Charitable Insolvency and Corporate Governance in Bankruptcy Reorganization

Poor corporate governance is a pervasive problem in the charitable nonprofit sector. Prominent examples of mismanagement and abuse include instances of intentional misconduct, such as embezzlement and unauthorized self-dealing, and negligent conduct, such as failure to diversify the organization’s investment assets. In numerous cases, the lack of good corporate governance has led to the financial distress or failure of a charitable nonprofit firm. A rich literature on nonprofit law has considered the need for better corporate governance and enforcement of fiduciary duties, but the scholarship has yet to address the implications of financial distress and insolvency on corporate governance.

My forthcoming article, “Charitable Insolvency and Corporate Governance in Bankruptcy Reorganization,” fills that void and argues that, when a charity encounters financial distress and approaches the point of insolvency, features and customs of nonprofit and bankruptcy law tend to exacerbate rather than ameliorate the corporate governance problem. Consequently, charitable insiders who breach their fiduciary duties are in a better position to entrench themselves and avoid termination than their for-profit counterparts.

In the for-profit sector, three constraints tend to regulate corporate governance by helping to oust fiduciaries responsible for financial distress: (1) bank monitoring of commercial loan covenants; (2) absolute priority and the transfer of ownership in bankruptcy; and (3) involuntary bankruptcy proceedings. In the nonprofit sector, however, those constraints are either less effective or do not apply. As a result, blameworthy charitable fiduciaries are better able to entrench themselves and, without new competent leadership, financially distressed charities are less likely to achieve a full and sustainable financial recovery. My article contains some nascent ideas for reform, including a suggestion that the law might better protect the public interest in charitable assets from waste and abuse by presumptively appointing bankruptcy examiners in all Chapter 11 reorganization proceedings involving substantial charitable assets. Once appointed, bankruptcy examiners would be tasked with identifying the cause of insolvency and individuals responsible for the charity’s financial distress.

My article, recently posted here, is still in manuscript form, so your comments and feedback would be both welcomed and appreciated.