Friday, February 1, 2013
From Monday's The Wall Street Journal comes this story on the acceptance of a nonprofit start-up into the accelerator program of Y Combinator out of California.
Wait, this is a nonprofit blog! Accelerator programs??
Accelerator and incubator programs are all the rage in the entreprenurial business world. In general, they are places where an entreprenur with a good idea - but not much more - can find support and advice in growing a new business. In the case of incubators, that typically means a hub for shared space, networking, and professional resources. An accelerator program, essentially, is an incubator on steroids. An accelerator often provides a structured program that is designed to help in a concrete way the limited number of businesses that are accepted into the program. The goal is for those participants to be market-ready on an expedited basis (think three to six months). The program often concludes with an event that brings together the participant startups and local equity investors ("Demo Day" in the article). In return for this assistance, the accelerator typically takes a small equity stake in the business. The growth of the business obviously rewards the startup's founders and the outside investors that come to the table, but also it also funds the operations and future investments of the accelerator itself through its equity stake. Y Combinator is one of the most innovative accelerator programs out there, the former home of success stories Scribd, Reddit, and DropBox.
Wait, this a nonprofit blog! What is this equity investing of which you speak??
That's what makes the notion of Y Combinator accepting a nonprofit so interesting! As we know from Prof. Hansmann and others, one of the hallmarks of a nonprofit is the "nondistribution contstraint." Under both state law and federal tax law, a nonprofit can't have equity investors. The net earnings of the organization don't get distributed as income; rather, they are retained by the nonprofit to be devoted to its mission. At the end of the day, neither the local investors nor the accelerator program itself can take a cut of the accelerated nonprofit's earnings - by definition!
I curious about how the admission of nonprofits to an accelerator impacts the accelerator's business model. Undoubtedly, even with only for-profits involved, the accelerator assumes that for every Reddit, there are a handful of organizations that don't provide any meaningful return on the accelerator's investment. As the accelerator can't take an equity interest in a nonprofit participant, does it just assume that the nonprofit is one of the losers (with an internal rate of return of, well, zero) and hope the others will balance out accordingly? (That is what I gather from the article, by the way.) Or could it mitigate this risk by essentially charging an alternative fee schedule - for example, providing mentoring and facilities at cost, which means nothing out-of-pocket for the accelerator other than the opportunity cost of admitting an additional for-profit startup.
I'm also curious about this as yet another manifestation of the social entreprenuership movement. In the article, Paul Graham, the founder of Y Combinator, says:
I was talking to a friend who wanted to do a nonprofit project and I realized that i was giving exactly the same advice I'd be giving to a startup.
To some degree, that has to be undoubtly true and right. Every new venture, for-profit or not, has similar concerns: where do I get my money? what space am I going to use (if any)? how many employees will I have. And yet, there are fundamental differences in goals and methods of the organization - as much as nonprofits can (and to some degree should) adopt business ideas for the purpose of serving the organization's mission more efficiently, a nonprofit is, at its core, a very different animal with a very different mission. Can a nonprofit successfully co-exist in a private equity environment driven by return?
We shall see - certainly, something to follow!
Wednesday, January 30, 2013
In Belk v Comm’r, 140 T.C. No. 1 (Jan. 28, 2013), a regular Tax Court opinion, the court held that a conservation easement that permits the parties to agree to “substitutions,” even if subject to certain limitations, is not eligible for a charitable income tax deduction under IRC § 170(h). The taxpayers had donated the easement, which encumbers a 184.627-acre golf course in the Olde Sycamore residential development, to a land trust in 2004 and claimed a $10.5 million deduction.
Article III of the conservation easement authorizes the landowner to remove land from the protection of the easement in exchange for adding an equal or greater amount of contiguous land to the easement, provided, inter alia, that in the opinion of the grantee: (i) the substitute land “is of the same or better ecological stability” as the land removed, (ii) the fair market value of the “easement interest” on the substitute land will be at least equal to or greater than the fair market value of the “easement interest” that encumbers the land to be removed (and that will be extinguished as a result of the substitution), and (iii) the substitution will have no adverse effect on the conservation purposes of the easement. Article III further provides that substitutions must be documented in a recorded amendment. Article VIII of the easement contains a typical “amendment clause” that authorizes the landowner and grantee to agree to amendments that, inter alia, are not inconsistent with the conservation purposes of the easement and will not result in the easement failing to qualify for a deduction under § 170(h).
The IRS argued that an easement that does not relate to a specific piece of property (a “floating easement”) is not eligible for a deduction under § 170(h) because it violates the perpetuity requirements. The Tax Court agreed, holding that the easement failed to satisfy the requirement that a tax-deductible conservation easement be a “use restriction granted in perpetuity.” See IRC § 170(h)(2)(C); Treas. Reg. § 1.170A-14(b)(2). “To conclude otherwise,” explained the court, “would permit petitioners a deduction for agreeing not to develop the golf course when the golf course can be developed by substituting [other property for] the property subject to the conservation easement.”
