Incorporation of Churches: A New Day

While it is estimated that over 90% of all churches are now incorporated with all states now permitting it, most governing documents are not well drafted, woefully out of date or not followed. Thus, they do not adequately protect the church or its leadership or contain the 21^st century risk management provisions that are now available to churches throughout the country. Tax exempt regulations, nonprofit/church corporation laws and liability concerns have changed more in the last 10 years than the last 100 years put together.

Why should a church care about its governing documents and risk management provisions like incorporation. The primary answer to this question is that there is significant change in the legal climate of this country.  Twenty or thirty years ago, most Americans, whether Christian or not, held a common framework of basic moral values such as honesty, fairness, respect for others, self-discipline and accountability.  However, in recent years, respect for these values and qualities have been undermined by a growing emphasis on individualism, diminished respect for authorities, acceptance of relative morality and a loss of common norms and values.  The loss of common values even within the church can cause a great deal of confusion and conflict.  It can also expose a church to devastating losses.  A generation ago, very few people—especially members of the church—would have dreamed of suing the church, but the legal climate today has changed dramatically and lawsuits and claims against churches now are commonplace.  Part of the reason for this recent change is that people have different expectations as to how a church should conduct its affairs and treat its members.  When these expectations are not met, a lawsuit often follows, which can ruin a church spiritually, reputationally, and financially.

As Prov. 22:3 warns, “A prudent man sees danger and takes refuge, but the simple keep going and suffer for it”.  Understanding the absence of common norms and values can pose a threat to the unity and well being of your church.  You are prudent to incorporate but even wiser to develop a good Constitution and Bylaws as a means of establishing common accepted standards for how we should treat one another and govern ourselves as a body of believers.  In particular, incorporation and its governing documents are designed to accomplish the following goals:

• To prevent surprises and disappointed expectations by providing potential members a thorough explanation of how the church intends to govern itself;
• To reduce the likelihood of confusion and conflict within the church by establishing clear operational guidelines;
• To prevent the misuse of authority by church leaders by balancing these powers and establishing procedures that protect members from being disciplined or losing rights without due process and full notice;
• To reduce the church’s exposure to legal liability by satisfying recently developed legal requirements, even in areas we deny that the state has jurisdiction, and by requiring that potential lawsuits will be resolved by biblical mediation or arbitration rather than through civil litigation.

1. The Benefits of Church Incorporation

Prior to the landmark Falwell case, Virginia and West Virginia were the only two states in the United States where churches and religious denominations could not incorporate.  Thus, Virginia churches were unincorporated associations, which status subjected their members2 and particularly their leaders, such as the pastors and boards, to all forms of liability and precluded a church’s ability to hold title to its property.  There are many forms of liability where either an insurance policy does not cover the acts upon which a lawsuit against a church is based, or its coverage is limited.  A Board of Directors (elders, deacons or pastors) could be personally liable for the liabilities which were essentially against the church.  There have been cases where a pastor, deacon or elder has suffered greatly due to this unincorporated association status and the imposed personal liability for the negligent or reckless acts of the church or its officers, directors or agents.

The top ten benefits for Church Incorporation include:

1)   Incorporation will substantially limit liability of the Pastor(s), Board and members, providing a sure liability shield, provided the church board is not ‘grossly negligent’.

• Under incorporation, trustees are no longer needed for church corporations and court appointment of such trustees is not required to hold, manage, buy, sell, transfer or encumber real property of the church corporation. Of course, church corporations may still authorize trustees to have that legal authority with the church members’ approval, or it can delegate it to one or more of its officers or directors. Unincorporated churches, however, must comply with all the old law provisions requiring court approval for appointment of Trustees and court approval for all buying, selling, encumbering or transferring land to another entity (other than the new church corporation).

3)   Under incorporation, real or personal property for church corporations no longer need to be held by trustees (with its corresponding liability) but can be held in the name of the church corporation or a separate property holding nonprofit corporation.

4)   Incorporation often makes it easier for a church to buy, sell, and encumber real estate, operate bank accounts and engage in other business transactions.

5)   Incorporation protects the corporate name in the state and eases trade name registration and trademarking the name where appropriate.

6)   Intellectual property (copyrights, trademarks and licenses) can be held in the name of the church corporation and not individuals since corporations are legal entities.

7)  Incorporation also lends to stability of an organization more so than an unincorporated association, since the members, directors, trustees, and officers of a church may change over the years.

8) Churches must be incorporated in order to receive grants through government faith-based social service provider programs or private foundations.

9)  Incorporation and tax exemption can often permit special nonprofit mailing rates and procure discounts from vendors.

• Finally, most banks and lending institutions prefer to deal with an incorporated entity to assure its governance, purpose and legal status.

However, churches need not be incorporated to be exempt from federal income tax or state tax laws.  However, at least one court has observed that, “while not a pre-requisite for exemption, a showing that an organization seeking a property tax exemption is incorporated as a church or religious association will lend credence to that organization’s claim that it is a bona fide church or religious organization.” 

