The Child Victims Act

The response to the new law has been swift and overwhelming: On August 14, the first day of the one-year period for individuals to assert previously time-barred claims, more than 400 filings were made. Importantly, however, these claims don’t only apply to just abusers. The CVA also expands the window for claims against allegedly negligent organizations.

This raises understandable concerns for donors, who might be reluctant to contribute to charitable entities out of fear their donations will be used to pay decades-old claims rather than sustain worthwhile causes.

Following are strategies that charitable organizations potentially impacted by the CVA can employ to ease the minds of donors and incentivize their continued support.

The Legal Landscape

In considering donor strategies, there are two competing interests at play: protecting the charitable mission; and, protecting creditors’ rights. It is impossible to thwart all creditors, and any system designed to do so likely would be rejected by a court. Organizations also must be mindful of the sensitive nature of CVA-related allegations.

When considering donor concerns, it is important to analyze how the relevant statutes and case law balance donor and creditor rights. Generally, in New York, significant deference is given to clearly articulated donor-imposed use restrictions, even in the face of creditor challenge.

Section 513(a) of New York’s Not-For-Profit Corporation Law (the N-PCL) states that any corporation, classified as a charitable corporation under the N-PCL, is considered to be the owner, not a trustee, of any assets, funds or real property given or granted to it for the purposes specified in its certificate of incorporation.

Section 513(b) further provides, however, that the charitable corporation must direct any gift that specifies a purpose, to be used solely for that purpose along with any reasonable administration expenses that might be incurred with the execution of that purpose.

Accordingly, when read together, the sections of the N-PCL suggest that unless impressed with a donor-imposed restriction on use for a specific purpose, a donation, even one made to a general endowment fund, will be available to the organization for any purpose, including the satisfaction of pre-existing obligations.

The impact of donor intent on a charitable organization’s ability to use a gift is also evident from the 2010 removal of Section 513(c) from, and addition of Section 553 to, the NYNPCL. Previously, Section 513(c) required a not-for-profit corporation to maintain the historic dollar value of an endowment fund. Now, Sections 553(B) and (C) require that, for a donor to limit a gift instrument’s use and purpose, the donor must explicitly specify if the principal must remain intact and that the not-for-profit is only permitted to use the income, interest or dividends. If the gift does not include limiting language, the corporation can use principal and interest from a gift as it wants, so long as it does so prudently and in good faith.

Moreover, if a donation was made prior to 2010 with ambiguous restrictive language, those donors must be informed at least 90 days before the not-for-profit uses the gift for anything beyond its intended purpose. The notice must allow the donor to choose between allowing the institution to use the gift at its discretion or prohibiting the institution from diminishing the gift’s original dollar value.

These statutory themes reflect pre-existing case law.

Although cases regarding the application and enforceability of donor limitations often turn on their facts, they also generally involve situations (1) where the organization wishes to use the funds for other than a specified purpose; or, (2) where the organization is bankrupt and creditors want access to restricted funds to pay their claims.

In RE: Friends for Long Island’s Heritage there is a classic example of a New York court holding that a charitable corporation must honor the restricted purpose of a donor’s gift even in the face of unpaid creditors. In late 2004, the board of Friends, a historical museum, decided to dissolve the organization. Part of the dissolution plan included the sale of assets, which comprised collections donated by various individuals.

Each collection had its own restricted purpose including development of museum activities, historic sites, and a center to study English ceramics, and a permanent endowment fund to be used for the maintenance and repair of specific buildings.

When word of the impending dissolution got out, various creditors made claims against Friends. The court, however, rejected the argument that their claims have greater weight than donor restrictions, and it required the organization to honor those restrictions by transferring restricted assets to other similar charitable organizations, leaving creditor claims unsatisfied. The court held that dissolution does not “render inoperative [donor] limitations during the period of dissolution only to revive them after debts are paid.” To hold otherwise, the court found, would “sanction a gap in the protection of donors’ expressed limitations,” where the public places “greater importance on the limitations on the use of the asset than on which entity actually holds it.”

Potential Strategies

Here are strategies that might be deployed to give donors more comfort that their charitable gifts will be used as they direct. These strategies, however, cannot be used to change the character of existing donations and endowment assets. Each option has attributes and detriments or costs, and although presented separately, they are not mutually exclusive.

1. Utilize Restricted Use Gift Agreements: An organization can create gift agreements that permit donors to select (contemporaneously with making a gift) to designate restricted purposes for their gift from a list of specific uses or funds proposed by the organization. Each fund would have a clear “gift-over” enabling the organization’s board to redeploy the donation if it concludes the specified purpose is no longer achievable.

