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Strategic
Source Online
April 2005
Feature: Preserving Donor Intent
How does the founder know that his or her wishes will be honored by future board members and trustees? If you have formed a foundation for specific purposes, would it bother you if those purposes were changed, even with the best of intentions, by others? Some background first, and then let’s explore two recent cases that illustrate the problem.
A corporation is governed by its Board of Directors, in accordance with the organization’s charter (Articles of Incorporation) and Bylaws. Depending upon state law, it may be possible for the founder to impose restrictions and different voting thresholds to change the mission or other key components of the organization. But, at the end of the day, a board can modify the Articles and Bylaws. This is often a positive feature of a corporate structure, because flexibility, especially through the generations, is important to keep the organization relevant and efficient. But, it creates some level of risk to the founder, if the core mission is crucial to the founder’s motivation.
A trust structure is often utilized when the mission of the founder is so important that the risk of a material change is unacceptable to the founder. While flexibility can be integrated into the design, the trust can be drawn so that it cannot be changed except in the event that it violates public policy or is impossible to achieve because of changed circumstances. At that point, the trustee, or even a court of law, can be given the authority to modify the critical portions of the trust to enable it to achieve as close to the objective of the founder as possible. But this process can be tortuous, long, and expensive (which may, of course, be the point intended by the founder).
The Barnes Foundation
Albert Barnes, who made a fortune in the pharmaceutical industry, established his foundation through a trust document in 1922. His goal was to advance his ideas about fine arts. The foundation built a small building in a suburb of Philadelphia, and housed a collection of one of the great collections of impressionist art, including 67 Cézannes, 50 Matisses, and 180 Renoirs. The collection is estimated to be worth nearly $25 billion, but the trust required that the funds be invested in government securities and the Foundation could not move its facilities out of Merion, Pa. Unfortunately, the facilities were too small to exhibit the collection and the community was too far removed from the population base to support the museum. The Foundation has nearly gone broke. Several very large foundations offered to contribute or raise $150 million to enable it to move to larger quarters in Philadelphia, provided that some of its restrictions were removed.
After years of litigation, a court in Philadelphia has agreed to lift the restrictions. It relied on a combination of two common law concepts, one called the doctrine of deviation and another known as the doctrine of cy pres.
The doctrine of deviation permits a court to override certain restrictions in the trust instrument if the court determines that compliance with the restrictions is impossible or illegal, or, due to unforeseen circumstances, compliance would make it impossible or unlikely to achieve the objectives of the settlor (creator) of the trust. This doctrine applies to what is deemed to be an administrative restriction. In the Barnes case, the court found the requirement to exhibit the art in Merion, Pa, was an administrative restriction.
The doctrine of cy pres is even more difficult to apply. Before a court will utilize this doctrine, it must be convinced that it is impossible, impractical, or illegal to achieve the donor’s specific objectives and, in addition, the donor had broader charitable intent than just the specific objectives that are impossible or impractical to achieve or which are illegal.
In the Barnes case, the settlor restricted the investment of the liquid funds (initially $10 million) to government securities. This prevented its growth in the more than 50 years since the founder’s death. Even though most states have adopted the Uniform Management of Institutional Funds Act, which would require a more diversified investment portfolio, specific restrictions in the trust can override this duty.
It’s not always clear who has the right to bring an action to change a trust for either of these reasons. In some states, it falls on the office of the Attorney General. In other states, the charity itself or a trustee may bring the action. In only rare cases can the family members of the donor bring an action to change the terms of the trust. Of course, the trust document itself can delegate this power, and some states have enacted legislation that overrides a trust document and gives the donor, certain family members, and others, the right to bring an action.
Maddox Foundation
Dan Maddox was a Tennessee millionaire who designed his estate plan, in part, to keep his fortune away from his three children, whom he felt were spoiled and ungrateful. He created a foundation to benefit the state of Tennessee, and gave control to his much younger wife. Unfortunately, both Mr. Maddox and his wife died in a common accident, and control of the Foundation was left to his assistant of 14 years. The Foundation was funded with nearly $100 million.
