How does the Illinois Attorney General regulate charities? The Illinois First District case People v. Maxwell Manor provides a rare glimpse at how the Attorney General utilizes the Illinois Charitable Trust Act (the “Act”) to enforce the public’s interest in nonprofit corporations. While the IRS is often seen as the main regulator of charities, each state’s Attorney General also plays a predominant role .
The Attorney General brought suit against Maxwell Manor, Inc., a nonprofit corporation operating a nursing home, as well as its officers and directors. Maxwell Manor had allowed its registration with the AG to lapse and failed to annually file financial reports. Furthermore, its President had used the corporation’s bank account to write herself a $2 million check. She claimed that it was repayment for a loan she had given the corporation. The Illinois appellate court found the officers and directors violated several provisions of the Act.
Here are three lessons nonprofit corporations and directors should learn from this case:
1) The Attorney General has extraordinary remedies available to ensure proper compliance by nonprofit boards and officers.
The Maxwell Manor case provides a clear example of the many remedies available to the AG when nonprofit organizations, officers, and directors fail to comply with requirements under the Act. In Maxwell Manor, the AG sought several equitable remedies:
· To impose a constructive trust over the assets of the corporation;
· To dissolve and liquidate the corporation;
· To remove the President and other directors and officers; and
· To permanently enjoin the President from ever soliciting, receiving, or holding assets for any charitable entity in the State.
In addition, the AG sought the return of $2 million from the President and thousands of dollars in civil penalty fines. The Charitable Trust Act provides that a director who uses charitable funds for his own personal benefit in excess of $1,000 within a 5 year period may be guilty of a felony, be subject to punitive damages up to or equal to the amount misused, and be charged an additional $50,000 civil penalty for each intentional knowing violation. Nonprofit corporations and their directors should take note of these serious consequences for noncompliance. Failure to comply with the Charitable Trust Act may subject the organization and its directors to similar remedies available to the Attorney General under the Act. These penalties are in addition to the draconian federal excise taxes imposed by the IRS for similar self-dealing transactions under Sections 4958 and 4941 of the Code.
2) Directors are held to a very high standard under the Act.
A second interesting lesson from Maxwell Manor is the application of state charitable trust laws to directors governing nonprofit corporations. The Illinois Not For Profit Corporation Act shields volunteer directors, absent willful or wanton conduct, from being held personally liable for damages caused by the nonprofit’s executive director who engages in false reporting or intentional tampering with financial records of the organization. This limited immunity, however, does not apply to actions against the volunteer directors brought by the Attorney General under the Charitable Trust Act. Charitable trust laws under Illinois law impose a higher standard because a nonprofit corporation and its directors are treated as trustees holding charitable assets for the benefit of the public. The Maxwell Manor court stated, “A trustee owes a fiduciary duty to the trust’s beneficiaries and is obligated to carry out the trust according to its terms and to act with the highest degrees of fidelity and good faith” (emphasis added).
Volunteer directors should carefully note this important nuance under Illinois law and understand their governance responsibilities over a nonprofit’s executive director.
3) Documents, Documents, Documents
The court noted the manifold legal problems associated with the $2 million check the President wrote to herself. The check was supposed to be repayment for loans she personally made to the corporation. However, the only evidence produced at trial was a copy of the check itself, which had “loan” written in the memo line. The court held that loan documents later submitted to the court were insufficient to prove the payment was not a breach of her fiduciary duties. To begin with, the loan documents did not add up to $2 million. Moreover, there were no financial records produced to show that Maxwell Manor actually received the loan from the President.
Loans from founders or key directors to an organization are quite common, particularly in the initial startup years. However, nonprofits should be careful in dealing with loans from directors. Payments to directors are automatically presumed to be a violation of the prohibition against self-dealing. Without proof that such payments are repayment for a loan, the director may be forced to return any such payments and may be subject to large fines.
To help avoid such problems, nonprofit corporations should have detailed documentation showing approval by an independent board for any transactions involving directors and officers. As seen in Maxwell Manor, however, this is often not enough. The nonprofit must also keep meticulous financial records evidencing that the loan payments were actually made to the corporation under the loan agreement and all repayments made to the director. Repayments should be memorialized by resolutions of an independent board, and the director providing the funding should not be involved in, nor be present for, any vote related to the loan or its repayment.
