The International Journal
of Not-for-Profit Law

Volume 2, Issue 3, March 2000

Introduction

This paper discusses the limitations of law as a means of ensuring good governance and accountability for not-for-profit, nongovernmental organizations (NGOs). Its analyzes the types of laws that contribute to an enabling environment for the growth of responsibly governed not-for-profit organizations, including the various types of legal mechanisms used to establish standards for conduct and fiduciary responsibility of boards and management, and for financial reporting and other accountability measures. It acknowledges, however, the limitations of the law in ensuring high standards for ethical conduct. It then suggests other means by which nonprofit organizations can provide for stronger governance and better accountability measures. The paper takes an international perspective, based on research conducted by the International Center for Not-for-Profit Law.[1]

Appropriate and necessary legal mechanisms regulating the affairs of NGOs address both internal governance and external accountability and transparency measures. Legal rules setting minimum standards for the internal governance should not only accommodate norms of transparency and accountability but also should provide specific guidance regarding the structure and operations of the governing bodies of the organization. For example, the law needs to tell NGOs that their governing bodies must have meetings to discuss their activities to ensure adequate oversight; that they should, under defined circumstances, publish annual reports; that they must meet certain minimum standards of labor relations; what they must do if their members dissent, etc. Moreover, the law has an important role to play in setting standards or guidelines – sometimes in codified law, sometimes in case law – that apply to ethical dealings by NGOs with their founders, managers, boards, etc.

In addition, the law needs to set the external reporting and other accountability standards that NGOs must meet. In that sense the law develops minimum standards that promote public confidence in the NGO sector. Although NGOs are private organizations, they frequently receive tax and other benefits from the government, which makes it incumbent on them to report to the public about what they do. External accountability standards set by law include report-filing requirements as well as publication of information about the organization and its activities.

The law must also specify the appropriate enforcement mechanisms to ensure compliance with the legal rules. Defining which is the proper agency to oversee NGO activities is an important function of the law, and the way in which that agency functions vis-à-vis the NGOs can have a significant bearing on whether the legal norms are respected (e.g., does it provide training and support as well as regulatory oversight?). It is also important for law to set out procedural aspects of oversight, including the various sanctions that apply when there is non-compliance. The law should also address such issues as when non-member private citizens have standing to complain about illegitimate actions by an NGO.

1. Integrity and Good Governance

There are several different types of legal rules for NGOs that are designed to ensure their internal integrity and good governance. In this area in particular the interrelationship between law and voluntary regulation is exceedingly complex, with various countries requiring numerous strict legal rules and with others tending to rely to a greater extent on voluntary regulation. This section delineates in particular between the rules that the laws should mandate and those that an organization may devise on its own and that will contribute to good governance.

An important aspect of the not-for-profit sector is its ability to adequately police its own activities by voluntary measures of self-restraint and internal supervision. In general the sector prefers to rely on internal supervision rather than external supervision, and it is largely successful in doing so. Strong internal reporting requirements and good governance structures that ensure appropriate dealings with the public are the principal means by which the sector develops and maintains the public trust. The law has a role to play in establishing the applicable standards, but that role is limited to spelling out a minimum set of legal requirements. These include:

1. setting out basic requirements for an organization’s governing documents;
2. delineating basic responsibilities of an organization’s governing bodies, including establishing the rules of fiduciary responsibility and establishing the rules regarding liabilities of the members of the governing bodies;
3. prohibiting conflicts of interest between an organization and those that govern it; and
4. prohibiting the distribution, directly or indirectly, of an organization’s profits except in pursuance of its not-for-profit purposes.

Other aspects of organizational integrity and good governance are the province of self-regulation and are outside the dictates of law.

