If I could point to the one decision my clients almost always end up regretting, it’s the decision to enter into a comprehensive management contract. Some management companies prey on nonprofits, taking control over the nonprofit’s operations and charging unreasonable fees for services of questionable value. While there are management companies that provide valuable services and it is possible to construct a fair, arm’s length agreement, hallmarks of abusive management contracts include the following:
- Lengthy Terms. Longer terms tend to benefit management companies while limiting the flexibility of nonprofits. It is always in the nonprofit’s interest to retain the flexibility to change or terminate management contracts if the relationship isn’t working.
- Management Company Dictating Policy and Strategy. A nonprofit’s policies should be set by an independent board and not by a management company. By way of example, the board should establish and define the mission, goals, strategy, budget, operational procedures, financial policies and governance policies.
- Services. Management contracts should specifically detail which responsibilities belong to the management company and which belong to the nonprofit. The failure to be specific can result in the nonprofit not getting the full benefit of all the services it is paying for. Management contracts should also clarify when the management company needs the nonprofit’s approval before performing specific services. This is especially important when the management company charges hourly fees, as opposed to a flat monthly service fee.
- Personnel. Management contracts that rely on the management company to supply key employees or that includes anti-compete clauses that limit the nonprofit’s hiring to personnel affiliated with the management company tend to serve the interests of the management company while depriving the nonprofit of the opportunity to hire staff of its choosing. Relying too heavily on a management company’s staff can also make it harder to terminate a management company agreement that isn’t working.
- Compensation. Compensation paid to the management company must be reasonable as compared to market rates for similar services. If the management company is a disqualified person (insider) with respect to the charity, excessive compensation could be deemed an excess benefit transaction. If the management company is not a disqualified person with respect to the nonprofit, then excessive payments could still result in a private benefit that threatens the nonprofit’s tax-exempt status.
- Termination. Termination and default provisions should not unreasonably restrict the nonprofit’s option to terminate the contract. The ability to end the relationship is key to maintaining a healthy vendor/vendee relationship.
- Access to Data. Permitting a management company to unilaterally control financial data, vendor information, donor information, program data, or to control websites and social media accounts can be disastrous in the event the nonprofit and the management company part ways. Ideally, both the nonprofit and the management company should be able to access company information and data.
- Ownership of Intellectual Property. Licensing a name, trademark or other brand related intellectual property from a management company favors the management company and can leave the nonprofit without any goodwill of its own once the agreement is terminated. Also, management company agreements should specify that intellectual property created as part of the management company’s duties for the nonprofit are work made for hire that belongs to the nonprofit so the nonprofit can continue using such intellectual property after the agreement is terminated.
In our experience, the factor that most often leads to abusive management arrangements when there is a conflict of interest such that a board member, lender, grantor or other influential party has a connection to the management company. When such relationships develop, it is critical that strong conflict management procedures be followed.
Ideally, nonprofits that contract for services will retain control over overall management and only contract with consultants for discrete services. If a comprehensive management relationship is desired, nonprofits should work with experienced counsel to ensure their interests are protected.\
This post was written by Ellis Carter and Deanna Rader. Ellis Carter represents nonprofit, tax-exempt and mission based companies and is licensed to practice in Washington and Arizona. Ellis advises tax-exempt clients on federal tax matters nationwide. Deanna Rader devotes her practice to litigation, employment and school law matters and has extensive experience litigating abusive nonprofit management contracts.