Alternatives to For-Profit Status for Participating in Title IV Programs 062112, by Neil Lefkowitz, Dickstein Shapiro LLP Partner (2012 APSCU Annual Convention)

© 2012 Dickstein Shapiro LLP. All Rights Reserved.

Alternatives to For-ProfitStatus For Participating inTitle IV Programs

June 21, 2012

Neil Lefkowitz

#3067381


General Advantages of Not-for-ProfitStatus

May qualify for exemptions from federal and stateincome taxes

May qualify for exemptions from sales tax

May qualify for exemptionsfrom property tax

May be able to obtaintax-exempt financing

May qualify for tax-exemptU.S. postal rates


General Advantages of Not-for-ProfitStatus

Students may be able to obtain stategrants available only to students ofnot-for-profit higher educationinstitutions

May be able to participate in libraryand other programs available only tonot-for-profit education institutions

May receive charitable donations orparticipate in grant programsreserved for not-for-profit institutions


Regulatory Advantages ofNot-for-Profit Status

Following the first full fiscal year after completion ofthe “conversion” transaction, not subject to 90-10 rule

Degree programs of not-for-profit institution notsubject to GE rule

• Not clear whether DOE will require a transition period


Disadvantages of “Converting” toNot-for-Profit Status

Transaction will constitute adisposition at present for marketvalue, which is generally lowerthan the fair market value offor-profit higher educationinstitutions in 2003-2009.

Very limited amounts payable tomanagement former owners in theevent of a subsequent disposition of the institution

• Any amounts payable to management former ownerswill be taxed at ordinary income rates



Present owners will provide all orsubstantially all of the financing as“seller financing”

• Owners bear the risk ofnonperformance/nonpayment

Compensation payable to owners intransaction is limited by federal incometax laws

Compensation payable to former owners by thenot-for-profit after the transaction closes is limitedby federal income tax laws



Proceeds of transaction will be taxable to owners butinstallment sale treatment should apply to deferredpayments of purchase price

• Tax rates may increase in the future

Owners lose control of institution• Board of directors of not-for-profit

corporation must be independentfrom the former owners

Greater disclosure of financial activities of 501(c)(3)corporations on IRS Form 990, which is publiclyavailable



Activities of not-for-profit afterclosing is limited by federalincome tax laws

• Restrictions on engaging inancillary, for-profit activities

• Restrictions on joint ventureswith for-profit enterprises

• Restrictions on politicalactivities

Generally, more limited financing alternatives fornot-for-profit corporations than for-profit corporations


Regulatory Disadvantages of“Converting” to a Not-for-Profit Status

Transaction will constitute a change of control forpurposes of participating in federal student aidprograms

• Letter of credit of 25% or more of anticipated federalstudent aid required to be posted with the DOE

• Restrictions in PPA on adding new programs orlocations or substantially modifying existing programs

• PPA will be provisional


Regulatory Disadvantages of“Converting” to a Not-for-Profit Status

Substantive change for accreditation purposes• Certain accreditors may view negatively and impose

new restrictions

• May take months to obtain accreditor approval as aconsequence of document review and schedule ofcommission meetings

Change of control for state education agencies

May lead to change of state regulatory agency


Timing of “Conversion” Transaction:Allow 6-8 months to complete

Retention of professionals, includingappraisers

Analysis of transaction structure andtax planning

Selection of independent directors

Preparation of transaction documents

Determination of fair market value

Preparation of application to the IRS


Timing of “Conversion” Transaction:Allow 6-8 months to complete

Preparation of an application to DOE for pre-acquisition review

Preparation of substantive change or otherapplication for accrediting bodies

Preparation of change of control applications forstate education agencies

Obtain required consents of private parties such asfinancing sources, landlords, equipment lessors andsoftware licensors


Transaction Structure

Transaction structure is determinedby income tax consequences, taxplanning objectives, financingobjectives, the existence of liabilitiesoutside of the ordinary course ofbusiness and any challenges inobtaining third-party consents, aswell as flexibility in state law

• Generally, recommend Delawarelaw for clarity and flexibilityregarding non-profit, nonstockcorporations



Sale of Assets of For-Profit Entity to Not-for-ProfitCorporation

• Define which assets, liabilities and contracts are transferred orassumed and which are retained

• Importance of paying fair market value for acquired assets and fairrental value for leased assets to the Section 501(c)(3) status ofpurchaser. Fair market value will be determined by independentvaluation expert

• Purchase price will be paid over time and evidenced by loandocuments which include a market rate of interest

• Likely contain subordination provisions for the benefit of present orfuture lenders

• Fewer representations and warranties and indemnification provisionsthan in other sale transactions

• Conditions to closing for regulatory and private party approvals



Merger• Transfer of assets and assumption of liabilities and contracts happens

by operation of merger and minimizes transfer and assumptionlogistics

• If certain asserts, liabilities or contracts will be retained by the for-profitentity, the assets, liabilities and contracts to be transferred can beplaced in a newly-formed subsidiary, which is then merged into thenot-for-profit corporation

• May not be available under all state laws

• Merger consideration must be for fair market value

• Merger consideration will be paid over time and evidenced by loandocuments which include a market rate of interest

• Fewer representations and warranties and indemnification provisionsthan in other sale transactions

• Conditions to closing for regulatory and private party approvals



“Conversion In Place”• Change in organizational documents of for-profit corporation to not-for-

profit corporation which qualify for 501(c)(3) status

• Election of independent board of directors

• Former stockholders surrender stock to the corporation and receivefair market value for shares, which is paid over time and evidenced byloan documents

• Transactional documentation is less than in asset sale and mergerstructures

• There may be lesser requirements for regulatory and private partyapprovals. The transaction will constitute a change of control forpurpose of participating in federal student aid.

• Variety of administrative changes, such as changes to employeebenefit plans


Other Topics

Charitable contributions may be part of thetransaction

• Deductions arising from contribution may be veryhelpful for owners butcomplexities arise ifassets other than cashare contributed


Other Topics

Corporate governance• Not-for-profit corporation must be under the control of a

board of directors which is independent of formerowners

• Caution as to persons who serve as directors of otherhigher education institutions participating in federalstudent aid programs serving on not-for-profitcorporation’s board of directors


Other Topics

Corporate governance, cont.• Board of directors approve compensation arrangements

for any former owners who continue to serve asemployees. Income tax laws and regulations limit theamount of compensation

• Members of board of directors may be personally liablefor “excess benefit” transactions

Law

Alternatives to For-Profit Status for Participating in Title IV Programs 062112, by Neil Lefkowitz, Dickstein Shapiro LLP Partner (2012 APSCU Annual Convention)