Charity’s Lapse of Corporate Status Leads to Loss of Property

Ruling has significant impact for churches and charities.

Church Law and Tax1993-03-01Recent Developments

Unincorporated Churches

Key point: In many states, incorporated churches can lose their corporate status by failing to submit an annual corporate report to the secretary of state. Loss of corporate status can create a number of adverse consequences, including possible loss of the church’s property.

A New Mexico appeals court ruled that a charitable organization’s corporate status “lapsed” when it failed to submit an annual corporate report to the secretary of state, and that the organization’s property automatically passed to the organization described in its dissolution clause. A charitable organization was incorporated as a nonprofit corporation in 1957. In 1969, the state corporation commission issued an order dissolving the corporation because of its failure to file annual corporate reports for three years. The dissolved corporation later attempted to “re-incorporate,” using the same directors, place of business, and federal tax identification number. The directors assumed that the property of the old corporation automatically vested in the new corporation upon its creation. A dispute arose several years later as to the legal ownership of the corporation’s property. A trial court ruled that the property automatically passed to new corporation upon its creation, but this conclusion was rejected by a state appeals court in an important ruling. The appeals court noted that the new corporation “claims title to the property by virtue of operation of law, contending that as a result of its subsequent incorporation adopting the same name, general purposes, and having the same officers as the previously dissolved corporation, title vested in it as a successor corporation to all of the assets previously held in the name of the dissolved corporation.” The court stated the issue in this case as follows: “When an order dissolving a corporation is issued, what disposition may properly be made of [the assets] held in the corporation’s name?” The court concluded that “dissolution of a corporation is tantamount to corporate death and effectively terminates the existence of the corporation,” and that “after dissolution, a corporation is without power to dispose of its property, except as specifically authorized by law or judicial order.” The court noted that under state law (as it existed at the time of the corporation’s dissolution in 1969) a nonprofit corporation’s corporate existence “dissolved” or lapsed upon its failure to file an annual corporate report with the secretary of state within one year of the due date. Since the corporation’s corporate status lapsed as a matter of law in 1969, it was without power to dispose of its property following its dissolution. The court noted that “in the absence of a statute specifying the method of distribution of the assets of a dissolved corporation, the articles of incorporation of the corporation control and are its fundamental and organic law.” As a result, the court concluded that the corporation’s assets (at the time of its dissolution) passed to the organization described in the “dissolution clause” contained in its articles of incorporation (e.g., corporate charter). A dissolution clause is a clause specifying how a corporation’s assets shall be distributed upon its dissolution. Such a clause is a requirement in a tax-exempt organization’s articles of incorporation, according to the income tax regulations. In conclusion, the court ruled that the assets of the dissolved corporation did not pass to the successor corporation, but rather went to the organization described in the dissolved corporation’s “dissolution clause.”

This case is of extraordinary relevance to churches and other religious organizations. Most states have nonprofit corporation laws that require corporations to file annual corporate reports. In a number of these states, a corporation’s corporate status can lapse or be dissolved in the event of a failure to submit the annual report. As noted in previous issues of this newsletter, the primary legal effect of such a dissolution would be the potential personal legal liability of every member of the church for the actions of other members and the obligations of the church itself. This case illustrates another potential problem—the church’s “dissolution clause” may be triggered by a revocation of its corporate status resulting from a failure to submit the annual corporate reports. This means that the church’s property would automatically vest in the organization specified in the dissolution clause set forth in the church’s articles of incorporation (charter). In some cases, this could result in very unfortunate consequences, depending on the identity of the organization named in the dissolution clause. Many church leaders do not even know what organization is listed in their dissolution clause. What can church leaders learn from this ruling? Consider the following: (1) If you are incorporated, check with your secretary of state to determine under what statute you are incorporated. Ask if the statute requires your church to file annual reports. If it does, ask if your church has filed all necessary reports. If it has not, ask about the status of your church. Is it still incorporated? Or, has its corporate status lapsed? (2) If your church is required to file annual reports with the secretary of state, be sure that it does so! Our recommendation is that you contact the secretary of state every year to confirm that your church has filed all necessary corporate reports and that it is a corporation in good standing. We also recommend that you obtain a certificate of good standing each year from the secretary of state. This will confirm your corporate status. It is available for a nominal fee. (3) Read the dissolution clause in your church’s articles of incorporation. What organization is named as the recipient of all of your church’s assets upon a dissolution of the church? This is the organization that may own your assets if you fail to file your annual corporate reports. Matter of the Will of Coe, 826 P.2d 576 (N.M. App. 1992).

See Also: Unincorporated Associations |Corporations | Reporting Requirements | Exemption of Churches

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