Can We Use Charitable Funds More Broadly During the Crisis? Dealing With Donor Restrictions on Use in the Time of COVID-19

Like all sectors of the economy, charities are facing unprecedented times right now due to the coronavirus. Demand for their services are surging, while at the same time, many have had to cancel their spring fundraising galas—a main source of unrestricted funds—and face dwindling donations from individual and corporate donors or revenue loss from the absence of patrons and program participants. Many do not have large operating reserves and may have only a few months’ unrestricted cash flow available.

During times like these, charities may be wondering—do these exigent circumstances allow us to tap into restricted funds to cover operating losses or to meet unexpected new demands? Do state charitable trust laws allow for a more flexible use of donated funds during a crisis like the coronavirus pandemic?

Unfortunately, the laws generally do not permit charities unilaterally to lift donor-imposed restrictions, even in difficult times. Indeed, donor restrictions are legally binding obligations that charities are bound to follow unless they have taken legally prescribed steps to have them lifted or modified. Below, we discuss the most common methods of lifting and modifying donor restrictions to allow a charity more latitude to channel its funds where they are most needed during the crisis. In urgent times like these, directly approaching the donor, if the individual donor is alive or if the corporate or foundation donor is still in existence, is likely the most expedient method of getting a restriction lifted to give the charity the flexible funding they desperately need.

Charity's Legal Obligation to Comply with Donor Restrictions

As a general matter, charities are legally required to comply with donor restrictions that are made in writing at the time the restricted gift is made. These restrictions are typically found in the gift instrument or grant agreement executed by the donor. Donors may place restrictions on the use of donated funds, e.g., a restriction to use the funds for scholarships, or on the spending of the funds, e.g., a designation of the funds as an endowment. A binding donor restriction can also arise if a charity solicits funds from donors and makes representations in the solicitation materials that donations in response to the solicitation will be used for a specific purpose (e.g., “Donate to our COVID-19 Rapid Response Fund”).

Given the binding nature of such representations, charities would be well-advised to leave some flexibility in their solicitations regarding the ultimate use of the donated funds (e.g., “Your funds will be used to provide support to essential frontline workers who are without childcare during the crisis, and to strengthen our other human service programs that provide a safety net to the most vulnerable.”)

Note: not all donor restrictions are legally binding. For example, a restriction that a donor seeks to impose after the donor has made a completed gift is not legally binding. Additionally, a donor’s request, advice or recommendation, made either at the time of the gift or later, is also not legally binding (i.e., language like, “I request, but do not require, that charity use the funds for Y program”).

However, restrictions that are unequivocal and made prior to (e.g., in a pledge agreement) or contemporaneously with the gift are generally binding.

Liability for Failure to Comply With Donor Restrictions

What are the consequences if a charity disregards or fails to comply with a donor’s gift restrictions? A charity may face legal consequences, although the erosion of trust and credibility with donors may be more important than actual liability.

A key issue is who has “standing,” i.e., the authority to bring suit against the charity to enforce the breached donor restriction. In general, the state attorneys general, who hold plenary statutory powers to oversee charitable trusts in their respective states, have standing to enforce donor restrictions on charitable assets. Donors may lodge their complaints with their state attorneys general, who may (subject to resources and priorities) take up the mantle on the donor’s behalf. Courts historically have not permitted donors themselves to have direct standing to enforce charitable gift restrictions in actions against charities formed as corporations.

More recently, however, courts have occasionally permitted donors to bring actions if the gift agreement specifically provides that the donor has a right to enforce the restriction. Courts have not generally allowed a donor’s family or heirs to bring suit to enforce a donor’s restriction.

Procedures for Modifying Donor Restrictions

Given that charities are not permitted to engage in self-help to lift donor restrictions, what legally permissible avenues are open to them to obtain more flexibility in their use of funds? The following are the most common legally permissible methods.

1) Donor Consent

The most expedient path, if a donor is available and willing, is to seek written donor consent to release or modify a restriction. Charities can directly approach donors, explain the financial challenges and circumstances they find themselves in due to the pandemic, and seek a written release or modification of the restriction in the original gift or grant agreement. Such a release can take the form of a simple letter from the donor amending their prior agreement and lifting the restrictions.

Indeed, numerous foundations are in fact taking it upon themselves to affirmatively release restricted gifts to grantees and remove or delay reporting obligations in an effort to help their grantees through the crisis. (See Antony Bugg-Levine, “A ‘New Normal’ for Foundation Giving: 3 Acts That Will Make a Difference” Chronicle of Philanthropy, March 20, 2020, available here.) Donors may prove more than usually receptive to requests for flexible funding at this time, as they recognize that charities are particularly vulnerable in this crisis.

