The International Journal
of Not-for-Profit Law

Volume 12, Issue 3, May 2010

Georg von Schnurbein1 and Daniela Schönenberg2

Associations and foundations are typical legal forms of Civil Society Organizations (CSOs) in Switzerland. During the past years, several transformations of associations into foundations can be observed. This study analyzes the legal and managerial aspects and consequences of CSO transformations. It highlights the differences in the governance structures, and displays the changes in terms of members’ rights, control, and accountability. The managerial analysis gives a preference to the foundation governance structure according to coordination, decision-making, and innovation.

Introduction

In Switzerland, associations and foundations are the most common legal forms of civil society organizations (CSOs). Under certain conditions, both are CSOs. However, there are considerable differences between these two legal persons under legal and managerial governance aspects. Although the choice of the legal form is of long-term influence, it is rarely done based on strategic considerations. Often, the choice is mainly influenced by reasons of practicability, costs, or habit. While the organization develops, the legal form might become inappropriate or even restraining. However, if a CSO changes its legal form, some legal constraints have to be taken into account. From a managerial perspective, the changes in the strategic management of an organization have to be respected.

Until now, the literature has put an emphasis on analyzing the influence of different governance structures among profit, public, and nonprofit organizations (NPO) (Eldenburg and Krishnan, 2003). While the differences between these varying legal structures can be demonstrated, less knowledge has been gained about the differences within legal forms of nonprofits. This article analyzes the reasons for and the consequences of CSO transformations in the Swiss context. In Switzerland, a trend of transformation of associations into foundations can be observed (von Schnurbein, 2008). Employment in foundations grew much more than in associations. This extreme difference cannot simply be explained by the growth of the foundation sector during the last years. The other reason is the shift from associations to foundations through legal transformation. Hence, our research question focuses on two major aspects: What are the legal and managerial consequences of CSO transformations for the governance structure?

Legal differences and reasons for CSO transformations

The study is based on theoretical considerations from literature reviews and the analysis of Swiss law. It is an interdisciplinary paper where legal and managerial aspects are taken into account. The article is enriched with results drawn from different case studies of CSO transformations in Switzerland.

Under Swiss law, associations and foundations are both legal persons regulated in the Swiss Civil Code (CC). However, there are quite significant differences (table 1). Associations are corporate entities whereas foundations represent establishments.

Associations are constituted by owners of fractional interests in the entity’s assets (members) who have decision-making power. The articles of association may be changed in the general meeting.

Foundations are legal entities constituted by a founder by dedicating the assets to a particular purpose (art 80 CC). Modifications of the organization and the purpose of the foundation can only be made under certain conditions (art 85 et seq. CC). Foundations have no members but do exist exclusively of legally independent assets. Foundations are set out with its own governance bodies, i.e., the foundation board. Foundations are in contrast to associations subject to supervision by a public authority.

Table 1: Differences between associations and foundations under Swiss law:

	Association	Foundation
Legal person	Corporate entity	Establishment
Member	Juristic persons or natural persons as members	No members
Alteration of the will	Will may be altered by the members	Will may not be altered
Change of articles	Articles of association may be changed by the general meeting	Articles may be changed by the founder under the conditions of art 86a CC
Liquidation	Association may be liquidated through a decision of the members	Association may not be liquidated through a decision of the founder or the foundation board
Reassignment of assets	Not possible because of tax reasons	Not possible because of regulations in the CC
Supervision	No supervision by a public authority	Supervision by a public authority

There exist considerable differences between associations and foundations with regard to members and the decision-making process. An association that transforms into a foundation tries to benefit from the advantages of the newly chosen legal form. There are various reasons that can move an association to transform into a foundation, e.g., because of the desire for independence (ZEWO3), governance (Brot für alle, Freunde der SOS Kinderdörfer, Helsana), asset protection (Huelfsgesellschaft Winterthur), or access to new donors (Verein Kinderschutz Schweiz).

The Huelfsgesellschaft Winterthur, which has supported persons in need in the city of Winterthur for nearly 200 years, may be mentioned as an example. The association was transformed into a foundation in 2007 to secure its assets for the long term. The association worked in a similar way to a foundation by distributing assets to beneficiaries. It was difficult to engage members actively, and the benefit of the membership was restricted to the ideal support of the association. The board of directors worked independently, and was confirmed or complemented at the annual general meeting by a modest number of members. The transformation from an association to a foundation served to secure the assets and left out the possibility to make some organizational changes in the future (von Schnurbein, 2008).

