The International Journal
of Not-for-Profit Law
Volume 3, Issue 2, December 2000
Non-Commercial Organizations Law Signed into Law
By Gerald Lorentz
ICNL Project Director for Central Asia
On January 16 2001 the president of Kazakhstan, Nursultan Nazarbaev, signed into law legislation on non-commercial organizations. The new Law of the Republic of Kazakhstan “On Non-commercial Organizations”, (hereinafter referred to the as the “NCO Law”), is one of the few laws of Kazakhstan that was initiated by Parliament. The genesis of the law began in 1998 with the ICNL facilitated creation of an unofficial working group of lawyers, NGOs and parliamentarians. The drafting process of the NCO Law was initiated in 1999 by a group of deputies within Parliament and in turn submitted to the lower chamber of Parliament January of 2000. The drafting of the NCO Law was an open and transparent legislative activity. Public comments were solicited and accepted from a number of sources and a public hearing was conducted to allow NGOs to present testimony.
Before the adoption of the NCO Law a few provisions in the Civil Code and some specific laws such as the 1996 Law on Public Associations, 1996 Law on Political Parties, and the 1993 Law on Trade Unions primarily regulated specific areas of non-commercial activity. The NCO Law creates a more developed and detailed environment for non-commercial organizations in Kazakhstan.
There are no provisions in the NCO Law that will necessitate NGO’s or non-commercial organizations to re-register or amend their bylaws. The NCO Law may be described as a “framework act” governing non-commercial organizations rather than a law creating a new regulative regime. This NCO Law, unlike the Civil Code, clearly defines and differentiates Foundations from Public Associations and describes various types of foundations.
Of particular note in the new NCO Law are exemplary provisions that define non-commercial organizations in terms of goals rather than types of activity, prevent the misuse of property or funds of a non-commercial organization upon liquidation, and adequately detail conflict of interest rules that non-commercial organizations must follow in order to prevent misappropriation of property or funds by either the members or management.
I) The Bill on Non-Business Corporations is Passed at First Reading
By Alexander Vinnikov, Legal Advisor
Counterpart Alliance for Partnership, Kyiv
On October 19, the Verkhovna Rada (Parliament of Ukraine) adopted the bill on Non-Entrepreneurial Organizations at the first reading by a vote of 242 to 208. The October 19 vote was not final, and some amendments may be made before the bill’s passage. However, these amendments are unlikely to change the basic structure of the law.
The bill is consistent with the Ukrainian Constitution and the draft new civil code. It makes significant progress in the Ukrainian legal framework for NGOs as well as in expertise and lobbying by domestic NGO and foreign donors. The major innovations of the bill are the following:
- A definition of non-business activity that equates the term with activities that aid in securing personal rights. This is an improvement over former drafts, which listed specific activities or secured only membership rights.
- A distinction between public (PBOs) and mutual benefit organizations (MBOs). Such a clear division is novel for Ukrainian NGO legislation.
- An allowance for both domestic and foreign legal entities to become founders or members of Ukrainian NGOs. This right was formerly restricted to charities and associations of NGOs.
- A reduction of the minimum number of founders required: two founders for associations and one founder for a foundation.
- A regulation concerning the creation of a foundation via a will. Previously a Ukrainian NGO could only be established inter vivos.
- Establishment of the Ministry of Justice and its branches as the single registration body for NGOs.
- Clearer procedures for registration and appeals for refusal of registration.
- Reduction of registration fees (a five-fold decrease for foreign and international NGOs).
- A detailed list of documents and information to be included in the register and a guarantee of the public’s right to access this information.
- A definition of “stakeholders” and procedures for preventing conflicts of interest and eventual penalties, including joint and several liability of the board members for any damages caused by the NGO.
- Permission for NGOs to engage in business activity. There are some restrictions for public benefit organizations: PBOs may engage in related business activities only if they are consistent with PBO statutory objectives, and unrelated business activities may be carried out only through wholly-owned subsidiaries of the PBO. These restrictions do not apply to the activities of MBOs, though it is implied that the activities must be related to the provision of services for the MBOs’ members.
