In business transactions, each party generally seeks to maximize his advantage. But for charitable gifts, typically the donor and the charity have the same goal — to best further the charity's mission. Nevertheless, donors want their directions for the uses of their gifts followed, and charities want flexibility if other needs become more important or the original restrictions are no longer appropriate. In a perfect philanthropic world, the gift agreement would give flexibility to the charity while striving to honor the donor's directions. But that world isn't always perfect. So how can donors turn the use strings into steel cables? Is there a buzz saw that charities can use if necessary, being mindful of maintaining enthusiastic relationships with donors and their heirs and with potential donors who are onlookers? What role does the state attorney general play? The courts? Read on.

A Balancing Act

Leona Helmsley famously observed that only the little people pay taxes. She didn't comment, however, on how some of the big people are unable to control the use of their charitable gifts. She left the bulk of her $4 billion-plus estate to her private foundation (PF), The Leona M. and Harry B. Helmsley Charitable Trust, to benefit dogs. She also created a $5 million testamentary charitable remainder trust for each of two grandchildren, with the proviso that their life interests would terminate if they failed to visit their father's grave annually and sign the registration book proving their presence at the gravesite. So she retained some control over her grandchildren. But a New York Surrogate's Court broadened the purpose of her bequest to her PF so that it's not required to use the funds solely for the welfare of dogs. Several animal welfare organizations followed the proceedings closely and were disappointed with the court's decision to broaden the trust's purpose.

As an aside, Helmsley's will created a $12 million trust for her Maltese, Trouble. (The pooch was aptly named and reputed to bite with no provocation.) The Surrogate's Court reduced Trouble's trust to $2 million — calculated to be enough to pay for Trouble's care, including $100,000 per year for security, for his remaining life.

“The evil that men [women, too] do lives after them. The good is oft interred with their bones.”1 That was the case in the so-called “Queen of Mean's” death. Most radio, television and print coverage dwelled on the provisions of her will that disinherited two of her four grandchildren “for reasons which are known to them,” created a $12 million trust fund for her lap dog to live in luxury and directed that the family mausoleum be acid washed or steam cleaned at least once a year. But buried in the media coverage — or not mentioned at all — was that Helmsley's $4 billion-plus estate was all to benefit charity, except for about $35 million to family members and life interests in charitable remainder trusts for two grandchildren and Helmsley's brother.

Three Arrows

A donor has three arrows in his quiver to force a charity to comply with his gift restrictions.

  1. The boomerang gift agreement

    The donor can turn the use string into a steel cable by providing that if the charity doesn't comply with the restrictions, the gift will revert to the donor. However, if the gifted assets are returned to the donor, the tax benefit rule under Internal Revenue Code Section 111 applies. Thus, if the donor took a charitable deduction in prior years and the gifted property is subsequently returned to him, he must include the gift's value in income in the year it's returned. Take the case of Rosen v. Commissioner.2 In 1972, the Rosens donated property to the City of Fall River and took a charitable deduction. The city then returned the property to them in the following year because it couldn't find a suitable use. The Rosens then gave the land to the Union Hospital of Fall River, claiming another charitable deduction. The hospital returned the property to them the following year. The Internal Revenue Service assessed deficiencies against the Rosens, stating that they should have included the fair market value of the property in their gross income in each of the years that the property was returned to them. Note that property returned to a donor is included as income at the value at the time it's returned (not at the time of the gift) and at the donor's then current income tax rate. This is so even if the property has appreciated and the donor is in a higher tax bracket than in the year the gift was made. The Court of Claims in Alice Phelan Sullivan Corp. v. United States held that “since taxpayer in this case did obtain full tax benefit for its earlier deductions, those deductions were properly classified as income upon recoupment and must be taxed as such. This can mean nothing less than the application of that tax rate which is in effect during the year in which the recovered item is recognized as a factor of income.”3

  2. Pinch-hitter charity

    The donor can name another charity to take over the gift if the original charity fails to follow the restrictions. The donor identifies the contingent charity at the time of the gift and names it in the gift agreement. Alternatively, the donor might retain the right to name a new charity at a later time, if one is needed. Caution: If a PF could potentially be a contingent charitable beneficiary of a gift originally made to a public charity, the donor's charitable deduction will likely be smaller at the outset — even if a substitute charity is never named or a public charity is named.

