Dept. of Sticky Gifts: Changing the Purpose of a Restricted Endowment

As discussed in a prior post, a restricted endowment is one in which the donor has specified the purpose toward which the income is to be spent. But what happens if conditions change and the charity can no longer comply with the spending restriction? Endowments are forever, but society changes.

I once had a client that had been given land and a financial endowment to be used for an orphanage. Today, though, residential institutions dedicated to the care of orphans are not the favored way of addressing this issue. Can the charity simply direct these assets to the costs of 21st century orphan care?

What happens if the charity simply wants to change the spending restriction? Suppose, in the preceding example, the charity was exiting the orphanage business altogether because it wanted to concentrate on foster care and adoption services? Can this charity simply divert the funds generated by the restricted endowment toward these other services? The charity would try to make the case that last century’s orphanage is today’s foster care and adoption system, and the orphanage money should naturally flow to these more modern services. Is it that simple?

The answer is usually "no"—the charity cannot simply change how it uses a donor-restricted endowment where the donor has specified how the income is to be spent. In most states, however, the legislature (as part of the nonprofit corporation statute or some other law) allows organizations to seek judicial release or modification of donor restrictions if certain common law and/or statutory standards are met.

This usually involves petitioning the state’s attorney general; ultimately the attorney general and the charity appear before a court to obtain approval of the proposed change. In theory, the attorney general represents the people and the charity represents itself. Ideally, a charity would like to appear in court with an attorney general who does not object to the proposed change or changes.

In most states, the language of the statute regarding the release of donor restrictions addresses restrictions that have become “obsolete,” “inappropriate,” “impracticable,” or “impossible.”  Determining this is not as easy as one might think.

There was once a famous Ivy League university which held a nearly 200-year-old endowment, the income from which was to be used for scholarships for Baptist students. In the 1960s, when the university stopped asking a student’s religion on its application form, complying with this endowment’s scholarship restriction became “impossible.” The university approached the state attorney general, who agreed that a change was likely appropriate and a date was set to appear before a Judge.

The university argued that it could no longer comply with the terms of the endowment and that it wanted to spend the endowment’s annual income within the regular scholarship program. The judge, however, questioned how the university could be so sure that the donor from two centuries ago was primarily interested in subsidizing the education of students to that university vs. subsidizing the education of Baptist students at any university. If the donor was, in fact, most interested in the education of Baptists, then releasing the religious restriction on this scholarship money appeared inappropriate to the judge. The university countered that it was inappropriate to ask the religious preferences of its applicants and students in this day and age.

The judge asked the attorney general to poll other institutions of higher education in the area and ask if any of them could and would administer a scholarship program directed toward Baptist students as beneficiaries. When the attorney general came back to the court with the news that there was, indeed, another higher education institution willing to provide specific scholarship funds to Baptist students, the judge ordered the $30 million endowment transferred to the other institution. Needless to say, this was not the ruling that the Ivy League university anticipated.

Variance Power

It may not have any relationship to the above case, but a relatively new clause has been added to the gift instruments in place at community trusts and institutions of higher education. This clause is known as the variance power clause of the gift instrument. Charities now either provide their donors with boilerplate gift instruments encouraging the donor to use that document for making their gift or they insist upon the insertion of the variance power clause into the donor’s gift instrument.

Variance power clauses indicate that if changed circumstances have rendered it unnecessary, undesirable, impracticable, or impossible to comply with a restriction imposed on an endowment fund, the board of the trust or charity may redirect the assets to other appropriate charitable purposes without the need for a court proceeding or attorney general review. Quite simply, this means that the charity has unilateral power to change the purpose for which the endowment was given. To date, there have been few situations where charities have used this variance power—possibly because it is so new.

However, donors should not take variance power lightly. Had this Ivy League university had variance power over the endowment discussed above, those college scholarships restricted to Baptist students would be gone forever.

Also, while few charities have used their variance power to this point, note that the language allowing the institution to release the donor restriction is quite broad: “Changed circumstances have rendered it unnecessary, undesirable, impracticable, or impossible to comply with a restriction…”  Let’s take one example and see how this might play out some day.

Assume a donor has provided a community foundation with an endowment directing income is to the local Boy Scouts chapter. Now, however, as a result of the Boy Scouts policy against gay scout leaders, the community foundation believes it is undesirable to fund that institution. If the community foundation has variance power over that endowment, it can simply redirect the income to another charity and away from the Boy Scout organization. Impossible, you say? If I were advising a donor, I would raise this potential and ask what the donor thinks of the variance power clause.

Suppose a charity will not accept an endowment gift without a variance power clause in the gift instrument? What can a donor do? The donor can establish a charitable trust staffed with trustees who are charged with distributing the income to the intended charity. The donor can also provide the trustees with specific instructions should it ever become “impracticable” or “impossible” to comply with the income restrictions of the trust. Presumably, the donor’s hand-picked trustees are more likely to follow his or her desires than those of the charity board. Could this be a reason why some donors create charitable trusts while others donate directly to the beneficiary charity?

Alternatively, if the donor does not want to create a charitable trust, then he or she might consider providing the recipient charity with specific instructions regarding when and where the charity may repurpose the gift. Those instructions could also include requesting that the charity transfer the endowment to another charity that more closely matches the donor’s original intentions. If this option is included, the donor should provide for some financial compensation to the charity that is being asked to conduct a search for an alternative organization and to pass the endowment along.

In summary, it is very important for both the charities and the donors to recognize that with endowment gifts that are designed to last in perpetuity, a little planning and anticipation for changes in the future is definitely in order.