How should we close a nonprofit that still has debts?

Building a nonprofit organization is hard work. Winding it down can be even harder. When board members of a nonprofit decide it is time to close down their charity there are many steps that need to be taken. They want to make sure that the programs they have funded will continue and that the intent of their founders is honored. They also want to handle the legal aspects properly. Several methods exist for closing down a nonprofit properly:

• Voluntary dissolution
• Court-supervised dissolution and liquidation
• Chapter 7 bankruptcy
• Receivership
• Assignment for benefit of creditors (ABC)

In practice, dissolution refers to the termination of the organization, while liquidation means selling off its assets usually to cover debts. The procedures for doing these can differ a lot from place to place. All of these options should be discussed with legal counsel.

Voluntary dissolution is a suitable choice for a charity that is still able to pay its debts or whose creditors have agreed to a payment plan. The nonprofit’s mission may continue, for example, by providing referrals to agencies who can help, or through the transfer of assets to agencies who take on the work. However, voluntary dissolution still entails several important steps. These include voting to dissolve, filing articles of dissolution with the secretary of state and carrying out a plan of dissolution. The plan also needs to cover completing final filings, notifying creditors and the attorney general, paying off all creditors, and giving any leftover net assets to another charity. These things are commonly referred to as winding up.

Judicial Dissolution

A nonprofit can also be dissolved by court order. Judicial dissolution is a good option for nonprofits whose debts exceed their assets. It is also a good choice when there are several creditors with different kinds of debt to sort out. Unlike bankruptcy, it can leave the mission intact. A nonprofit’s creditors or the attorney general could also petition for judicial dissolution because of unpaid debts, insolvency or wasted assets. The attorney general could also seek dissolution if the nonprofit has failed to achieve its goals. For nonprofits and their board members, judicial dissolution usually ends in a quasi-discharge of the liabilities. Board members feel more confident they won’t be personally liable for the outstanding debts.

Chapter 7 is a good option for nonprofits that know they have to fully liquidate and close down. The bankruptcy trustee takes full control. So the board no longer has a duty to keep the nonprofit running. Further, the automatic stay that goes into effect can stop collection efforts by creditors. Chapter 7 bankruptcy does not discharge unpaid debts, and board members may still be personally liable for those. The corporation also still exists, even after bankruptcy; voluntary dissolution and winding-up are needed.

Receivership and custodianship also deserve discussion. They tend to be expensive and often don’t take into account the charity’s mission. Receivership and custodianship are based in state law. A receiver takes over control, judges whether the nonprofit is viable as a going concern, liquidates the remaining assets, closes the nonprofit and usually handles winding up.

ABC, also known as General Assignment, substitutes for receivership and bankruptcy. In this method, all of a nonprofit’s assets, including mission-based programs, go to a trustee. The trustee sells off these assets in order to pay the creditors. The downside of assignment is that it stops programs immediately, may be inconsistent with the charity’s mission and may involve restrictions for charitable funds. However, assignment is less expensive and faster than receivership or bankruptcy. It is also a private, non-court procedure. In order for a nonprofit to do an ABC, they have to get the state’s attorney general to give their consent. This is an important part of the process, though small-business debtor lawyers don’t always notice it right away, because the state doesn’t require attorney general consent for for-profit businesses.