Nonprofit Church Law Ministry

By H. Robert Showers, Esq.

 

While it is estimated that over 85% of all churches are now incorporated with 49 states permitting incorporation and West Virginia on the verge of permitting it, most governing documents are poorly drafted, woefully out of date, or not followed. Thus, they do not protect or contain the 21st-century risk-management provisions that are now available to churches throughout the country. Why should a church care about its governing documents and risk-management provisions like incorporation? The primary answer to this question is that there is significant change in the legal climate of this country.

 Twenty or 30 years ago, most Americans, whether Christian or not, held a common framework of basic moral values such as honesty, fairness, respect for others, self-discipline, and accountability. In recent years, however, respect for these values and qualities have been undermined by a growing emphasis on individualism, diminished respect for authorities, acceptance of relative morality, and a loss of common norms and values. The loss of common values even within the church can cause a great deal of confusion and conflict. It can also expose a church to devastating losses. A generation ago, very few people—especially members of the church—would have dreamed of suing the church, but the legal climate today has changed dramatically and lawsuits against churches now are commonplace. Part of the reason for this recent change is that people have different expectations about how a church should conduct its affairs and treat its members. When these expectations are not met, a lawsuit often follows, which can ruin a church’s spiritual life, reputation, and finances.

As Proverbs 22:3 warns, “A prudent man sees danger and takes refuge, but the simple keep going and suffer for it.” Understanding the absence of common norms and values can pose a threat to the unity and well being of your church. You would be prudent to incorporate and develop bylaws as a means of establishing commonly accepted standards for how church members should treat one another and govern themselves as a body of believers. In particular, incorporation and its governing documents are designed to accomplish the following four goals:

• to prevent surprises and disappointed expectations by providing potential members a thorough explanation of how the church intends to govern itself;

• to reduce the likelihood of confusion and conflict within the church by establishing clear operational guidelines;

• to prevent the misuse of authority by church leaders by balancing these powers and establishing procedures that protect members from being disciplined or losing rights without due process and full notice; and

• to reduce the church’s exposure to legal liability by satisfying recently developed legal requirements, even in areas we deny that the state has jurisdiction, and by requiring that potential lawsuits will be resolved through biblical mediation or arbitration rather than through civil litigation.

 

The benefits of church incorporation

Before the Falwell case, Virginia and West Virginia were the only two states in the United States where churches and religious denominations could not incorporate. Thus, Virginia churches were unincorporated associations, which subjected their members² and particularly their leaders, such as the pastors and boards, to all forms of liability and precluded a church’s ability to hold title to its property. There are many forms of liability for which either an insurance policy does not cover the acts upon which a lawsuit against a church is based, or its coverage is limited. A board of directors (elders, deacons, or pastors) could be personally liable for the liabilities that were essentially against the church. There have been cases in which a pastor, deacon, or elder has suffered greatly because of this status as an unincorporated association, and the courts have imposed personal liability for the negligent or reckless acts of the church or its officers, directors, or agents.

Now, here are nine benefits for church incorporation:

• Incorporation will substantially limit liability of the pastor or pastors, the board, and the members, which, as long as the church board is not “grossly negligent,” would provide a sure liability shield.

• Under incorporation, trustees are no longer needed for church corporations and court appointment of such trustees is not required to hold, manage, buy, sell, transfer, or encumber real property of the church corporation. Of course, church corporations may still authorize trustees to have that legal authority with the church members’ approval, or it can delegate it to one or more of its officers or directors. Unincorporated churches, however, must comply with all the old law provisions requiring court approval for appointment of trustees and court approval for all buying, selling, encumbering, or transferring land to another entity (other than the new church corporation).

• Under incorporation, real or personal property for church corporations no longer needs to be held by trustees, but can be held in the name of the church corporation or a separate property-holding nonprofit corporation.

• Incorporation often makes it easier for a church to buy, sell, and encumber real estate, operate bank accounts, and engage in other business transactions.

• Incorporation protects the corporate name in the state and eases tradename and trademark registration where appropriate.