- Endowments. The legal possibility of establishing an endowment is implied in the legislation. However, this provision must be amended to be applicable to founders. At the present time, its major requirement is establishes the minimum capital for such institutions (equal only to 300 USD, just like for business companies with limited responsibility).
- Stricter requirements for reporting and audits. Internal audits are compulsory for all NGOs and the members have the right to access any financial information. An external audit is also permitted.
- Clarification of the non-distribution requirement. The bill clearly demands prohibition of assets or dividends distribution between members and their affiliated persons and creditors.
NGOs and legal experts in Ukraine will continue to discuss the bill and submit suggested amendments to Parliament.
II) Analysis of the Regulation on Social Order of the City of Odessa
By Caroline Newman, ICNL
On August 10, 2000 the city of Odessa adopted a regulation on social order . This is the first regulation of its kind adopted in the Ukraine. The adoption of this regulation will enable the municipality of Odessa to continue providing essential social activities at a lower cost thanks to the efficiency and flexibility provided by the non-commercial sector.
As in all of the Ukraine, the non-commercial sector is currently mainly funded by foreign donors who will at some point withdraw from the region. Therefore, this regulation will also enable the non-commercial sector in Odessa to become more self-sustainable through financing from state budget.
Delegation of social services to NGOs is a practice that is very common worldwide. The regulation complies with international good practices and could be used as a model in other regions of Ukraine. In addition, state delegation of social services is more efficient at the local level. Social problems are likely to vary from region to region, between rural and urban areas, or the types of industries in which a region may specialize. Therefore, local NGOs or community based organizations (CBOs) are more likely to identify and respond to social problems faced in the community. In addition, it is easier for a local government and a local organization to establish a relationship of trust than it would be at the national level.
A. Delegation of Social Services to NGOs
1. Advantages of Delegation
The delegation of the provision of social services to NGOs presents governments with many advantages.
NGOs are mcore efficient than government bodies as social providers. NGOs, have a more flexible structure than the bureaucrati structure of government agencies, which enables them to respond to social issues on a more spontaneous basis. In addition, NGOs, in particular grass-root organizations, can perceive social problems in a more anticipated way than would government agencies because of continuous contact with the populations they serve.
1.2. Cost Effectiveness
It is cost effective for the government to use NGOs as service providers. NGOs do not rely entirely on government money, they also are funded through private donations, membership dues, grant from other donors, and economic activities. Therefore, if the legal environment, particularly the tax legislation, enables such private incentives, the sources of funding of NGOs will be varied and state funding to NGOs to provide needed services will be reduced. In addition, when a particular social service is no longer needed, it is easier for the state to cut the funding of an NGO than to close down a government agency staffed by civil servants.
2. Methods of State Direct Financing of NGOs
As a general rule, government provides assistance to NGOs through various mechanisms, including subsidies or cooperative agreements. Procurement mechanisms are not assistance tools, although NGOs may participate in procurement tenders addressing social service.
Most Western European countries provide subsidies to finance the operational expenses of public benefit organizations carrying out activities regarded as activities the state is responsible to guaranty. As a general rule, these subsidies are provided on an annual basis by the competent ministry and are proportional to the size of the activities of the organization and the expenses incurred by the organization. In most cases, once accredited to carry out a certain type of activity, the organization is eligible to receive public funding. This is a costly financing method not all governments can afford.
An alternative is provided by the Hungarian government, which adopted a law referred to as the 1% rule where the taxpayers decide which organizations to which the government should provide subsidies from the national budget. According to this rule, individual tax payers may request that 1% of their income tax be allocated to civil society organizations of their choice (except political parties and professional unions), public benefit foundations, and/or certain cultural institutions. The individual taxpayer may designate an additional 1% of his income tax to be allocated to a church of his choice or an earmarked purpose specified by the parliament in its annual act on the central budget.
