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Implementing a Partnership

Which Organization Should "Dissolve" in a Merger?

When two or more nonprofits decide to merge, there comes a time when they must decide how they will do this. This decision, while largely technical, can be the cause of great anxiety for some organizations. Here's a quick explanation of the options, as well as some things to consider when making your decision. For the sake of these examples, we will assume that two organizations are merging.

Note: the laws governing the specifics of nonprofit mergers differ by state. You should always check with an attorney about the specifics of implementing a merger in your state.

Implementing a merger

Legally, a merger between nonprofits can be implemented in several ways. The first is sometimes known as "merger by dissolution into." Here you dissolve one of the corporations (known legally as the disappearing corporation) into the other (the surviving corporation). This means that the disappearing corporation leaves all of its assets and liabilities to the other. One of the advantages of this approach is that it is clear to all participants and observers what has occurred. If, years later, a donor of the disappearing corporation dies, leaving money to that corporation in its old name and form, the estate will be better able to find the successor corporation and pay out the bequest. A disadvantage of this method is that the surviving corporation assumes the disappearing corporation's debts and other liabilities, some of which, such as lawsuits, may not have been disclosed - or even known about - during the negotiations process.

A second option is to simply dissolve one corporation, as if it were going out of business. Federal law dictates that no individual can benefit from the proceeds of a nonprofit 501(c)(3) organization, even in dissolution. Moreover, most state law, based on the common law doctrine of Cy Pres, provides that in the case of the dissolution of a nonprofit corporation, any remaining assets must be transferred to a nonprofit that is similar in mission. This could be the merger partner.

The advantage of this option is that it limits the surviving corporation's liability for the disappearing corporation's debts. The disappearing corporation may in fact be required to go through bankruptcy proceedings prior to dissolution, but if it is, at least its debts will be settled. Obviously, in this scenario it is unlikely that any cash assets will remain to be passed on to the surviving corporation. However, other valuable assets -- such as an organization's name, donor records, and possibly its government contracts -- can often be passed on to another corporation. A disadvantage here is apparent in the situation cited earlier, where the donor leaves a bequest in the name of the now long ago dissolved corporation. The administrator of the bequest may not find a clear legal trail leading it to the successor corporation.

A third option often appears at first to be the most reasonable, but is in fact usually the least desirable method to achieve merger. This approach has both corporations dissolving into a new third corporation. This option is sometimes chosen because of the reluctance of either partner to be the corporation which dissolves, while the other survives. However, it can take as long as a year to create the new entity and gain an IRS exemption, and in the meantime both frustration and legal fees will mount. Thus, this variation offers few practical advantages, but does offer plenty of headache potential.

Choosing the dissolving corporation

Under either of the first two options, a decision must be made about which corporation will survive and which will dissolve. This decision should be made on technical rather than emotional grounds. While this makes logical sense, emotions do often rise to the fore, and organizations often resist the idea of dissolving while their partner continues to exist as a legal entity. There are ways to work around most people's concerns, however. For example, if corporations "A" and "B" are considering a merger, and it makes more sense for "B" to dissolve into "A" for technical reasons, the merged entity - which is legally the "A" corporation - could change its name to "B."

Here are some questions to keep in mind when deciding which corporation will survive and which will dissolve:

• Does one corporation have a license or certification that would be very difficult to obtain or transfer?
• Does one corporation have significant debt which must be repaid if it dissolves, and the creditor is unwilling to transfer the obligation to a different entity?
• Does one corporation have a funding source that is unwilling to transfer the funding to a new entity?
• Was one corporation created by statute and require governmental action to dissolve?
• Is one corporation a membership organization, with members that would not approve a dissolution of the corporation?

The more you answered "yes" for a particular organization, the less likely it is that it should be the dissolving corporation

While this issue should be definitely be discussed by the negotiating committee at some point in its process, a final decision is often left until after legal advice has been sought. A lawyer can help with identifying or investigating the possible issues involved, as well as provide advice on any state-specific considerations.