    As this article went to press, the Washington National Opera was in danger of losing a multimillion dollar charitable gift made by Betty Brown Casey, according to an article in the Wall Street Journal.4 Reportedly, Casey's gifts to the Washington National Opera came with a restriction — that the opera company remain independent. If not, the gifted funds would revert to the Metropolitan Opera in New York. The Journal article reported that as the Washington National Opera has begun talking merger with the John F. Kennedy Center for the Performing Arts, the Metropolitan Opera may be on the “verge of a funding windfall.”

  3. “Charity, I'll see you in court.”

    If the gift agreement is silent on the consequences of the charity's not complying with the donor's directions, the first step is for the donor to contact the charity and “try to work things out.” If the charity won't budge, what can a donor do?

    Whether a donor or his heirs has standing in court to enforce the gift restrictions is a matter of state law. Historically, a donor of a restricted gift hasn't had standing to sue to enforce the restrictions. In Carl J. Herzog Foundation, Inc. v. University of Bridgeport, the Connecticut Supreme Court stated that where “property is given to a charitable corporation and it is directed by the terms of the gift to devote the property to a particular one of its purposes, it is under a duty, enforceable at the suit of the attorney general, to devote property to that purpose” [emphasis supplied].5 Thus, the Connecticut court held that only the attorney general (AG) could enforce the donor's intention. The donor himself had no standing to enforce the terms of his gift when he hadn't retained a specific right to control the property, such as a right of reverter, after giving up possession of the property.6 Naturally, the donor can ask the AG to get into the act. But the AG may be unwilling to do so.

Standing, Schmanding

The common law rule that only the AG has standing to enforce a restricted gift has been loosened in recent years. Charles and Marie Robertson created a supporting organization, the Robertson Foundation (the Foundation) in 1961, to provide funding for the Woodrow Wilson School of International and Public Affairs at Princeton University. The Robertsons funded the Foundation with a $35 million gift.7 The donors intended that the gift be used to promote education leading to careers in government service. Two of the Robertsons' descendants and some members of the Foundation's board sued Princeton in 2002, in part claiming that the Robertsons' intent wasn't being followed. Graduates of the Woodrow Wilson School weren't taking jobs in international relations and government service. The plaintiffs wanted to convert the supporting organization to a PF and thus be able to distribute income from the PF to other schools that fit the donors' original intent. The litigation was settled before the trial began; however, the New Jersey trial judge didn't dismiss the case due to the plaintiffs' lack of standing. New Jersey allows individual donors and their families to bring suit against charitable organizations.

New York courts have also allowed donors (or their representatives) to sue charitable organizations for failure to follow the restrictions placed on charitable gifts. In Smithers v. St. Luke's-Roosevelt Hospital Center, the court concluded that both a donor of a gift and the AG have concurrent standing to enforce the terms of the donor's gift.8 R. Brinkley Smithers left funds to St. Luke's-Roosevelt Hospital Center in New York for an alcoholism treatment facility. Smithers died in 1994 and the hospital proposed using the funds for other purposes that the AG approved.9 The court held that Smithers' widow, as representative of Smithers' estate, had standing to challenge this proposed change in the use of the funds.10

Even though some states allow donors to sue to enforce gift restrictions, don't leave the issue of standing to the courts. Provide in the gift agreement who has the right to sue if the restrictions aren't followed. In all cases, state law will govern whether the donor can confer standing on himself and others. Thus, always check governing law. If the donor and charity are in different states and the agreement is silent on which state's law will apply, applicable state law can also be an issue. Thus, specify the governing state law in the gift agreement.

Cy Pres to the Rescue

If circumstances change over time, the charity may not be able to comply with the gift restrictions. The cy pres doctrine — translated as “as near as (possible)” — enables courts to modify or remove donor restrictions when the restrictions become too burdensome. This doctrine says that if “property is given in trust to be applied to a particular charitable purpose, and it is or becomes impossible, impracticable or illegal to carry out the particular purpose, and if the settlor manifested a more general intention to devote the property to charitable purposes, the trust will not fail but the Court will direct the application of the property to some charitable purpose which falls within the general charitable intention of the settlor.”11

