THE MARCUS FIRM, PLLC

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1 THE MARCUS FIRM, PLLC 1730 Rhode Island Avenue, N.W. Suite 713 Washington, D.C Tel: (202) Fax: (202) PRESENTATION TO ASSOCIATION OF PUBLIC CHARTER SCHOOL ATTORNEYS FALL 2014 LEGAL SEMINAR SANTA MONICA, CA September 12, 2014 CHARTER SCHOOL CLOSURE AND TAKEOVER I. INTRODUCTION An underlying premise of charter schools is that in exchange for autonomy in their operations, they are held accountable for their performance; Although closure has always been a part of the charter school landscape, as authorizers step up their efforts to demand better performance from charter schools, we can expect to see more closures; Closure is a challenging and painful process for everyone involved and, if possible, reasonable alternatives should be considered; But even where closure is required, there are options that are preferable to outright closure; This presentation addresses one such option, which is to incorporate a takeover by another charter school into the closure process; This approach creates its own complexities: there may not be much guidance from the authorizer since it generally focuses on pure closure; the statutory requirements may be inapt since they focus on closure; there can be tricky issues relating to the disposition of assets and money; and there may be friction on a variety of fronts between the closing school and the acquiring school; 1

2 This presentation looks at the mechanics of closure and takeover and identifies some of the issues that arise when they are combined; It is largely based on my law firm s experience representing a large DC charter school that had to close and dissolve due to poor academic performance and which transferred its students, building, bank accounts and debt to a high-performing charter school; II. MAPPING THE CLOSURE PROCESS Closure touches on many statutory, regulatory and contractual issues; It is crucial to identify those issues at the beginning of the closure process to make sure that closure is done correctly; While specific legal requirements will vary in every state, it is likely that in every state, there are certain common requirements; It is advisable to create a checklist with all of the legal requirements necessary to close the charter school and dissolve the entity that holds the charter; Here are some places to look: o State charter school statutes may have a provision dealing with closure requirements. I included a provision from DC s statute in the materials. It requires that when a nonprofit loses its charter, the nonprofit must dissolve and distribute its assets pursuant to a plan of distribution. The plan must liquidate the corporation s assets, discharge its debts, distribute remaining assets to the State Education Office, and prepare a closeout audit; o Charter schools are usually incorporated as nonprofit corporations. State nonprofit corporation statutes deal with dissolution. DC s statute prescribes the process for dissolution, limits on the nonprofit s authority after it files articles of dissolution, the procedure for notifying both known and unknown creditors of the dissolution, and statutory immunity for directors who follow the statute s dissolution procedures; o The state charter school authorizer may have a closure manual. I included DC Public Charter School Board s closure manual in the materials. It contains a very detailed set of procedures that must be followed together with helpful forms. DC s Office of the State Superintendent of Education (OSSE) also has a closure manual. However, it is important to review the forms carefully as they may not be appropriate to the transaction or legally insufficient; o Corporate practice is another source in that it provides guidance on steps that should be taken in order to wind down and dissolve a corporation. You can 2

3 obtain useful information on the website for the Nonprofit Risk Management Center. See, e.g., III. IS TAKEOVER A POSSIBILITY? A closing schools may have valuable assets that could make it attractive to another charter school students, real estate or cash; It is worth pursuing takeover, if possible, for several reasons: o It is less disruptive to students and their families; o It may give the closing school an opportunity to structure an acquisition that preserves its unique mission; o It may allow some of the faculty and staff to continue to work at the school; o It will simplify at least part of the closure process by avoiding the need to dispose of assets; o It may be an efficient way to deal with debt if the acquiring charter school is willing to pay it off; IV. SELECTING A TAKEOVER PARTNER If a closing school has assets, including its students, it may be an attractive target for takeover by another charter school; If more than one charter school is interested in the acquisition, the closing school has to evaluate which school is the best takeover partner; There are several considerations to take into account: o Does the takeover school have a mission and culture that are compatible mission with the closing school? o Will the acquiring school make commitments to improve academic programing and facilities? o If the closing school has debt, is the takeover school is the takeover school acceptable to the bank? o Is the takeover school acceptable to the authorizer? 3