• Incorporation also lends to the stability of an organization more than an unincorporated association does, because the members, directors, trustees, and officers of a church may change over the years.

• Churches must be incorporated to receive grants through government faith-based social-service-provider programs or private foundations.

• Incorporation and tax exemption can often permit special nonprofit mailing rates and procure discounts from vendors.

• Finally, most banks and lending institutions prefer to deal with an incorporated entity to assure its governance, purpose, and legal status.

But churches need not be incorporated to be exempt from federal income tax. At least one court, though, has observed that, “[W]hile not a pre-requisite for exemption, a showing that an organization seeking a property tax exemption is incorporated as a church or religious association will lend credence to that organization’s claim that it is a bona fide church or religious organization.”

 

Concerns about church incorporation

Other than ill-placed theological concerns about separation of church and state,³ the primary downside to incorporation may be the upfront costs and the requirement that an informational report and nominal fee must be paid annually to the State Corporation Commission (“SCC”) or suffer the loss of its nonprofit-corporate status. Some commentators have alleged the following other disadvantages of incorporation:

• It requires the rewriting of a congregation’s constitution and bylaws to conform to the requirements of the IRS and the SCC, which could cause dissension since some provisions may be matters of disagreement within a church; however, most church bylaws are out of date and desperately need updating for 21st-century legal compliance and risk-management purposes, as well as for streamlining.

• There is a cost to setting up and maintaining the church corporation. Currently, the SCC charges for filing the articles of incorporation. Additional attorney fees from a knowledgeable attorney skilled in church laws and tax-exempt entities and knowledgeable about your church government will also be needed to tailor your church corporation’s articles of incorporation, and the constitution and bylaws. An annual report—which reflects an updated list of officers and directors—often must be filed each year with the SCC.

• A registered agent, instead of trustees, must be designated to receive service on behalf of the corporation. (He or she must be either a member of the Virginia State Bar or a director of the corporation.) A good attorney who serves as a registered agent, however, will have a system for recording all incoming and outgoing mail and faxes and will better be able than lay trustees to handle legal documents with deadlines and to correctly answer complex legal issues.

• Names on bank accounts need to be changed to the corporate name and all property should be transferred to the church corporation. (This provides much better protection for the church and can be done easily by a knowledgeable church- and real-estate-law attorney).

• Certain rules are determined by statute, unless the bylaws or constitution provide differently, which good bylaws will, including the following:  annual meeting, quorum requirements, notice provisions, use of proxies, terms for directors and officers, removal of an officer by the board of directors, judicial dissolution of the corporation, and court-ordered meetings of the corporation.

• Although inspection of records by members would appear to be governed by the Nonstock Corporation Act, it is debatable whether that can be changed by the church’s constitution or bylaws. While it can be limited or restricted through bylaws—especially as a church corporation under separate church-law sections—most churches make records to members available (except salary information) since churches desire to be transparent to its donors and fellow Christian brothers and sisters.

• A church-corporation director is liable for failure to exercise “good faith business judgment of the best interest of the corporation”; however, a leader in an unincorporated association is completely liable for acts of the association.

Church property is held in the name of the church corporation and not by trustees. Once transferred to the church corporation, it may be bought, sold, or mortgaged without court approval. Simplifying the purchase and sale of property, however, may open the door to the possibility of abuse by church leaders. But with limits in good bylaws, it will provide for easier property transactions without state involvement or court oversight.

Over the years, many states have passed several statutory provisions that have tried to protect members and officers or directors of churches from being liable for the negligence of others in a church setting. Ostensibly, these laws were enacted to give churches some of the same protections that churches in other states receive by incorporating when incorporation was disallowed. Here are some examples: (1) No member of a church is liable in tort or contract for the actions of any other member of the church or the actions of the church itself; (2) unpaid officers, trustees and directors of certain tax-exempt organizations may have immunity from liability; and (3) the fiscal officer of the church who signs a deed or mortgage on behalf of the church is generally not personally liable on the debt.

