provide them under the circumstances, but the law does not mandate them in the name of  “right-to-work.”

— Melanie S. Tuttle

I have been speaking recently to groups of nonprofit board members and executive directors. A question came up at one session that reflects a common problem – founder’s syndrome. A woman expressed surprise that she could be removed from “her” nonprofit organization. After all, she had formed the organization; she was its president and chair of the board. She claimed to own it. She was mistaken.

In an earlier Legal Musing, I discussed that nonprofit corporations differ from their for-profit kin in a very significant way: they do not have owners. This comes as a surprise to many nonprofit founders. They created their nonprofits and they have invested much of their time, money, skill, energy and devotion to them. They are their “babies.” But, like human babies, they are not owned. Babies grow up to stand on their own, separate and apart from their parents. Parents are caretakers, not owners, of their children. So it is with nonprofit founders.

Founders, with the mistaken notion that they own their organization, believe that they are in charge of all the organization’s affairs and answer to no one. They select the initial board of directors, oftentimes from among their friends. They expect loyalty from the directors and a continued position of importance in the organization. Their expectations may be the downfall of the organization, if they are unwilling to secure board members with the range of skill sets and abilities necessary to responsibly oversee the organization’s affairs and who recognize that their obligations run to the organization and not its founder.

A nonprofit’s directors must be mindful of founder’s syndrome and ensure that they are acting with due care and in the best interests of the organization, not its founder. If the nonprofit has outgrown its founder, the board must be able to act to obtain the right talent and management for the organization. Friendship should not interfere with the director’s ability to fulfill his or her duties of care and loyalty to the organization.

Directors should review the nonprofit’s bylaws and other governing documents and make sure that the founder takes direction from the board and may be replaced if he or she does not adhere to board policies or is otherwise not capable of leading the organization. Directors should ensure that the founder’s job description has been prepared and is up-to-date. Regular performance reviews are essential. Founders should welcome this oversight.

When the board members and the founder are truly working in the best interests of the organization and not their own self-interests or in the interests of only the founder, their actions are likely to be aligned. The founder, by allowing others to share his or her vision and work to fulfill the mission of the nonprofit, may find greater security. Letting go may be what it takes to hold on.

— Melanie S. Tuttle

A misapprehension exists that directors of North Carolina nonprofit corporations are immune from liability for their decisions, actions and inactions as directors. Indeed, a well-respected and successful businessman and chair of the board of a well-respected nonprofit corporation recently told me that he had been advised by counsel that he need not be concerned with liability issues. Is that advice correct? Are directors free to engage or not engage with their organizations and fellow board members without fear of liability?

A North Carolina statute does afford directors of nonprofit corporations immunity from civil liability for money damages. But it does so only in limited circumstances and it does not alleviate the directors’ obligation to adhere to the prescribed statutory standards of conduct. Those standards require directors of North Carolina nonprofits to act in good faith, with due care and in a manner reasonably believed to be in the corporation’s – as opposed to the director’s – best interests. Due care is the care that an ordinarily prudent person in a like position would exercise under similar circumstances. It is characterized by attentiveness, diligence, and thoughtfulness and requires informed, active participation.

The immunity statute’s protection of nonprofit directors is unavailable if, among other things, they are compensated for their services, did not act in good faith, acted outside the scope of their official duties, or committed gross negligence or willful or wanton misconduct. Immunity does not exist to the extent there is insurance coverage.

How does one square the directors’ duties with immunity from liability? Contrary to commonly held belief, the immunity statute does not conflate the directors’ duties with the shield from liability, i.e., the director’s duties are not properly understood or described to be the single duty to not be grossly negligent. The standard of conduct exists separate and apart from statutory immunity; the directors’ duties are in no way lessened by the promise of immunity.

In a sense, the immunity statute restates the standard of care – a director who adheres to the standard of care will not be held liable for money damages – and permits a degree of deviation from the standard before a director is answerable from his or her own pocket. What is that degree? The common element between the standard of conduct and the liability shield is good faith. Directors are required to act in good faith. The failure to act in good faith makes immunity unavailable. Hence, any deviation from the standard of due care must be undertaken in good faith.

Can a director who fails to act with due care in the belief that he or she is immune from liability for money damages be said to be acting in good faith? I would argue no. Good faith generally requires that the director be acting in what he or she truly and sincerely believes to be in the best interests of the corporation. The director must have a basis for that belief. A promise of immunity should not lessen one’s commitment to the organization and to the director’s standard of care. If it does so, good faith is lacking.

Directors also oftentimes believe that statutory immunity provides a greater shield than it really does. Although immunity from liability for money damages is tremendous protection to directors, it does nothing to protect a director from removal as a director, injunctive relief or being barred from serving on other nonprofit boards. Moreover, statutory immunity does not protect against public humiliation or embarrassment – reputational damage. That damage to reputation will likely follow the director into his or her for-profit positions, hardly a welcome outcome. And, the costs to successfully invoke immunity may be significant.

So, a director of a North Carolina nonprofit corporation does have to adhere to the statutory standard of conduct. A promise of immunity from civil liability for money damages does not lift the burden. To directors who question whether they must attend meetings, participate, review financial statements and reports, and perform the myriad other tasks that are the responsibility of the board, the answer is yes, you have to! The risks of not doing so are greater than they might appear.

— Melanie S. Tuttle