4 If several charter schools express interest in taking over a closing charter school, it is important to put a process in place to fairly evaluate the candidates; That process could include requiring interested schools to make a presentation to the closing school s board, provide a written proposal and requiring that the acquiring school selected memorialize its promises in an agreement; V. PARTICIPANTS IN THE CLOSURE/TAKEOVER PROCESS A. Students, Faculty and Parents They are the key constituency and need to be kept informed of key developments; B. Boards of Trustees of Closing School and Acquiring School Essential that both boards be involved throughout the process; The closing school will have to address a host of issues during the closing process and there needs to be a process in place for making informed and quick decisions; A good approach is for the board to appoint a committee of key board members to oversee the process and for the committee to have weekly conference calls during which the participants in the closure process can provide status reports and the committee can give direction; C. Authorizer The authorizer will want to know that its closure requirements are being followed and that the takeover process proceeds smoothly to minimize any impact on students and school operations; The authorizer will likely have a closure specialist who can coordinate regular conference calls with the closing school to ensure that its closing requirements are met; Also advisable for closing school counsel to engage with authorizer counsel to make sure that all legal requirements are being met; D. The Bank Closure may trigger a default under the terms of a closing school s loan agreements; The lender will be concerned about the status of debt repayment; Determine if you are in default and identify your rights in the event of default; 4

5 At the same time, keep the bank informed of what is happening to avoid the bank from calling the loan; The bank may be willing to declare a technical default but forebear from calling the loan in order to allow the school to arrange for a takeover; The bank will be very interested in knowing whether the acquirer has the financial strength to assume the closing school s debt; E. Legal Counsel Legal counsel needs to take a lead role in guiding his or her client through the many legal requirements that have to be met in closing a school and dissolving the nonprofit corporation that holds the charter; Takeover is a complex acquisition of assets and assumption of liabilities that also requires legal counsel as you would with any commercial acquisition; Counsel also plays an important role in helping keep the closing school s board focused and informed so that it can make key decisions as the closure and takeover process unfolds; VI. LEGAL FRAMEWORK FOR CLOSURE A. Closure Plan The authorizer may have a template for a closure plan that it expects closing schools to follow. These are typically one-size-fits-all forms that need to be tailored to the specific transaction; The closure plan should include requirements for notifying the school community, transfer and storage of school records, summer school, notifications to parents of SPED students and review of IEP plans, notification to benefit providers, termination of employment contracts, tax filings, plans for paying liabilities, termination of vendor contracts, return of federal grants, return of school assets, submitting student data, providing financial reports, preparing a closeout audit, storage of corporate records, maintaining D&O coverage, and dissolution; Counsel for the closing school should review the closure plan to make sure it is complete, accurate and tailored to the transaction; The authorizer may also have a closure specialist who can assist the closing school during the closing process; 5

6 B. Worker Adjustment and Retraining Notification (WARN) Federal statute requires that an employee with more than 100 employees give its employees at least 60 days notice of closings and mass layoffs; If a closing charter school has more than 100 employees, it must send a WARN letter; The required notification can be included in a more comprehensive letter to employees updating them about the status of closure; C. Termination of Employment Contracts, Incentive Pay and Release Employees must also be given notice of termination or nonrenewal of their employment contracts; It is important to review their contracts to ensure this doesn t create a potential breach of contract argument by employees; Consideration should also be given to making incentive payments to employees to encourage them to stay with the school for the balance of the school year. The payments should be reasonable, and require that they give advance notice of time they intend to spend away from school interviewing for a new job, require that they otherwise report to work on time and continue to fulfill their duties as employees; It is also important that employees be told that in order to receive incentive pay, they must sign a release of any claims; You need to make sure that the release complies with legal requirements including giving the employee the requisite time to waive any discrimination claim; Need to work out timing issues to make sure that the release is binding at the time you give the incentive payment and that it coincides with the end of the school year and termination of the employment relationship. If you don t have employment law expertise, you should consult an employment lawyer to ensure you have a valid release; D. Termination of 401(k) Plan There is a good chance the closing school will have a 401(k) plan; You should get tax advice to make sure that in terminating the plan, the plan doesn t lose its tax qualified status; 6

