RESTRICTED FUNDS – SOMETIMES A DILEMMA FOR FRATERNITY FOUNDATIONS

Barbara Schwartz Bromberg, Esq., Dinsmore & Shohl LLP

INTRODUCTION

Because of the unique nature of fraternal foundations and the fact that many of their donors wish to establish named restricted funds that benefit a particular chapter or area of particular interest to the donor, and because historically, organizations did not work with the donor to craft restricted fund language that would withstand the test of time, many fraternal foundations find themselves in the position of having restricted funds containing large amounts of money that cannot be used because the donor had specified a particular use that no longer is possible (e.g., to benefit the educational purposes of a chapter that has been dissolved).  This can be a very frustrating situation and, understandably, the foundations often wish to nullify or amend the restrictions on these funds and be able to use them for other charitable purposes of the organization.  This article will discuss the legalities of taking this kind of action and suggest some remedial steps that can be taken to avoid this type of situation in the future.

UNIFORM MANAGEMENT OF INSTITUTIONAL FUNDS ACT

While an organization that finds itself in the above situation would, through its board of directors, like to amend the terms of a restricted fund, that is usually problematic legally.  In other words, simple action of the board of directors often will not suffice.  This is because of a little known law called the Uniform Management of Institutional Funds Act (“Act”), which has been adopted in many states.  While, like most Uniform Acts, model language has been suggested for the states to use in this connection, each state may add its own variations to the basic verbiage of the Act.  In this article, we will focus upon and contrast two versions of the Act – Ohio and Indiana – because they are somewhat typical of other states in their approach to the subject.

In general, the Act provides that a restriction imposed by a donor on the use (or the investment) of such a fund may be released with the written consent of the donor.  Obviously, this is a problem if the donor is deceased or unavailable, or in some cases where the contribution has been provided by a number of donors and the donor is therefore difficult to identify.  The Ohio Act provides that if written consent of the donor cannot be obtained for these reasons, the organization may apply to the appropriate court for such release of the restrictions.  In Ohio, the attorney general is a necessary party to the action and must be served with process in all proceedings pertaining to this kind of application – in fact, the Act provides that if this is not done, any judgment rendered in such proceedings will be void.

In the Ohio Act, in order to grant a release of restriction pursuant to the statute, the court must find that the restriction involved is “obsolete, inappropriate, impracticable or impossible,” and then it may order the release of the restriction, in whole or in part.  In other words, the Ohio Act requires a showing that at least one of these tests has been met.  To give some examples, if a restricted fund provides that a scholarship is to be awarded in the field of engineering and the organization would prefer that the scholarship could be awarded generally, that would probably not be the type of restriction which an Ohio court would release, absent a showing that it has become impossible for the organization to award the scholarship because none of the possible awardees studies engineering.  On the other hand, a restriction with respect to a fund that it may award scholarships only to a member of a certain chapter, where that chapter is no longer in existence, would seem to be an appropriate subject of release by an Ohio Court.  In other words, it will be incumbent upon an organization seeking such a release in Ohio (and in other states that use this or a similar test), to make a showing that the release is obsolete, inappropriate, impracticable or impossible, as the case may be.

The Ohio Act, like many states’ versions of the Act, does provide that a release by court order may not change an endowment fund to a fund that is not an endowment fund.  Therefore,  only the signature of the donor can accomplish this.  Of course, the Act further provides that the fund may not be changed from a fund for a charitable or educational purpose to a non-charitable or non-educational purpose.  The Act also provides that it does not limit the application of the doctrine of cy pres, which is an historic legal doctrine allowing a court to reform a charitable purpose under appropriate circumstances.

It is interesting to contrast the Indiana version of the Act with the Ohio version.  While many of the provisions are similar, as one would expect since their genesis is the Uniform Act, the Indiana Act has an important variation and exception in that it does not apply to charitable organizations unless they have “an endowment fund with a fair market value of at least ten million dollars.”  Effectively, this would appear to allow smaller organizations the ability to deal with donor imposed restrictions through their boards of directors applying normal fiduciary principles.  If the Indiana Act does apply, in addition to obtaining the written consent of the donor for a release, the Act provides that it also does not limit the application of the doctrine of cy pres or the ability of a board of an organization through legal or equitable proceedings to obtain a release of restriction.  No test for such a release as is found in the Ohio Act as described above is provided in the Indiana Act.

PRACTICAL TIPS FOR DEALING WITH THIS SUBJECT

Having dealt with a number of organizations attempting to handle this type of situation in a cost effective and proper fiduciary manner, the following should be noted:

1. Note that the Act has no application to restrictions that are not imposed by donors – in other words, restrictions created by the board of an organization, commonly known as designated funds, can be released by the board through a resolution adopted in a manner which complies with applicable state law.
2. Since the cost of a court proceeding is not inexpensive, even under the best of conditions, every effort should be made to contact the donor in such a case to obtain his or her written consent to the requested change or release of restriction. In any event, the cost of such litigation must be weighed against the amount of the fund and the organization must decide, with the help of its counsel, at what financial point it is cost effective to embark on a court proceeding.
3. While this article has primarily dealt with restrictions on the charitable use of a fund, it should be kept in mind that the Act generally also provides for the release or change of a restriction on the investment of funds which has been imposed by a donor – such restrictions were common a generation or two ago and therefore are sometimes found with respect to such restricted funds.
4. Most fraternal foundations today will not accept a restricted fund unless it allows for some elasticity in the future in order to avoid these types of problems. For example, a typical provision in such a restricted fund would be: “If  __________ chapter is closed, then the income from this fund may be used to provide scholarships to deserving members in good standing of ___________ Fraternity who reside in the states of _______________;  however, if there are no such deserving applicants, then the income from this fund may be used to provide scholarships to members in good standing of _______________ Fraternity.”
5. Another measure that has been employed by some fraternity foundations, is to widen the group of donors, so that if the originally named donor is deceased, there are other individuals that can be regarded as donors for purposes of the Act and thus consent in writing to a release, in whole or in part, to the restriction if it becomes necessary. For example, the donors of a fund could be listed as the donor, his or her spouse, his or her children and even grandchildren if they exist.

CONCLUSION

While this article has of necessity been somewhat general, it should make fraternal foundations aware that any change of restrictions in a donor-restricted fund must be handled very carefully in order that the changes are accomplished legally and free from challenge.  However, if the organization works closely with its counsel, in most cases, it should be able to change a restricted fund that is not fulfilling its charitable purpose, hopefully to one that is an active partner in the fraternal foundation’s charitable and educational work.  Finally, fraternal foundations should work with their counsel to make sure that their practices with regard to the intake of restricted funds and drafting of  restricted fund language provide the maximum flexibility should the purposes of any such fund need to be changed in the future.