A few years later, at the instigation of the new president, the Foundation was relocated to Mississippi, a state which the founder’s friends stated he never liked. To add to the mix, the Foundation purchased ownership in two sports teams, and paid for chartered plane trips to transport its president. There are questions about her compensation and widely varying reports about the current value of the Foundation assets.
The battle has been joined. The state of Tennessee has sued to return the Foundation to Tennessee. Mississippi and the Foundation lawyers maintain that Tennessee has no jurisdiction, since the corporation was reincorporated in Mississippi, which allows a single director to control the organization.
In this case, it would seem that both the new president of the Foundation and the Attorney General in Mississippi have some explaining to do.
Some conclusions that one may draw from these cases…
Legislative Update: Senate Finance Committee Continues to Call for Charity and Giving Reform
Each month we veer from proposed legislation that encourages charitable giving even though reports from the Senate Finance Committee call for reform. Don’t be surprised if the former is tied to the latter.
- Under the reintroduced proposal for charitable giving, the Bush Administration reintroduced the IRA/charitable rollover legislation that would enable individuals over 65 years to exclude from gross income IRA distributions made directly to charity (including a foundation). No deduction would be allowed, but the donor would not be deemed to have received any income. This version is similar to prior bills passed by both Houses of Congress, except that proposed changes would not apply to life income gifts (like charitable remainder trusts).
- On the other hand, President Bush has withdrawn his support for legislation that would allow taxpayers who do not itemize to claim a charitable contribution deduction on their tax returns. This feature was long part of the package of charitable tax changes that Congress had been considering.
- A national committee of 175 nonprofit leaders, led by Diana Aviv, president of Independent Sector, submitted a report in March that was intended to respond to the issues raised by the Senate Finance Committee in its recent investigation of perceived abuses in charitable organizations and foundations. The key recommendations included:
- Nonprofit groups should adopt conflict of interest policies.
- Nonprofits should be required to have a separate audit committee on their board and to conduct an audit of their financial operations if they generate $2 million or more in annual revenue (similar to the California Non-Profit Integrity Act, which became law in 2005).
- IRS should be given more money to enforce nonprofit laws by actually applying the proceeds from the 2% excise tax on private foundation earnings, as originally intended when this legislation was enacted.
- Increase penalties on foundation managers and other insiders who participate in self-dealing transactions.
- Impose penalties on charities that participate in illegal tax shelters.
- Prohibit donor-advised funds from paying for travel and consulting expenses of donors, advisers, and others who help to choose charities that receive money from the fund.
- Prohibit donor-advised funds from using the money to cover costs of tuition, tickets to charity events, and similar expenses.
- Require organizations that hold donor-advised funds that have been inactive for a long period of time to distribute the money in the accounts.
The Senate expects to conduct further hearings this Spring. The pressure on Congress to offset a budget deficit of more than $400 billion reduces the chances of expanded charitable deductions, and increases the chances of passage of proposals to limit the amount of deductions a taxpayer can claim for contributions of land or other noncash items.
There are a number of issues raised by the Senate which were not discussed in the report of the panel of nonprofits, including the recommendation raised by the Joint Committee on Taxation, which advises both the House and Senate tax committees, that every five years charities should be required to submit financial statements and other written documents to the IRS to show that they deserve to maintain the tax-exempt status.
The nonprofit panel has focused on donor-advised funds more than any other problem, but they did not address the Senate Committee’s proposal to require donor-advised funds to distribute an average of 5% of the net assets in the fund each year (similar to the rule that applies to private foundations).
 Panel on the Nonprofit Sector: Interim Report
Register Today! Foundation Management Certificate Program at Fielding Graduate University to Begin April 8
If you are a founder, director, or trustee, foundation manager, or an advisor who regularly consults with foundations, then you should attend the Foundation Management Certificate Program, offered by IFF Advisors, Inc., and the Fielding Graduate University. This program provides the most comprehensive, hands-on and practical training available in the country.
Upon completion of the program, students will receive a Certificate from the Fielding Graduate University. The Certificate Program begins on April 8.
Fielding Graduate University: Register Today!
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