From a tax perspective, these donations are made directly to the organization.

The benefit to the organization from this arrangement is that the board defines the specific purposes for which the donations will be used consistent with mission and need. It also permits the board to establish an administratively manageable number of special funds.

From a donor’s perspective, this arrangement enhances the likelihood that a gift will be used to sustain and advance program because the organization will have a written record of the donor’s intended restrictions on use.

Gift agreements, however, do not provide the strongest protection for donor intent. By giving the board some discretion over the future use of the funds, protections are eroded. Indeed, the more control the board has to change use restriction, the less protected original donor intent is. Further, these arrangements can become administratively burdensome and complicated, requiring that detailed records, even for relatively small donations, be maintained.

1. Establish a Fund under a Community Foundation: A community foundation pools charitable gifts from many donors. The gifts are held in trust and managed for the benefit of the community. Community foundations often offer donors the option to contribute to designated funds or donor-advised funds. For example, the New York Community Trust (NYCT) offers both designated and donor-advised funds.

With a designated fund, the donor selects an organization(s) to support and may specify the terms of the support, but the community foundation administers the fund. A donor-advised fund has a donor-designated Advisory Committee that can make recommendations to the community foundation on distributions.

The benefits to the donor of establishing a fund under a community foundation include:

• Generally, they are public charities for tax purposes;
• Donations to a fund established under a community foundation are treated as donations to a public charity; and,
• The time to establish a fund with a community foundation likely is minimal.

There are detriments and costs to establishing a fund under a community foundation, however. Ultimate control over investment management and distributions is surrendered to the community foundation, which might come to see the organization the donor intended to support as more or less worthy of support. This is true even for a donor-advised fund where, although a donor’s intent might be expressly stated in the original agreement, the Advisory Committee is limited to making recommendations to the community foundation. The community foundation also charges investment management fees.

1. Establish a Private “Donor” Advised Fund: This option is very similar to establishing a donor-advised fund under a community foundation, except that the charitable organization establishes a private fund with a private bank (the sponsor organization) to which its donors contribute. The charitable organization also serves as the “donor advisor,” meaning it advises the sponsor organization about the distributions to be made, subject to the sponsor organization having ultimate control over the timing and amount of any distributions.

A significant benefit of a private “donor” advised fund is the opportunity to customize service. As a fund’s size increases, many sponsor organizations permit increased input from the donor advisor. For example, Fidelity Charitable permits donors with more than $250,000 in a Giving Account to nominate an investment manager. Donors with accounts exceeding $5 million are permitted to recommend that investments be made in hedge funds, private equity funds, mutual funds, treasuries and ETFs.

Other benefits include tax benefits and ease of setup. Although donations to this type of private fund are ostensibly made to the for-profit sponsor organization, the sponsor organization is treated as a public charity for tax purposes. The effort to establish a private donor advised fund likely is minimal as the service is among the suite of services provided by the sponsor organization.

Like a fund established with a community foundation, a private fund has some downside. The charitable organization has to relinquish control over investments and distributions and will need to pay an investment management fee.

Because certain investment options may only become available to larger funds, utilizing a private donor advised fund might be more advisable if the organization intends to allow future contributions to accumulate and use its existing resources to support current operations. Accumulating funds in a donor advised fund may ultimately be consistent with the organization’s needs.

The Internal Revenue Service (IRS) recently increased its scrutiny of the practices of private funds. Because more than $100 billion is held in these funds, they likely will remain a viable option for the foreseeable future, even if their investment flexibility is ultimately limited.

1. Establish a “Supporting Organization;” According to the Internal Revenue Code (IRC), a supporting organization is a Section 501(c) (3) organization that supports one or more publicly supported charities (qualifying under Sections 509(a)(1) or 509(a)(2) of the IRC). Supporting organizations serve a variety of functions including acting as a more flexible alternative to a private foundation, autotomizing functions of a private charity and limiting liability. To be considered a supporting organization, the organization must be “organized, and at all times thereafter…operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified organizations” described in Section 509(a)(1) or Section 509(a)(2). It must have the relationship specified under Type I, Type II or Type III and must not be “controlled directly or indirectly by one or more disqualified persons (as defined in Section 4946) other than foundation managers and other than one or more organizations” described in Section 509(a)(1)or Section 509(a)(2).

