September 30, 2023
Navigating Governance Challenges: Strengthening Non-Profit Organizations in India
India’s social sector has seen substantial growth over the last two decades, with a surge in registered societies collectively valued at approximately Rs.41,292 crore.1 These organizations have become instrumental in driving social transformation and philanthropic endeavors. However, as the sector expands, it faces a range of governance challenges that require careful legal consideration and analysis.2
While many people associate non-profit organizations (“NPOs”) primarily with fundraising, their true purpose extends far beyond that. Each NPO has a unique mission that guides its efforts towards making a positive impact on society. NPOs hold a vital position within our society, delivering a diverse array of services spanning healthcare, education, religion, social assistance, industry and professional initiatives, amateur sports, and fundraising for medical research and public awareness. In an ever more intricate operational landscape, all entities with public accountability, including NPOs, confront a multitude of significant challenges as they strive to meet the escalating expectations of their stakeholders. Within this context, it has been demonstrated that organizations with strong governance are more effective and stand a higher chance of success when compared to those with inadequate governance.
NPOs in India encounter unique governance challenges due to their diverse stakeholders, complex financial models and a largely self-regulated environment. Therefore, with the expansion of the social sector, it becomes important to investigate these challenges and strategize solutions to mitigate the risk involved with these factors. This article aims to delve into the legal aspects of NPOs governance, highlighting the complexities and proposing solutions that can help these organizations thrive its potential to drive positive change in the society.
As governance practices have developed, stakeholders’ expectations have expanded to encompass all organizations with public accountability, including NPOs. Nowadays, many NPOs have progressed beyond mere compliance with regulatory mandates and have embraced governance best practices drawn from publicly-listed companies, in addition to those formulated and advocated for by both the public and the NPO community.
Corporate Governance norms for NPOs:
The NPOs in India comply with the same basic principles of corporate governance applicable under Companies Act, 2013, as they apply to for-profit enterprises (“FPE”).3 However, due to the unique organizational structure of each NPO, the state and federal laws generally allow for the NPOs to outline the powers and responsibilities of the board of the company.
In India, an entity is referred to as an NPO, if it is registered as any one of the following entities:
Why is governance so crucial for NPOs?
In the contemporary landscape, NPOs must not only institute effective governance but also project a transparent image of strong governance. This is of paramount importance to successfully address a host of challenges, including:
Media outlets have often highlighted cases of NPOs marred by inadequate management or ineffective boards. However, the purpose of sound governance extends beyond averting negative headlines. Governance deficiencies can tarnish an NPO’s reputation, hinder fundraising efforts, and impede the fulfillment of its mission. Increasingly, governments, corporations, and private donors require NPOs to furnish information about their governance structure to ensure that their contributions are allocated judiciously for their intended purposes.
Unique Governance Challenges faced by NPOs:
NPOs in India operate under a unique governance framework with distinct legal factors as discussed above. Unlike their for-profit counterparts, NPOs in India are largely self-accountable due to limited regulatory oversight, emphasizing the importance of robust internal governance. Additionally, their mission-driven focus, distinct from profit maximization, requires legal protection and recognition which calls for a stronger governance standard within the legal framework to hold NPOs accountable.
Therefore, given the unique nature and organizational structures of NPOs prevalent in India, they face specific internal and external contingencies that negatively affects the governance framework of the organizations to facilitate their operations:
1. Regulatory complexity:
One of the foremost challenges is navigating the intricate web of regulations. Indian NPOs are subject to various laws, including the Income Tax Act, 1961 (“IT Act”)4; the Foreign Contribution (Regulation) Act, 20105 (“FCRA”) and the Companies Act, 2013 (“Companies Act”) for Section 8 companies. Ensuring compliance with these laws, while simultaneously pursuing their charitable missions, can be an overwhelming task. There have been many instances where the regulatory bodies have cancelled or suspended the licenses of various NPOs in case of any default/alleged default in their regulatory compliances. e.g. Oxfam India6, Missionaries of Charities, Amnesty International India etc.7
2. Multi-State operations:
As NPOs increasingly expand their reach across state borders to address pressing issues, they encounter governance challenges rooted in the fact that most regulations assume localized operations. This multi-state presence can lead to regulatory disparities and compliance complexities that require adept legal solutions. The complex task of complying with the respective local laws and the federal laws at the same time can be a challenging and an expensive task which restricts many NPOs from expanding their charitable objectives outside their geographic boundaries.
