The Basics of California Mutual Benefit Corporation Statutes

The Lowdown on Mutual Benefit Corporations

Mutual benefit corporations are defined under the California Corporations Code. See Cal. Corp. Code § 7220. The full text of the statute is included at the end of this article.
The law prescribes that mutual benefit corporations may be either "nonprofit" or "for profit." California Corporations Code § 53601. A nonprofit mutual benefit corporation is an entity formed for the purposes "other than pecuniary gain or profit to its members." Cal. Corp. Code § 5131. Such entities are commonly organized in the form of a homeowners association, a golf club, a labor union, or a lodge. See Clark v. Rancho Santa Fe Assn., 639 P.2d 609 (Cal. 1982). For profit mutual benefit corporations, on the other hand, are organizations that are generally formed to make a "disproportionate economic distribution to its members." Cal. Corp. Code § 5133. This type of mutual benefit corporation is usually organized as a cooperative (e.g. a housing cooperative or a produce cooperative) or another type of business that requires "substantial member involvement in the activities of the company." See State of California Dep’t of Consumer Affairs v. Omega National Ins. Co. , 19 Cal. Rptr. 2d 186 (Cal. App. 1993).
Most mutual benefit corporations are voluntary associations governed by a board of directors elected by the collective membership. However, a special type of mutual benefit corporation known as a "common interest development" (or "CID") association creates a unique set of conditions and rights outside what is generally found in other mutual benefit corporations. CID associations are corporations that provide a common interest for the members who reside in a subdivision of homes where the properties are subject to a Declaration of Covenants, Conditions & Restrictions or a "CC&R." Such associations are compulsory and have been created throughout California in order to help maintain the value of real property in various communities.

The Legal Essentials

Most organizations that benefit a private interest are organized in accordance with California non-profit mutual benefit corporation law ("the Mutual Benefit Act"). Many common charities fall under the category of the mutual benefit corporation, including most co-operatives and limited equity housing co-ops. Nonprofit mutual benefit corporations are associations that are not charities and are not strictly organized for charitable purposes or for the people’s general interest.
One way a person can create a non-profit mutual benefit corporation is by following the procedures and requirements of the General Corporation Law ("Corporation Act"). A corporation for profit would adjust the selection of incorporators to be in accordance with California’s laws relating to for-profits, and the corporation itself would be taxed as a corporation. Corporation Law Section 2302.
To form a Nonprofit Mutual Benefit Corporation a person must: (1) draft articles of incorporation; (2) file them with the Secretary of State; and (3) create bylaws as a fundamental component of the corporation. A mutual benefit corporation does not have to have members or have a board of directors to incorporate, but it must include certain mandatory provisions in its articles of incorporation. The organization must provide a purpose for which it was formed, contain a name and a name for the agent, including a statement that the agent is the address for service of process, and include a dedication to president and secretary or a similar principal officer. The provisions found in Section 5140(a)-(c) apply to all corporations and explain the requirements needed to establish an entity: (1) places limitation on the powers of that entity; (2) defines a corporate purpose; and (3) states that the entity was organized under a certain section of California law. The corporation may have additional provisions, including the powers of the corporation and the characteristics of the corporation’s members, if any. Mutual Benefit Corporations must file Articles of Incorporation with Secretary of State and obtain an Employee Identification Number from IRS within 60 days of the incorporation. Generally, Articles of Incorporation must be filed in California by a filing of Articles of Incorporation with the Secretary of State. (See California Corporations Code §§ 200-220). The secretary of state provides a general instructions for completing the forms. After filing for a nonprofit mutual benefit corporation, the Secretary of State will issue a certificate citing the "stated corporate purposes." California law requires that the "stated corporate purpose" be a lawful business or charitable activity that is "perpetual" or of "indefinite duration." Examples of nonprofit mutual benefit corporation purposes are:

• Providing a mutual benefit to the public.
• Operate for the efficient marketing of goods and supplies. Many farmers’ cooperatives are mutual benefit corporations. One example is a mutual benefit corporation designed promote the provision of agricultural goods to the public.
• Providers of goods or services to particular members. For example, non-profit corporations may provide beverages to particular membership on the West Coast.
• Organizations of personal or financial interests such as fraternal organizations. Fraternity and sororities are common examples.
• Benefit of a select group. For example, a security group might incorporate as a nonprofit corporation. Once the secretary receives the Articles of Incorporation, he or she will issue a statement of incorporation containing the name of the corporation, the address of its initial registered office, the name of the initial agent for service of process, and a statement of its corporate purposes. The requirements for incorporating a nonprofit mutual benefit corporation are listed in California Corporations Code Sections 5130-5133, 5140-5150. A nonprofit mutual benefit corporation is a nonprofit corporation not organized exclusively for religious, charitable, scientific, or educational purposes but that is organized for the mutual benefit of its members. A nonprofit mutual benefit corporation may be either a stock or nonstock corporation.

Structure and Governance

The internal organization and governance of mutual benefit corporations in California is relatively simple to follow, as the law recognizes both directors and ordinary members.
Directors
As with nonprofits in other contexts, a California mutual benefit corporation is generally governed by its board of directors. Directors must generally discharge their duties in good faith, exercise the care that a prudent person in a like position would exercise under similar circumstances in a manner that the director believes to be in the best interest of the corporation and consider the effects of any action or inaction on the members of the corporation and on the community at large. (Cal. Corp. Code § 7231(a))
The corporation’s board of directors may delegate all or a portion of its powers, except for certain powers such as to declare a dividend, recommend to members a dissolution of the corporation or the revocation of dissolution of the corporation, to approve a purchase, sale, lease, mortgage, or other disposition of all or substantially all of the corporation’s assets, to select the principal officers, to amend or repeal bylaws or articles of incorporation, appoint or remove the other members of a self-perpetuating board or fix their number (Cal. Corp. Code § 7210).
Members
Members of mutual benefit corporations are defined in the corporate articles and are generally governed by mutual benefit corporation bylaws, which cannot be inconsistent with the articles or the Corporations Code. (Cal. Corp. Code §§ 7150(b)(2), 7310.) Members of mutual benefit corporations are generally vested with the right to vote on any action that requires member approval, as provided in the bylaws or articles of incorporation. Such actions includes among others amending bylaws or articles, electing directors, and effectuating a voluntary dissolution (Cal. Corp. Code § 7220).
Members also have judicial rights for the inspection of books and records of the corporation. The Articles of Incorporation or the Bylaws may impose certain requirements upon any member wishing to inspect or obtain copies of corporate records. Although such restrictions are not against public policy, the statute specifically provides that no such restriction may be imposed upon any member with a proper purpose. (Cal. Corp. Code § 8330.)

Tax and Financial Responsibilities

Unlike charitable nonprofit organizations such as 501(c)(3) public benefit corporations and private foundations, mutual benefit corporations like HOA and community service organizations typically do not qualify for federal income tax exemptions. However, this principle has exceptions. Although our client base primarily consists of community associations, we have formed the occasional nonprofit mutual benefit corporation that utilizes the California Nonprofit Public Benefit Corporation Law (CNPBCL), and it is our experience that the CNPBCL provides guidance for several key tax benefits. The California Nonprofit Mutual Benefit Corporation Law allows nonprofit mutual benefit corporations to qualify as a "cooperative." Even without seeking official recognition from the IRS as a "cooperative," a nonprofit mutual benefit corporation may qualify for the tax benefit of not paying franchise taxes, like those paid by corporate shareholders, on their allocated or non-allocated share of net income. California Franchise Tax Board (FTB) Information Release 678 clarifies that a "qualified cooperative" is an entity organized and operated to produce and market agricultural products marketed by the cooperative on behalf of its members. Similar provisions exist in the California Revenue and Taxation Code (CRTC). Taxes paid by the shareholders of a qualified cooperative are also limited to state property taxes, sales and use taxes, and special assessments charged by an irrigation or flood control district. (California Revenue and Taxation Code [Cal. Rev. & Tax. Code] 6367 subd. (a).) As a practical matter, this means that only a nonprofit mutual benefit corporation organized as a Cooperative will be able to take advantage of the state’s Cooperative Revenue Tax Law and avoid paying franchise taxes on their income. There is no state sales and use tax exemption for incorporated nonprofit mutual benefit corporations, including those run by charitable organizations such as 501(c)(3) public benefit corporations, private foundations, community service organizations and homeowners associations.