Unfortunately, even these provisions are like Swiss cheese when it comes to limiting personal liability and thus, church incorporation appears to provide additional protection, perhaps as a belt-and-suspenders approach, on top of these provisions.

 

Process of incorporation

 While it would be understandable that the state Nonstock Corporation Act may be applicable,⁴ since now there is no special incorporation for religious corporations in some states, one must remember that there is church law sprinkled throughout the state code and in case-law history interpreting such church-law provisions. Thus, such nonstock–nonprofit law will probably only be used if the bylaws, church-law provisions, and case law do not cover the issue at hand. Thus, a church’s incorporation should be handled as a church corporation, not a nonprofit or nonstock corporation under nonstock statutes, in order to achieve all the church-law benefits and protections.

The general procedure for filing the articles of incorporation consists of the following steps: (1) preparation of duplicate articles of incorporation setting forth the corporation’s name, period of duration, registered agent and address within the state, registered office address, purposes and names and addresses of the board of directors, how they will be appointed or elected and set forth the incorporator or incorporators; (2) signatures of the incorporator or incorporators; 3) inclusion of all IRS-required tax-exempt language and (4) submission of the articles of incorporation, together with the prescribed filing fee to the SCC.

After approval by the SCC, it issues a certificate of incorporation. The church’s corporate existence begins at the moment the certificate of incorporation is issued. After such a certificate of incorporation is issued, however, the state and common law specify that an organizational meeting of the board or congregation (depending on church government) must be held at the call of the incorporator or incorporators to adopt the initial bylaws and constitution of the corporation, accepting members from the unincorporated entity to new church incorporation, confirming new directors and officers, authorizing new bank accounts, giving the corporation all authority and power to act, and changing legal documents to reflect the corporate status (see my article entitled Power in the Bylaws, Constitution and Policies for Incorporated Churches), and such other purposes as may come before the meeting.

After reviewing hundreds of church constitutions and bylaws documents over the past several years, we have concluded that it is imperative that a church’s constitution and bylaws be reviewed and amended by competent legal counsel knowledgeable in church- and tax-exempt law for legal compliance, governance changes, updating to conform to current church practice and best practices of risk management. There are too many nuances in church- and tax-exempt law and too many idiosyncrasies with churches and denominations to believe any longer that a lawyer can just dabble in this area of law.

Some of the typical provisions in the articles of incorporation will be whether the church corporation is to have members or not, the right of the members to vote, statement of the manner in which directors shall be elected, appointed or designated, amendment provisions, statement of the tax-exempt purposes and limitations, and the powers of the nonprofit tax-exempt corporation, as well as a statement of what happens upon dissolution. While some of these provisions are mandatory and others are permissive, it is essential that a number of the provisions, including the tax-exempt provisions, be strictly adhered to, in order to both protect and promote the corporate and tax-exempt status and its powers.

 

Frequently asked questions

 Who should serve as the church’s registered agent?

• Ideally, the Incorporator and registered agent should generally be a member of the Virginia State Bar since Virginia law provides for that qualification and most, if not all, of the documents that will be delivered to the registered agent will be legal in nature. Some documents, such as lawsuits and annual reports, will contain important deadlines that, if missed, could incur significant liability on the church. To minimize the chances of important legal papers being lost, the registered address of the church should be a law office or other location with a system in place for recording all incoming mail and facsimiles. If the registered agent is not a state-licensed attorney, he or she generally must be a director of the corporation, and the registered address must be the same as the individual’s state business address.

What is an organizational meeting?

• After incorporation, every new corporation is required by law to hold an organizational meeting at which members join the new church corporation, the bylaws are formally adopted, officers are elected or appointed, and other powers and policies are authorized for the new corporation or for officers to conduct the business of ministry. Depending on the form of church governance, upon request, the author will either schedule a phone conference with the client’s directors of the church corporation after the certificate of incorporation is received but before the bylaws and constitution are redrafted to determine the governance, etc., of the church and send a sample agenda and minutes for a congregational meeting to be conducted. Upon request and additional fee, the author’s firm representative may conduct the question and answer meeting with the members and board and the organizational meeting, but that service is generally not needed since this article and sample organizational meeting agenda and minutes are self-explanatory.

