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Know when to do a legal audit — and what to include

A legal audit is an overview of an organization's non-financial compliance, governance and risk management issues. Organizations typically consider a legal audit in the wake of a costly mistake or when new management takes over and wants to ensure they're starting with a clean slate. A typical legal audit will include a review of the following:

1. Corporate status

Incorporating a nonprofit organization helps to protect the directors, officers and members from personal liability. However, to reap the benefits of incorporating, the corporation must remain in good standing. Reviewing corporate status typically requires a review of articles of incorporation, bylaws and minutes as well as corporate filings. This review is to ensure the organization is not only in good standing, but is also operating in a manner that is consistent with the law and its governance documents.

Note that significant operations in other states may trigger a duty to register to "do business" as a foreign corporation in that state. This can be done quickly using a reputable document service company.

2. Chapters and affiliates

If your organization has chapters or other affiliates, your bylaws should be clear about authority to create chapters. In addition, there should be a charter and license or similar agreement in place outlining the terms of the relationship.

3. Governance policies

Over the last decade, nonprofits have been formalizing more of their policies and procedures. This trend is due in part to the encouragement of certain policies by the IRS. For example, the Form 990 references a number of governance policies and requires organizations to disclose whether they have been implemented. Accordingly, it is a good idea to review governance policies periodically.

This review should consider:

  • Which policies exist
  • If additional policies make sense for the organization
  • Whether the policies are reasonable
  • Whether the policies are consistent with existing practice

4. Tax-exempt status

An important part of any tax-exempt nonprofit's legal audit is a review of its tax-exempt status. A key consideration is whether the organization is properly classified with respect to its tax exemption and its public charity status. The reviewer should also consider whether the organization's activities are still within the scope of its ruling. This requires an analysis of the application for recognition of exemption, the IRS determination letter and the yearly Form 990. Changes to governing documents and significant changes in sources of support, programs, purposes, etc. must be reported to the IRS on the organization's Form 990.

5. Other federal tax matters

A review of the federal information and unrelated business income tax returns (Forms 990 and 990-T) is important because, in addition to tax compliance, the Form 990 is a publicly available document. A legal analysis of tax forms focuses on the accuracy of the information reflected on the returns in light of the other information gleaned from the legal audit as well as the presentation of the overall return.

6. State taxation issues

It is a good idea to review any property tax and/or sales tax exemptions from time to time to determine whether the organization still qualifies for exemptions. It is also a good idea to consider the exemptions that are available and whether the organization qualifies for exemptions it has not applied for before.

7. State charitable solicitation requirements

No legal audit is complete without a review of whether the organization is complying with the various regulations that govern fundraising. This entails a review of the jurisdictions where the organization is actively fundraising. Once the jurisdictions where the organization is soliciting are known, the next step is to examine the status of the organization's registrations in each jurisdiction.

8. Gift administration issues

Many nonprofits do not adequately monitor the restrictions on their restricted gifts. Accordingly, a periodic review of these restrictions is recommended to ensure that funds are properly classified with respect to time, use or other restrictions and that the terms and restrictions are being honored. A legal audit should also include a review of gift acceptance policies as well as substantiation and acknowledgement forms.

9. Insurance policies

From time to time, organizations should review their insurance policies (such as general liability, directors and officers insurance, errors and omissions, etc.) to determine whether the organization's activities are adequately covered.

10. Volunteer and participant waivers

Depending on the nature of the organization's activities, the organization should have waivers and participation agreements where volunteers and participants accept any risks and release the organization from liability. A legal audit should consider:

  • Whether appropriate releases and waivers exist
  • Whether the releases and waivers are adequate
  • Whether procedures have been implemented to ensure the releases and waivers are consistently used

11. Contractual obligations

Significant contracts should be reviewed to ensure notice and termination dates are properly monitored as well as to ensure compliance with any restrictive covenants.

Depending on the size of the organization and its activities, a legal audit may also consider personnel policies, intellectual property issues, real estate issues and so on. Like a financial audit, a legal audit can be tailored to cover areas of particular concern. The audit can also be conducted at one time or divided into phases.

While nonprofits are used to financial audits to ensure the integrity of their financial statements, a periodic overview of legal matters is just as crucial to ensuring the integrity of the organization.

For more from Ellis Carter, visit CharityLawyer.



MissionBox editorial content is offered as guidance only, and is not meant, nor should it be construed as, a replacement for certified, professional expertise.




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