The state may also subsidize specific programs through the form of grants. The state may issue a grant to an organization on a solicited or unsolicited basis. However it is recommended that unsolicited grants be issued only for renewal of an agreement. Others should be granted through a competitive contest to ensure that the organization most deserving of state support based on of the quality of the services it provides will benefit from state assistance.
A grant is a form of subsidy, but instead of financing the operational cost of NGOs, the funds are allocated to specific programs or projects.
2.2. Cooperative Agreements
A cooperative agreement is a deeper partnership between the state and an NGO. The NGO is less independent in carrying out the activities covered by the cooperative agreement. Because both parties are involved in the implementation of the program and make decisions together as partners, the supervision by the State is closer than for regular grants.
2.3. Procurement for Social Services
States may be confronted with situations where they need to purchase a social service to address a very specific need. In this case, the state is in the position of a consumer and has the duty to find an adequate supplier, which will satisfy the demand in terms of price and quality of service. The duty of the state is to identify through a tender the cheapest provider of such a service, good or work in order to use budget finances in a responsible manner. The procurement should therefore be open to any person able to provide such service, whether this is a for-profit or not-for-profit entity or an individual.
This mechanism is to be distinguished from subsidies and cooperative agreements in the sense that the latter are used by the state to finance public benefit activities, whereas in a traditional procurement mechanism, the state is the consumer. Procurement contracts result in obtaining a final product (service or work), which is paid for upon completion. It is not possible to finance programs or projects carried out by NGOs only once they are accomplished. NGOs need advanced payment in order to implement their programs. Therefore, procurement for social services is not well suited to NGOs.
In the case of subsidies, cooperative agreements or procurement, an agreement is usually signed between both parties, which states each parties rights and obligations. The state must verify that the funds are appropriately used. In this respect, the Brazilian law on Civil Society Organizations of Public Interest offers organizations which have acquired the status referred to, the possibility to enter into partnership agreements with the state. However, in order to qualify, organizations must adopt certain rules in their charter such as the publication of financial reports and the creation of a financial oversight council.
Entities selected to fulfill these duties through any of the mechanisms described above, should be selected through a fair and transparent public contest. However, for the stability of provision of social programs, it is recommended that contracts regarding social programs or projects be renewed if the work of the implementing organization was carried out in a satisfactory manner. In addition, it is possible for unsolicited grants to be awarded when an organization submits a proposal that is of significant interest.
B. Compliance of the Regulation from the City of Odessa with Best Practices
1. Conducting of Contest
1.1. Public and Open Tender Procedure
According to the regulation from Odessa, the tender is published in the mass media and the local official gazette including all information necessary for NGOs to apply to the contest about to take place. The minimal information required in order for a tender procedure to be fair are provided in the regulation:
- Types of organizations eligible,
- Technical aspects of the project to be financed, such as the mission, activities to be carried out, and maximum amount granted.
- Deadline for the submission of the proposal.
- Documentation to be submitted for the application.
- Approximate date of the results.
It is a good practice that tenders be made public in such a way as to enable all potential candidates to be aware that a contest is about to take place. The fact that in Odessa the tender is publicized in both the official gazette and the media enables a larger group of organizations to apply. However, the regulation does not establish a minimum time period between the publication of the tender and the deadline for sending an application to the state bodies. Such a requirement would give interested organizations enough time to become aware of the contest and prepare their applications. This time period should be of at least 1 month such as is provided in the Regulation on municipal social order of the Russian city of Tomsk.
1.2. Eligible Organizations
1.2.1. Types of Eligible Entities
Non-commercial organizations are eligible for both contests established in the regulation- the “contest for social programs and projects,” and the “contest for user of social order.” With respect to the organizations eligible to participate in the “contest for social programs and projects,” it is usual in most countries that only organizations recognized as public benefit organizations benefit from state funding, when the funding is under the form of subsidies. The state recognizes these organizations as serving a mission of public service. Since there is no clear public benefit status in Ukraine, the requirement that the main statutory purpose of the organization applying to the tender be related to solving the social problem identified by the municipality ensures that the organization is the equivalent of a public benefit organization by the city’s standards and not a mutual benefit organization which could carry out the social activity as a secondary activity.
