Charities and non-profits are often faced with the question of whether to incorporate. Our simple answer is this: prevention is the best medicine. While members may have the best of intentions, a lack of forethought can have catastrophic outcomes. Any charity or non-profit organization that exists as an unincorporated association is well-advised to ensure that their governance protocols are clear and should consider the benefits of incorporation. Such forward thinking will pay off in the long run.
It is not unusual for startup organizations to be attracted to the concept of an unincorporated association, since unincorporated associations require little effort to form and are less costly to run than corporations. Further, it is not uncommon for people to form an unincorporated association without even being aware of it. A group of individuals can form an unincorporated association simply by coming together and engaging in activities in furtherance of a common goal or for the benefit of an ostensibly defined group. Unincorporated associations include non-profits, such as golf clubs, social clubs, and neighbourhood associations, but can also include registered charities, comprising of members who seek to further a common charitable mission.
There are two main benefits of carrying on business as an unincorporated association: (1) their structure is flexible, as they are not governed by a statute; and (2) there are no statutory filing obligations. It is not unusual for small associations with no property to remain unincorporated for many years. However, an association that has a large membership or that wishes to generate revenue and hold property should consider incorporation. While incorporating and attending to statutory filings may appear burdensome, the efforts may be well worth their cost.
Incorporation and constating documents
Each province has its own legislation governing non-profit corporations. In Ontario, non-share capital corporations are currently incorporated under the Corporations Act (Ontario) (“OCA”). Organizations may also choose to incorporate federally under the Canada Not-for-Profit Corporations Act (“CNCA”). Upon incorporation, the corporation is established with a legal personality separate and distinct from its members. Because the corporation is its own “person” at law, directors, officers, and employees can be protected from liability. Conversely, the individual members of an unincorporated association are exposed to personal liability that may otherwise be limited if the organization was incorporated. Due to the fact that an unincorporated association does not have a separate legal personality, it cannot sue or be sued, and instead, its members must sue or be sued personally. A corporation can obtain liability insurance to protect directors and officers when an indemnity provided by the corporation is insufficient. In contrast, an unincorporated association cannot purchase such insurance because it cannot enter into contracts.
Most non-profit corporate statutes contain rules regarding a corporation’s powers and procedures. They also provide requirements for the constating documents, which establish the rights of the members and the corporation’s decision-making procedures. For instance, any organization incorporating under the CNCA or OCA must create at least two constating documents: (1) Articles of Incorporation (or Letters Patent), which set out the corporation’s general structure and purposes; and (2) By-Laws, which govern the corporation’s decision-making processes.
In contrast, because it is not mandatory, an unincorporated association must be proactive in establishing a “rulebook” such as a constitution or by-law that sets out the governance protocols for the association. For that reason, it is not uncommon for unincorporated associations to have no written constitution at all, and instead operate through a common understanding amongst its members. While such informal and oral agreements may be sufficient when all members are in agreement, they become problematic when conflict arises.
The unanimity rule: Grinding decision-making to a halt
Where an unincorporated association fails to create a governing document that sets out how decisions are to be made, lawful decision-making can be quite onerous. This is because each member of an unincorporated association, upon being granted membership, enters into a contractual relationship with every other member. Because of this contractual relationship, consent of all members is required to approve any fundamental decision since such decisions are deemed to affect the rights and obligations of every other member. This is called the “unanimity rule.” Proper adherence to this common law rule means that one member (or a minority of members) with a difference of opinion has a veto over fundamental decisions that may otherwise be approved by the rest (or a majority) of the members. As an extreme example, this can mean that should one member choose to merely not show up or cast his/her vote some other way, decision-making can grind to a halt.
As there is no governing statute that provides default rules where an unincorporated association does not have a constitution or where any approved governing document is silent on a particular governance matter, a well-drafted constitution is especially important. Organizations that choose to operate as unincorporated associations are well-advised to provide for a voting mechanism for fundamental changes so that one member cannot obstruct the decision-making of the entire group.
Property: Who owns what and when?
Most Canadian banks will open an account for an unincorporated association and require only that the association provide documentation disclosing who has signing authority on behalf of the association. However, banks will not review the association’s constating documents with a fine-tooth comb to make sure that members have adequately provided for procedures with respect to property. Therefore, circumstances can arise where an association holds property (i.e. cash in a bank account), but has not established an agreed upon process for how to manage it.
Unlike the members of non-profit corporations, the members of an unincorporated association jointly own its assets, but unlike the shareholders of for-profit corporations, their share is undivided. This means that the members of an unincorporated association have an interest in the property, but once they cease to be members, that interest reverts to the association. In this way, the property exists separate and apart from the members who own it. Therefore, without a clear voting mechanism on how to deal with property, a majority of members of an unincorporated association cannot divert the property of the association from the purposes that have been proclaimed in its constitution (if any) against the wishes of a minority (or even one) of its members.
A provision for what happens to the unincorporated association’s property on dissolution is just as important as a voting mechanism to deal with such property. When constating documents do not provide for a dissolution procedure, a unanimous resolution of the members is required to approve the dissolution of the association and the manner in which its assets are distributed. The members may wish to distribute the assets to one or more charities or associations with similar purposes. However, as mentioned above, one member could prevent the others from doing so if a constitution is non-existent, does not deal with what happens on dissolution, and/or does not contain a clear voting mechanism.
If this gridlock persists and the association becomes dormant, a court may deem the association dissolved. In this case, upon dissolution, the assets may be subject to escheat by the Crown and the association’s assets would become the property of the government.
By-law best practices
A well-drafted by-law or constitution (if abided by) facilitates governance. Since, legally, an unincorporated association is nothing more than a group of members, it is important to know exactly who those members are and how they will make decisions.
It follows that the by-laws or constitution of an unincorporated association should contain at a minimum:
- The purposes of the organization;
- The classes of membership and conditions of membership;
- The membership dues payable (if any);
- If membership dues are payable, the consequences of non-payment;
- The circumstances in which membership will be terminated;
- Member discipline procedures, including grounds for expulsion, the relevant notice periods and the appeal process, if any;
- The requisite notice for meetings of members;
- Whether there will be a board in place to make decisions in the interim between members’ meetings and the scope of its power; and
- A provision dealing with how the by-law may be amended or how fundamental decisions may be effected (note: something less than full consensus is likely most practical).
Although flexible in structure and low in cost, unincorporated associations have many drawbacks that can be avoided easily by incorporation. For a small association, such as a community book club, incorporation is likely more trouble than it is worth. However, an association that is anticipated to grow and hold property or other assets (even membership dues) should consider incorporating earlier rather than later. Any organization, whether incorporated or not, is advised to have well-drafted constating documents to enable it to run smoothly and efficiently.
By Natasha Smith and Katrina Kairys, Miller Thomson