When one thinks of a company, trading activities and profit-making typically come to mind, with dividends eventually distributed to shareholders. The trading “purposes” of a company are in its Memorandum and Articles of Association and while the Companies Act allows companies to be established for any lawful purpose, it is unusual for a company’s purpose to focus solely on the public good rather than the financial benefit of its stakeholders—whether shareholders, employees, creditors, or others.
In our legal system, non-profit organisations are traditionally the domain of religious and voluntary organisations, typically structured as foundations or associations. In order to avoid confusion in the perception of supporting members of the public, the Voluntary Organisations Act (VOA) expressly states that “a voluntary organisation may not be established as a limited liability company or any commercial partnership.” However, the concept of a non-profit-making company does exist. This raises questions: Is this designation appropriate? Why are these entities not set up as trusts, associations or foundations – the more typical forms – instead?
Voluntary organisations and trading activities
Voluntary organisations do not usually engage in trading activities. Their primary focus is on public benefit purposes, even when raising funds through public appeals, fundraising activities, or grants. Engaging in extensive trading activities could detract from achieving the organisation’s public benefit objectives. The VOA allows exceptions where trading is essential to achieve an organisation’s objectives – for example, museums selling entrance tickets or schools charging tuition fees. Additionally, a voluntary organisation is permitted to engage in commercial activities provided the income generated remains minor compared to its overall income from public benefit activities.
For significant trading activities unrelated to their public benefit purposes, voluntary organisations are required to set up a limited liability company where the focus is the trading activities intended to generate income and which need to be carried on legally, professionally and in a manner compliant with many laws applicable to traders. This ensures a level playing field by subjecting such activities to the same trading, compliance, health and safety, consumer protection and taxation rules as other commercial enterprises, thereby avoiding discrimination within the commercial sector. The VOA seeks to ensure that proper resources are placed within the trading company to ensure that appropriate resources and focus remain dedicated to the voluntary organisation and its public benefit purposes. Without this division, a real risk would arise that the resources (human and financial) needed for the voluntary organisation would be distracted and upset by the challenges posed to operate a trading operation.
Although it is much easier to operate an association or a foundation, as there are far less rules applicable to these forms when compared to a limited liability company, many already find the demands of the VOA to be too cumbersome, just imagine adding to these all the rules applicable to trading companies. So, the law requires a dedicated legal form (a limited liability company), if a voluntary organisation decides to stretch itself into trading activities beyond its own public benefit purposes.
In such cases, the flow of funds between the company and the voluntary organisation operates similarly to that between a parent and subsidiary. The dominance of the public benefit purpose in this structure requires, for consistency with the most basic principles of voluntary organisations, that no private interest benefits from the profits generated by the limited liability company.
How does it work in practice?
When a voluntary organisation establishes a limited liability company, the law mandates that non-profit-making principles must apply to the company to prevent abuse. While the company may generate profit, its purpose must not include the promotion of private interests, such as benefiting its directors, nor can that happen in practice. Profits are to be used solely to advance the objectives of the parent voluntary organisation through direct distributions up to the parent only. The company serves as a vehicle for profit generation to help achieve the voluntary organisation’s goals. Upon liquidation, any capital distribution must go exclusively to the parent voluntary organisation.
Voluntary organisations do not usually engage in trading activities
The directors of the company do not directly fulfill the public benefit purposes of the voluntary organisation. Instead, their role is to generate profits, which are then applied to those purposes. Administrators of the voluntary organisation who also serve as directors of the company are generally prohibited from receiving remuneration, ensuring compliance with restrictions on private benefits. If a remunerated director is engaged to better operate the company, as opposed to relying on volunteers, then strict rules apply to such engagement and such persons’ remuneration, which must reflect market conditions.
Practical considerations
While establishing a company allows the voluntary organisation to compete effectively in commercial markets, it also imposes significant administrative burdens. Limited liability companies must appoint auditors, adhere to compliance rules, and observe accounting standards. It is often argued that voluntary organisations face considerable strain from increasing bureaucratic burdens. Adding further obligations to the voluntary organisation’s structure for the sake of potential profit generation may not be justifiable in real terms.
Each case must therefore be assessed on its own merits, considering factors such as costs, resources, compliance obligations, and feasibility. While establishing a company is legally possible and can provide valuable tools for achieving public benefit goals, it may not always be the best solution for every voluntary organisation.
Conclusion
When a voluntary organisation makes the choice to set up a limited liability company for trading purposes, and thus complies with the VOA to ensure that none of its generated profits go to any private interest, we have a special case not addressed in the Companies Act. This is an atypical company but one which is clearly regulated in the VOA through a superstructure of additional rules to those in the Companies Act. These rules are not contradictory, and one set merely modifies the other to consistently achieve the public benefit purposes of the former.
It is not uncommon for this type of company to be referred to as a “non-profit making company” although the term is not technically used or defined in the VOA. It is, however, in practical terms, an appropriate term to use for this special type of company as it can only make profit for one purpose – that of passing all of it onto the parent voluntary organisation. If this does not happen in such a company, then there would be a serious breach of the VOA, undermining the credibility and good reputation of the voluntary and non-profit sector. So, we all need to be vigilant to ensure that this does not happen.
That is what a non-profit making company is under Maltese Law.
The authors would like to thank Max Ganado for his contribution to this article.
This article was first published in The Corporate Times.