Legal Compliance and Issues

Compliance with California mutual benefit corporation law can be a minefield for associations, requiring them to balance strict legal obligations with the practical realities of day-to-day operations. Failure to comply can lead to significant legal exposure. Some of the more common pitfalls are listed below.
General Association Meetings
General membership meetings are often ripe for noncompliance, resulting in expensive and time-consuming legal actions from disgruntled members who are unhappy with the outcome of their association’s business.
A general membership meeting where certain issues are being presented for vote by the members is considered an "owners’ meeting" under California non-profit law. The failure to conduct a valid owners’ meeting at least once each year puts an association at risk of losing its corporate status as well as its right to collect past delinquent assessments via lien and foreclosure.
Technical requirements for various owner meeting processes must be followed, including timing for notice of the meeting, delivery or mailing of the ballots, and counting of results. Failure to follow the rules can result in a delay or outright rejection of the collection of delinquent assessments via lien and foreclosure when contested by an owner at the meeting.
Owner Voting
The legal issues surrounding voting at a general membership meeting have become very complex and have resulted in multiple legal challenges over the last few years. Although many issues are still being litigated, recent case law has outlined the requirement that associations must typically issue owner ballots and/or proxies for owners to cast votes.
As a result of multiple lawsuits involving a number of common interest developments in California, the California Legislature adopted Civil Code Section 1363.03 in January 2005 and pre-existing Corporations Code Section 7512.5 in 1986. These statutes outline the requirements for mail-in ballots and proxies under California law.
Proxies may only be used for owner election issues. Proxies may not be used for other types of owner meetings , such as board meetings. Proxies must sufficiently identify the meeting for which they are given, either generally, in response to specific ballots, or both.
Both statutes require that owners have an opportunity to revoke their proxies prior to the election.
Any ballot or proxy that contains a signature other than the name of the subscriber is ineffective and the subscribers must be provided with copies of ballots. Rule 9.5 and Rule 9.7 of the Elections Rules adopted by the California Civil Code and Davis-Stirling provide for secret ballots.
Enforcement and Penalties
As a result of the large amount of litigation involving associations on cases of noncompliance, there are numerous potential penalties that associations could face. Civil Code Sections 5145 and 5145.5 impose penalties for failure to comply with Davis-Stirling procedures and require that associations pay attorney’s fees for the losing party.
If owners seek to litigate a claim due to a violation of the elections procedures, they are entitled to recover their attorney’s fees even if the lawsuit is unsuccessful.
Legal Actions
The most common legal action taken by homeowners against their associations over various voting procedures is a writ of mandamus to invalidate an election or to halt the execution of an election until all legal requirements are met under the Davis-Stirling Act and the Non-Profit Corporation Law. The latter is usually the claim made when materials are not properly delivered under the procedure required by Davis-Stirling.
Other legal actions are claims filed by owners, corporations, or state attorneys general for damages arising out of the following non-compliance issues: These cases often include punitive damages and amounts for pain and suffering.
Compliance with California mutual benefit non-profit corporation law is critical to an association’s ability to collect delinquent assessments and achieve a high level of community harmony.