7 Some of the steps to take terminate the plan include the following: o Review the plan document to ensure that the school has the right to terminate the plan; o Establish a plan termination date; o Determine if you need to update the plan to conform to any new legislative requirements; o Prepare a board resolution setting a plan termination date; o Calculate participant account balances as of the plan termination date; o Do a plan audit to ensure the plan is compliant with IRS requirements as the IRS will allow the closing school to correct errors in plan administration without penalties if detected and addressed prior to plan termination/distribution; o Consider getting a determination letter from the IRS confirming that the plan is legally compliant and that termination does not affect the taxqualified status of the plan. However, the cost and time required to obtain such a letter may not be justified; o Notify all plan participants about the plan termination and request that they elect a distribution option; o Distribute assets in accordance with participant elections; E. Return of Government Funds and Assets Purchased With Government Funds The closure process should address what happens to any federal or state funds that will be left over after closure or which were allocated to be used after closure; While state requirements on the return of funds will vary, this is likely to be an important issue; The closing school may be required to return any unused operating funds or other government funding; There may also be statutory requirements governing the obligations of a dissolving school or nonprofit corporation with respect to assets purchased with government funds. This may require that such assets be transferred to another nonprofit corporation dedicated to a charitable purpose in which case you may have a good argument for transferring assets to the acquiring school, not the authorizer or some other state entity; 7

8 F. Vendor Contract Review and Termination It is very important to review each vendor contract to ensure that you terminate it in accordance with its terms; The closing school should not send out a form letter terminating all contracts; The letter has to be tailored to each specific contract; Since some contracts have automatic renewal provisions, you should deal with this issue very early in the closure process so that you don t find that the school has allowed contracts to renew and is now liable for breach of contract for early termination; G. Assets and Liabilities If this was only a closure, the applicable state statute would probably direct the charter school to marshal its assets and pay off its creditors; But in a closure/takeover situation, the closing school and the takeover school have the ability to negotiate, as you would in any commercial transaction, determine, through negotiation, which assets and liabilities should be transferred; This issue is addressed more fully in the discussion of negotiating an asset acquisition agreement; H. Dissolution Procedures The state nonprofit corporation statute will typically include dissolution procedures; In DC, a dissolving nonprofit corporation must take the following steps to dissolve: o The board must adopt a dissolution resolution; o The school must give notice of dissolution to the Attorney General o File articles of dissolution; o Give notice of dissolution to potential claimants; o Publish notice of dissolution in a newspaper of general circulation stating that claims must be filed within three years; 8

9 I. Insurance All of the closing school s insurance coverages must be reviewed and decisions made about cancelation and renewal of different types of coverage; The school is going to want to cancel health care and other insurance coverages for its staff, liability coverage and property coverage. Staff should be informed of this in a letter. It is important to note that there probably won t be an option for continuing coverage under COBRA because the closing school will be terminating its benefit plans; D&O coverage should be continued to protect board members and staff against claims that could be asserted against them in the future arising out of school operations or the closure process. The renewal period should track the limitation period for claims that could potentially be asserted; J. Document Retention and Destruction A closing school will be required to ensure that certain documents are maintained and available for a period of several years after dissolution. The primary purpose of retaining documents is to ensure that information is available to (i) the IRS in the event there is a tax liability issue; and (ii) any other interested party who may have a claim or need corporate information in connection with a potential claim; Although most of the guidance on this issue suggests 4 years, the IRS may look back 6 years and there is some guidance to be found that suggests that documents be kept for 7 years; The authorizer will also likely have some record retention requirements; The types of documents that need to be retained include: organizational documents; tax and accounting records; payroll and employment tax records; banking records; personnel and employment records; contracts; grant records; insurance policies and records; legal records; and correspondence; The closing school will need to select a custodian of record who agrees to maintain the retained documents for the required number of years and to make them available in accordance with applicable law; VII. LEGAL FRAMEWORK FOR TAKEOVER If the closing school is a candidate for a takeover, the terms of the takeover need to be negotiated and agreed; Some of these terms may already have been agreed when the closing school was deciding which school it wanted to take over their school; 9