Statistical evidence of the increased number of transformations can be taken from the official statistics of employment. In the period from 1995 to 2005, employment in associations grew by 3.8 per cent, in foundations by 45.9 per cent, and in the economy in general by 4.2 per cent. The development of working units4 shows even more significant differences. Among associations the number of working units decreased by 20.5 per cent, while the number of working units among foundations rose by 26.3 per cent (the general economic development rate was 0.1%). These figures allow the assumption that the growth among foundations is not only due to new establishments, as foundations usually do not employ many people. Moreover, we assume that the increase is partly a result of the transformation of associations into foundations.

Compared to establishment of a legal person, a transformation is a decision where legal and managerial aspects have to be taken into account (Nowotny and Fida, 2007). Thus, the following section analyzes the legal and managerial aspects and consequences of the transformation of CSOs.

Legal aspects of the transformation under Swiss law

The federal law on merger, demerger, conversion, and transfer of assets and liabilities (subsequently referred to as Merger Law) entered into force in 2004. This law regulates amongst other things the adaption of the legal structures of associations and foundations in connection with mergers, demergers, conversions, and transfers of assets and liabilities (see art 1 para 1 Merger Law). However, the direct conversion of an association into a foundation is not possible even though there are associations with activities similar to those of foundations (e.g., the allocation of assets for certain purposes).

The transfer of assets and liabilities from the association to the newly established foundation (art 69 et seq Merger Act) may serve as an alternative option. This transfer regards only the association’s assets and not the members’ rights. The latter exist until the liquidation of the association. As the liquidation of the association is not imperative, the association may continue to exist as a sponsor of the new foundation. However, it could lead to a factual liquidation of the association if all assets of the association are transferred to the foundation. The association’s members lose their rights with the liquidation of the association. The question then arises on how the former members may be integrated in the new structure.

The transfer contract shall be concluded by the supreme managing or administrative body of the association (see art 70 Merger Law). According to art 69 CC, this is the board of directors. If all assets are transferred, a two-thirds majority of the members of the association is needed. A re-transformation from the foundation back into the association or any other legal form is not possible.

It may be seen as a positive aspect that, due to the new governance structure, the foundation could gain independence from the democratic structures that dominated the member-based association. In a foundation, the duties are concentrated on fewer persons as the organs of a foundation are usually smaller, and there are no members with a right to participate. The board of a foundation has the decision-making power. Therefore, higher flexibility in the management of a foundation may be achieved as there are no changeable wishes of members that must be respected; thus, long-term planning becomes easier.

The downside of this transformation may be seen in the fact that, because of the absence of members in a foundation, there is no possibility to integrate donors directly into the legal person. Furthermore, the purpose of a foundation as set forth by the founder is, in principle, fixed and cannot be modified after the establishment of the foundation. This inflexibility may be seen as a disadvantage to a CSO, which should be adaptable to new trends.

In the following section, the legal consequences of the transformation are analyzed with regard to members’ rights, control, and accountability before and after the transformation.

Members’ Rights

As mentioned above, the main difference between an association and a foundation is that the former has members whilst the latter does not. The question arises how the former members’ rights might be preserved after the transformation of an association into a foundation. This section (i) outlines what rights the members have in an association; (ii) discusses whether former association members may be regarded as founders of, and therefore exert influence on, the new foundation; (iii) tackles the possibility of former association members, or some of them, being appointed to the foundation council; and (iv) discusses possible ways through which former members may be protected.

1. An association has at least two organs: the general meeting (art 64 para 1 CC) and the board of directors (art 69 CC). The general meeting has different indefeasible competences (e.g., the authority to change the articles of association, supervision authority, and the right to recall the board of directors). Thus, the general meeting may change the articles of association in order to adapt to changing circumstances.

In Switzerland a lot of associations do exist. They are, for example, used for sports clubs and choirs. The members have the right to administer the association and use its assets. However, the members also have the right to be protected. Art 75 CC protects the legality of corporate life: Each member shall be entitled by force of law to challenge in court, within one month of his having gained knowledge thereof, resolutions that he has not consented to, and that violate the law or the articles of association.