Turning first to the four different aspects of what law should provide, we begin by looking at what the law should prescribe with respect to the governing documents of an organization. These are the essential elements of the contract establishing an organization. They tell the state authorities that permit the organization to become established as an entity that is viewed as separate from its founders who the founders of the organization are and what the organization intends to do. These documents also make essential information available to the persons who will become involved with the organization as donors, creditors (e.g., landlords), beneficiaries, etc. Thus, the laws governing NGOs should require that certain minimum provisions necessary to the organization, operation, and governance of the organization be stated in the governing documents of an NGO. The requirements may be different for membership and nonmembership organizations, with the latter possibly being required to have additional governing bodies (e.g., supervisory boards, audit commissions, etc.) because they do not have members.

The minimum contents of a governing documents of a NGO vary from country to country, and local tradition will play a significant role in determining what kinds of provisions must be included in the governing documents. The following items are ordinarily required by law:

• name of the organization;
• its purposes;
• address of the organization;
• names and addresses of the founders or incorporators;
• name of the general representative;
• whether or not the organization will have members; and
• provisions not inconsistent with law regarding distribution of assets on dissolution.

In some instances it may also be necessary to state what the governing bodies of the NGO are and who the initial members of those bodies will be. It may also be necessary to state how often the highest governing body (general assembly or governing board) must meet. Membership organizations are usually required to state rules for admitting and expelling members. Practices as to additional requirements vary widely from country to country.

The law should also delineate the duties and liabilities of an organization’s governing bodies and their members. In order to ensure good internal governance, the highest governing body of a NGO (or its delegate) should be required by law to have meetings periodically (some countries mandate that annual meetings be held) and to receive and approve internal reports from management on the finances and operations of an NGO. The law should also set out the fiduciary responsibilities of staff, officers, and board members of an NGO, including the duties to exercise loyalty to the organization, to execute their responsibilities to the organization with care and diligence, and to maintain the confidentiality of non-public information about the organization.

The members of all the governing bodies, but most particularly the members of the highest governing body of an NGO – the governing board or the general assembly of members — have a responsibility to ensure that the organization complies with the law in all respects. In the case of a large membership organization this responsibility of the general assembly is frequently delegated to a governing board or to an audit committee. Laws governing NGOs should also provide that officers, members of the governing board and supervisory board (if one is required), and managerial and other employees of a NGO should not ordinarily be personally liable for the debts, obligations, or liabilities of the NGO.[2] The rules applicable to NGOs in this regard should be the same as the rules for officers and board members of other legal persons. They may be provided for in a law separate from the law governing NGOs, or simply be an established doctrine in the legal system.

Although such rules are not always provided in law, it is also a good practice to have legal rules providing that founders, officers, board members, and employees of an NGO must avoid any actual or potential conflict between their personal or business interests and the interests of the NGO. Because of the many differences in the structures and activities of NGOs, and because of the innumerable ways in which individuals may be involved with an NGO and also with another entity that relates to the NGO in some way, it is nearly impossible to stipulate with specificity the kinds of conflicts of interest that should be avoided. One possible approach is to have the law prohibit conflicts of interest in general terms and allow courts to determine on a case by case basis whether there has been a violation. It would also be possible for the law to require NGOs to adopt specific conflict of interest provisions in their governing documents, in light of their particular facts and circumstances. In some legal systems the obligation to avoid or correct a conflict of interest is an established doctrine of law that has general application to anyone in a fiduciary position, and thus no special rules are required for NGOs.

In addition to these rules regarding the operations of an NGO’s governing bodies, the law governing NGOs should provide that profits of an NGO are not permitted to be distributed, directly or indirectly, except in pursuance of its not-for-profit purposes. As a practical matter this means that no earnings or profits of an NGO may be distributed as such to founders, members, officers, board members, or employees. Such a rule is important because the not-for-profit sector is distinguished from the for-profit sector by the fact that profits of not-for-profit organizations, if earned, cannot be distributed.[3] This principle — the principle of nondistribution — is the single most important aspect of the definition of an NGO.