10 In some ways, the agreement by which a takeover school acquires the assets of a closing school should resemble what you would expect to find in the commercial context; However, commercial agreements are typically full of representations and warranties designed to give the acquiring party recourse if the situation is not as appeared to be. This assumes that the seller is going to be around after the transaction to respond to a claim of misrepresentation or breach; This is not the case with closure the school will be a dissolved corporation with no assets. For that reason, a charter school asset acquisition agreement could be very short. On the other hand, the acquirer may still want certain representations and warranties in order to force the closing school to be sure of its facts before signing an agreement which contains representations based on those facts; What follows, are some of the key terms that should be negotiated and included in an asset acquisition agreement to takeover a charter school; A. Due Diligence The acquiring school should have the opportunity to conduct due diligence before committing to going forward with the transaction closing in order to assess the physical and financial condition of the closing school and school operations and to confirm the underlying economics of the transaction; Due diligence should include a building conditions report, review of financial information, books and records, contracts, review of student composition, title search and an environmental investigation; The acquiring school may also want access to key individuals such as the Board, Head of School, Treasurer and CFO to help it understand the closing school s operations; B. Enrollment The parties need to consider if students in the closing school will have guaranteed seats in the takeover school; This is an important factor for the closing school since it may have chosen the takeover school because of the benefits it brings to its students; The legal issue is whether the acquiring school can guarantee seats to current students in light of the open enrollment requirements in the applicable charter school statute; This would enable current students to avoid a lottery if there is overenrollment; 10

11 This will require legal analysis and consultation with your authorizer to ensure it won t object to guaranteed seats; C. Transition Plan It is advisable to establish a transition team consisting of leadership from both the closing school and the takeover school to familiarize parents and students with the new school. This can include an outreach program to encourage students to enroll in the new school; The team should develop a transition plan that will guide the closure process; D. Educational Programs The closing school may have special programming that it wants to see continued by the takeover school. An agreement to do so should be memorialized in the agreement; If there are academic weaknesses in the school, the parties can agree to enhance programming, say in reading and math, to bring those students up to grade level; If the academic program of the takeover school is more rigorous, the agreement can include the requirement that it provide academic support to students and counseling to families to help them make a successful transition; The agreement should also give administrators, teachers and staff of the closing school the opportunity to learn about the takeover school and the right to interview for a position; There may be other agreements that can be reached to improve the quality of the educational experience for students. This could include building new facilities, expansion in the number of seats or grade levels, etc. E. Individual Education Plans (IEP) Special needs students with IEPs should also be addressed in the agreement. The takeover school can review IEP s and services provided, and provide professional development and support to special education teachers; Notices should be sent to parents of students with IEPs who choose to enroll with the acquiring school inviting them to meet with representatives of the acquiring school to discuss IEP s and educational and support services that will be required; F. Summer School 11