3. Transparency and accountability:
Maintaining transparency and accountability is essential for NPOs to earn and retain public trust. However, achieving this can be challenging, particularly when it comes to transparent financial reporting and effective stakeholder communication. A legal framework that facilitates and enforces transparency is crucial. While the Supreme Court has asked the central government to formulate a comprehensive legislation or administrative scheme with respect to regulations of funds which come to NGOs, the central government is yet to take action.8
4. Impact of FCRA on NPOs:
The FCRA Act and its subsequent amendments have had a significant impact on NPOs in India. The 2020 Amendment,9 upheld by the Supreme Court in Noel Harper & Ors. v. Union of India10 case, introduced several stringent provisions that have consequences for the functioning of NPOs in India.
Firstly, the Amendment restricts recipient NPOs from sub-granting foreign funds to other smaller NGOs, which may hinder collaborative efforts and the reach of development programs. Secondly, it reduces the amount of foreign donations that NPOs may spend on administrative expenses from 50% to 20%, potentially limiting their operational capabilities. Thirdly, it mandates that all foreign funds must be received through an account in the State Bank of India’s headquarters in New Delhi, adding to the compliance burden.11
The FCRA Amendments have faced legal challenges, with some NGOs arguing that they place arbitrary and unconstitutional limits on their functioning. However, the Supreme Court has upheld the Amendments inter alia citing concerns about potential misuse of foreign funds to threaten national security. 12
While the government’s rationale is to track and regulate foreign contributions, certain NPOs argue that the Amendments stifle the work of smaller grassroots organizations and place a privilege upon certain types of social work over others. The implications of these Amendments raise questions about the proportionality of the restrictions imposed on NGOs and their impact on the right to association, as well as the funding landscape for the social sector in India, which is increasingly reliant on domestic philanthropy.
Overall, the FCRA Act and its Amendments have imposed significant legal and regulatory constraints on NPOs in India, by cancelling the licenses of various NPOs in India for non-compliances and other reasons13, affecting their ability to operate effectively. While concerns about misuse of foreign funds are valid, striking the right balance between regulations and facilitating the vital work of NGOs remains a challenge.
5. Composition and Independence of the Board:
The composition of NPOs boards is again a governance challenge. Some organizations tend to be closely held by founders or families, raising questions of independence and potential conflicts of interest. Additionally, NPOs with diverse presence in India face challenges in establishing a unified board with the authority and independence to regulate operations throughout India and protect the brand name of the NPO. Therefore, legal mechanisms that promote diverse, independent boards are critical.14
Further, while NPO directors may serve as volunteers, their responsibilities and liabilities are often comparable to those of compensated directors in for-profit entities. It is crucial for NPO directors to have a comprehensive understanding of their role, responsibilities, and liabilities. If they are unable or unwilling to dedicate the necessary time and effort to fulfill their duties diligently, it is advisable for them to step down from the board.
6. Risk Management
NPOs, like any other organization, are exposed to various risks. While some risks can be identified and anticipated, others may remain unknown and unexpected. It is crucial to effectively manage these risks, as their mismanagement can have detrimental effects on the reputation and overall ability of the NPO to accomplish its objectives. Challenge faced by NPO’s is how to oversee risk management and how to establish NPO’s risk tolerance to ensure a suitable balance between pursuing opportunities and managing the inherent risks associated with them.
The general public has high standards for charities. They place trust above everything else. People are eager to provide money to worthwhile organizations. In return for their financial support, donors count on the organization’s leadership, employees and partners to behave ethically and account for every rupee or dollar they spend.
The corporate governance challenges faced by NPOs in India demand proactive measures and recommendations for effective resolution. We have outlined certain recommendations and measures that NPOs can adopt to overcome the corporate governance challenges they face while staying compliant with legal and regulatory frameworks.