In order to make this principle meaningful, however, it is necessary to have rules that preclude indirect as well as direct distribution of profits. In addition, to the extent that a NGO has received direct or indirect benefits from the public — e.g., donations, government grants or contracts, or tax exemption — its assets are not just private but are, to some extent, derived from public sources. Assets derived from public sources should never inure to the personal benefit of the founders, officers, board members, or employees of a NGO. For this additional reason, as well as to prevent the distribution of profits, it is necessary to have rules that implement the principles discussed here.

It is also important to have the non-distribution principle apply to the termination of an NGO. The law should permit an NGO that is being dissolved to designate another similar NGO to be the recipient of any assets remaining after the payment of all debts and obligations. An NGO normally selects an NGO organized for the same public purpose and engaged in the same or a very similar kind of activity to receive its assets upon termination and states that selection in its governing documents or in a resolution of the governing board. In the absence of any such designation and where the court cannot find an appropriate NGO to receive the assets, the assets should revert to the government.[4]

Exceptions to the general rule may apply in certain cases. For example, where the government is the founder of an NGO, the law may require that the assets revert to the government upon dissolution of the organization. Contractual obligations to donors may also require reversion of certain donated funds and assets to them. Membership organizations that never received substantial tax or other benefits from the government may be permitted to distribute assets to members upon dissolution.

Apart from these four areas in which the law must state minimum standards, it is generally up to individual organizations to set additional rules for their own governance. Of course such rules may be encouraged by umbrella or watch-dog organizations that assist the sector in achieving high standards of good governance, as discussed in section 4. Here it is important to state that laws governing NGOs should give an NGO (through its highest governing body) broad discretion to set and change the governance structure and operations of the organization within the limits provided by the law. Because organizations change and grow over time, there needs to be flexibility about matters of internal governance that do not have overarching significance for the general public. The highest governing body of an organization should be allowed, consistent with the terms of the law and its governing documents, to adopt rules, regulations, or resolutions that govern the details of the operations of the organization. These typically deal with personnel practices (apart from those required by labor codes), communications, fund raising, volunteer policies, etc.

2. Accountability and Transparency

This section considers aspects of the “life cycle” of NGOs that are related to external supervision of their activities by agencies of the government. Government agencies exercising supervisory powers include: the general agency supervising NGOs (which is generally also the registering agency — e.g., a ministry or government department, a court, or a local administrative body), special agencies that supervise public benefit NGOs (such as the Charity Commission for England and Wales), licensing agencies (e.g., health and education departments or ministries), and tax authorities. This section also considers transparency of NGO operations to the general public.

The discussion that follows recognizes first and foremost that a delicate balancing is necessary between, on the one hand, the freedom of association of the individuals who form not-for-profit associations and the freedom of expression for NGOs that engage in public policy activities, and, on the other, the need for protection of the public from fraud, abuse, and infringement of the rights of others. Accountability to government agencies has always been considered to be necessary to prevent inappropriate activities by NGOs. Some of the mechanisms designed to ensure accountability are more intrusive than others. In the first instance, therefore, the legal system should encourage self-reliance by NGOs to ensure their own internal accountability and organizational integrity as discussed above.

Inevitably, however, it is deemed desirable to create by legislation some form of government supervision of NGOs, if only to permit the government to ensure that NGOs do not violate the rights of any citizens. Thus, in addition to the internal and self-regulatory mechanisms that have been mentioned, the basic tools for achieving accountability are set out in the law. These include licenses and permits for specific activities and a variety of reports required to be filed with a variety of government agencies. These licensing and reporting obligations must, of course, be taken in the context of the need to protect the freedoms of expression, association, and peaceful assembly of the NGOs and the individuals associated with them.