The regulation specifies which types of NGOs may be eligible in accordance with the geographical scope of their activity. It refers to regional, city or neighborhood organizations. The main concern with this provision is the so-called “status” of the organizations being a requirement for participating in the contest. The regulation prevents an organization that would operate at the neighborhood level from participating in a contest for providing services at the city level. It may well be that a neighborhood organization provide services of a better quality than a city organization and therefore the city would prevent itself using the services of such organization for the benefit of the city.
The second type of contest, which the regulation refers to as the “contest for user of social order,” seems to be a traditional procurement situation where the city is a buyer who seeks a supplier. It would be reasonable that, since these involve to a greater extent the rules of supply and demand, the contest be opened as well to commercial organizations or individuals (consultants) which may be more qualified, efficient and cost effective than non-commercial organizations.
This scenario is obviously not the case in the first type of contest referred to as the “contest for social programs and projects,” where in fact only a non-commercial organization can serve the city in solving social issues such as education and housing for the elderly. In this case, the contract agreement between an organization and the municipality to carry out such services appears more like a grant from the city with the purpose of assisting in the implementation of such activities.
1.2.2. Co-Financing Requirement
The candidate organizations should be able to demonstrate that they are responsible organizations (have fulfilled their fiscal duties) and that they can provide co-financing (the city cannot request more than 25% of co-funding). The co-financing required can originate with a sponsor or from the candidate organization’s own resources. This requirement not only enables the city to lower its costs for solving social problems- it also should facilitate community development in the city of Odessa on the one hand through sponsorship, and on the other hand through incentives for organizations to be more self-sustainable through engaging in economic activities.
Unfortunately, at the current time in the Ukraine, organizations engaging in economic activities lose their tax benefits status. Because of this, NGOs are discouraged from engaging in economic activities. The regulation from Odessa grants to organizations selected to provide social services additional tax exemptions, including from income from rent (article 7.4.) It is essential that organizations that have been contracted to provide these services not be liable to income tax on the sums allocated to the implementation of the social contract. However, organizations that provide identical services and do not benefit from a contract with the local government should not be penalized and liable to tax while they too are assisting in solving social problems of the city. Expanding these benefits to all organizations providing social services that have been identified as priority services by the city may also provide incentives for such organizations to engage in economic activities, become more sustainable and be able to contribute a greater part of co-financing with their own resources.
1.3. Selection Mechanisms
The fairness of the selection process is ensured through several mechanisms:
- The contest commission established is composed of a city official as well as representatives of the non-commercial sector. The establishment of independent commissions composed of local government representatives and representatives of the NGO sector is a good mechanism that enables a fair evaluation of the candidates and avoid that contracts be awarded on an arbitrary basis for political or personal reasons and ensure independence of this body from the municipal organs. However, it is not clear how the representatives of the NGO sector will be selected. Mechanisms should be adopted in order to avoid that the representatives of the NGO sector remain in the hands of some particular group that would not be representative of the entire NGO sector of Odessa.
- Proposals are sealed and opened at the time of the contest by the commission, preventing leakage of information about competing candidates.
- Transparent mechanisms are established. All organizations applying for a tender can attend the selection process of the commission and are even able to provide some explanation regarding their application. The final decision of the commission is described in the minutes of the commission’s proceedings, which is published in the official gazette and the mass media.
- The commission invites neutral experts, to evaluate the proposals.
- In case there is only one candidate, or all submitted proposals do not meet the minimum standards, a final decision is made only after a second tender is published giving the possibility for other organizations to apply for the contest.
However, the regulation does not provide for avoiding conflicts of interest among members of the commission. In order to ensure that the commission is effectively conducting fair evaluations, it is necessary to avoid conflicts of interest among the members of the commission. Direct or indirect interest in the NGOs applying for social order must be avoided. For this purpose, members of the commission, whether representatives of the non-commercial sector or the municipal bodies, must not participate in the selection of candidate organizations if they have a direct of indirect interest in one of the candidate organizations participating in the contest.
