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Legal Watch: Say It with Confidence: “Yes! We Do That.” Institutional Attentiveness to Donor Restrictions

6/12/2015

 

Asking for money is baked into the job description of every college and university president in America. There is one critical fundraising question that may seldom be asked bluntly by a prospective donor, but it is vital that a president be prepared to answer it with a single word. The question: “Does your institution always use gifts in a manner that is consistent with restrictions placed on them by the donor?” The answer: “Yes.” The far harder question, though, is the next one: “How do you know?” This one needs an answer, too.

It is not a question to avoid, or to equivocate about. Gifts made by donors who condition their donations on the funds being used in a specific area or for a specific purpose are the lifeblood of robust and significant fundraising. No president is immune from queries about restricted funds, or from complaints about rumored misuse of funds. Unflattering publicity goes viral in seconds. From the wealthiest to the most strapped, private and public institutions alike have found themselves at the wrong end of accusations, screeds, investigations, and lawsuits claiming intentional impermissible or neglectful use of restricted gifted funds.

A president’s response to the “How do you know?” question need not be peppered with in-the-weeds details. But in 2015, every president should be prepared to comfortably, directly, and accurately answer it, noting institutional processes, systems, and culture.

If there are inadequate processes and systems for knowing about and abiding by donor-imposed restrictions on gifted funds, or worse, if an institution’s culture does not lend itself to awareness of and respect for those restrictions by faculty and staff, a good night’s sleep should be hard to come by, since each new day offers an opportunity for crisis.

What’s in the playbook for minimizing problems in this area, and avoiding crises? Can the “How do you know?” question invite an answer that further enhances a donor’s respect for a president and trust in the institution, and cements a relationship?

These six things go a long way toward enabling an institution to abide by its legal obligations and its promises. They provide a basis upon which to say, “How do I know? Here’s how.”

Make sure somebody knowledgeable and trustworthy is in charge. The buck stops somewhere at each institution regarding allocation of restricted gifted funds to institutional programs and priorities. Make sure that person or committee understands and is committed to applying guiding principles and has access to capable legal advice. Don’t skimp on supporting gift administration. One university’s gift administration office explains its role this way: allocating gifts to the appropriate accounts and setting up new gift accounts; maintaining the university’s gifted funds database; monitoring compliance with donor restrictions and financial stewardship of the funds; preparing annual endowment income budgets; acting as a resource regarding the usage of restricted gifts; and providing training regarding the administration of restricted funds.

Have a robust database that catalogs all donor-restricted funds. Scholarships and financial aid, prizes, professorships, fellowships, endowed coaching positions, athletics funds, academic department funds, research funds, etc., should all be cataloged in a restricted funds database, accessible to individuals with authority to spend or allocate the funds. For each fund, the restrictions should be explained in end-user friendly language, and the system should enable linkage to the gift instrument and other significant portions of the gift file. Bottom line: The database should provide sufficient information to enable informed decision making about the availability of particular restricted funds for the designated or desired purpose and the operational allocation of those funds in a manner that does not run afoul of the restrictions.

Conduct a restricted funds business process review. Colleges and universities don’t stand still. Internally, systems change. Administrations grow . . . and shrink. People come and go. But a purpose-restricted endowment is forever. So is the institution’s responsibility to maintain suitable gift acceptance and funds management processes. How do you know if your institution has suitable processes? If a restricted funds business process review has not been undertaken in recent years, do one.

The review’s initial stage is likely to involve mapping the current state of affairs, and perhaps assessing whether the design of internal controls is adequate to mitigate significant risks. What kind of risks? A sampling: Donations may be classified incorrectly; internal sharing of information regarding restricted funds and related expenditures may be suboptimal or downright nonexistent; there may not be a restricted funds database, or it may need upgrading; there may be inadequate access controls to maximize the privacy of donor information; database restriction descriptions or end-user spending decisions may be made without access to proper legal review; or departing personnel may not adequately transfer knowledge to others to ensure smooth transitions and continued attentiveness to restrictions.

A restricted funds business process review may conclude with a variety of context-appropriate outcomes and improvements. Examples include consistent and understood definitions and gift administration terminology; improved security for donor information; tools for proper end-user spending and policies for monitoring end-user spending; and processes for keeping a particular eye on high-risk end-users.

Assess situations where time or experience has shown donor-imposed restrictions to be problematic. Perhaps a restricted fund has supported a program or department that is being eliminated. Maybe a restricted gift 70 years ago endowed a relatively modest prize, but the fund now creeps toward $1 million. A bequest years back may have conditioned its support of a scholarship fund on awards to students of a certain gender or race. With the passage of time, carrying out a donor’s wishes reflected in a gift’s restrictions may prove impossible, impracticable, or illegal. These situations are ripe for well-intentioned, but improper, deviation of restricted funds at operational levels of the institution, particularly in resource-challenged times. If the donor is alive, a respectful explanation of the situation may be all that is needed, as it can result in an agreed-upon, permissible amendment to the original gift terms.

More likely, however, the donor is deceased, or other circumstances negate the possibility of a donor-approved modification. In most states, an opportunity may exist to ask a court to modify the terms of the restricted gift, typically via a principle known as cy pres, an abbreviated form of cy pres comme possible, French for “as near as possible.”

Although recent years have seen a liberalizing trend, the evidentiary bar for cy pres requests is high, and a strong case must be made for a court order redirecting application of restricted funds to another purpose that reasonably approximates the donor-designated purpose. Since 2006, some states have modified their laws to allow for cy pres of restricted funds that are small (less than $25,000) and old (more than 20 years), upon notice to the state’s attorney general.

Don’t accept a gift with restrictions that are intolerable, unreasonable, or misaligned with institutional priorities or culture. Easier said than done, to be sure. But back in in 1907, Swarthmore College (PA) turned down a bequest worth as much as $3 million—nearly $75 million in today’s dollars—rather than abide by the bequest’s condition that the school cease all participation in intercollegiate sports. Sometimes, a gracious “no” may be necessary now, to ensure that “yes” is the future answer to the simple question about institutional diligence in always abiding by donor restrictions.

Strive for donor understanding that the institution will be around long after we are gone, and have the gift instrument reflect that understanding. Donors can be energized about supporting a particular program or initiative, but they can also appreciate that permanently denying flexibility in the future could present problems for institutions that they would never want to cause. With this in mind, clarity with donors at the time of making the gift about the reality that circumstances change is a delicate but extraordinarily important matter. Including “cy pres language” in deeds of gift and wills is one of the simplest and most effective ways of achieving this. An institution’s preferred articulation may vary dramatically, and be tailored to the circumstances, yet still achieve the desired purpose. One generic example: “If, as a result of changed conditions in the future, the income from this fund shall not be needed for the purpose I have described, the university is authorized to use the income for such other purposes as nearly as possible akin to the original purpose, as in its judgment will help advance the institution’s mission.”

None of this ensures that gift restriction problems will never arise, with the attendant publicity, donor discomfort, and, perhaps, legal challenges. But it will go a long way toward minimizing the possibility, and keeping a president’s answer to a critical question short, sweet, and accurate.

 

Peter McDonough is ACE’s interim general counsel.

 

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