In addition, the licensing and reporting requirements that are imposed on NGOs must necessarily be commensurate with the benefits the organizations obtain from the government. If, for example, an organization receives no government benefits whatsoever, including tax exemption, then reporting to government authorities should be minimal. In exchange for protection of the laws as a legal person, and the limited liability that goes along with it, an NGO must be willing to accept some reporting obligations. These may only be minimal – they may require the NGO merely to disclose to the government authorities where its operations are conducted and who the responsible persons for the organization are. This information will allow the government to ensure that the NGO is engaged in the activities allowed by its governing documents and is behaving in a responsible manner. An example of such an organization might be a social club, although in many countries such organizations do, in fact, receive tax exemption, and they must therefore make special tax filings as well.

If, on the other hand, an NGO engages in activities that touch the public in a very significant way (e.g., by setting up a day care center for small children), then it must obtain all the licenses required by a business organization, an individual, or a government agency engaged in such an activity and meet all sorts of reporting requirements to ensure the health and safety of the children. In addition, if an NGO seeks to be classified as a public benefit organization in order to obtain the highest level of tax benefits or if it seeks a government grant to support its operations, then the reporting is once again properly more burdensome. In between the two extremes described in these two paragraphs lie many different kinds of situations, and it is not easy to differentiate among them.

In general it is useful for the law to establish rules for the following aspects of NGO activities and government oversight:

1. appropriate record-keeping by NGOs;
2. adequate reporting by NGOs;
3. appropriate rules for transparency of NGO operations; and
4. rules regarding audits of NGO activities.

These different aspects of accountability and transparency are discussed in the paragraphs that follow.

1. 1. Appropriate record-keeping. NGOs should be required, as all other operating legal entities are, to keep books of account, as well as other records of their activities. These include minutes of the meetings of the organization’s governing bodies. With respect to the books of account, it is logical that NGOs must follow rules of accounting, some of which are applicable to their own special circumstances. In some countries all NGOs are required to have their accounts audited, but in most countries only larger NGOs or those with government contracts are required to do so. Experiments are presently underway to develop and test simplified methods of accounting for smaller NGOs.
   2. Adequate reporting. A variety of different types of reports are generally required to be filed with a variety of government agencies. In some cases these are specific to a specific activity (e.g., a licensed activity or public fund raising) or they deal particularly with the financial operations of the NGO (e.g., tax reports). But more general reports are often required. It would be much easier for NGOs if there could be a single and simple form of reporting for all NGOs and for all of their activities. Unfortunately, the activities of NGOs are too numerous and diverse, and the legitimate interests of the government are too broad, to make this possible.It is necessary for the laws applicable to NGOs to state clearly what organizations must file reports and with whom. In general, mutual benefit organizations that do not have significant activities that affect the public (e.g., a sewing club or a hiking club) or that do not hold significant assets can generally be exempted from reporting requirements or be allowed to file simplified reports. Small public benefit NGOs or those with minimal activities (e.g., a neighborhood cleanup organization that meets once a month) should be allowed to file simplified reports or none at all. Raising money from the public tends to generally require reporting by an organization, although the reports required may be inadequate to ensure effective oversight and prevent fraud. What the appropriate level of activity is before reports are required is a judgment to be made by the law writers in each country in light of local circumstances and traditions.

 