The regulation provides for three types of contests. The “contest for social programs and projects,” the “contest for user of social order” and the “contest for contracting local authority.” The contest regarding the contracting authority, in case several bodies are competent for the activity financed, is probably an internal mechanism of the City of Odessa. This mechanism may not be transposed to other cities.
The regulation provides in Articles 3.6.12, 3.6.14, and 3.6.23 criteria to be used to select the winning organization. Criteria such as the compliance of the proposal with the purposes, the reality of realization of the program, the economic, social and other effects of the programs, as well as the capacity of organizations are highly reasonable evaluation criteria. However, the originality of a proposal as a criterion for selection of a candidate may be dangerous. Originality may be interesting for the members of the commission but it is really the effectiveness that must be taken into consideration. This criterion is included in the “economic, social and other effects of the programs” criteria.
The contest for social projects and programs includes a two round selection mechanism. The criteria regarding the capacity of the organization is reviewed only during the first round. It might be preferable to review these criteria also at the second round when the commission is able to review the full proposal of the organization.
1.3.3. Financing of the Contest
According to the regulation, members of the contest commission are not compensated for performing their duties. However, some expenses are still related to the conducting of the contest such as publication of the tender in the mass media, the compensation of invited experts, copying expenses, and other related expenses. These expenses are to be supported by the selected organization. The problem with such practice is that when an organization applies for either the social program, project or order, they establish a budget based on the announced amount published in the tender. At this point, it is not possible to know the cost of the contest and how much will remain to carry out the social contract. This could be an obstacle for the implementation of the contract. It would be good to include the estimated sum for conducting the contest in the announcement of the tender to enable the applicants to prepare their proposal accordingly. In case the cost of the contest was higher than the announced sum, the excess amount should be allocated from the city budget.
Once the organization has been selected, a contract is signed between the parties. To ensure a real partnership between the parties, it is necessary that the terms of the contract be negotiated by both parties and not imposed on the beneficiary without its prior approval. The regulation from Odessa seems to guaranty this process since Article 4.1.3. provides that the contract negotiated between the parties is to be approved by the contest commission and then confirmed by the mayor of the city. Such a mechanism leads to the inference that this contract is the result of negotiations between the parties and not prepared in advance to be presented to the selected organization. This approach should encourage both parties to the contract to treat each other as equal partners, to evaluate the benefits for both parties and as a result a relation of mutual trust can be built from the beginning of the agreement. This trust relationship should be maintained throughout the existence of the agreement, transparency being a key element to ensure it. Article 5.3. of the regulation provides that in case of disagreement between the parties during negotiations, the conflict may be settled in accordance with Ukrainian legislation. This is rather unusual. No legal obligation is established until a contract is signed and the parties have no obligations towards the other parties until the signature of the contract. Therefore, no conflict may be settled before the contract is negotiated.
The contract signed between the parties states the rights and obligations of the selected organization and the municipal body. The rights and obligations stipulated in the regulation are reasonable with relation to funding and reporting requirements.
The regulation stipulates that any conflict regarding the validity of the contract is to be settled in the arbitrage court in accordance with Ukrainian legislation, provision which guarantees that both parties regard each other as equal partners, both liable for their responsibilities and able to protect their rights.
The contracted entity should receive the funds to which it is entitled under the agreement and according to the conditions set up in the agreement. Such requirements are provided for in the regulation under the obligation of the municipality and the rights of the organization part to the contract. The funds received from the city budget must of course be used exclusively for the execution of the contract agreement. In addition, the funds the organization committed to provide as co-financing are also to be used exclusively for the implementation of the social contract. It is a good practice that the contracted entity have the right to manage the execution of its activities independently from the state body and enter into agreements with other state bodies or private entities. The regulation guarantees, in Articles 5.1.1 and 5.2.1, the independence of the contracted organization in the implementation of the contract. It is however not clear whether the organization is entitled to the right to sub-contract with other organizations without prior approval from the municipal organs. Organizations should be free to use their funds as they wish as long as the expenses are incurred to implement the contract. Therefore they should be free to choose their sub-contractors. However, the regulation does not fully provide this freedom to the organization since the prior agreement from the municipality is necessary.
