DATELINE: June 1, 2011, Chicago
Judge Richard Posner issued what is an important legal decision for any national nonprofit that licenses or otherwise makes its name available to local affiliates. This particular dispute was between the Girl Scouts of Manitou Council (located in Wisconsin) and the Girls Scouts of the United States of America. The crux of the matter centered on efforts by the National Girl Scouts to...
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consolidate their then existing 300 councils. The downsizing would have resulted in the elimination of the Manitou Girl Scouts Council.
The local councils were organized as separate legal entities and were not subsidiaries of the National Girl Scouts. The national organization "charters" the local entities and authorizes them to sell cookies and other merchandise under the "Girl Scout" trademark.
The Manitou Girl Scouts responded to the National Girl Scouts by filing a lawsuit under the Wisconsin Fair Dealership Law. The central question before Judge Posner was whether nonprofits were subject to this legislation. Although there were First Amendment overtones to the application of the Fair Dealership Act in this case--particularly because the lower court seems to have decided the case along those lines--Judge Posner had little trouble dismissing those arguments. Judge Posner instead focused on whether there was any reason the Fair Dealership Act should not apply to a nonprofit. He placed heavy emphasis on the commercial aspects of the Girl Scout's activities, writing:
From a commercial standpoint the Girl Scouts are not readily distinguishable from Dunkin’ Donuts.
Judge Posner offered one of the best discussions of the distinction between nonprofits and for profits that we have encountered, writing:
The principal difference between the two types of firm is not that nonprofits eschew typical commercial activities such as the sale of services—they do not—but that a nonprofit enterprise is forbidden to distribute any surplus of revenues over expenses as dividends or other income to owners of the enterprise, but must apply the surplus to the enterprise’s mission. That does not seem to alter the incentives of the people who run such organizations much, if one may judge from the many scandals involving nonprofit colleges and universities, which seem to compete for students, faculties, research grants, and alumni gifts with a zeal comparable to that of their for-profit counterparts.
This will and should become a go-to quote, particularly when government officials argue that states somehow have a property interest in nonprofit property.
When all the dust settled, Posner ruled that the National Girl Scouts were subject to Wisconsin's Fair Dealership Act, which prohibits a franchisor from:
terminat[ing], cancel[ing], fail[ing] to renew or substantially change the competitive circumstances of a dealership agreement without good cause.
The opinion is not entirely clear, but Judge Posner appears to have reversed the district court on its application of the First Amendment and remanded the case for proceedings consistent with his decision.
We don't want to get into Judge Posner's economic arguments or the specifics of the Wisconsin Fair Dealership Act. Instead, we offer the following lessons that can be drawn from the decision:
Lesson 1: As we have noted, Judge Posner offered some very powerful language regarding the distinction between nonprofits and for-profits. This alone should be tucked away for future use in cases where state charity regulators encroach on nonprofit property rights.
Lesson 2: But it isn't only charity regulators who should take note of this language. If your organization is engaged in hard-core commercial activity, it should be prepared to comply with laws that apply to for-profit entities unless there is a specific statutory exemption for nonprofits. At least that is the case if Judge Posner will be resolving any dispute involving whether the statute applies to nonprofits. We suspect many other judges will take a similar position. In short, if your organization hocks its halo to compete in a competitive marketplace, don't be surprised if a regulator or a judge rejects your claim that you are charity in the Dickensian sense. In this case, Judge Posner didn't hear violins playing in the background.
Lesson 3: The national organization should think long and hard before extending affiliation to local entities. It may not be so easy to revoke what has been conferred if the state or locality has fair dealership laws on the books. In every case, the national organization should consult with qualified local counsel with expertise in the fair dealership and other relevant laws before conferring any license or other rights to a local organization.
Lesson 4: If fair dealership laws apply, the nonprofit should write the contracts or license with the procedure outlined in the statute for adjusting the relationship in mind. The national organization is not going to be able to make it up as it goes. This may mean that standard-form licensing agreements must be modified on a state-by-state basis to address nuances in state statutes.
Lesson 5: Newly-formed national organizations should give special consideration to the potential loss in flexibility that could result if the national organization adopts a franchise model. Wholly-controlled (through membership) local subsidiaries may make more sense. Of course, there are many factors that must be weighed in that calculus, including the willingness of locals to do the hard work, but yield local autonomy.
Lesson 6: Existing organizations should consult with legal counsel and their local affiliates rather than springing reorganization plans in a top-down control maneuver. Obtaining buy-in from below may be irritating and inconvenient, but will hopefully reduce legal challenges under state fair dealership laws. More important, the national organization should never overlook the sensitivities of those at the local level. First and foremost, these folks are important organizational boosters, fundraisers, and goodwill ambassadors. It makes sense to avoid lawsuits resulting from any reorganization plan. It makes even more sense to have a plan that works from a business standpoint, which most likely means stronger bridges with local groups rather than burnt bridges.
Lesson 7: Central organizations with group rulings from the IRS may want to ask themselves whether Judge Posner's opinion or applicable fair dealership laws undermine their ability to exercise sufficient supervision or control over subordinates to warrant inclusion in a group ruling. We suspect the decision will not create insurmountable problems, but the issue is worth consideration.
If you are a lawyer, reading the opinion is well worth your time and effort.
Internal Revenue Service - Circular 230 Disclosure: As provided for in Treasury regulations, any advice (but none is intended) relating to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.
THE FOREGOING IS NOT AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. IF LEGAL ADVICE IS REQUIRED, THE NONPROFIT OR OTHER PARTY IN QUESTION SHOULD SEEK THE ADVICE OF QUALIFIED LEGAL COUNSEL.
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