The Swiss NPO Code5 is devoted to safeguarding the interests of association members. According to § 7 para 1 of the Swiss NPO Code, all members are entitled to voice their opinion on the items on the agenda, and to exercise their corresponding right to vote on the occasion of the general or delegates’ assembly. However, it has to be mentioned that the protection of members’ rights under the Swiss NPO Code is not as broad as under the Swiss Civil Code since the Swiss NPO Code is only subject to the rule “comply or explain.”6 If an association does not adhere to a regulation laid down in the Swiss NPO Code (if this is possible under the Swiss law), it has to be publicly and clearly justified.

2. May the former members of the association exert influence on the new foundation? May they, for example, modify the purpose of the foundation? There is a difference between if the association as a legal person acts as founder and if its members become the founders of the foundation.

Since the revision of the Swiss foundation law, there has existed a new art 86a CC (in force since 1 January 2006), according to which a founder may request for modification of purpose. However, according to art 86 para 3 CC, if the foundation is a legal entity, the right to modify its purpose lapses, at the latest, upon the expiration of 20 years after its establishment. If several persons have established the foundation, they may only jointly request modification of the purpose of the foundation (art 86a para 4 CC). If the association as a legal body is the founder, it may request modification of purpose. However, it should be kept in mind that the association should not be liquidated after the transfer of assets to the foundation, as otherwise nobody may claim founders’ rights. If the founders are the former members of the association, the modification of the purpose of the foundation will often fall short of the required unanimity in art 86a para 4 CC, especially if there are a large number of former members. Based on these considerations, it makes sense that the association becomes the founder, as the decision-making regarding the modification of purpose may be made with a quorum other than unanimity.

3. As the association’s members cannot become members of the foundation (because the foundation does not have members), the question arises whether the former members may have influence on the foundation in another way. Is there a possibility for them to be entitled to a seat in the foundation board?

To start with, it has to be mentioned that the foundation board – in contrast to the members of an association – does not have any influence on the formation of the will of the foundation. A foundation is not able to form a will, as it is bound to the will expressed by the founder upon the formation of the foundation. However, the foundation board has discretion, within the foundation’s purpose, on the fulfillment of its tasks. If the purpose of the foundation is broadly formulated, the foundation council has greater discretion.

The founder, i.e., the association or the former association’s members, has the right to name the first foundation board members in the deed of foundation or regulations, and to regulate the appointment of their successors. There is a possibility to appoint the former association’s members as members of the foundation board. The members may be appointed for life. Nevertheless, it becomes problematic if a plurality of former members claims a seat in the foundation council. Although the size of the foundation board is not regulated under Swiss law, its ideal size results from the function of the foundation board as supreme leading organ. Baumann (2009) determines that, for the purpose of efficiency, small and medium foundations should have at least three and a maximum of five members in the foundation board, and big foundations at least seven and a maximum of nine members. The former members would have the chance to become a member of the foundation board, one after another, if a limitation on the mandate is introduced and the procedure on the appointment of successors is regulated.

4. The Swiss NPO Code protects the former members and co-founders, as well as donors/sponsors as they support the foundation financially without getting the rights of the members of an association. According to § 11 para 1 of the Swiss NPO Code, full disclosure in the form of a business report is required in order to inform co-founders and donors/sponsors of the use of their contributions; they are to be granted information on the development of the organization and the strategic management-body’s business policies. According to the commentary of the Swiss NPO Code, the willingness to engage in a dialogue should be encouraged with this regulation. Former members of the association have another right, according to § 12 para 2 lit. h Swiss NPO-Code: The members of the council of governors have to keep all members regularly informed, ensuring transparency concerning the use of funds.To conclude, in comparison to an association, a foundation has no members. With the transformation from an association to a foundation, the members lose all their statutory rights. The former members of the association may still have a certain influence on the foundation. On one hand, they have as founders (i.e., the association or the former members of the association) the right to modify the purpose of the foundation. On the other hand, the former members may take a seat in the supreme corporate body of the foundation, which may have discretion in the implementation of the purpose of the foundation. The Swiss NPO Code grants the right to information regarding the foundation to the former members of the association. However, under certain conditions, this right does not have to be respected. In addition, the greater the number of members, the more difficult the division of founders’ rights becomes. Thus, in many cases the association is not liquidated but remains as a donor club with close connection to the foundation. With all this said, it has to be stressed that the former members of the association have far less rights in the foundation than in the association, and lose some rights as well (e.g., the right to change the articles of association).

