Successful Mergers – The Right Fit in Child Welfare
A precipitous drop in the foster care census1, the failure of third party payors to reimburse for actual costs of providing services and the sluggish economy account for just a few of the reasons more child welfare agencies are or will be considering merging or affiliating with another agency. In a merger, two agencies become one with the survivor for the most part assuming the assets and liabilities of the other. An affiliation, on the other hand, leaves each agency intact, under a variety of possible management and financial interrelations. One agency may manage or provide financial resources to the other, alternatively, the two agencies may share certain costs. This article focuses on mergers between child welfare agencies.
One of the first issues for the board or executive committee2 of a child welfare agency to articulate is what are the factors motivating the merger? What are the goals? As Dr. Phil would say “what is the payoff.” What are you and your potential partner trying to accomplish? One agency may be in financial difficulties and therefore in need of a partner to infuse cash or to create economies of scale – e.g. instead of each agency having its own HR department or MIS department, the two agencies share one of each. In another scenario, one agency may be at a size where it cannot create surpluses without additional care days. In an environment of declining census, the only source of additional kids may be another agency’s.
The bottom line is that the boards or executive committees of each agency (not the Executive Director/CEO) must take the lead in analyzing the agency’s stated goals and determining whether a merger will address those goals. Pursuant to the N.Y. Not-For-Profit Corporation Law, Board members have the exclusive fiduciary duty to pursue the best interests of the agency’s mission and stated purposes. Theoretically, board members also are objective as well as bring their backgrounds/expertise into play in connection with consideration of a potential merger. The board/executive committee is ultimately responsible for the policy decisions of the corporation while the Executive Director/CEO is responsible for implementation of that policy. Perhaps an agency board’s strategic plan is or will be a starting point in the deliberations. Alternatively, the board’s strategic plan can encompass or focus entirely on a contemplated merger.
Assuming the respective boards reach the conclusion that a merger with the other agency will theoretically meet their individual and collective goals, the next three significant issues to be addressed are: (a) what will the membership3 and board look like in the survivor entity; (b) what will be the selection process for the Executive Director/CEO; and (c) how to reassure staff that all is well. This author would be remiss if I failed to address one of the toughest issues in considering a merger: obtaining Board approval for a merger often times is where a merger discussion ends. It is no small feat to get past this all-important hurdle.
Composition of Membership and Board
In a merger, often the overriding motivation for each agency is the belief that, with a combined agency, efficiencies and higher levels of services will result. This principle is no less true when it comes to the composition of the membership and board post-merger. If one of the goals of the proposed merger is for one or both agencies to increase fundraising (a noble but increasingly challenging goal), the membership and/or board of the survivor might be reconstituted with individuals most capable of donating or most capable of getting others to do so. Perhaps individuals with certain expertise are needed on the board at the survivor entity and therefore the board could be augmented with such individuals. A merger also presents the opportunity re-energizing a board around a tangible issue as well as providing an opportunity to allow non-participating or “dead wood” directors to depart gracefully. On this latter point, instead of asking for resignations, when the new entity's board is set forth in the Plan of Merger it simply does not list any directors who will not be with the survivor.
Procedurally, each board should appoint a special or ad hoc merger committee (which can have non-directors as members) to handle the analysis and negotiation for the merger. That committee should include at least one director from each agency’s nominating committee so that these individuals can give guidance on the make-up of the reconstituted membership and board. Care should be taken that the decision-making process on this sensitive issue appear fair, since the Plan of Merger setting forth the new board and membership must be approved by the respective boards and membership of each agency.
Selection of Executive Director/CEO
Our experience is that unless one agency’s management is clearly superior (beauty is in the eye of the beholder), choosing the Executive Director/CEO of the survivor agency is a major challenge. Sometimes the committee recommends a structure where there is an Executive Director/CEO in charge of the overall agency and a Chief Operating Officer in charge of a program i.e., foster care and adoption. In the health care industry some mergers result in co-executive directors. We do not encourage this approach since we have never seen it work even though much care was paid to separating the duties. Alternatively, if politically or otherwise a decision on one top executive cannot be reached, one executive may be coaxed into retirement with the appropriate incentive package. Recently we handled a merger for two providers of OMRDD services, in which one executive director became a consultant to the survivor agency while the other executive took over the survivor agency.
The special or ad hoc merger committees of each agency will make recommendations but ultimately the decision rests with the larger4 or “acquiring” agency. The process of deciding who will be the Executive Director/CEO is as important in due diligence as the decision as to which individual(s) will lead the new agency. Due diligence is the process of evaluating an agency to determine whether its legal (corporate), accounting (financial) and infrastructure circumstances are in shape for a merger. Corporate/regulatory, financial and related documents must be reviewed. An evaluation of infrastructure issues is necessary for due diligence. For example, do the operational and fiscal personal and systems of each agency, provide assistance and information in an accurate and timely way. While agency management should conduct programmatic due diligence, accountants and lawyers are critical for the operational legal and financial analysis.