To meet the first prong of this test (the organizational test), the supporting organization’s articles of organization or governing instrument must: (1) limit the purposes of the organization to certain specified purposes; (2) must not expressly empower the organization to engage in activities not in furtherance of those specified purposes; (3) indicate the specific publicly supported organizations the organization will support; and, (4) not expressly empower the organization to operate for the support or benefit of any other organization.

As noted, the IRC defines three types of supporting organizations. These organizational types are distinguished by the specifics of the relationship between the supporting organization and supported organizations.

• Type I supporting organizations must be operated, supervised, or controlled by one or more publicly supported organizations. Typically, the publicly supported organization has the power to appoint or elect a majority of the directors of the supporting organization, similar to a parent-subsidiary relationship.
• Type II supporting organizations must be supervised or controlled in connection with one or more publicly supported organizations. Typically, publicly supported organization and the supporting organization have a majority of the same directors, similar to a brother-sister corporate relationship.
• Type III supporting organizations must be operated in connection with one or more publicly supported organizations. Typically, a Type III organization would not have a majority of overlapping directors with the supported organization and must meet separate responsiveness and integral part tests.

For the reasons discussed above in the “Legal Landscape” section of this article, donations made to a Type III supporting organization are most likely to be protected for use by a supported organization to sustain its mission and future program in the face of claims made against the supported organization. The closer the affiliation of the supporting organization to the charitable organization, the more likely it is to be found that the charitable organization has discretion to use the funds of the supporting organization for its general purposes.

In contrast, the less overlap there is between the supporting organization and the charity, the less discretion the charitable organization likely will viewed as having over the funds. Given this conclusion, the remainder of this article focuses on Type III supporting organizations where the lack of organizational and governance overlap reflects a lack of control by the supported organization.

A Type III supporting organization will meet the responsiveness test if the supported organization is adequately represented on the governing body of the supporting organization through (a) the ability to appoint at least one officer, director or trustee; (b) at least one common officer, director or trustee; or, (c) the maintenance of a close and continuing working relationship between the organizations. It will also meet the test if because of this relationship the supported organization has a significant voice in the use and management of the supporting organization’s assets.

Type III supporting organizations must furnish their supported organization with an annual notice regarding the amount and type of support they provide along with copies of their Form 990 and governing documents. They are also classified as either “functionally integrated” or “nonfunctionally integrated.”

Functionally integrated supporting organizations must meet one of three alternative tests:

• Substantially all of the organization’s activities are in direct furtherance of the supported organization’s activities, which do not include fundraising, managing non-exempt-use assets and certain other activities;
• The supporting organization must have the power to appoint a majority of the officers, directors or trustees of the supported organization; or,
• The supported organization is a governmental entity. A non-functionally integrated Type III supporting organization must distribute a certain amount of capital -- generally equal to the greater of 85 percent of its adjusted net income for the prior taxable year and 3.5 percent of the aggregate fair market value of its non-exempt use assets -- and must be considered “attentive” to the supported organization’s needs, which may be determined upon a facts and circumstances assessment. It will likely be easier for the organization to be a non-functionally integrated Type III organization, as this is a less close-knit relationship, thereby also maximizing the likelihood of protecting donor intent into the future.

There are a number of other benefits to the supporting organization approach. For many (though not all) purposes, supporting organizations are treated like public charities, and donations made to supporting organizations are accordingly tax-deductible as made to a public charity. Supporting organizations provide an efficient vehicle to autotomize functions a public charity wishes to keep separate from its general operations. They also offer significant protection for donations intended to benefit the supported entity while not leaving decisions regarding distributions to a completely unaffiliated private entity.

And, as noted above, while the boards of a Type III supporting entity and a supported entity will not have a majority of overlapping members, the supported organization can be represented on the supporting entity’s board and its remaining members likely will be chosen not only for their skills but there support of the supported entity’s mission.

Of course, establishing a supporting organization will have greater up-front costs and will take more time to form. A corporation or trust would need to be created and an application for tax-exempt status would need to be filed with the Internal Revenue Service. The entity would also need to be registered with the New York State Attorney General.

Concern about the impact of the CVA on charitable giving should not paralyze donors or organizations. As noted above, there are several viable options to assuage donor concerns that current philanthropy will be diverted from sustained and advancing the mission of a charity and current services it provides, without impacting a charity’s current asset and fund configuration. Which option is best for your organization will depend on a number of considerations that reflect your resources, your preferences, your administrative structure and your donors.