Can a Nonprofit File for Bankruptcy?

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Nonprofits are a backbone of the modern American economy. They provide help to millions of Americans and serve as a safety net in addition to government programs. Many of them have a ubiquitous presence after national disasters and throughout the holiday season. There are also misconceptions about their size and their relationship to money. In fact, nonprofits are more similar to for-profit corporations than many people realize. A particularly thorny similarity is bankruptcy. Nonprofit bankruptcy is a real possibility and one that all nonprofit owners should be familiar with.

Nonprofit Finances

There is a certain stereotype attached to nonprofits that mirrors that of charities and religious institutions. These institutions are seen as labors of love staffed by volunteers and running off of handouts and donations. Money does not seem to be a concern for these individuals and the idea of making money and paying bills is rarely attached to their image in the minds of most people.

Many nonprofits could not survive without volunteer labor and donations. However, that does not mean nonprofits have no sort of financial incentive for their operations. Indeed, many common nonprofits have stores that sell goods and services and employees that are paid wages. At that level, a nonprofit is subject to all of the same pressures and rules associated with for-profit companies.

Nonprofits and Bankruptcy

To that end, a non-profit can definitely file for bankruptcy. Many financially-oriented nonprofits are similar in many ways to for-profit companies. They both bring in revenue and have a list of expenses. For-profit corporations often bring in large amounts of debt in order to fuel expansions and meet bills in lean times. Nonprofit corporations do not take on as much debt because their budgets are lean and their business model is focused on spending as much money as it has instead of making as much money as possible. But nonprofits have financial pressures that lead them to take on debt.

For instance, a nonprofit may have a large piece of real estate that they have to make monthly rent payments to and a large workforce that they have to pay wages for. The individuals in that workforce may make considerably less than their counterparts in the for-profit sector. However, they still need to get paid on a regular basis. A nonprofit’s business model may be split between a store that they run, staffed by former inmates, and a yearly telethon. The nonprofit may make business decisions based off of strong sales at the store and a strong showing for the telethon.

But stores can have variable sales that rise and fall due to weather, changing traffic patterns, or shifting consumer tastes. At the same time, the yearly telethon is no guarantee. The telethon may not be carried on as many television stations as the nonprofit had hoped. A particularly generous donor may not have the funds to contribute this year. The nonprofit, as a result, has to take on debt.

Therefore, the cause for bankruptcy applies to both types of companies equally. Both forms of corporations risk bankruptcy when they do not have the income to pay off their debts, and do not have a reasonable plan to pay those debts that satisfies the needs of their creditors. While this issue is rare for nonprofits, it definitely occurs.

The Bankruptcy Process

The different forms of bankruptcy apply in the case of a nonprofit. There is the possibility of a Chapter 11 bankruptcy. In Chapter 11 bankruptcy, a nonprofit sells some of its assets and restructures its debts to the satisfaction of its creditors. Chapter 11 bankruptcy has a complex structure that grants a certain amount of protection to the corporation involved. There is a period of time where companies are protected from their creditors and not forced to meet payments.

Then, the bankruptcy court restructures debts and pays off certain creditors first. Resulting assets are then protected and a plan is devised to pay off creditors to the best of the ability of the company in question. With nonprofits, there is a considerable chance that the company will be able to emerge from Chapter 11 bankruptcy. Nonprofits often attract charitable contributions and companies or financial institutions that believe in their purpose. These groups want the institution to continue its work. As a result, they will often settle on more favorable terms than they might settle for in a proceeding with a for-profit company.

Chapter 7 bankruptcy, on the other hand, is a total liquidation. The company sells all of its assets and a court decides what creditors get paid with the remaining funds. There is a similar process of priority. Certain debts such as wages and contracts are paid off first. Then, individuals with secured loans, debts, and bonds are paid off next. The entity liquidates and does not legally exist afterwards.

Chapter 7 bankruptcy is extremely rare for a nonprofit. In cases where the failure of a nonprofit is clear and imminent, Chapter 7 bankruptcy may be the best approach. In all other cases, the new settlement that results from Chapter 11 bankruptcy may be helpful and allow a nonprofit to survive.

A nonprofit that is considering bankruptcy must look at its finances and its potential future as an entity. There is the possibility that bankruptcy might allow a nonprofit to restructure its debts and become more financially viable over time. However, this is a double-edged sword for any nonprofit. Nonprofits thrive on their reputation and their brand. The public needs to be able to trust that their money will be spent responsibly and on the task that the nonprofit is committed to.

Conclusion

Nonprofits need to be treated with the same level of care and attention as for-profit corporations. Their accounting and finances need to be handled by experienced professionals. While nonprofit work is a labor of love in many ways, bankruptcy can harm a nonprofit’s mission and lead to its untimely end. Becoming more familiar with bankruptcy can help nonprofit owners realize the financial implications of their organization and make better decisions with its money.

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