Non-Profit Corporations Must Operate Pursuant to the Rules

By Arlen R. Gunner

I was recently asked to serve as an expert witness in a case that demonstrates the abuse that occurs when people form a non-profit for the sole purpose of personal gain.

As an experienced attorney representing non-profits, I was hired by the plaintiff’s attorney to testify as an expert witness against the founders of a non-profit organization. Rather than using the money raised for the mission of the organization, they were using the entity as their personal piggy bank and had already pocketed large amounts of cash.

They had no interest in running a charitable organization for the public benefit; they were out to milk the business for themselves. Ignoring even the most basic rules, they controlled everything and hired “front men” to run the charity. These individuals were highly paid and were used to front the organization.  Although they were officers of the entity, they were never allowed to review financial statements, attend board meetings, or run the business.

Over the course of my preparation to be deposed, I discovered that this wasn’t the first time they had carried out this scheme. The founders had a history of using a non-profit corporation as a vehicle to line their own pockets.  This is a serious offense, and violates both California and IRS rules for tax-exempt organizations. Finally the IRS pulled the plug on them and revoked their 501(c)(3) status.

As part of the suit against the founders for the recovery of lost funds, I was deposed by the defendants' counsel. When the nitty-gritty details were laid bare, the defendants’ legal team eventually determined they were fighting a lost cause and offered to settle.

The lesson to be learned is that there are very specific rules and requirements to operate a non-profit corporation. Non-profits are not a vehicle for personal enrichment. Business must be conducted in accordance with the mission for which the non-profit was formed.

To obtain tax-exempt status, the corporation must file an application with the IRS and, if granted, it must also obtain exemption from state taxes as well. Once a non-profit entity is formed, a trust is legally impressed upon its assets, which are held for the benefit of the public. The attorney general is responsible for preserving those assets. If you violate non-profit rules, the attorney general and/or the IRS have broad enforcement power to pursue the entity and those who violated the law, in addition, you will likely face the repercussions from those whose funds have been collected under false pretenses.