Who should serve as the Directors of the Corporation?

• Typically, it is wisest to simply designate the church’s current governing board (trustees, organizational meeting, elders, or deacons) as the directors of the new church corporation and make the transition in the bylaws and over the years. This avoids extra meetings, confusion, and political strife, since it allows most of the duties and responsibilities of the governing individuals to remain the same.

Is it necessary to revise the church’s constitution and bylaws after incorporation?

•  Absolutely yes. In incorporating many churches over the last several years, the author has found that all churches’ constitutions or bylaws, or both, are outdated, legally inadequate, or inconsistent with the new articles of incorporation. To ensure legal compliance, good risk management and clear, best practices for operating the church, Simms Showers strongly advises that a church revise its constitution or bylaws, or both, at the time of incorporation. Moreover, some revisions of the constitution and bylaws can be contentious, but incorporation provides an excellent reason to finally solve these problems. The organizational meeting provides a good easy opportunity to adopt these new governing documents.

Do most states require an annual report after a church is incorporated?

•  Yes. Every year the SCC will mail to your registered agent an annual-report form containing the name and address of the corporation, registered agent’s name and address, and the names and addresses of the directors. Updates to the information on record of the church can be made at that time.

Is there an annual fee to keep the corporation’s status active?

• Yes. Currently, the annual fee to remain active with the SCC is $25 in Virginia and many states. This fee is submitted along with the annual report form by the registered agent.

What is the best way to introduce the new members’ covenant or statement for members of the old unincorporated church?

•  While church covenants or applications that each member signs are optional to legally enforce risk-management provisions, such as biblical conciliation and church discipline, it is best to get all members to sign the document of how we will live together as a body of believers. It is best to treat the organizational meeting as a charter celebration and have the members sign the members’ covenant as “charter members.” The more positive the process and celebration, the easier it will be received. Also, explain that the 21st century brings new challenges and risks, and the new bylaws and member covenants will best meet the increasing 21st-century risks of the church. We have developed a sample letter for our clients to accompany the new constitution and bylaws that can be tailored for the pastor or church leader to sign and be made available to church members to explain why the church is incorporating, changing its constitution and bylaws, and having a members’ covenant and other legal requirements.

Do we have to change the legal documents (deed, mortgages, bank accounts, etc.) after we incorporate our church?

• Yes. When a church incorporates and becomes its own legal entity, trustees are no longer required for church corporations to hold, manage, buy, sell, encumber, or transfer real property and court appointment of such trustees are obviously no longer required. Thus, upon incorporation being finalized (bylaws and constitution revised and organizational meeting held), court-appointed trustees may now transfer real and personal property to the new incorporated church without the need for court approval by simply sending a gift deed for recordation or letter to transfer property to the clerk of the county court where the property is located with instructions to transfer to the new church corporation. See state law for further instructions or contact a knowledgeable church-law attorney to help in this process. Beware, however, that the signing trustees are properly appointed by the church and approved by the court and empowered by the unincorporated association through minutes to transfer the property to the new church corporation to be accepted by the president or secretary of the new church corporation. Of course, if there is refinancing or other property issues involved you may want to use the court to approve the transfer, etc.

Is there a detailed process concerning transferring property from the unincorporated association to the new church corporation and is it necessary?

