Understanding the Role of a Management Agreement in a Nonprofit Subsidiary Structure
Establishing a nonprofit subsidiary can be a prudent way to manage risk, segregate programs, or comply with regulatory requirements. However, once the subsidiary exists, the parent organization frequently wishes to centralize administrative, financial, and operational functions for efficiency. A well-drafted management agreement is the vehicle that enables this without blurring legal lines or compromising tax-exempt status. In practice, this agreement is not simply a collection of boilerplate provisions. It must reflect the organization’s governance architecture, the unique regulatory overlay applicable to charitable entities, and the precise allocation of duties, risks, and compensation.
Many boards assume that a management agreement is a routine back-office contract. It is not. The agreement can influence the subsidiary’s independence, affect private benefit and private inurement analyses, and shape the way auditors, state charity regulators, and the Internal Revenue Service interpret the relationship between entities. As an attorney and CPA, I have seen even “simple” arrangements trigger significant compliance concerns because stakeholders relied on templates borrowed from the for-profit sector. Tailoring the agreement to nonprofit rules and the specific structure of the parent-subsidiary relationship is essential for sustainability and regulatory credibility.
Defining Scope of Services with Precision
The scope of services is the backbone of the management agreement. It should articulate, with specificity, what functions the manager will perform for the subsidiary, such as accounting, budgeting, cash management, human resources, information technology, fundraising support, facilities, compliance, program development assistance, and strategic planning support. Vague descriptions, such as “general oversight” or “advisory services,” invite disputes and create ambiguity regarding fiduciary responsibilities. Use detailed descriptions and, where appropriate, attach service schedules that outline deliverables, timelines, and performance standards for each functional area.
Nonprofits often assume that a broad scope gives “flexibility.” In reality, an overly broad scope can unintentionally transfer effective control to the manager and blur the line between oversight and operational authority. The agreement should differentiate between advisory authority and decision-making authority and should reserve legally required decisions to the subsidiary’s board. For example, decisions about mission, programs, budgets, and leadership appointments should remain with the subsidiary’s governing body, unless the applicable bylaws or corporate charter expressly allocate certain reserved powers to the parent entity in compliance with state nonprofit law.
Governance, Control, and Reserved Powers
Because nonprofit entities are governed by fiduciary duties rather than shareholder primacy, governance provisions require careful drafting. The management agreement must acknowledge that the subsidiary board retains ultimate authority over charitable assets and operations, even when delegating day-to-day functions. If the parent is also the sole member of the subsidiary, the agreement should align with any member “reserved powers” listed in the subsidiary’s governing documents, such as approving budgets, appointing directors, or authorizing major transactions. The management agreement should never attempt to expand reserved powers beyond what the governing documents and state law permit.
To avoid conflicts with charity oversight principles, the agreement should explicitly state that the manager does not have authority to usurp fiduciary decision-making, bind the subsidiary to extraordinary obligations without prior approval, or alter the subsidiary’s charitable mission. It should also address the interplay with board committees, conflict-of-interest policies, and whistleblower procedures. The internal controls landscape matters: an auditor or state Attorney General will examine whether the board meaningfully supervises the manager. The document should therefore require regular reporting, approval thresholds, and documented board review of key management actions.
Compensation, Cost Allocation, and Avoiding Private Inurement
Compensation structures for management services must be reasonably related to the value of the services provided. Flat fees, cost-reimbursement, time-and-materials, or hybrid models are common, but each carries distinct risks. A fixed fee may be efficient, but it must be periodically revalidated against market data to avoid overpayment. Cost-reimbursement mechanisms require clean allocation methodologies and contemporaneous documentation. Time-and-materials approaches need clear rates, caps, and robust timekeeping. Whatever the model, the agreement should include a defensible rationale for fees tied to objective benchmarks and independent comparables where available.
Improper compensation can trigger allegations of private inurement or private benefit, especially where insiders or related organizations are involved. The agreement should adopt an allocation policy across entities that withstands scrutiny, including methodologies for shared staff time, occupancy, IT infrastructure, and insurance. Incorporate a strong statement that compensation will not exceed fair market value, coupled with a process for periodic review by an independent committee. The agreement should also address treatment of deficits and surpluses in cost pools, timing of reconciliations, and audit rights to validate allocations. Without this rigor, a well-intentioned central services arrangement can undermine the organization’s exempt status.
