The impact of COVID-19 on the nonprofit and tax-exempt organization community is unprecedented. It has drastically affected the sustainability of organizations in many industries – no organization will emerge untouched. In these uncertain times, clients are increasingly asking how they can access assets held in their endowments.
What is an Endowment?
Though “endowment” is colloquially used to mean any assets that are held for the long term, an “endowment fund” is a legal, defined term of art under the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which has been adopted in 49 states and the District of Columbia. Specifically, an “endowment fund” is “an institutional fund or any part thereof that, under the terms of a gift instrument, is not wholly expendable by the [nonprofit organization holding the fund] on a current basis.” In other words, if a donor restricts the timing during which a fund may be used – often by restricting the organization’s use to the “income” of the fund each year, then it is an endowed fund. Funds which the board of an organization designates to be held long term or restricts so that the only assets available to be spent each year is limited to an organization’s spending policy — typically expressed as a percentage of a fund — are not considered endowment funds under UPMIFA. Sometimes organizations refer to these funds as “board-designated funds” or “quasi-endowments.”
Why Does It Matter if a Fund Is an Endowment Fund?
Organizations may only spend endowment funds in accordance with the terms of the gift instrument. In other words, if a donor sets a spending rate or annual amount, that rate or amount must be followed — or, absent an expression by the donor other than that the fund is to be treated as an endowment, in accordance with the terms of an organization’s spending policy. Spending policies vary, but organizations usually adopt an annual spending rate between 4% and 6% of the average endowment fund balance over a historical period for the specific fund (e.g. the past 12 quarters). The spending policy rate is adopted by an organization’s board of directors, and the presumption of prudence with respect to the spending rate varies based on the state in which the organization is located. The UPMIFA model act provides an optional provision that a greater than 7% spending rate is rebuttably presumed to be imprudent. However, Ohio, for example, took a divergent approach, providing that an annual spending rate of 5% or less is presumed to be prudent — without creating a presumption for higher spending rates. Illinois, Indiana, and Minnesota are silent on a presumption of prudence.
What if Your Organization Needs More From Your Endowment Than Your Spending Rate?
In times of crisis, organizations often find it challenging to raise funds at the same rate as during “normal” times. During the COVID-19 pandemic, organizations that rely on ticket sales, memberships, or revenue from operating activities are in especially difficult positions. The usual spending policy draw from an organization’s endowment therefore may not be enough to close a budgetary gap. Fortunately, organizations have options to increase access to their endowment funds.
- Modify Spending Policy Rate. Depending on the circumstances, an organization may be able to increase the spending policy rate for a short period of time. This should be done based on a careful consideration of the factors required under UPMIFA by the organization’s board.
- Seek to Modify or Release Fund-Specific Restrictions. In addition to stipulating that gifts are to be treated as endowed funds — a timing restriction on spending — donors also may require that funds may be spent only for specified purposes — a purpose restriction on spending. For example, the gift may only be used for scholarships, a specified program, or capital project. Funds also can be both timing and purpose restricted. For example, a donor may create a fund with a school to provide scholarships — a purpose restriction — from which only the income may be spent each year — a timing restriction. There is a strong policy concern under UPMIFA that organizations comply with a donor’s intent when making a charitable gift, including both timing and purpose restrictions; organizations must honor those restrictions unless the requirements of UPMIFA to modify or release a restriction are met.
The process for seeking modification or release of a restriction depends on a number of factors. If a donor is living, an organization generally should seek the donor’s consent to modify the restriction. If a donor is not living, UPMIFA provides a process for modification or release of restrictions provided that the fund is old enough (this threshold varies by state and can be as little as ten years and as many as twenty-five), small enough (again, varies by state and can be as low as $25,000 or up to $250,000), and the organization believes that the restriction is “impracticable or wasteful,” “impairs the management or investment of the fund,” or that a modification “will further the purposes of the . . . fund.” If a fund is eligible under the UPMIFA process, the organization generally must notify the state attorney general of its intention to modify or release the restriction and wait the proscribed period of time (e.g., 60 days) before the organization is able to do so. The state attorney general may object to the modification or release or request additional information. Finally, if a donor is not living and a fund does not qualify for the UPMIFA small, old fund process, an organization may seek a court modification of the restriction.
- Looking Forward. Many of the problems that organizations are currently encountering with respect to their endowments can be addressed proactively through a clear and flexible gift agreement with donors. A gift agreement that clearly sets out the donor’s intentions both at the time of the gift and should unexpected circumstances arise in the future is helpful for both the donor and the organization receiving the gift.
Taft has advised many organizations with respect to questions about their endowments, as well as donors intending to make large gifts to nonprofit organizations. We help both organizations and donors understand and anticipate that circumstances can and often do change over time and include provisions in gift agreements to address such changes to the extent possible. We also have worked with state attorney generals throughout the Midwest to modify or release restrictions under UPMIFA. Please contact our team if you have questions or we may be of assistance.