Control

The control of an association lies within the power of the general meeting, which is constituted by its members. The general meeting is the supreme corporate body of the association (art 64 para 1 CC). It supervises the activity of the organizational bodies and may, at any time, dismiss them without prejudice to the contractual rights of the dismissed persons (art 65 para 2 CC). The supervisory right as well as the demission right are indefeasible rights of the supreme corporate body. The general meeting may exercise control over the board of directors and dismiss the same if it is does not agree with its actions.

There is no possibility to restrain the autonomy of the general meeting to issue or amend the articles of association. The right of the meeting to change the articles of association may be seen as a certain possibility for control.

A foundation does not have members – also the founder cannot be a member – who may control the actions of the foundation’s organs. How can the former members of an association proceed against the actions and omissions of the foundation board? In principle there is no possibility to challenge the decisions of the foundation board in court. An exception is the declaration of nullity of such a decision. According to art 84 para 2 CC, the supervisory authority shall ensure that the assets of the foundation are used according to their purpose. The supervisory authority has to ensure that the foundation board does not violate the law, the foundation deed, and relevant regulations, and that it does not exercise its discretion incorrectly. The doctrine deduces from art 84 para 2 CC the right to file a complaint with the supervisory authority. The supervisory authority has to look into the complaint and grant party rights. Anyone with a close interest in the foundation has the right to file such a complaint. These include, for example, the actual and potential beneficiaries of the foundation, the founder and his or her heirs, a potential executor of the founder’s last will, as well as the organs of the foundation and its members (e.g., the overruled members of the foundation board). If the former members of the association are not the founders of the foundation, members of the foundation board, or potential beneficiaries, there is no possibility for them to file a complaint with the supervisory authority. They only have the right to report their observations to the supervisory authority, according to art 84 para 2 CC. As this is not a proper legal remedy, they do not get party rights, nor is there a possibility for them to appeal against a possible negative decision of the supervision authority.

It is possible to give the former members of the association the right to dismiss the foundation board to assure their influence on the foundation. The foundation deed or regulation may provide for a regulation stating that the foundation board or third persons may dismiss members of the foundation board.

There is a difference between an association and a foundation with regard to the separation of powers. The separation of powers is a crucial element of the Swiss NPO-Code, which states in it § 6 that strict separation has to be observed between individuals serving in the strategic management body and those serving in an operative management capacity. § 10 Swiss NPO Code is devoted to the separation of responsibilities with regard to the foundation. It is possible that the council of governors assumes both the function of the highest governing body as well as of the strategic management body. If the foundation board has such double function, it has to ensure full transparency with regard to how this double function is carried out (see § 10 para 2 Swiss NPO Code).

To sum up, it may be stated that state control through the supervision authority cannot be compared with the control exercised by the members in an association. First, the former members have only, under the above-mentioned conditions, the possibility to do something against the acts and omissions of the foundation organs. Second, state control takes place retrospectively. The supervision authority will hardly be able to impede imminent misuses in time. Thus, granting the former members the right to dismiss those members of the foundation board who do not fulfill the expectations should be considered. The separation of powers between the strategic and operative management bodies does not go as far in a foundation as in an association.

While the exertion of control through members offers democratic legitimacy towards the public, the state supervision of foundations ensures an independent control mechanism. As accountability is becoming more and more important today, independency of supervision is rated higher than democratic legitimacy.

Accountability

The members of the board of directors of an association and the members of the foundation council are binding as bodies of the legal entity through the conclusion of legal transactions as well as through their conduct otherwise (directors’ and officers’ liability) (see art 55 para 2 CC). Furthermore, persons in acting positions shall be personally liable for their fault (art 55 para 3 CC). Therefore, the liability of the above-mentioned persons for culpable action is not excluded. Art 55 para 3 is not an independent liability rule; for example, the conditions in art 41 of the Swiss Code of Obligations for general liability in tort have to be fulfilled. The board of directors has the right and the duty to attend to the affairs of the association, and represent the association in accordance with the activities conferred to it under the articles of association (art 69 CC). It is responsible to the general meeting (see art 65 para 2 CC).