1. Rules for transparency. The public at large has a legitimate interest in the activities and sources of funds of NGOs, particularly public benefit organizations. In addition, when an NGO seeks to raise funds from the general public, that public has a legitimate interest in knowing how the funds will be spent. The specific legal rules adopted to implement the principle of transparency should not require large or needless expenditures by NGOs to disseminate their public reports. Some legal systems allow an annual publication in newspaper or journal generally used for publishing legal notices. Under other systems a copy of the report is filed with the supervisory agency, which places it in a public reading room, while the NGO is required to provide a copy to any member of the public who requests it, charging no more than a reasonable photocopying charge. Some legal regimes require that the minutes of the annual general meeting must be filed with the supervisory agency, which then makes them available for inspection by the public. This is probably not necessary, as long as the public can obtain information in other ways.
2. Availability of audit. Consistent with the normal government powers of inspection for all legal entities, the agency supervising NGOs should have the right to examine the books, records, and activities of an NGO during ordinary business hours, with adequate advance notice and, when necessary, on random occasions. This audit power should not be used to inhibit the freedom of association of the individuals connected with the organization nor to harass the organization. There should be protections in place to prevent the supervising organ from using the pretext of an audit of an NGO to develop information about one or more individuals or to harass the individuals or the organization. Enforcement of audit responsibilities should be even-handed and fair, but it should also be rigorous enough to reduce abuse and corruption among NGOs. Thus, it might be appropriate for the very large reporting NGOs to be audited annually. Further, as soon as the investigators have reason to believe that criminal conduct may be involved, they should be required to notify those that are the target of the investigation that it has taken on criminal overtones, so that the individual can take appropriate action to protect his, her, or its interests.In considering what record-keeping, reports, and audits are appropriate in a legal system applicable to NGOs, it is important to remember that there is an ever-present danger of over-regulation by the government, or, indeed, the use of reporting and audit requirements to harass NGOs that are critical of the government or are otherwise unpopular. There is no certain protection against governmental abuse, and it exists to some extent in every society. One of the most important reasons why every country should have sound administrative laws that permit actions by government agencies to be challenged in court, and independent judges to hear those appeals, is to provide a correction for governmental abuse and a deterrent to future abuse.

3. Enforcement mechanisms, including sanctions and private lawsuits

In addition to the general sanctions to which an NGO is subject equally with other legal persons (e.g., contract or tort law), it is appropriate to have special sanctions (e.g., fines or penalty taxes, or the possibility of involuntary termination) for violations peculiar to NGOs (e.g., self-dealing, improper public fundraising practices, special rules contained in tax legislation). In any modern legal system, where the principal method of supervision of NGOs is performed through the review and checking by government agencies of reports filed by NGOs, many of the special sanctions for NGOs relate to these reports and the supervision resulting from them. For example, the fact that the governing board of an NGO is given primary responsibility for supervising its activities means that there should be sanctions available to enforce the obligations of the board members. With respect to reports to be filed with the supervising agency, with a licensing agency, and with the tax authorities, there should be fines for failing to file a report, filing a report late, or filing a false report. The penalties should be graduated, their imposition should be subject to appeal, and, in some instances, such as where criminal sanctions apply, they should not be self-enforcing.

If an NGO fails to file the basic annual report for an extended period of time (e.g., two to three years), the supervising agency should be permitted to commence proceedings to dissolve the organization, again with adequate provision for notice, an opportunity to correct the situation, and administrative and judicial appeals. This is appropriate because it removes from the register of NGOs those entities that no longer have any functions. Of course, any step as drastic as the involuntary dissolution of an organization should not be allowed to occur until appeal rights have been exhausted or the time to file an appeal has expired.

Other government agencies with more specialized supervisory powers (e.g., an agency that determines whether a NGO is a public benefit organization or a licensing agency) should have only specialized sanctions, such as the removal of the license or the special status in the event that the NGO fails to file proper reports, etc. Violations of any criminal laws would, of course, subject the NGO (and its founders, officers, board members, and employees where they have willfully caused the violation) to criminal sanctions.

The role of private lawsuits in enforcing aspects of the rights and responsibilities of NGOs is complicated. In general, directors are permitted to sue to ensure that other directors do not allow an organization to act in ways that are contrary to its charter and that would contravene its purposes. Other parties, regardless of their interest, tend to have limited rights to go to court to compel or prohibit action by an organization. In most instances the right to bring such suits is left to an attorney for the government body charged with supervising NGOs, such as the prosecutor or attorney general. The rationale for limiting private suits against NGOs is to save them from harassment by, e.g., disgruntled potential beneficiaries. On the other hand, there have been instances in which a class of beneficiaries have been accorded the right to sue to enforce provisions in an organization’s governing documents.