12 The parties need to address what will happen to the closing school s summer school program. There needs to be clarity on whether the closing school or the acquiring school will operate the summer school at the end of the academic year; If it is going to be the acquiring school, there should be agreement on the specifics of the program. The closing school does not want its parents to be surprised by a summer school that is something less than what was provided in prior years. This will be particularly important for parents who send their children to summer school as part of an Extended School Year (ESY); It will be important to notify parents as part of the closure process as to what to expect with respect to the summer school program; G. Closure Budget Both parties have an interest in having a closure budget and making it part of their agreement. The acquiring school has an interest in a closure budget to ensure that the closing school does its best to conserve financial resources that can be transferred to the new school. The closing school has an interest in a closure budget so that it can project expenses, ensure that it has reserves sufficient funds to pay its expenses, and keep control over expenditures during a very difficult time; H. Transfer of Assets The asset acquisition agreement needs to specify those assets that will be transferred; This should include the school s real property, personal property (furniture, equipment, teaching materials, books, etc.), cash, permits, school records, intellectual property, rights under insurance policies, and personnel records for employees hired by the acquiring school; At the same time, the closing school will need to reserve sufficient cash to wind down its operations and pay any liabilities that are not assumed by the acquiring school; These funds should be excluded from the assets that would otherwise be transferred to the acquiring school; Be careful to determine whether there are any legal obligations imposed on closing charter schools or dissolving nonprofit corporations relating to the disposition of assets. There may be statutory requirements requiring a dissolving charter school to transfer assets to a governmental entity or to another nonprofit corporation. If such requirements exist, you will need to think carefully about how to satisfy those requirements while, at the same time, transferring assets to the acquiring school; I. Assumption of Liabilities 12

13 The parties need to decide on how to handle the repayment of bank loans. There are several options here including having the closing school repay some or all of the loan or having the acquiring school repay some or all of the loan; If the acquiring school is going to assume or repay some of the closing school s debt, you may need to have an agreement to which the closing school, acquiring school and bank are all parties that deals with the loan; There may also be equipment leases and other financial obligations of the closing school that the acquiring school will want to assume. These need to be carefully delineated in the agreement; The agreement should also specify those obligations that the acquiring school is not acquiring to avoid being saddled with unwarranted debt or obligations; J. Representations and Warranties Although there is no enforcement value to representations and warranties, the acquiring school may want to include them in the asset acquisition agreement nevertheless to increase its confidence that there will be no hidden surprises after takeover; Representations of the type you would expect to see in a typical commercial transaction that should be considered include: the closing school is a duly organized nonprofit corporation; it has the authority to execute the asset acquisition agreement; it is not in violation of any law; the agreement does not conflict with any legal obligations; no consents are required for the transaction other than those identified in the agreement; it has good title to all of its assets; its financial statements are accurate; there are no undisclosed liabilities; all employee and vendor contracts have been or will be terminated; The closing school can, through a board member, certify as to the accuracy of representations and warranties; however, the scope of the officer s due diligence inquiry needs to be carefully defined so there is no risk the officer will commit to a statement that isn t true or which can t be verified. The due diligence inquiry can be handled by having the certifying officer make reasonable inquiry of a defined knowledge group. This could be the Board, Head of School and Chief Operating Officer; The closing school should consider putting in a broad disclaimer of warranties other than those specifically made in the agreement; K. Sale of Real Estate 13

14 This component of the transaction will follow the form of a typical real estate transaction; One important difference though is that the acquiring school may not be paying the fair market value of the real estate; The difference between the total value of the assets acquired by the acquiring school and the assumption and payment of its debts is the equity that makes a closing school an attractive takeover candidate; The fact the acquiring charter school is not paying full value for the real estate and other assets gives the closing school an argument to limit some of the representations and warranties that might otherwise be a part of the sale of real property; The condition to sale that the acquiring charter should insist upon is that it will receive insurable fee simple title conveyed by a deed in a form, a survey, the right to object to any issues that are raised in the title commitment or the survey, and the right to terminate the transaction of the closing school is unable to cure the defects; The lawyer handling the closure process should have experience handling real estate closing; otherwise, advisable to bring in a lawyer who has this expertise; L. Preservation of Status Quo and Providing Updated Financial Information The board of a closing charter school may feel pressure to reward loyal staff with large bonuses; While a bonus, in concept, may be reasonable, a closing school needs to be careful not to make excessive payments; Authorizers may become concerned if they discover that public funds are not being spent prudently; The board needs to approve these compensation issues thoughtfully; These issues can be addressed in the acquisition agreement by attaching a closure budget, by requiring that the closing school operate in the ordinary course of business (taking into account the fact that it is closing), and by requiring that it provide updated financial information to the acquiring school on a regular basis from the date of contract to the date of closing; M. Status of Pending SPED Cases and Settlement Obligations 14