This avenue is available to a charity only, however, if an individual donor is still alive or if a corporate or foundation donor remains in existence. Under certain circumstances, a donor’s heirs or others (such as an executor) may have authority to release or modify a restriction, but only if the donor has delegated such authority to these individuals in the gift document.

2) Noticing the AG for Release of Restrictions on "Old and Small" Funds

But what if a donor is no longer available? The Uniform Prudent Management of Institutional Funds Act (UPMIFA), which has been adopted by nearly all 50 states, permits a charity to release or modify a donor’s restriction without the donor’s consent with prior written notice to the Attorney General if:

• The charity determines that the restriction is unlawful, impracticable, impossible to achieve, or wasteful;
• The restricted fund has a value of less than a certain amount, ranging from $100,000 to 175,000, depending on the state;
• The fund is more than 20 years old; and
• The charity uses the fund in a way that is consistent with the charitable purposes expressed in the gift document.

This form of relief is limited to, these certain “old and small” funds, and typically requires a charity to provide 60 to 90 days prior notice to the Attorney General before releasing the funds. But a charity with reserves that will last them at least several months may wish to consider releasing restrictions in certain “old and small” funds to give them some further flexible funding.

3) Court Petition ("Cy Pres")

Another avenue for releasing or modify a donor restriction is to petition the court for relief. However, this is probably the most expensive and lengthy method of releasing restrictions, and is unlikely to bridge a charity through the crisis unless it has sufficient cash flow to finance and await the court proceeding.

A charity may petition a court to release or modify a donor restriction, with notice to the Attorney General, if:

• The restriction has become unlawful, impracticable or wasteful;
• The restriction impairs the management or investment of the fund; or
• Because of circumstances not anticipated by the donor, a modification will further the purposes of the fund.

The charity must propose an alternative use for the funds that is as close as possible (“cy pres”) to the original use and the charitable purposes expressed in the gift document.

Certainly, the COVID-19 pandemic has created many circumstances that could not have been anticipated by donors at the time they made their gifts—either by rendering the purpose of their donation obsolete (i.e., supporting a conference or university program that has been canceled) or by putting charities on the brink of insolvency such that they will be unable to deliver an activity if they do not have unrestricted funds with which to operate. These changed circumstances may all prove to be sufficient grounds to petition for judicial modification or release of donor restrictions.

4) Washington's Trust and Estate Dispute Resolution Agreement ("TEDRA") Procedures

Washington State law provides a more expedient alternative for charities than bringing a court action when the Attorney General and any charitable beneficiaries agree to a release or modification of a donor restriction. Instead of petitioning the court, the charity requests to enter into an agreement (a “TEDRA”) with (i) the Attorney General, (ii) the donor(s), if living and not incapacitated, or the legal representative(s) of any living incapacitated donor(s), and (iii) any named charitable beneficiaries, to modify or release the restriction.

While the Attorney General will likely apply the same standards for release or modification that would apply in the context of a cy pres petition, the process does not require court involvement until the agreement is executed by all parties, at which point a memorandum of the agreement is simply filed with the court. The agreement then has the effect of a court order.

5) Variance Power

Finally, charities that are community foundations or similar charitable sponsors, such as Jewish Federations, may also have a unique ability to release restrictions on their own during these difficult times. Community foundations generally include a variance power, i.e., a unilateral power to modify donor restrictions under certain circumstances, in their organizing documents and gift agreements.

The variance power permits the charity’s board, in its sole discretion and without seeking donor consent or petitioning a court, to modify a donor restriction if the restriction becomes:

• Unnecessary (e.g., a requirement to use funds to develop a vaccine for polio when a cure has already been found);
• Incapable of fulfillment (e.g., the charity designated to receive distributions no longer exists); or
• Inconsistent with the charitable needs of the community or area served.

For the variance power to be effective, the donor must be made aware of it through sufficiently clear disclosure. It is therefore essential for community foundations to make donors aware through gift agreements and other means that their gifts are being made to the community foundation, subject to the community foundation’s variance power over the gift.

A community foundation or other charity that has a variance power in its organizing documents and gift agreements may be able, for example, during the COVID-19 pandemic, to move certain disaster relief funds that were pledged during a prior disaster and use them to assist frontline workers or people laid off during the current crisis. Variance power, when properly exercised against the backdrop of the community foundation’s broad mandate, allows a community foundation the discretion to channel funds to those who are most in need.

The facts, laws, and regulations regarding COVID-19 are developing rapidly. Since the date of publication, there may be new or additional information not referenced in this advisory. Please consult with your legal counsel for guidance.

DWT will continue to provide up-to-date insights and virtual events regarding COVID-19 concerns. Our most recent insights, as well as information about recorded and upcoming virtual events, are available at www.dwt.com/COVID-19.