Disclosure to Staff
Advising key staff early and often of the potential for a merger is advisable in achieving a successful result. There are certain situations in corporate culture where confidentiality non-disclosure is indicated until the “ink is dry,” so to speak. However when a merger is a rumor, the facts and fiction become blurred and not necessarily in the way the board and management intend or desire. In the absence of disclosure, the seeds of disruption and defection will be sown. Little extra tension is needed to push front line workers into jobs outside of the industry.
In the event the workforce of both agencies is unionized, special considerations apply as to when and to whom disclosure is made in the union leadership. If one agency is unionized and the other is not, whether the survivor’s workforce will be unionized is a tricky issue. This issue alone has stopped a lot of otherwise well-planned mergers from taking place. Nevertheless, the boards of each agency must make certain that management keeps its staff informed as to how and when a merger may occur as well as the impact of the merger on them. By way of example, in one merger we assisted on, the failure of management to disclose merger-related information caused the workforce to bring in a union.
Real Estate Issues
In preparation for a merger, agencies will sometimes need or desire to sell or lease assets, including real estate. Many not-for-profit boards do not realize that real estate transactions must be approved by a “super majority.” A board of less than twenty-one directors requires the affirmative vote of two-thirds of the entire board to sell (or even lease) real estate. A board of twenty-one or more directors must approve real estate transactions by a majority of the entire board. The phrase “entire board” means the total number of directors authorized in the bylaws as if there were no vacancies. Thus an agency with a board capacity of eighteen in the bylaws with only eleven directors in office would require a minimum of twelve directors to affirmatively vote in favor of a sale or lease of real estate. Falling short of the needed vote, the agency would either have to bring on one additional director or the transaction would be subject to a claim that the authorization for the sale was improper. This super majority provision applies to purchases, leases and mortgages no matter how small. Consequently, if one agency is liquidating real estate pre-merger, care should be taken to ensure the vote authorizing the sale is proper.
Supreme Court/Attorney General Approvals
Perhaps the most frustrating aspects of a merger between two child welfare agencies (aside from obtaining Board approval) are the various approvals that must be obtained from the regulators of N.Y. not-for-profit corporations. An order permitting the merger must be obtained from a Supreme Court justice in the county where either corporation has its principal office. The court will set a date for hearing the application for an order to approve the merger. Notice must be given to all interested persons unless dispensed with by the court; notice may be dispensed with by the court if no votes against adoption of the resolution for the merger were cast at the resolution meeting of any constituent corporation. Under all conditions, notice is necessary for the Attorney General and the various regulatory bodies whose consent or approval is required5. The Attorney General’s review of the proposed merger documents is focused primarily on a.) verifying that the required “regulatory” consents or approvals have been obtained and b.) making sure that any assets being transferred pursuant to the merger are or will be used for a specific or the intended purpose. Agencies are advised to consult with OCFS’s legal department prior to submitting any merger documents to them to be sure all of the necessary information is presented and the wording is acceptable for regulatory consents or approvals. Likewise, the legal departments of other regulatory bodies should be contacted i.e., the State Education Department, the Office of Mental Retardation and Developmental Disabilities and the Office of Mental Health, etc.
If the Attorney General finds that all regulatory consents/approvals have been obtained and that the assets of the constituent corporations are held for a charitable purpose or that the assets are to be used for a specific purpose, but not requiring return, transfer or conveyance by reason of the merger, the court may direct that the assets be transferred to the surviving corporation or to one or more domestic or foreign corporations engaged in substantially similar activities.
If you have questions about these or other legal issues facing charitable organizations and fundraising professionals, please contact Eliot Green (email@example.com) at 212.407.4908.
1. This phenomenon may only be true in NYC and for downstate agencies.
2. While an executive committee cannot vote to authorize a merger, in most cases it is the group or some reiteration of this group that will lead the discussion.
3. Members of not-for-profits are analogous to shareholders of for profit entities. Not all agencies have members but if you do their rights in a merger are very important. Legal advice on what those rights are and how to properly handle the membership in a merger is critical.
4. When we say larger, we generally mean the agency with the larger budget or the one with the higher net worth.
5. For child welfare agencies, this means, in most cases, the New York State Office of Children & Family Services ("OCFS") must also approve the merger. There may be other regulatory approvals as well as i.e. State Education Department ("SED").
This client alert is a publication of Loeb & Loeb and is intended to provide information on recent legal developments. This client alert does not create or continue an attorney client relationship nor should it be construed as legal advice or an opinion on specific situations.
Circular 230 Disclosure: To assure compliance with Treasury Department rules governing tax practice, we inform you that any advice (including in any attachment) (1) was not written and is not intended to be used, and cannot be used, for the purpose of avoiding any federal tax penalty that may be imposed on the taxpayer, and (2) may not be used in connection with promoting, marketing or recommending to another person any transaction or matter addressed herein.