UPMIFA, UMIFA (not a college cheer) to the rescue

The common law cy pres doctrine is incorporated in the Uniform Prudent Management of Institutional Funds Act (UPMIFA). Adopted in 2006, UPMIFA replaced the Uniform Management of Institutional Funds Act (UMIFA), in existence since 1972. UPMIFA provides a way to modify restrictions placed on charitable gifts down the road once circumstances have changed. UPMIFA has been enacted by all but four states. As of August 2010, Mississippi and New York had had UPMIFA bills introduced, and Florida and Pennsylvania had taken no action. The remaining states and the District of Columbia have enacted UPMIFA in some form. As with virtually all uniform laws, they aren't always uniform. Naturally, check governing state law. UPMIFA generally provides flexibility by allowing the charity to modify donor restrictions. The charity can modify or remove a restriction with the donor's consent. The charity may also request that a court modify a restriction if the restriction is too burdensome or if the modification will further the donor's intentions.12

To successfully modify a donor's restrictions under UPMIFA, the charity needs to prove the original purpose of the gift and that such purpose is now impracticable. Recently, in Rhode Island Hospital v. Lynch, the trial court refused to approve a change in the use of a hospital gift fund that was used to purchase radium for treating cancer. The hospital stated it no longer used radium for that purpose and that it wanted to use the fund for research and other items relating to the treatment of cancer. The court stated that Rhode Island had recently adopted UPMIFA, but focused on the fact that the hospital failed to show any proof of the original purpose of the gift. The hospital was unable to produce any documentation that created the fund or outlined the purpose of the fund. The fund had always been used to purchase radium but everyone involved was relying on institutional memory and no one had any documents to back this up. Since the hospital couldn't even prove the original purpose of the gift, the court refused to find that purpose was obsolete.13

Donor-advised fund (DAF)

Another way for a donor to retain control over gifted assets: Create a DAF. The donor will obtain a current income tax charitable deduction for the gift and will retain a good measure of control over the distribution of the assets to various charities. Depending on the particular DAF, family members can be named as advisors for both inter vivos and testamentary charitable gifts.

Working Together

More and more donors wish to control the future use of their gifts — especially younger generation entrepreneurs, hedge funders and trustafarians. It's important for donors and charities to work together to ensure that the donor's directions can be honored today and provide flexibility to deal with an uncertain future. Avoid litigation. Create a mechanism to settle disputes. Borrowing from the business world, consider providing for mediation or arbitration. A charity's funds should be used to further its mission — not to defend lawsuits. And donors and their heirs can make additional charitable gifts instead of paying the high costs of litigation.

Endnotes

  1. William Shakespeare, Julius Caesar, Act III, Scene ii.
  2. Rosen v. Commissioner, 71 T.C. 226 (U.S. Tax Ct. Nov. 21, 1978), aff'd 611 F.2d 942 (1st Cir. 1980).
  3. Alice Phelan Sullivan Corp. v. United States, 381 F.2d 399, 403 (Ct. Cl. 1967).
  4. Erica Orden, “Met Opera on Verge of Funding Windfall,” Wall Street Journal, Aug. 7-8, 2010, at p. A-15.
  5. Carl J. Herzog Foundation, Inc. v. University of Bridgeport, 699 A.2d 995, 997 (Conn. 1997).
  6. Ibid. at p. 998.
  7. Robertson v. Princeton University, Civil Action No. 99-02 (N.J. Super. Ct. July 17, 2002, amended Nov. 12, 2004).
  8. Smithers v. St. Luke's-Roosevelt Hospital Center, 281 A.D.2d 127, 140 (N.Y.A.D. 2001).
  9. Ibid. at pp. 131-132.
  10. Ibid. at p. 140.
  11. Restatement (Second) of Trusts Section 399 (1959).
  12. Uniform Prudent Management of Institutional Funds Act Sections 6(a) and 6 (c).
  13. Rhode Island Hospital v. Lynch, Providence Superior Ct., Docket No. P.M. 2009-6120 (Nov. 22, 2009).

Heather J. Rhoades is a principal in the West Hartford, Conn. office of Cummings & Lockwood LLC and a member of the law firm's National Charitable Planning Group

SPOT LIGHT

Deep in Thought — Alberto Morrocco's “The Harbor, Aberdeen” sold for £24,000 (approximately $37,311) at Bonham's “The Scottish Sale” held in Edinburgh, Scotland on Aug. 17-20, 2010. Morrocco's contemplative 50.6 cm. by 63.5 cm. oil on canvas, painted in 1947, depicts the tonal landcape of his birthplace, Aberdeen, Scotland.