2. Concerns about Church Incorporation.

Other than ill-placed theological concerns about separation of church and state3, the primary downside to incorporation may be the common  phrase that “we have never done it that way before”.  Also there may be some concern about upfront costs and requirement that an informational report and nominal fee must be paid annually to the State Corporation Commission (true in many states) or suffer the loss of its non-profit corporate status.  Some commentators have alleged the following other disadvantages of incorporation:

• It requires the re-writing of a congregation’s Constitution and Bylaws to conform to the requirements of the IRS and the State Corporation Commission which could cause dissention since some provisions may be matters of disagreement within a church; however, most church Bylaws are out of date and desperately need updating for 21^st century legal compliance and risk management purposes, as well as streamlining.
• There is a cost to setting up and maintaining the church corporation. Currently, the State Corporation Commission (“SCC”) charges for filing the Articles of Incorporation.  Additional attorney fees from a knowledgeable attorney skilled in church laws and tax exempt entities and knowledgeable about your church government will also be needed to tailor your church corporation’s Articles of Incorporation, and the Constitution and Bylaws. An Annual Report often must be filed each year with the SCC which reflects an updated list of officers and directors..
• A registered/resident agent must be designated to receive service on behalf of the corporation instead of trustees (he or she must be either a member of the State Bar or a director of the corporation); however, a good attorney who serves as a registered agent will have a system for recording all incoming and outgoing mail/faxes and will better be able than lay Trustees to handle legal documents with deadlines and correctly answer complex legal issues.
• Names on bank accounts need to be changed to the corporate name and all property should be transferred to the church corporation (however, it provides much better protection for the church and can be done easily by a knowledgeable church and real estate law attorney).
• Certain rules are determined by statute unless the Bylaws or Constitution provide differently, which good Bylaws will, including:  annual meeting, quorum requirements, notice provisions; use of proxies, terms for directors and officers, removal of an officer by the board of directors, judicial dissolution of the corporation and court ordered meetings of the corporation.
• While inspection of records by members would appear to be governed by the Non Stock Corporation Act, most states allow that requirement to be changed by the Constitution or Bylaws of the church. However, while it can be limited or restricted by Bylaws especially as church corporation under separate church law sections,, most churches make records to members available (except salary information) since they desire to be transparent to its donors and fellow Christian brothers and sisters.
• A church corporation director is liable for failure to exercise “good faith business judgment of the best interest of the corporation.”; however, a leader in an unincorporated association is completely liable for acts of the association.
• Church property is held in the name of the church corporation and not by trustees. Once transferred to the church corporation, it may be bought, sold or mortgaged without court approval. However, simplifying the purchase and sale of property may open the door to the possibility of abuse by church leaders but with limits in good Bylaws it will provide for easier property transactions without the state involvement and court oversight.
• However, the most common reason that churches do not incorporate is “that we have never done it that way before”. However, we have never lived in the 21^st century before with rising liability and changing culture against churches and its leaders.

Over the years, many states have passed several statutory provisions that have tried to protect members and officers/directors of churches from being liable for the negligence of others in a church setting.  Ostensibly, these laws were enacted in order to give churches some of the same protections that churches in other states receive by incorporating when incorporation was disallowed. Here are some examples: 1) No member of a church is liable in tort or contract for the actions of any other member of the church or the actions of the church itself; 2)  Unpaid officers, trustees and directors of certain tax-exempt organizations may have immunity from liability; and 3) The fiscal officer of the church who signs a deed or mortgage on behalf of the church is generally not personally liable on the debt.

Unfortunately, even these provisions are like Swiss cheese when it comes to limiting personal liability and thus, church incorporation appears to be a better alternative and perhaps a “belt and suspenders approach” still utilizing these provisions and insurance.

…WANT TO READ MORE? The full-length article provides 6 more pages of in-depth analysis of the intricacies of church incorporation in 2017, including the process of incorporation and answers to frequently asked questions. If you are operating in these areas and would like further advice, please contact H. Robert Showers, Esq., call 703-771-4671 to purchase the full article and discuss how we can help address your specific concerns.  

Legal Disclaimer:  This Article and related material have been prepared specifically for churches seeking to incorporate in the mid Atlantic states.  It is not meant to provide legal advice or substitute for competent legal counsel that can address specifics of each church.  Any reader is encouraged to seek appropriately trained and experienced professional legal counsel who specializes in tax exempt and church law prior to taking the step of incorporating and redrafting governing documents and policies for legal compliance and risk management.

2 For example, under VA Code §8.01-220.13 members of any church, synagogue or religious body shall not be liable in tort or contract for actions of any officer, director, employee or other member of such church solely because of membership.  VA Code § 8-220.1.1 provides some limited immunity for volunteer officers, trustees and directors of 501(c )(3) tax exempt organization and limits liability in some cases for paid Directors & Officers to 1year salary and benefits.

3 Another concern may be the time involved in changing all legal documents (deeds, titles, bank accounts, loans, etc.) to reflect the new incorporation states.  However, the word ‘incorporated” or “Inc.’ does not need to appear as part of the Church’s name, on its stationery, checks, church signs, etc. and at this point a name change to “______ Church  Inc.” will suffice for other legal documents.  Some church leaders also believe incorporation makes a church more liable to government regulation.  Church law expert Richard Hammar disagrees: “That argument fails to distinguish between the church as a corporate entity and the church as the Body of Christ.  Any church that incorporates is not subservient to the state but provides advantages to its members and leaders.” With all the government privileges, protections and rights already accepted long accepted by churches and other religious organizations, such as tax deductibility of donations, no corporate tax, sales and use tax exemptions, property tax exemptions, housing allowances for ministers etc. the argument was ended or severely diluted over 100 years ago to no longer have much, if any, validity!