Tax-Exempt Compliance and Related-Party Considerations
When a parent nonprofit manages its subsidiary, the arrangement may be a related-party transaction subject to heightened scrutiny under federal and state laws. The agreement should reference the organization’s conflict-of-interest policy, require disclosure of all related-party relationships, and mandate independent review and approval. For 501(c)(3) entities, take special care to avoid conferring undue private benefit, even if there is no insider enrichment. The agreement should also address whether the manager will engage in activities that could generate unrelated business taxable income and, if so, how those activities will be tracked, reported, and managed to minimize tax exposure.
For organizations with multiple exempt entities (for example, a 501(c)(3) parent and a 501(c)(4) or 501(c)(6) subsidiary), the agreement must delineate impermissible cross-subsidization. Cost allocations should prevent charitable funds from subsidizing lobbying or other non-charitable activities conducted by affiliates. Include explicit protocols for timekeeping, expense coding, and review of communications to ensure that charitable resources are not used for non-charitable purposes. Additionally, consider how the arrangement will be disclosed on annual filings, such as Form 990, Schedule R, and state charity reports. Accurate disclosures are part of the compliance story regulators expect to see.
Performance Standards, Reporting, and Oversight Mechanisms
Performance obligations are not mere niceties; they are essential guardrails that protect mission integrity. The agreement should define service-level standards that are measurable and relevant, such as financial reporting deadlines, error thresholds for accounting entries, HR onboarding timelines, ticket resolution times for IT support, grant compliance reporting accuracy, and stewardship communications cadence. To ensure accountability, embed key performance indicators with clear remedies for failure, including cure periods, fee credits, or termination rights for persistent underperformance.
Robust reporting is equally important. The manager should deliver monthly financial statements, quarterly budget-to-actual analyses, compliance dashboards, and annual risk assessments to the subsidiary board. Define who receives reports, in what format, and by when. Obligate the manager to escalate material weaknesses, suspected misuse of funds, data incidents, or legal threats promptly. Include a provision authorizing the subsidiary’s auditors and compliance officers to access relevant records and personnel. This formal oversight structure evidences the board’s active duty of care and helps prevent common pitfalls associated with over-delegation.
Term, Termination, and Transition Planning
Prudent boards plan for both continuity and exit. The agreement should specify an initial term and clear renewal mechanics, ideally conditioned on performance review. Termination for cause should include material breach, persistent failure to meet performance standards, loss of licensure, insolvency, or regulatory sanctions. Termination for convenience may be appropriate but should include sufficient notice to facilitate an orderly transition of services and records. The agreement should avoid provisions that make termination impracticable, such as steep break fees or excessively long notice periods that can be perceived as restraints on the board’s fiduciary discretion.
Transition planning is often overlooked, yet it is crucial. Incorporate a detailed transition services clause requiring the manager to cooperate in transferring data, files, systems access, and third-party contracts to the subsidiary or a successor provider. Specify the format for data export, the timeline for handoff, and the continuation of key licenses during transition. Provide for knowledge transfer sessions, staff introductions, and continuity of mission-critical functions. A well-defined transition reduces business interruption risk and demonstrates that the subsidiary board remains in command of its affairs.
Data Governance, Confidentiality, and Cybersecurity
Nonprofits handle sensitive information, including donor data, beneficiary records, payment card information, and employee files. The agreement should include robust confidentiality obligations, data classification requirements, and data handling protocols. Identify which party is the system of record for each data set and who controls user provisioning and access rights. Address data retention schedules and lawful destruction protocols consistent with the subsidiary’s records management policy. If the manager uses subcontractors, require flow-down confidentiality and security obligations and prohibit unauthorized offshore data storage when inappropriate under applicable law or organizational policy.
Cybersecurity is now a fundamental governance issue. Require the manager to maintain appropriate administrative, technical, and physical safeguards aligned with recognized frameworks, such as risk-based controls, encryption in transit and at rest where feasible, multi-factor authentication for privileged access, endpoint protection, and vulnerability management. Mandate prompt incident notification, cooperation in forensic investigation, and breach remediation support. If applicable, address regulatory regimes such as HIPAA, GLBA, FERPA, GDPR, or state privacy laws, and incorporate data processing addenda when the manager acts as a service provider or processor. Include cyber insurance requirements that reflect the organization’s risk profile.