The board of directors of the association are not only liable to the members of the association and third parties but also to the association itself. In the latter case, a member of the association may file an action against the association and claim for payment to the association. This claim may only be made if the members of the board of directors did not file the action. The association may discharge the members of the board of directors from liability. With this procedure, the association renounces making a claim during a certain period of time. The discharge is only valid for facts that are known at the time of the resolution. The right to claim of members that did not agree expires upon six months after the resolution (in analogy to the right to claim in corporations). The resolution with regard to the discharge does not have external effects. The creditors’ rights to claim will not be restricted.

The foundation board may become liable to the foundation as well as to third parties (beneficiaries and creditors). In principle, the foundation and the supervision authority (but not the beneficiaries) are authorized to file an action. The enforcement of such rights often fails for lack of interest among the members of the foundation board. Due to the fact that a foundation does not have members who take care of the interests of the foundation, the supervision authority has to enforce the claims. In foundation law, there is no possibility for either the supervision authority or anybody else to grant the foundation board discharge from its liability (Sprecher/von Salis-Lütolf, 1999). Although this is mentioned in § 9 para 2 lit. e Swiss NPO Code, there is no possibility to give discharge to the council of governors.

A question arises concerning to whom the foundation board is responsible. A foundation may be responsible to the beneficiaries, to the supervisory authority, or to its donors. In practice, nonprofits have a tendency to report primarily to their donors (Callen, Klein, and Tinkelmann, 2003). To secure their donors, foundations often create complementary donor clubs that “copy” the principles of associations but without the democratic influence on the organization’s activities.

In conclusion, we can say that, in contrast to the law of associations, foundation law does not recognize the possibility to give discharge to the foundation board. Discharge may only be given to a board of directors of an association with regard to the association, but the board of directors remains liable with regard to third parties if certain conditions are met. While the members of an association may enforce their rights, comparable claims in a foundation can only be made by the supervision authority.

Managerial consequences of the transformation

The legal aspects of the transformation are concentrated in the process of transferring assets and liquidating the association. However, from a managerial perspective, the differences in the governance structures and the coordination before and after the transformation are of special interest. Usually, the operations and external perception of a transformed nonprofit do not change considerably. However, on the strategic level extensive differences can be observed. Schwarz et al. (2005) differentiate five management tasks of nonprofits, which comprise the structure that will be used for our analysis: organization, leadership, decision-making, coordination, and innovation.

Organization

As mentioned before, members are a constitutive criterion of associations. The members execute various roles within the association (Schwarz, 2005). First, they are the constitutional body of the association, and they contribute financially to the association through member fees. Second, the members invest time as volunteers, and members of boards and advisory groups. Third, the members profit from the services of the association and might profit from special conditions. Thus, the members are, at the same time, a legitimating body and primary beneficiaries of the association. This constellation is not possible in a foundation, which has no members at all.

The foundation is an independent organization that is structured centrally. A foundation can be a member of an association or a federation itself. However, federal structures beyond membership have to be organized via contracts. Most importantly, regional or local organizations cannot become members of a national organization that is a foundation. Apart from drafting contracts, another solution is to guarantee the regional units a position in the board. However, this limits the board’s capacity to act independently. Moreover, there are no direct possibilities for the beneficiaries of a foundation to participate in decision making.

Leadership

Democratic elections are the primary means of leadership enactment in associations. In federal structures, a stepwise procedure assures the legitimacy of the elections at all levels. Regional units elect their delegates, who vote for the members of the board of trustees. Finally, the board of trustees elects the CEO and the board of directors. At every stage, the voting organ is afterwards in control of the elected organ. Member fees are another instrument of leadership enactment. If the members are unsatisfied with the association’s leaders, they can express their complaints by leaving the organization (Hirschman, 1970). If this happens significantly, the association’s leaders will have to react. A notable example in Switzerland was the dispute between Swissmem, the trade association of the metal industry, and economiesuisse, the umbrella organization of the Swiss economy in 2006. Swissmem, the biggest payer of fees to economiesuisse, threatened to leave the organization because it was unsatisfied with the latter’s policy. After several negotiations, Swissmem remained a member but with a reduced membership fee; in addition, the president-elect of economiesuisse lost his post in the following elections.

