The Commonwealth Court of Pennsylvania has rejected an attempt by the state’s Attorney General to close down a volunteer fire company that had been prohibited from fighting fires in its community and to force the transfer of its assets to a different company continuing to serve the area. The Court rejected the AG’s claim that all of the assets of the decertified company were held “in trust” and should be transferred under the cy pres provisions of the state’s Trust Code when it became “impracticable” for it to pursue its mission.
Until May, 2016, the Independent Fire Company No. 1 was one of three companies certified to fight fires in South Williamsport Borough (home of the Little League World Series). At that point, the South Williamsport Fire Department was formed through a merger of the two other companies. When Independent did not join in the merger, it was decertified by the Borough and could no longer fight fires in the Borough.
Independent continued to function as a separate 501(c)(3) nonprofit corporation, however. It reached out to other municipalities to offer services there, engaged in charitable community activities, held meetings and filed tax returns, and responded to multiple emergency calls. It argued that the state could not force its involuntary dissolution (a claim the state abandoned during the trial court proceeding) and therefore lacked authority to force a transfer of its assets to another nonprofit organization. The Commonwealth Court agreed “in large part” with the Company.
The state argued that charitable nonprofit corporations like Independent “are treated as charitable trusts” with the public as the beneficiary. Relying on the Comment to Section 7740.3 of the Trust Code and Section 5547(a) of the Nonprofit Corporation Law, the AG maintained that all of the assets of Independent were held “in trust” to further its charitable purpose as stated in its articles of incorporation, and that once it ceased fighting fires in South Williamsport, its charitable purpose was extinguished. It argued that the Trust Code mandated that the trial court apply the cy pres doctrine and designate a substitute beneficiary.
The Court noted that the AG did not attempt to apportion the assets of Independent into separate categories, such as those received through donations and those representing the proceeds of incidental profit. Citing a prior decision involving another volunteer fire company and an effort by a borough to redeploy its property, the Court found that the volunteer fire company owned the assets and “until such time as the members decide the future of the corporation and the property, it is premature for the lower court to consider distribution of such property.”
The Court noted that the state had the authority to seek an involuntary dissolution and to revoke Independent’s articles of incorporation, but only upon a proper showing of impropriety and that involuntary termination should be employed “only in extreme circumstances.” It also noted that the state had abandoned its effort to dissolve the corporation during the trial.
The state then relied on the Trust Code section authorizing cy pres of a trust if its purpose has become unlawful, impracticable or wasteful. But the Court cited further authority that the cy pres provisions of the Trust Code apply only to trusts, and not to other types of charitable dispositions, including those to charitable corporations.
The state argued that, pursuant to Section 5547(a) of the Nonprofit Corporation Law, all of the assets and property that Independent owns “are unconditionally placed in a charitable ‘trust’ by operation of law.” It argued that the trial court had no choice but to apply the doctrine of cy pres. But the Court disagreed.
In a 2018 case involving a claim of breach of fiduciary duty by directors of a nonprofit service provider, the Commonwealth Court had rejected the same argument by the state. There, the Commonwealth Court had ruled that the “in trust” language of the Nonprofit Corporation Law deals with property given to the nonprofit and not something generated from internal operations.
Pursuant to that case, the Court said, the NPCL “denotes that a nonprofit holds in ‘trust’ only those assets or property that were ‘given, devised to, or … vested’ in it from an outside source. Or, phrased differently, a nonprofit holds assets or property in ‘trust’ when the outside source ‘donated, granted or devised’ the assets or property to the nonprofit…. Ultimately, it is these types of assets, or, more precisely, the manner in which these assets are transferred and/or otherwise devoted to a nonprofit, that potentially renders them subject to the doctrine of cy pres.”
The Court noted that in the earlier case it had pointed out that if the Legislature meant the “in trust” principles to apply to all assets committed to the charitable purpose of the organization, “it would have said so.” The Court rejected the state’s “all or nothing” approach as “simply incorrect.”
Since the state did not prove that any specific assets had been placed in trust at Independent, the Court said, the state’s claim for cy pres was “fatally flawed and meritless from the inception.”
Having adopted that rationale for its decision to affirm the trial court’s decision, albeit on a slightly different basis, the Court said it did not have to address “the broader and more complicated issue of whether the Nonprofit Law and/or Trust Law permit a trial court to apply the doctrine of cy pres, absent a claim for involuntary dissolution or a diversion of the nonprofit’s assets.” (In re: Independent Fire Company No. 1, PA Commonwealth Ct., No. 1489 C.D. 2018, 2/5/20.)
YOU NEED TO KNOW
This is a critical case rejecting the Pennsylvania Attorney General’s long-standing position that all assets held by a Pennsylvania charity are held “in trust” for the benefit of the public. The fiduciary duty of a trustee holding property in trust is more stringent than the fiduciary duty of a director of a nonprofit corporation and this case confirms the distinction.