Human Resources, Employment, and Co-Employment Risk
When a manager provides HR services, the agreement must clearly state whether staff performing services are employees of the manager or the subsidiary. Ambiguity can lead to co-employment disputes, wage-and-hour exposure, and unemployment and workers’ compensation issues. If staff remain employed by the manager, the agreement should require compliance with employment laws, background checks as appropriate, training on harassment and discrimination, and adherence to the subsidiary’s code of conduct while on assignment. For shared employees, implement written allocation methodologies for salaries and benefits tied to contemporaneous time records.
The manager’s authority over hiring, discipline, and termination of personnel who materially affect the subsidiary’s operations must be carefully defined. The subsidiary board should retain approval rights over leadership roles that influence the mission, finances, or public image. Address access to personnel records, confidentiality of employee information, and ownership of work product created by staff. If the manager provides a PEO-like function, incorporate indemnification provisions and confirm responsibility for payroll tax deposits, benefit plan compliance, and labor law postings. Precision here reduces the risk of disputes and regulatory penalties.
Intellectual Property and Branding
Nonprofit program materials, grant deliverables, curricula, software, and branding elements are often developed during the relationship. The agreement should address ownership of intellectual property created in the course of services. Typically, the subsidiary should own program-related intellectual property that is central to its mission, while the manager may retain ownership of preexisting tools or general know-how. Include licenses where necessary to ensure uninterrupted use of operational systems following termination. Clarify who controls trademarks and service marks, including the subsidiary’s business name and logos, and specify brand guidelines for the manager’s use of marks.
Branding and public communications require alignment. The agreement should require the manager to coordinate with the subsidiary on external messaging, fundraising materials, and website content to ensure accuracy and regulatory compliance, especially where charitable solicitations are involved. Include approval processes for significant public statements, crisis communications protocols, and rules for social media engagement. These details help preserve donor trust, avoid misleading statements, and ensure that the subsidiary’s independent identity is respected.
Insurance, Indemnification, and Risk Transfer
Risk allocation is a central theme in any management agreement. Require the manager to maintain appropriate insurance, such as commercial general liability, professional liability or errors and omissions, cyber liability, workers’ compensation, and, where relevant, auto liability. The agreement should specify minimum limits, additional insured status for the subsidiary where appropriate, primary and noncontributory wording, and waiver of subrogation. Certificates of insurance should be provided on request, and any material changes in coverage should trigger prompt notice.
Indemnification provisions must be calibrated to the nonprofit context. The manager should indemnify the subsidiary for losses arising from the manager’s negligence, willful misconduct, breach of the agreement, or violation of law. Consider separate caps or exclusions for data incidents, IP infringement, or employment claims. Conversely, the subsidiary’s indemnity should be limited and aligned with its charitable asset stewardship obligations. Include a cooperation clause for defense of claims, control of defense provisions, and settlement consent rights. A carefully balanced risk transfer framework protects mission assets without creating uninsurable obligations.
Regulatory Compliance, Fundraising, and Charitable Solicitation
Fundraising support is a frequent component of management services, but it is fraught with regulatory nuance. Many states regulate professional fundraisers and fundraising counsel, imposing registration, bonding, and disclosure requirements. If the manager will assist with solicitations, draft the agreement to reflect roles compliant with state law, including required legends on solicitations, control over donor lists, and documentation of fundraising costs. Emphasize that donor intent governs use of restricted gifts and that the manager will not commingle donations received on behalf of the subsidiary with other funds except as permitted under a documented cash management policy.
Grant compliance adds another layer. If the manager assists with grant writing, reporting, or subrecipient monitoring, the agreement must incorporate Uniform Guidance concepts for federal awards, including allowability of costs, time-and-effort reporting, procurement standards, and subaward oversight. For private grants, include donor-imposed restrictions tracking, budget adherence, and deliverable management. The manager should commit to maintaining records sufficient to support audits and site visits and to cooperate in responding to funder inquiries. These provisions demonstrate a culture of compliance and reduce the risk of grant clawbacks.