In order to ensure the transparency of activities performed by the organization, activity and finance reports should be submitted to the municipal body. Finance reports enable the municipal body to exercise oversight over how the organization uses the funds. Such reporting is required in the regulation of Odessa. However, finance reports are not sufficient to guaranty that the activities are implemented in accordance with the contract agreement. It is good practice for periodical activity reports to be required as well and disclosed to the public, who can indirectly monitor the accuracy of the reports. According to the regulation, control over the implementation of the social contract is performed by the municipal body, which may invite experts for this purpose. This may be an expensive way to control the implementation of the contract. Requiring the preparation of activity reports to be disclosed to the public may be just as efficient.
The control over the finances and activities of an organization by the government should respect its autonomy. Government supervision must be reasonable. The draft Handbook on Good Practices for Laws Relating to Non-Governmental Organizations (Discussion Draft) recommends that “reports should be as simple to complete and as uniform among agencies as is possible. There should, of course, be penalties for failing to file reports, for failing to file them on time, or for filing false reports.”
2.4. Tax and Other Benefits
The regulation from Odessa, in order to promote the participation of NGOs in social order, grants some benefits to the entities contracted as well as to sponsors to these entities in Article 7.4.
It is a good practice that NGOs providing services of public benefit be granted tax and other privileges. However these privileges should be granted to all organizations that provide public benefit services. Granting such privileges exclusively to these organizations which benefit from state funding does not seem fair to those that do not benefit from state funding and still provide the same service.
In addition, sponsors are also entitled to benefits. It is also a good practice that persons obtain tax deductions from donations to organizations providing public benefit services. However, the regulation is not clear on the type of tax benefits granted. Additional privileges on rental payment should not be granted to sponsors. Benefits granted to sponsors should be limited to tax deductions for their contributions. Again such benefits should be granted with respect to donations to any public benefit organization and not limited to organizations engaging in social contracting.
2.5. Amendments and Renewal of the Contract
The Odessa regulation provides rules to be followed in order to amend the conditions of the contract or to interrupt the contract.
Unfortunately, the regulation does not provide for the possibility to renew the contract. Some social services, such as hospitals or schools, need to be performed on a continuous basis and therefore should not be interrupted. For the stability of the provision of social services and to avoid disrupting the recipients of such services, it is recommended these services be performed on a continuous basis by the same organization, provided that this organization has met all the required criteria during the contract. It is therefore important to provide a renewal clause of the contract at the term of expiration, of course under the condition that the social service was provided in a satisfactory manner. As the quality of life improves and the quality of services improve when provided by other institutions, standards regarding the quality of the services shall be strengthened by the local authorities as a condition for renewal. The new contract may include new requirements not only to elevate the quality of the services to be provided but also in order to solve social problems identified throughout the previous contract. In the case of services needing to be continuously provided, Article 6.3. on the organization of post contract monitoring is irrelevant, in particular when the contract has been renewed by local authorities.
However, a new contest must be organized when the organization does not satisfy the requirements of the contract.
Violation of the agreement by either parties must be sanctioned. The provision does not provide sanctions for violation of the contract agreement to be contemplated in the contract. It may be possible to foresee such clauses in the contract. The regulation from Odessa provides that if the municipality violates its responsibilities, the contracted organization may use all legal procedure to protect its rights, including ceasing the court. It also provides that any conflict between the parties will be considered in accordance with Ukrainian legislation. Sanctions will therefore be applied in accordance with the Ukrainian legislation.
The mechanisms adopted in this regulation are in full compliance with international best practices. The adoption of better mechanisms for avoiding conflict of interest, for financing of the contest or for renewal of contract for essential social services would be beneficial for Odessa and for the use of this regulation as a model for other regions of Ukraine. In addition, it is necessary to make sure that the provisions referring to procurement mechanisms regarding social services do not contradict the law of Ukraine on State purchase of goods, works and services adopted on February 22, 2000.