15 The closing school may have pending SPED litigation that should be disclosed to the acquiring school; In addition, it may have settled SPED cases and agreed to take certain actions to assist students with IEP s. The acquiring school should know what IEP obligations it may be assuming; N. Press Releases and Confidentiality It is a good idea for the parties to consider requiring that no press release be issued without the consent of both parties; The parties should also consider if they want to impose any confidentiality requirements relating to disclosure of the agreement; O. Enforcement If the closing school has chosen a takeover school because it has agreement to preserve components of the closing school s mission or made other commitments, the board of the closing school will want confidence that the acquiring school will satisfy those commitments; This poses a unique problem because the closing school or its board won t be in existence and therefore able to enforce its contract with the acquiring school; There are several ways to address this including giving the parents association thirdparty beneficiary rights under the contract or agreeing that parents can seek recourse with the authorizer; P. Regulatory Review and Approvals It is important early on to identify any regulatory approvals necessary to execute the transaction, including from the charter school authorizer; The authorizer may have views on which charter school should acquire the closing school based on academic and financial considerations; The authorizer may also have views on the structure of the transaction, requirements, transfer of assets, and the approval process for the acquisition; It is important to keep in regular communication with the authorizer so that they have a good understanding of the closure/takeover process, advise as to what approvals are required, and can alert you to any concerns they may have about either the closure process or the terms of the acquisition agreement; 15

16 VIII. OTHER CONSIDERATIONS A. Morale Closing a charter school, even if combined with an acquisition, is a painful process; Not all staff will be hired by the acquiring school; They may feel financially and professional worried; Some staff members may not have looked for a job for a long time; This problem gets worse after the acquiring school decides which of the current members of staff it wants to hire for the next school year; That decision can create a rift and resentments between those who are staying and those who must leave; These issues should be anticipated and addressed in the closure/takeover process; Strategies to address this could include the following: o Provide counseling services; o Designate someone in a staff leadership position to lead the closure process who is not going to become an employee of the acquiring school. It will be very difficult for a school leader not to feel some divided loyalties if he or she is going to be employed by the acquiring school. It will be difficult for that person to maintain the confidence and loyalty of staff; o Set up a committee made up of the Head of School or whoever is leading the closure process and a few teachers as forum for raising issues of concern and that can be communicated to the board during the closure process; o Use the transition team a place to address issues that come up during the closure/takeover process; o The acquiring school should respect existing lines of authority and procedures while the closing school is still operating; o Don t encourage staff members who have been hired by the acquiring school to do anything that differentiates them from staff who won t be hired (e.g., don t have staff who will stay on wear something that shows the insignia of the acquiring school while the closing school is still operating); 16

17 B. Money o Have open lines of communication between the closing school and the acquiring school at the operational level, board-to-board, and between counsel; A takeover that is motivated, at least in part, by a closing school with a strong balance sheet may generate concerns about the closing school s expenditures during the closure process; The closing school may resent what it views as an attempt to micromanage or control its spending decisions; These tensions are inevitable but can be addressed through a closure budget, providing financial updates, and transparency; C. Transparency and Disclosure Both the closing school and the acquiring school will be able to negotiate and implement their agreements best if they are transparent in the dealings and forthright about their concerns; They should approach their authorizer in the same way and other state regulators in the same way; By approaching the process in this way, the parties will gain confidence and respect in each other that will translate into a better and more efficient result; A thoughtfully structured takeover can be an excellent way to reduce the hardship of closure and create a good outcome for students and their families. 17