4. Self-regulation

In addition to the minimum internal governance structures and standards required by law and discussed in the previous sections, NGOs should adopt appropriate self-regulation policies. In the first instance this is up to individual NGOs, which should themselves set internal standards for programs, organizational integrity, management practices, human resources policies, finances, communications, and fundraising.[5] In many countries associations of NGOs have established good practices guidelines for NGOs, which create standards that individual NGOs can look to for guidance.

In order to encourage such actions, the law should permit NGOs to form associations so that a group of NGOs will be able to form an umbrella organization to enforce standards such as those discussed here and in section 1.[6] For example, organizations operating in a particular field (e.g., social services for the elderly or environmental protection) might form an umbrella group that democratically adopts special standards (e.g., for governance, disclosure, fundraising, etc.) and requires member organizations to certify that they adhere to those standards. These are ordinarily called Codes of Conduct or Ethics, and the practice has been to use them to set out aspirational standards that member NGOs are required to meet. Other standards are set by “watch-dog” organizations, which give what amounts to a “seal of approval” to organizations seeking to be rated by them. Each of these self-regulation mechanisms is designed to enhance the regulatory mechanisms set out in the law and enforced by government agencies. Whether they actually succeed, where regulation often fails, is not easy to determine because little empirical research has been done on these issues.

In addition to setting standards, umbrella groups are often given power by their members to audit members or investigate complaints by the general public and to assure adherence to the standards that have been set. In some instances such an organization works by using certification as a means of establishing standards for its members (the carrot approach). Other organizations have the right to expel members that fail to correct noncomplying operations (the stick approach.) In practice, a combination of approaches appears to work best. By publicizing its membership (and its expulsions) as well as its standards, an umbrella organization can give added confidence to the public about the integrity and operations of its member organizations. Membership in such an organization, or lack of it, may become an important criterion in selecting an organization to receive a contract or grant. And the public may rely on the membership roster in deciding to make a donation. In the age of Internet fund raising, these mechanisms become more important as protection against consumer fraud.

Conclusion. As the foregoing discussion makes clear, organizational integrity, good governance, accountability, and transparency of NGOs cannot be promoted by law alone. Guidelines for NGOs are needed that go beyond the law and set higher standards for internal governance and external accountability. These include self-regulatory tools such as NGO Codes of Ethics or Standards of Conduct, developed and applied by umbrella or watchdog organizations, as a means by which individual NGOs and the sector generally can build capacity for self-governance. While these may not be panaceas, they are likely to supplement legal norms in a positive manner.

Notes

[1] The International Center for Not-for-Profit Law, ICNL, is the author of the Handbook on Good Practices for Laws Relating to Nongovernmental Organizations (Discussion Draft 1997), which it wrote for the World Bank. Further discussion of the issues in this paper can be found in that volume, which is available in several languages. For additional information about ICNL and the Handbook, please visit www.icnl.org.

[2] The rules applicable to NGOs are similar to the rules for officers and board members of other types of legal persons. They may be provided for in a law separate from the law governing NGOs, or simply be an established doctrine in the legal system.

[3] NGOs may have net profits from investment of their capital and from the conduct of other ongoing economic activities. If an NGO does derive net profits from an economic activity, they must be used principally for the public or mutual benefit purposes for which it was formed, and they must not be distributed to any person. Thus, it is permissible for earnings and profits from an economic activity to allow a mutual benefit NGO to provide greater benefits to its members, but it should be impermissible for any NGO to distribute profits as such — e.g., dividends. It would be permissible, of course, to use some net profits to reinvest in the for-profit activities that sustain the NGO because in that way the earnings and profits would be retained within the organization and not distributed to individuals.

[4] In many countries, a local government body is the preferred distributee in such instances.

[5] For a discussion of the types of standards that organizations should be encouraged to follow, see Working Group on Self-Regulation, Regulating Civil Society Conference, Sinaia, Romania, 1994, published in Appendix II, World Bank Handbook.

[6] Although this possibility may be taken for granted in some countries, e.g., the United States, it is not always available to NGOs in every country.