Financial Controls, Banking Authority, and Audit Rights
Financial stewardship is core to nonprofit credibility. The agreement should delineate authority over bank accounts, including who can initiate, approve, and release payments; how dual authorization thresholds are applied; and who reconciles accounts. Segregation of duties must be explicit: the person initiating a transaction should not be the same person approving or reconciling it. Describe cash management policies, investment oversight, and petty cash controls if applicable. If the manager provides treasury services, specify collateralization of funds as required by law and adherence to the subsidiary’s investment policy statement.
Audit rights reinforce transparency. Include a clause granting the subsidiary and its auditors access to books, records, systems, and personnel reasonably necessary to verify performance, allocations, and compliance. Define record retention periods consistent with legal requirements and funder expectations. Require the manager to assist with annual financial statement audits, single audits where applicable, and tax filings. Provide for management representation letters, timely responses to audit requests, and remediation of control deficiencies identified by auditors. Such rigor is expected by sophisticated donors, creditors, and regulators.
Conflict of Interest, Independent Review, and Documentation
Because parent-subsidiary arrangements are inherently related-party transactions, the approval process must be unimpeachable. The agreement should mandate disclosure of financial interests by directors, officers, and key employees of both entities. Require recusal where conflicts exist and ensure that the board or an independent committee reviews the terms using comparability data. Document the decision-making process in minutes that set forth the facts considered, the alternatives evaluated, and the rationale for concluding that the agreement is fair and in the best interests of the subsidiary.
Periodic revalidation is equally important. Incorporate a requirement for scheduled reviews of fees, performance, and scope, preferably annually. If market conditions or regulatory expectations change, the parties should update the agreement and document the changes through formal amendments. Consistent documentation shows that the organization treats the arrangement as a living instrument, not a one-time compliance exercise. This mindset is persuasive to auditors and regulators evaluating whether the organization has an effective governance framework.
Dispute Resolution, Choice of Law, and Venue
Dispute resolution provisions should reflect the nonprofit’s risk tolerance and resource constraints. Consider a tiered process: good-faith negotiation between designated senior representatives, followed by mediation, and only then litigation or arbitration if necessary. Mediation can be particularly mission-friendly by preserving relationships and confidentiality. If arbitration is selected, craft rules about arbitrator qualifications, seat, confidentiality, cost allocation, and interim relief. Regardless of forum, ensure that the subsidiary retains access to injunctive relief to protect confidential information and intellectual property.
Choice of law and venue should be aligned with the subsidiary’s state of incorporation and primary place of operations. This is not simply a convenience issue; it can affect enforceability of indemnities, damages limitations, and volunteer protections. Include a clause addressing severability, integration, and waiver, and confirm that the management agreement is consistent with the subsidiary’s articles, bylaws, and board policies. A well-chosen legal framework reduces uncertainty and litigation expense if a dispute arises.
Change in Law, Compliance Updates, and Continuous Improvement
Regulatory landscapes evolve, and nonprofit standards shift in response to enforcement trends. The agreement should include a change-in-law clause requiring the manager to adapt services and policies to maintain compliance as laws and donor requirements change. Build in a collaborative process for updating procedures, renegotiating fee impacts of significant new compliance burdens, and training relevant personnel. Tie this to a governance calendar that includes periodic policy reviews, tabletop exercises for incident response, and refresher training on conflicts and ethics.
Continuous improvement is not optional in a sector where public trust is paramount. Require the manager to propose efficiency enhancements, technology upgrades, and control improvements annually, accompanied by cost-benefit analyses. Encourage benchmarking against peer organizations and incorporate external quality reviews where appropriate. This disciplined approach helps the organization stay ahead of risks and demonstrates to stakeholders that stewardship is an ongoing priority.
Documentation Exhibits and Implementation Roadmap
A strong agreement benefits from structured exhibits that translate high-level promises into operational tools. Common exhibits include a detailed scope of services matrix, a rate card and cost allocation methodology, a data security schedule, insurance specifications, fundraising compliance protocols, grant management procedures, and a transition plan. Each exhibit should be referenced in the body of the agreement and updated periodically without reopening the entire contract, where feasible, through controlled change orders or board-approved addenda.
Implementation deserves as much attention as drafting. Establish a kickoff plan with milestones, designated points of contact, escalation paths, and a communications schedule. Require the manager to deliver a 90-day implementation report and a 6-month performance review comparing actual outcomes to the service plan. Align these checkpoints with board and committee calendars so that fiduciaries can exercise informed oversight. Thoughtful implementation ensures that the written agreement translates into practice.
