Nonprofit Mergers – Part 2: Step-by-Step

There are many ways in which two or more nonprofits can collaborate (see La Piana Consulting’s Collaborative Map), including (1) mergers and (2) dissolutions and asset transfers discussed in Part 1 of this series. This post specifically examines a merger between two California nonprofit corporations.

Prior to moving forward with a merger, the parties should each assess its own positions (financial, programmatic, public relations/marketing, leadership, governance, available resources); its existing relationship with the other party; the consistency of their missions and cultures; its motivations for the contemplated merger; and its knowledge and understanding of the other party and its positions. Assuming, after careful consideration of these factors, the parties are still interested in moving forward, the following steps offer a general framework for the merger process.

  1. Due Diligence

The primary goal of due diligence is to help assure a merger is in the best interests of a corporation, considering its mission, values, and key stakeholders. Reasonable due diligence under the circumstances is also necessary to satisfy the directors’ fiduciary duties of care and loyalty. Each corporation has the responsibility of conducting a thorough investigation into the other corporation’s organization and operations, including its governance structure, tax history, financials, real property, employment matters/human resources, intellectual property, contracts, and risk management. While there is no fixed list of materials which must be reviewed in all cases, each board should be aware of the relative benefits, detriments, opportunities, and threats with the merger, including any liabilities the other party may bring to the transaction. See Nonprofit Mergers – Due Diligence Items.

The most issue-laden areas tend to be real property, contracts, and employment. For example, transferring ownership of a property subject to a bank loan typically requires bank consent, which can be quite onerous. Similarly, government contracts generally cannot be transferred without obtaining the consent of the government agency and failure to get such consent could halt the merger altogether. Determining how to transition employees, specifically their compensation and benefits packages (which may not match between the two entities), HR databases, and software systems, and whether and who may be laid off, can be very costly and time consuming. Employment-related disputes are typically the number one reason why a nonprofit may find itself in court. Ascertaining whether the merging entity has any actual, pending, or threatened employment related matters is imperative. Additionally, post-merger, the surviving corporation must consider compliance with employment laws across the organization.

  1. Plan of Merger/Merger Agreement Drafting Process

Th next step is for the two parties to begin laying out the plan of merger and document it in a merger agreement. Sometimes, any binding contracts are preceded by letters of intent or term sheets, which may identify common areas of agreement, as well as a confidentiality agreement.

In California, some nonprofits choose to execute two merger agreements: (1) a long form merger agreement which details all of the terms and conditions of the merger; and (2) a short form merger agreement containing only the required provisions under state law, to be filed with the Secretary of State. This two agreement strategy can help make the filing simpler and faster by not providing the secretary of state with a long agreement to vet and then publish on its website.

The short form merger agreement (see a sample from the Secretary of State here) may include just the following four summarizing provisions:

  • Merging Corporation shall be merged into Surviving Corporation.
  • Each membership of Merging Corporation shall be converted into one membership of Surviving Corporation.
  • Merging Corporation shall from time to time, as and when requested by Surviving Corporation, execute and deliver all such documents and instruments and take all such action necessary or desirable to evidence or carry out this merger.
  • The effect of the merger and the effective date of the merger are as prescribed by law.

The long form merger agreement contains key terms negotiated by the parties regarding pre-merger conditions, representations and warranties (in support of the due diligence), and post-merger organization and operations. This agreement includes the often more emotionally-charged aspects of the merger such as the name of the merged (surviving) corporation, leadership and board representation, continuation of any of the merging corporation’s named programs, and how the merging corporation’s legacy will carry on.

Once the merger agreement and plan of merger are finalized, each board must approve it and document such approval in minutes. Additionally, if either entity has a voting membership structure, the members must also vote to approve it.

  1. 20 day Notice to the California Attorney General

The California Attorney General must receive 20-days’ prior notice before a California nonprofit corporation consummates a merger with another corporation. However, practitioners recommend proving the Attorney General with longer notice, and waiting for the Attorney General to respond before proceeding, in case there are any issues.

The California Attorney General requires the following to be included in the notice:

  • A letter signed by an attorney or director for the corporation setting forth a description of the proposed action and the material facts concerning the proposed action;
  • Copies of both merger agreements (the short and long form agreements);
  • A copy of the resolution of the board of directors authorizing the proposed action, and board meeting minutes reflecting discussion of the proposed action;
  • A copy of the corporation’s current financial statement; and
  • Copies of the current version of the corporation’s articles of incorporation, and the articles of incorporation of any other corporation that is a party to the proposed action.

Typically, during this notice period, the corporations will begin providing notices that the merger will take place and begin obtaining the necessary consents or approvals for the transaction itself or to transfer an agreement at the closing of the merger. The officers will also sign the merger agreements.

  1. Filing of the Merger Agreement and Officers’ Certificates with the Secretary of State

After the notice to the Attorney General has been satisfied and the parties are ready to move forward, the final step is to file the short form merger agreement and the officers’ certificate with the California Secretary of State. Due to the sensitive timing of merger transactions, practitioners recommend pre-filing these documents with the Secretary of State for a desired date of merger, in case such documents are initially rejected by the Secretary of State.

  1. Integration and Final Filings of the Merging Corporation

Integration may be the most difficult part of the merger process and the subject for a separate post. Elements to be integrated include governance, fundraising, programs, systems (including finance, communications, and information technology), and staffing. Cultural integration is critical to the perceived success of a merger, yet it is often insufficiently analyzed during the due diligence phase.

The final filings of the merging corporation must not be forgotten. Even after the merger, information returns to the Internal Revenue Service (e.g., Form 990) and California Franchise Tax Board (e.g., Form 199) will be due for the final tax year of the merging corporation, ending on the effective date of the merger. The surviving corporation will want to have assurances in the merger agreement that the such requirements will be fulfilled post-merger, particularly if those in charge of the merging corporation’s financials and filings are not part of the surviving corporation moving forward.