Citing to Treas. Reg. § 1.170A-14(c)(2) (the "restriction on transfer" requirement), the Tax Court noted that the regulations permit substitutions, but only under limited circumstances, including that an unexpected change in conditions has to have made continued use of the property for conservation purposes impossible or impractical. Treasury Regulation § 1.170A-14(c)(2) appears to provide that the restriction on transfer requirement will not be violated if the holder is permitted to extinguish (i.e., transfer) the easement in accordance with Treas. Reg. § 1.170A-14(g)(6), and that regulation sanctions substitutions in limited circumstances (i.e., in a judicial proceeding, upon a finding that continued use of the property for conservation purposes has become impossible or impractical, and with a payment of at least a minimum proportionate share of proceeds to the holder to be used “in a manner consistent with the conservation purposes of the original contribution”). The easement at issue in Belk did not limit substitutions to such circumstances. Although Treasury Regulation § 1.170A-14(c)(2) cross-references to Treasury Regulation § 1.170A-14(g)(5)(ii), the proper cross-reference is to -14(g)(6)(ii); the Treasury failed to update the cross-references when it finalized the proposed regulations in 1986.
The Tax Court found it immaterial that the land trust has to approve the substitutions, explaining:
There is nothing in the Code, the regulations, or the legislative history to suggest that section 170(h)(2)(C) is to be read to require that the interest in property donated be a restriction on the use of the real property granted in perpetuity unless the parties agree otherwise. The requirements of section 170(h) apply even if taxpayers and qualified organizations wish to agree otherwise.
The court also found it immaterial that Article VIII’s amendment clause prohibits the grantee from agreeing to amendments that would result in the easement failing to qualify for a deduction under § 170(h). The court explained that when there is a conflict between a specific provision (the substitution provision) and a general provision (the amendment clause), the specific provision controls. The court also noted that the parties’ intent controls and, by specifically reserving the right to agree to substitutions as provided in Article III, the parties evidenced an intent to neither prohibit substitutions nor limit them to the circumstances permitted under the Regulations.
In an IRS General Information Letter dated March 5, 2012, the agency advised that the contribution of a conservation easement that authorizes substitutions (sometimes referred to as "swaps") other in accordance with the extinguishment and proceeds requirements of Treasury Regulation § 1.170A-14(g)(6) will not be eligible for a federal charitable income tax deduction under section 170(h).
The Instructions to Schedule D for the Form 990, which require nonprofits to report on their conservation easement transfer, modification, and termination activities, explain that an easement is released, extinguished, or terminated “when all or part of the property subject to the easement is removed from the protection of the easement in exchange for the protection of some other property or cash to be used to protect some other property.”
Tuesday, January 29, 2013
Our friends at the Committee on Nonprofit Organizations of the Business Law Section of the ABA have issued a call for nominations for the 2013 Outstanding Nonprofit Lawyer Awards. Each year, the Committee recognizes outstanding legal professionals in each of the following categories:
- Attorney (principally for outside counsel to nonprofit organizations);
- Nonprofit In-House Counsel;
- Young Attorney (under 35 or in practice for less than 10 years);
- Vanguard Award (lifetime commitment/achievement).
A link to the Committee's website with additional information can be found here. At that website, you can find the nomination form and a list of past recipients. The deadline for nominations is March 15, 2013, and the award winners will be announced at the Business Law Section's Spring Meeting in Washington, D.C. in April. Please direct all nominations and questions to William M. Klimon, Caplin & Drysdale, One Thomas Circle, NW, Suite 1100, Washington, D.C. 20005, by phone (202) 862-5022, by fax (202) 429-3301, or by email email@example.com.
Monday, January 28, 2013
From The Chronicle of Philanthropy, citing The Kansas City Star and The New York Times, comes this report on a lawsuit brought by a foundation that received most of the proceeds from the 2003 sale of the nonprofit hospitals previously owned by Health Midwest to Hospital Corporation of America (HCA), the larger operator of for-profit hospitals in the country.
In the sales agreement, Health Midwest required HCA to undertake certain activities, including providing an estimated $500,000,000 in charity care and to spend approximately $450,000,000 to improve existing health care facilities. The Health Care Foundation of Greater Kansas City filed suit against HCA in 2009, allegeing that HCA had not complied with these provisions in the the original sales agreement. The case went to trial in late 2011.
In its Final Order (warning: 142 pages!) issued on January 24, 1013, the trial court found that HCA failed to comply with the requirement to spend the allotted funds on existing health care facilities. In addition, the court was concerned about HCA's compliance with its charity care requirements, but found that the level of detail provided by HCA was insufficient to make a final determination on the matter.
From my brief review of the Order (I emphasize brief - did I mention 142 pages?), it appears that the capital improvements issue hinged primarily on the language of the sales agreement, which required the capital improvement spending to occur in "existing" facilities, and not in new or replacement facilities. (My personal highlight of the Order in this regard - paragraphs 140 and 141, wherein the Court states that the then Chair and CEO of HCA admitted to not reading the full agreement before signing it and to understanding the operative language to be "legalese".) The court found a minimal short fall in capital improvements of approximately $162,000,000, to be paid immediately to the Foundation, with more possibly to follow based on a court-supervised accounting.
With regard to the issue of charity care, the sales agreement specifically divided the world between charity care and care for indigents (based on gross charges foregone), and uncompensated care (based on bad debt). See Paragraph 208. A separate part of the agreement required HCA to continue to participate in Medicare and Medicaid for ten years. See Paragraph 210. Apparently, the Attorneys General of both Kansas and Missouri had requested information breaking down HCA's expenditures between charity care and uncompensated care, to no avail. See Paragraph 456, et. seq. Some of the compliance reports issued by HCA with regard to charity care compliance appeared incomplete and inconsistent. As a result, the order requires the court-supervised accounting to look specifically at the provision of charity and uncompensated care as mandated by the sales agreement.
According to The Kansas City Star article, "HCA representatives have consistently said the company met or surpassed its obligations, and ... said the company would appeal the decision."