Common Misconceptions That Derail Well-Meaning Agreements
Several misconceptions routinely undermine nonprofit management agreements. One is the belief that a parent nonprofit can treat its subsidiary as a mere department for all practical purposes. This mindset leads to undocumented subsidies, unfettered access to bank accounts, and informal decision-making. Regulators scrutinize these behaviors as indicators that the board is not exercising independent judgment. Another misconception is that cost-sharing can be “good enough” if the entities have the same mission. In reality, allocation must be supported by objective, contemporaneous records, regardless of mission alignment.
A further misconception is that templates from the for-profit world suffice. Nonprofit law introduces concepts such as charitable asset protection, donor intent enforcement, and private benefit limitations that are not present in typical corporate management services agreements. Finally, some assume that audits will “catch” any issues after the fact. Audits are not a substitute for sound contracting and day-to-day controls. A well-drafted agreement, approved through a conflict-free process and implemented with rigor, is the front line of defense.
Practical Drafting Tips from Counsel and CPA Perspective
From a legal and tax perspective, clarity and documentation are paramount. Use defined terms consistently across the agreement and exhibits. Map each significant obligation to a corresponding control, report, or metric. Where the manager relies on third-party vendors, require written subcontracts that mirror critical obligations, including confidentiality, cybersecurity, insurance, and audit rights. Involve finance leadership early to ensure that cost allocation methods are operable with existing accounting systems and that chart-of-accounts structures support the desired transparency.
Build in periodic independent reviews, such as compensation benchmarking and controls assessments, and require that findings be presented to the subsidiary board. Draft with the end in mind: assume that a regulator, funder, or major donor will read the agreement after an adverse event. Provisions should evidence prudence, independence, and accountability. Finally, do not underestimate change management. The best agreement fails if internal stakeholders do not understand their roles. Provide training, quick-reference guides, and leadership reinforcement to embed the agreement into daily practice.
Checklist of Core Clauses to Include
While every organization’s needs are unique, the following clauses often form the core of a robust nonprofit management agreement. Treat this list as a starting point and tailor each provision to your facts, risk profile, and jurisdictional requirements. Draft with precision and ensure that each clause has a corresponding implementation plan and owner within the organization.
- Purpose and relationship statement clarifying fiduciary boundaries and mission alignment
- Detailed scope of services with service-level standards and measurable deliverables
- Governance and reserved powers aligned with governing documents and state law
- Compensation, fee methodology, and fair market value affirmation with review process
- Cost allocation schedules with timekeeping, expense coding, and reconciliation protocols
- Reporting cadence, KPIs, and board oversight mechanisms
- Term, renewal, termination for cause/convenience, and transition services
- Confidentiality, data governance, privacy compliance, and cybersecurity obligations
- HR and employment terms, co-employment risk allocation, and payroll tax responsibilities
- Intellectual property ownership, licenses, and branding controls
- Insurance requirements and calibrated indemnification
- Fundraising and charitable solicitation compliance, donor intent, and grant stewardship
- Financial controls, banking authority, segregation of duties, and audit rights
- Conflict of interest, related-party approval process, and documentation standards
- Dispute resolution, choice of law, venue, and equitable relief
- Change-in-law adjustments, compliance updates, and continuous improvement
- Record retention, access to records, and cooperation with audits and investigations
- Subcontractor management and flow-down of critical obligations
When to Seek Professional Assistance
Because these agreements sit at the intersection of governance, tax exemption, employment law, privacy, and fundraising regulation, even seemingly straightforward arrangements can have hidden complexities. The cost of an error can include regulatory enforcement, negative audit findings, donor distrust, and loss of exempt status. An experienced attorney and CPA can help design an agreement that is both operationally effective and defensible under scrutiny, while aligning the arrangement with your organization’s mission and risk appetite.
Professional guidance is especially important where there are multiple affiliates with differing exemption types, cross-border operations, federal awards, or material fundraising support. A tailored agreement, backed by comparable data and clear implementation protocols, signals to stakeholders that the organization treats fiduciary duties seriously. Investing in careful drafting and governance now reduces downstream risk and supports the long-term sustainability of your programs.