Management Best Practices

To successfully operate a California mutual benefit corporation, it’s important to have a clear understanding of its legal requirements and responsibilities. The following is a summary of recommended best practices that can help management ensure compliance with (and greater understanding of) the statutory laws which guide nonprofit operation and conduct.
In general, the board of directors (a.k.a. the "board") is responsible for the overall direction and management of the corporation – including the corporation’s policy decisions and formulation of long-range plans. As the legal "agents" of the corporation, directors also have fiduciary duties to the corporation and its members – including the duties of obedience, care and loyalty. Cal. Corp. Code §5231. This generally means that the board must act in good faith in furthering the interests of the corporation as opposed to their own personal interests, (known as the "business judgment rule"). Business & Professions Code §17200. For example, a director who uses his position or knowledge as such to gain a financial profit directly or indirectly (at the expense of the corporation) contravenes the duty of obedience.
While the board maintains certain powers set forth in the Nonprofit Corporation Law (commencing with Section 5130) over the corporation and its affairs, the members also maintain certain rights under the law – including right to participate in the affairs of the corporation and to approve corporate action such as amendments to the Articles or Bylaws or mergers. Cal. Corp. Code §§7510 – 7599 (nonprofit mutual benefit corporations). Those member rights are specifically set forth in the Articles and Bylaws. All potential members should be afforded the opportunity to review these documents prior to approving their membership application. Members should be made aware of these governing documents and how to access them if wanted, which will generally occur at a meeting where each voting member is first asked to approve (or not) the Articles as well as the Bylaws prior to being accepted for membership in the corporation. A set of the Bylaws must then be hand delivered, or sent to the members in a manner consistent with the manner set forth in the Bylaws for providing notice of meetings (or if no notice provision is stated, in a manner not inconsistent with Section 20 of the Code), Cal. Corp. Code §5340.
For any corporation with 100 members or more, member meetings need only be held once every year. Cal. Corp. Code §7513. An annual meeting of the members (consistent with Section 7513), however, does not take the place of a properly called special meeting so long as all statutory requirements are met. A special meeting of the members is any meeting other than an annual meeting. Cal. Corp. Code §§5038,7513. An annual meeting of members or special meetings of members may be held inside or outside of the State of California. Cal. Corp. Code §7513. California nonprofit public benefit corporations (those organized for charitable purposes) must hold their meetings inside California, however. Cal. Corp. Code §5210.
When called, the annual or special meeting of the members must be called in a manner consistent with the notice provisions set forth in the Articles of Incorporation and/or Bylaws. Therefore, for example, additional notice may be required if the public sentiment is to change the location of the meeting. Consistent with the statute, the notice requirements must be met even if the members are unanimous in their approval of the proposed business.
Notification to members of special meetings may be delivered in writing or electronic form, or by telephone. Cal. Corp. Code §7511(b). Notice of special meetings must contain the time and place of the meeting (and in case of a special meeting, the purpose of the meeting). Cal. Corp. Code §7511(b). There is no notice requirement for member meetings when the corporation is organized on a mutual benefit basis, unless a written demand upon the corporation is made by one or more members holding at least five percent (5%) of the voting power of the corporation. Cal. Corp. Code §7512.
Once a corporation has a minimum of 50 members, however, it is required to hold regular meetings of the members (as well as of the board of directors). Each director is required to attend at least a majority of those meetings (or what constitutes a majority of the meetings required in that group). Cal. Corp. Code §5230(b). Items of business requiring approval include: election of directors, annual report, indemnification of agents permitted by law (if any), appointment/removal of registered agent, and appointment/removal of the designated member of the accounting firm to audit and report on the books and accounts of the corporation. Cal. Corp. Code §§7511,5340.
The minutes of an annual or special meeting of members must be recorded and kept in a book kept by the corporation and open to the inspection of members. Cal. Corp. Code §7518. Corporate tax returns and the corporation’s accounting and financial records must also be kept in a place or places which the corporation maintains inside this state. Cal. Corp. Code §8320.

Real-World Examples and Case Studies

The California State Bar Sections Law Practice Management and Technology ("LPMT Section") provides mutual benefit corporation formation services to California consumers through qualified and trained volunteers, including members of the LPMT Section, and the California Lawyers Association. The quality of these services is maintained through the oversight of staff attorneys and law professionals on a dedicated volunteer taskforce. While these lawyers do not charge attorney fees, they provide their services as a community service. LPMT Section volunteers make up the majority of the "local counsel" from the community resources that handled formation services in 2018.
For example, last year , the LPMT Section helped a group of students study for the Bar Exam to form a non-profit educational corporation to teach others how to prepare for the Bar Exam. A former law firm business partner’s subsequent death complicated their efforts to transfer the existing law practice into the non-profit. But the LPMT Section persisted, and the California Secretary of State approved the business entity formation.
Another mutual benefit corporation, based in Northern California, is Sky Island Alliance, which offers citizen science and land stewardship programs. In addition to its local efforts, the group has a healthy online presence and hosts regular Sierra Nevada meadow monitoring and restoration training workshops. The workshops are a good example of accessible services designed to help protect, preserve, and restore our shared natural resources.