The board of directors of a nonprofit corporation may not by themselves amend the bylaws to deprive the corporation’s sole member of voting rights, an appellate court in New York has affirmed.  The member’s voting rights could be removed only by its removal as a member or its resignation under the state law.  (Gluck v. Chevre Liady Nusach Hoary, Supreme Ct., App. Div., Second Dept., 7/25/12.)

The issue arose following reorganization of Northern Services Group, a nonprofit corporation formed in 2000 to manage seven nursing homes and assisted living facilities which were “sponsored” by Chevre Liady Nusach Hoary, an Orthodox Jewish Congregation.  Although Chevre Liady did not formally participate in the management of the homes, its rabbi counseled on religious matters within the homes and NSG donated much of its excess income to Chevre Liady and the rabbi’s charitable endeavors.

In 2004, NSG was audited by the Internal Revenue Service, which raised concerns about the sums donated by NSG to Chevre Liady and Chevre Liady’s apparent control over NSG.  NSG’s three member board of directors amended the bylaws to make Chevre Liady the sole member of the corporation.

The IRS was not entirely satisfied, and in April 2006, the IRS and NSG entered into a closing agreement in which NSG agreed to expand its board to 13 members, at least 8 of whom were to be independent of the congregation and its rabbi.  In June, the three-member board elected the 10 new directors and also amended the bylaws to remove Chevre Liady’s right to vote, to amend bylaws, or to discharge directors.

When two of the newly elected directors refused to serve, the board called a special meeting to consider replacement nominees.  The rabbi of Chevre Liady, acting on behalf of the congregation, objected to the meeting. When the meeting was held anyway, Chevre Liady, as the sole member, held its own meeting and removed the entire board of directors of NSG.  In response, the board held another special meeting to amend the bylaws to remove Chevre Liady as NSG’s sole member.

With uncertainty over who could serve, ousted directors filed for a declaratory judgment seeking to establish their right to control.  Chevre Liady counterclaimed for judgment that it was sole member and the others had been removed.  A trial court granted judgment to Chevre Liady and the Appellate Division has affirmed.

When NSG had a sole member, the Court said, state law provides that the member may not be deprived of the right to vote except by removal or resignation.  To the extent that the three-member board made changes to expand the board and make other changes, they were effective.  But “to the extent that they attempted to abrogate Chevre Liady’s rights, there were legally ineffectual.”

Chevre also had the right to veto any other changes in the bylaws and it made clear that it vetoed those provisions affecting its right to vote, remove directors, and amend bylaws, the Court said.  Its subsequent removal of the board was therefore proper and effective.

The directors argued that they did not have notice of the member’s meeting and they had no chance to be heard.  But the Court said that only members are entitled to notice of members’ meetings.  “Given that a primary role of the membership is to elect or discharge directors … absent any statutory requirement or a provision in the certificate of incorporation or bylaws, there is no reason to read a requirement of notice” into the statute.  

In addition, although the directors argued that they were discharged without cause, the Court said the original bylaws gave Chevre Liady the right to remove directors without cause, and it had set forth adequate cause in its decision to discharge the directors.

YOU NEED TO KNOW

This is a classic example of the power of the sole member to control the actions of a board of directors when it retains for itself the right both to appoint and remove members of the board and the power to approve all amendments to the governing instruments.  (See Ready Reference Page: “Sole Member Bylaws Can Protect Founder of Nonprofit”)  This kind of fight is never very pretty, but it is clear who has the controlling hand.

If the IRS had better understood this dynamic, it might not have been satisfied with a mere expansion of the board with additional “independent” people.  It might have required the sole member to relinquish control of the organization.