• The basic reason is to more fully protect the property and church with the corporate shield. Of course, for more protection many larger churches with net assets worth more than $1 million are creating property-holding corporations or companies with the church being the sole member to separate its major liabilities from its major assets. (See Church and Nonprofit Affiliates and Subsidiaries legal memo for further information.) Here is the basic church gift-deed process:
• If the trustees have been court approved (signed court order proving appointment) and willing and able to sign the gift deed, then the members resolution authorizing these trustees to transfer to the new church corporation is all that is needed for the gift-deed authorization; however, if the trustees are not approved or are no longer living or in the area, able and willing to sign the gift deed, then new trustees must be appointed by the church (consistent with the number under the association bylaws) and then a petition and order filed with the court authorizing their appointment and approval to transfer property.
• Once that is accomplished, one has to research the deeds and land descriptions with the tax-identification numbers to begin to draft the gift deed or deeds (although it is not needed under the law, the church needs to make a decision on whether to notify the bank of the transfer).
• After the gift deed, or deeds, is drafted, then the trustees have to sign and get notarized and have the church chairman or president accept the gift.
• Then the signed and notarized gift deed gets recorded at the county courthouse either by the church or our firm and returned for the church and us to keep a filed recorded copy of the gift deed.
• Obviously, the cost depends on how much has already been done and how many parcels the church has along with how much title research we must do. A simple gift-deed process for one parcel with the resolution and church recording the gift deed generally runs around $500 an hour, but if one has to do the entire process including the petition and order, drafting and filing, or multiple gift deeds, the cost could rise considerably.

Will church incorporation require the church to file for 501(c)(3) tax-exempt status?

• Absolutely not. Churches that meet the requirements of IRC section 501(c)(3) are automatically considered tax exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS. See IRS Publication—Churches and Religious Organizations Benefits and Responsibilities under Federal Law at http://www.irs.gov/exempt. Although there is no requirement to do so, some churches seek recognition of tax-exempt status from the IRS because such recognition assures church leaders, members, and contributors that the church is recognized as exempt and qualifies for related tax benefits. For example, major contributors to a church that has been recognized as tax exempt would know that their contributions generally are tax-deductible, but vendors and government grant officials may want to see an IRS tax-exempt-determination letter.

How does a church get started with church incorporation, how long does it take and cost?

• First, we have a new church or nonprofit entity client fill out the Church Incorporation Questionnaire and Retainer and submit it, along with the requested documents, both in hard and electronic copy, to Simms Showers LLP. Presently, churches and denominations or associations who are existing clients receive a reduced fixed fee, while other churches will pay slightly more, plus a filing fee and optional costs for the entire package. The entire process normally takes two-to-four months, but it can be expedited in emergency situations or can take longer if the church needs more time to work the acceptance process for the new constitution and bylaws, etc.

Should we separately incorporate more risky ministries, such as childcare operations, schools, motorcycle clubs, social or community service, or camps associated with the church, or separate our valuable property assets from our operations liabilities?

• While this is beyond the scope of this article, and the author has written extensive articles on this complex question and these subjects, it is generally prudent in the 21st century to separate your major assets from your major liabilities. But you also have to decide whether you would file it as a separate tax-exempt entity with its own 501(c)(3) status or whether it would come under the church’s automatic tax-exempt status through a sole-member nonprofit LLC or integrated auxiliary of the church. Moreover, you have to also think of the practical aspects of running multiple organizations with different boards, financials, and corporate or tax-exempt status.

 

Conclusion

Incorporation provides a great opportunity for churches to revise, update, and make its constitution and bylaws legally compliant, more workable from a governance point of view, and better manage 21st-century risks. The entire process involves gathering documents and information to draft and file articles of incorporation, obtaining the certificate of incorporation, serving as registered agent, revising the constitution and bylaws, and working to tailor such documents to church needs, drafting the Members’ Covenant, helping church leaders with the approval process up to and including the organizational meeting, providing a sample agenda and minutes for that important meeting. Churches need knowledgeable attorneys who understand the nuances of tax-exempt law, church law, and other related religious nonprofit law to be able to tailor their bylaws and policies and set the organization up correctly for the present and the future. Local attorneys, attorneys in your church, or friends with your congregation are generally not able to do these tasks or understand the nuances of this complication and complex area. It is not what they know that hurts you, but what they do not know about this area.

 

Reprinted from “Nonprofit and Church Legal Trends,” September/October 2010 edition, with permission.