Constitution, Bylaws and Charters – Part 3

The Kansas Supreme Court ruled that a church-affiliated hospital’s “dissolution clause” was not triggered by the hospital’s sale of its assets, and therefore the sales proceeds did not belong to the church.

Church Law and Tax2000-03-01

Constitutions, Bylaws, and Charters

Key point 6-15. The procedure for dissolving an incorporated church is specified by state nonprofit corporation law.

The Kansas Supreme Court ruled that a church-affiliated hospital’s “dissolution clause,” which specified that the hospital’s assets would go to the church in the event of its dissolution, was not triggered by the hospital’s sale of its assets, and therefore the sales proceeds did not belong to the church. A hospital (“Bethany”) was founded in 1892 by five Methodists as a part of “the Methodist hospitalization movement.” The Kansas East Conference of the United Methodist Church was the original sponsor of the hospital, and “was a conduit through which individuals attending Methodist Churches in eastern Kansas could donate funds to help fulfill Bethany’s mission.” Bethany’s articles of incorporation contained a “dissolution clause,” specifying that its assets would go to the Conference in the event the hospital dissolved. Until 1972, the Conference elected a majority of the trustees to Bethany’s board of trustees. In 1972, Bethany’s articles of incorporation were amended to provide that 12 of the 15 board members should be elected by the outgoing board and confirmed by the Conference.

As the result of litigation which concluded in 1979 with the California Conference of the Methodist Church being held accountable for the activities of a Methodist-related retirement facility, the Conference became concerned about being held liable for Bethany’s activities. The Conference referred the question of legal separation from Bethany to a study committee. At the recommendation of the study committee, Bethany’s articles of incorporation were changed to “erect a wall” between it and the Conference. The requirement that Bethany’s board be confirmed and ratified by the Conference was deleted; the Conference’s right to veto nominations for Bethany’s board was deleted; and the condition that Bethany’s articles of incorporation and amendments to them were not effective until ratified by a majority of the Conference at its annual conference was lifted. In time, the Conference put more distance between itself and Bethany, as is reflected in the following excerpt from the 1983 journal of the Conference:

Bethany Medical Center … [and others are] wholly independent institutions from the Kansas East Annual Conference. The Annual Conference shall not elect or approve the entire board of trustees though it may from time to time elect less than a majority of its trustees or send Conference visitors. The Annual Conference shall not monitor, supervise, or, otherwise, review any of the affairs or operations of these institutions. The Annual Conference may, from time to time, provide financial support to any of these institutions as a contribution. The Annual Conference shall have no legal responsibility for any of these institutions.

The Conference donated no money to Bethany since 1975. Bethany’s revenues for the year ending September 30, 1996, exceeded $73 million.

Bethany’s current articles of incorporation permit its board to amend them without restriction. The articles contain the following dissolution clause: “Upon dissolution of the corporation and after payment of just debts and liabilities, all remaining assets shall be distributed to the Kansas City East Conference of the United Methodist Church.”

In 1997, Bethany executed a sales agreement in which it agreed to convey most of its assets to a third party. The Conference asserted that the proposed sale resulted in a dissolution of Bethany, which meant that all of its assets should be distributed to the Conference as a result of the dissolution clause in Bethany’s articles of incorporation. The Conference filed a lawsuit asking a court to rule that all of Bethany’s assets belonged to the Conference by virtue of the dissolution clause. The court declined to do so, and allowed Bethany to retain the proceeds from the sale. On the other hand, the court permanently enjoined Bethany from replacing the Conference as the recipient of Bethany’s assets in the event of its dissolution. The case was appealed to the state supreme court.

The dissolution clause

On appeal, the Conference argued that a corporation must have a purpose and is prohibited from conducting any activity outside its stated purpose. It noted that Bethany’s primary purpose had been to operate a hospital. In selling the hospital, the Conference argued, Bethany “contracted away its purpose,” and, therefore, the corporation must be dissolved. The court disagreed:

In order to accomplish dissolution, a majority of the members of the governing body adopt a resolution to dissolve the corporation, and a certificate of dissolution is filed with the Secretary of State. The Secretary of State issues its own certificate. When that certificate is recorded in the office of the register of deeds of the county in which the corporation maintained its registered office, the corporation is dissolved. None of the steps in this process has been undertaken by Bethany. In the absence of any inclination on the part of Bethany’s board to dissolve the corporation, the Conference sought to have the district court intervene to judicially dissolve the corporation and distribute its assets-the proceeds from the hospital sale.

amending the dissolution clause

The supreme court reversed the trial court’s order prohibiting Bethany from deleting the Conference as the recipient of its assets in the event of its dissolution. The court concluded that the trial court’s ruling violated Bethany’s due process rights since the Conference never asked the court for such a ruling and Bethany was not given an opportunity to present any arguments in opposition to the court’s order. The court further noted that absent “the greatest emergency,” the civil courts are not warranted in interfering with the internal operation of a corporation. The court concluded: “It is not the function of the court to manage a corporation nor substitute its own judgment for that of the officers thereof. It is only when the officers are guilty of willful abuse of their discretionary power or of bad faith, neglect of duty, perversion of the corporate purpose, or when fraud or breach of trust are involved, that the courts will interfere.” This standard was not met in this case, the court concluded.

Application. The subject of dissolution clauses is relevant to every church for two reasons. First, every church should have a dissolution clause in its articles of incorporation or bylaws. Second, many churches have incorporated a subsidiary ministry such as a preschool or private school, and the subsidiary ministry’s articles of incorporation or bylaws should have a dissolution clause which in most cases will name the church as the recipient of the ministry’s assets in the event of a dissolution. With these points in mind, here are some additional considerations that this case suggests:

1. The significance of a dissolution clause. In order to maintain exemption from federal income tax, a church must have a dissolution clause in its articles of incorporation (or, in some states, its bylaws) specifying another charitable organization which will receive its assets in the event of its dissolution. Does your church have such a clause in its articles of incorporation or bylaws?

2. Review your dissolution clause. Church leaders should review their church’s articles of incorporation (or bylaws) to determine (1) if a dissolution clause exists, (2) the identify of the charity that will receive the church’s assets in the event of its dissolution, and (3) if a change in the organization listed in the dissolution clause is warranted.

3. Review the dissolution clause of an affiliated ministry. Has your church incorporated an affiliated ministry, such as a school or preschool? If so, be sure to review the dissolution clause in the affiliate’s articles of incorporation or bylaws. Generally, your church should be listed as the organization that will receive the affiliate’s assets in the event of a dissolution.

4. Does a sale of corporate assets trigger a dissolution clause? This case demonstrates that a sale of a corporation’s assets will not necessarily trigger a dissolution clause, even if the sale severely limits the corporation’s ability to conduct its corporate purposes.

5. Amendments to a dissolution clause. This case also demonstrates that a church or other nonprofit corporation is free to change the name of the organization that is listed in its dissolution clause. Kansas East Conference of the United Methodist Church, Inc. v. Bethany Medical Center, Inc., 969 P.2d 859 (Kan. 1998). Dissolution of a Church

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