Decision-making

The decision-making process in associations is shared by organs on several levels. In reality, the absence of participation of a major part of the members and the high influence of the elected boards tips the association away from democracy and creates a tendency towards oligarchy. In contrast, a foundation is per se an oligarchy, and decisions are taken independently and by one board. Thus, the decision-making in foundations can be realized more easily and more quickly. This is because, one, the foundation’s board recruits its members mostly through co-optation, thus reducing the danger of fragmented boards because the existing board members vote for people like themselves; and two, foundations do not have to ask for legitimacy as long as they follow their stated purpose.

Coordination

Coordination encompasses the planning, quality management, and accountability of an organization (Schwarz, 2005). Strategic planning does not only mean goal definition but also the strategic coordination of planning in general. In the legal section, it became evident that associations can change their statutes and purpose at any time on the basis of members’ votes. This allows them to react to changes in their environment. However, the purpose of a foundation basically cannot be changed. It can only be interpreted, but it remains rather inflexible. Thus, through the transformation the organization takes a decision with long-term consequences.

The major difference in the accountability of the organization is the change from membership supervision to state supervision. The supervision of members has a reputation for amateurism, and growing regulations are leading associations into external revisions. State supervision offers an independent opinion, which is dominantly reduced to formal and legal aspects.

Innovation

Innovation is oriented toward organizational development and the ability to implement organizational change. In associations, two ways of development are possible. On the one side, innovation can start at the top level of the organization, initiated by the board of directors or the board of trustees. On the other side, the members can develop innovative ideas and bring them into the organization. Thus, the active participation of the members is a stimulatory element of organizational development. On the contrary, the members can consequently prohibit innovation and make organizational development impossible. In a foundation the board has much greater assertiveness and can easily implement change processes. However, the foundation lacks the innovative potential of member participation. Thus, organizational development is always a top-down process.

To conclude, the advantages and disadvantages of the transformation from an association to a foundation have been analyzed from a managerial point of view. The foundation has an advantage in having lean structures and smaller human resource requirements. On the one side, in times of decreasing voluntary action, foundations have a strategic advantage. On the other side, they are lacking subunits where interested and engaged members can gain their first experiences in voluntary boards. Foundations have the potential to make and implement decisions faster than associations can.

In contrast to the tedious and sometimes uncontrollable democratic processes of associations, the management of and coordination within foundations are better organized. Nevertheless, in practice there are many foundations with encrusted structures and old-fashioned management concepts. One reason for this might be that foundations do not feel external pressure to change, even from their members.

Conclusion

The main legal differences between foundations and associations lies in the fact that foundations have no members, have no influence on its purpose, and are under state supervision. If an association is transformed into a foundation, the crucial question arises of how the rights of the former members of the association may be respected in the new structure and what the effects on the control and accountability are.

There may be various reasons for a transformation (e.g., due to governance considerations). Due to the fact that there is no possibility to change an association directly into an association, one has to make the detour of transferring the association’s assets to a newly founded association.

In transforming an association into a foundation, the advantages and disadvantages of the different legal forms have to be kept in mind. Every foundation that wishes to be transformed should analyze carefully if its intended goals can really be achieved. All the same, foundations are becoming more attractive, and there have been more transformations observed recently. There are differences as well between foundations and associations under a legal and an economic point of view. In most cases, these differences do not have any effects on the business operation as the transformation seldom attacks the character of an organization. Hence, it seems reasonable to allow the direct change from an association to a foundation without having to take the detour of transferring assets. Such a possibility would fulfill the need of an association with tasks similar to that of a foundation (e.g., associations with a fairly small number of members, which distribute their assets to beneficiaries).

Considering the legal restrictions of a transformation, Riemer (2001 and 2003) would appreciate the possibility of a direct change from an association to a foundation in art 54 para 5 of the Merger Law. In his view, the argument of the members losing their rights is de facto not valid. From a managerial perspective, the relatively small impact of a transformation on the organization’s operations and external appearance simplifies the realization.

The managerial analysis shows that foundations have some advantages, especially in terms of decision-making, coordination, and innovation. However, the implications for the strategic level are not trivial. Hence, a transformation has to be well planned and executed in order to avoid problems in the structure of the foundation later on.

Notes