1. Board diversity and Responsibilities
To overcome governance challenges related to board composition, NPOs should prioritize diversity in board members, both in terms of skills and demographics. Appointing independent directors who are not affiliated with the organization’s founders or major donors should be encouraged to enhance objectivity and governance quality. Establishing committees responsible for board nominations and governance can systematically identify and recruit board members based on their qualifications, independence and alignment with the organization’s mission. Further, to help ensure that NPOs fulfill their stewardship responsibilities effectively, NPO boards should have a formal mandate that sets out the responsibilities of the board.
2. Strengthen financial transparency
To address transparency and accountability challenges, NPOs should adopt international standards for financial reporting and disclosure. They should also ensure regular, transparent communication with stakeholders. Implementing stringent financial auditing and reporting practices, underpinned by the legal framework, will enhance credibility and trust.15 NPOs must go beyond solely presenting financial results when explaining their performance to stakeholders. To ensure transparency and accountability, NPOs must establish controls and information systems that provide accurate and reliable data. By providing comprehensive understanding of NPO’s operations and impact, it enables relevant stakeholders to assess the NPO’s performance holistically and fosters a deeper understanding of its purpose and impact beyond financial metrics alone.
3. Capacity Building and training
Investing in capacity building and training programs for board members and staff is essential. These programs should focus on governance, financial management, compliance and ethical conduct. Government and non-government organizations can collaborate to provide training resources and guidelines to NPOs, ensuring they are well-equipped to navigate the regulatory landscape.16 As part of their responsibilities, NPOs typically establish and oversee a strategy for long-term succession planning in their board and management. Most of the strategies involve creation of a “leadership pipeline” within the organization. This pipeline aims to identify and develop potential future leaders who can effectively fill leadership positions in the future.
4. Regulatory compliance
In the case of NPOs with branches in different jurisdictions, regular audits by third-party auditors may be obligated in the governance structure of the organization to ensure reporting compliance of all NPOs. This will not only help NPOs regulate their internal governance structure but at the same time regulate transparency and accountability norms to gain donors trust in the organization.
5. Collaborative networking
NPOs should explore collaboration and networking opportunities with other organizations. By sharing resources, best practices and expertise, NPOs can collectively address common governance challenges. Legal structures for partnerships and collaboration can be established to facilitate these initiatives to increase the overall valuation of the entities to raise additional avenues of fundraising.
6. Define roles and responsibilities clearly
To mitigate the challenge of board members potentially overstepping their roles, NPOs should establish clear role definitions for both board members and managers. Legal charters and bylaws can outline these roles and responsibilities, providing a structured framework for governance to avoid unnecessary litigation costs.
7. Foster a culture of ethical governance
NPOs should instill a culture of ethical governance within their organizations. This involves setting ethical standards, creating channels for reporting misconduct and ensuring that the legal framework supports whistleblower protection. Ethical governance should be enshrined in the organization's policies and practices. Furthermore, in order to further ring-fence the organizations against any non-compliances, the NPOs may conduct regular risk assessments to identify potential challenges and threats. Develop risk mitigation strategies and include them in the organization's governance framework.
The role of NPOs and the demand for their services are consistently expanding. Despite the numerous challenges they encounter in fulfilling their mission and meeting stakeholder expectations, NPOs that possess a robust governance system are more likely to achieve success compared to organizations with weak governance practices.
With the expansion of social sector in India the strengthening of corporate governance in Indian NPOs becomes even more imperative for their continued growth and impact. By recognizing and addressing the unique challenges they face, NPOs can enhance transparency, accountability and their ability to fulfill their missions and make a lasting difference in the communities they serve. The legal framework, in conjunction with proactive measures and recommendations, plays a key role in achieving these governance objectives. As NPOs evolve and adapt, a commitment to ethical governance will foster public trust and contribute to positive change in India’s diverse and dynamic social landscape.
You can direct your queries or comments to the authors
10Noel Harper & Ors. v. Union of India, 2022 SCC OnLine SC 434
The contents of this hotline should not be construed as legal opinion. View detailed disclaimer.