Many colleges and universities have endowments. In the last few years, institutions of higher education have had more questions about how to access their endowments – between the COVID-19 pandemic and periods of significant market volatility, the need for cash has been acute at times. This brief piece addresses legal questions related to endowments and how colleges and universities can work with counsel to have greater access to their endowments when needed most.
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 some form in forty-nine (49) states — only Pennsylvania has not adopted in any form 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, or requiring that the fund be held “in perpetuity,” or with words of similar importance, then the fund is an endowed fund.
Alternatively, funds that the board of a college or university designates to be held long-term or restricts so that the only assets available to be spent each year are 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?
A college or university may only spend endowment funds in accordance with the terms of the gift instrument through which the donor made the gift to the college or university. Gift instruments can be documents that take effect at death like wills, living trusts, or beneficiary designations, or agreements negotiated with donors during their lives. Donor restrictions are not optional, nor can they be ignored, even if they are impossible to follow. In other words, if a donor sets a spending rate or annual amount, that rate or amount must be followed. If the donor has not set an annual spending amount but has indicated that the fund is to be treated as an endowment, then the fund should be spent in accordance with the terms of the college or university’s spending policy. Spending policies vary, but organizations typically adopt an annual spending rate between 3% and 5% of the average endowment fund balance over a historical period for the specific fund (e.g. the past 12 quarters – it is worth noting that although Pennsylvania has not adopted UPMIFA, it has provided for a similar calculation as a safe harbor in PA Act 141). The percentage adopted in the spending policy is expendable by the college or university each year for the purposes specified by the donor.
The spending policy rate is adopted by a college or university’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. Many states are silent on a presumption of prudence, so a college or university should consult its counsel and the version of UPMIFA applicable — or in Pennsylvania, PA Act 141 — to the college or university when developing or amending its spending policy.
What if a College or University Needs More From Its Endowment Than Spending Policy Allows?
In challenging economic times, many charitable organizations, including colleges and universities, often find it challenging to raise funds at the same rate as during “normal” times. As we saw during the COVID-19 pandemic, organizations that rely on revenue from operating activities can be in especially difficult positions, particularly when operating activities are inhibited by restrictions through state or local laws or regulations. During such times, the usual spending policy draw from a college or university’s endowment may not be enough to close a budgetary gap. Fortunately, colleges and universities have options to increase access to their endowment funds.
- Modify Spending Policy Rate. Depending on the circumstances a college or university may be able to increase the spending policy rate fairly dramatically for a short period of time. For example, a college with a standard spending policy of 4% may be able to increase its spending policy to 7% or higher for a year or two. A college or university with a conservative spending policy – generally 3% or less – may wish to take the opportunity to revisit its spending policy more generally and increase it more modestly with the intention that the new spending policy will be in place for as long as makes sense to the organization’s board. Any adjustment to the spending policy should be done based on careful consideration of the factors required under UPMIFA by the college or university’s board.
- Seek To Modify or Release Fund-Specific Restrictions. As indicated above, donor restrictions are not optional. 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 college or university 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. Colleges and universities must honor donor restrictions unless the requirements of UPMIFA to modify or release a restriction are met.
One common example of a fund that a college or university may seek to modify relates to programs that a college or university no longer offers. For example, ABC College was established in 1800 for women. During the nineteen century, ABC College offered a number of courses of study in home economics. Donor Smith left $5,000 to ABC College in 1920 to be used in perpetuity for scholarships for women studying home economics under her will. ABC College used the income from the Smith Fund to provide scholarships as required under the will. In 1965, ABC College became coeducational, but scholarship awards continued to be awarded to women. In 1975, the home economics course of study was discontinued. No distributions from the Smith Fund have been made after the discontinuation of home economics. The current value of the Smith Fund is $25,000. What should ABC College do? Because ABC College cannot administer the Smith Fund in accordance with the donor restrictions, it should look to the applicable statute in the state where ABC College is located to determine the process to seek modification or release of the home economics restriction.
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.
Donor Smith is no longer living, so Donor Smith cannot be consulted to modify the restriction. The age of the Smith Fund is old enough (more than 100 years) and the value of the Smith Fund is small enough ($25,000) under most, if not all, versions of UPMIFA to seek a modification. ABC College should work with its counsel to give notice to the state attorney general in accordance with the statute. ABC College could request a modification of the restriction to instead offer scholarships to women in a different specified course of study or it could seek to have all restrictions removed. The state attorney general will decide whether the modification or release sought is acceptable. Once ABC College has received notice of objection or has waited the proscribed period, ABC College may move forward accordingly.
Many of the problems that colleges or universities encounter 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 college or university receiving the gift.