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All About Nonstock Corporations

Lerch, Early & Brewer's Legal Update

Most people are familiar with the traditional structure of a privately held, for-profit corporation whose owners, known as stockholders or shareholders, elect a board of directors into whose hands the management of the corporation’s business and affairs is entrusted. Shareholders’ ownership interests in the corporation are represented by shares of stock, which entitle them to certain voting and dividend rights and an interest in the accumulated capital of the corporation. This corporate model is well suited to the management of a for-profit business enterprise, particularly one whose ownership is spread among many individuals.

Creation of a Nonstock Corporation

“Nonprofit” activities, however, can also be carried on through a corporation, and Title 5, Subtitle 2, of the Corporations and Associations Article of the Annotated Code of Maryland (the “Act”) provides for the creation of nonstock corporations, which can hold assets and carry out their purposes on behalf of their “members.” Maryland uses the term “nonstock” corporation to designate a corporation that does not have shareholders, and the nonstock corporation is the appropriate corporate form for carrying on nonprofit activities, or at least activities that are not solely motivated by profit. Members of a nonstock corporation, as opposed to shareholders in a corporation that is authorized to issue shares of stock, do not invest in such an entity with the expectation of receiving distributions of profits or realizing capital gains on their investment. If a corporation is formed with the expectation that it will seek an exemption from income taxes as a nonprofit entity, the nonstock corporate form provides a structure that is tailored to satisfy the most fundamental requirement of nonprofit status, (i.e., the corporation is not formed to create pecuniary benefits for its shareholders, members or directors). This is not to imply that nonstock corporations are barred from making profits from their activities. Indeed, some nonstock/ nonprofit corporations may make substantial profits, but the profits are not distributed to their members or directors. Instead, they are reinvested in order to further the purposes for which the nonstock corporation was formed. Nonstock/nonprofit corporations that sell services, such as nonprofit hospitals, research institutions, and schools are examples of entities that may realize profits (tax free) on their primary activities, although they also may receive donations to further their charitable or scientific purposes.

Memberships in certain other nonstock corporations can be sold by the corporations to prospective members (clubs, for example), and there can be provisions for redeeming such memberships under certain circumstances. Nonstock corporations are often formed as mutual benefit societies, organized for the exclusive benefit of their members, such as clubs, chambers of commerce, labor organizations, and trade associations. In any event, whatever their underlying purposes may be, organizing as a nonstock corporation provides its members with (i) limited liability, and (ii) centralized management, just as in the case of a for-profit corporation, and those benefits of the corporate model are compelling enough to justify the effort needed to form and operate as a nonstock corporation.

Most Provisions of General Corporation Law Apply to Nonstock Corporations

Unless a specific provision or the context of a provision clearly provides or suggests otherwise, the provisions of the Maryland General Corporation Law, as applied to corporations that have shareholders, apply to nonstock corporations as well. The primary exception is the requirement that the charter of a nonstock corporation must provide that the corporation has no authority to issue capital stock, and thus can have no shareholders. However, there is no requirement that the charter of a nonstock corporation must provide for members either. Under Section 5-204 of the Act, if neither the charter nor the bylaws of the nonstock corporation provides for members, or in fact there are no members, then the board of directors of the corporation shall be deemed the members for certain purposes. In Glass v. Doctor Hosp., 213 Md. 44, 131 A.2d 254 (1957), the Maryland Court of Appeals held that a nonstock corporation can restrict its membership to only its board of directors. Thus a nonstock corporation may take the form of a self-perpetuating board of directors, with no other constituency but the members of the Board themselves.

Unique Provisions

On the other hand, the charter of a nonstock corporation may envision the active participation of the membership regarding certain issues, and may require the election of directors by the members themselves. If the membership is large and diverse geographically, however, getting a required quorum of the membership together at a meeting to transact business may be difficult. Section 5-206 of the Act resolves that problem by providing a mechanism whereby a meeting at which a quorum was not present can be adjourned, notice of a subsequent meeting can be advertised in a newspaper published in the county where the principal office of the corporation is located, and the members who appear at the subsequent meeting, no matter how few they may be, will constitute a quorum. There are other unique provisions that apply to nonstock corporations only. For example, a nonstock corporation can only merge or consolidate with another nonstock corporation. Similarly, in the event of the dissolution of a nonstock corporation, assets held by the corporation subject to limitations permitting their use only for charitable, religious, benevolent, educational, or similar purposes, and which are not held subject to return or transfer to a designated beneficiary in the event of a dissolution, may only be transferred to organizations whose stated purposes are of a similar type.

On the other hand, the charter of a nonstock corporation, or a plan of distribution adopted by the corporation’s board of directors, may provide for a distribution of assets to the members in the event of a dissolution of the corporation, just as there would be a distribution to the shareholders in the event of a dissolution of a standard, for-profit corporation. Nonstock corporations are a large and diverse group of organizations, and drafting their corporate charters and bylaws requires unique provisions and an understanding of their special needs and purposes.

Ted Goldstock counsels businesses on a broad range of corporate and commercial law matters and represents clients in business-related disputes and litigation. For more information about nonstock corporations, contact Ted at trgoldstock@lerchearly.com or at 301-347-1274.

 

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This content is for your information only and is not intended to constitute legal advice. Please consult your attorney before acting on any information contained here.

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