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Endowment Considerations in Connection with the COVID-19 PandemicRelease date March 25, 2020This article is not intended to provide legal advice. Rather, it is intended to alert readers to considerations in connection with the management of endowment funds under Michigan law. Questions may arise during the COVID-19 pandemic on the use of endowment funds to respond. These questions could include how to set endowment investment and spending policies and when to remove restrictions placed on charitable funds. Community foundations may face scrutiny for their response to nonprofit organizations requesting additional resources be made from endowment funds held by community foundations to support those nonprofit organizations. Executive SummaryFoundations and nonprofits holding endowment funds should first review any spending directions and charitable purpose restrictions contained in the applicable gift and endowment fund agreements. Those agreements also may provide means by which those spending directions and purpose restrictions may be modified or removed.If not, Federal and Michigan laws and regulations provide flexibility to modify or remove those restrictions. The Michigan Uniform Prudent Management of Institutional Funds Act, MCL 451.921 et seq (“UPMIFA”) provides a process by which spending rates may be increased short-term for endowment funds provided the long-term purpose of the endowment is munity foundations may use their variance power to modify or remove endowment and charitable purpose restrictions if the conditions exist to trigger that power.Nonprofits and foundations (including community foundations) may be able to modify or remove endowment and charitable purpose restrictions using the processes provided in UPMIFA. The doctrine of cy pres and some of the processes provided for in UPMIFA may not be practical in the current environment as access to Michigan courts and the Office of the Attorney General is severely limited as a result of emergency actions taken in connection with the COVID-19 pandemic.More details regarding the determining of spending rates and the modification and removal of endowment restrictions follows. Spending Policy Under Michigan LawThe spending policy contained in a gift or endowment agreement is to be followed if that direction is clear and unambiguous. It is important to note that the Michigan Uniform Prudent Management of Institutional Funds Act, interprets certain phrases and words typically used in gift and endowment instruments as not defining what can be spent from an endowment fund. Rather, these words and phrases are interpreted to simply mean that an endowment is established. “(3) Terms in a gift instrument designating a gift as an endowment, or a direction or authorization in the gift instrument to use only "income", "interest", "dividends", "rents, issues, or profits", or "to preserve the principal intact", or words of similar import, do both of the following:(a) Create an endowment fund of permanent duration unless other language in the gift instrument limits the duration or purpose of the fund.(b) Do not otherwise limit the authority to appropriate for expenditure or accumulate under subsection (1).” MCL 451.924(3) [emphasis added]In the event there is ambiguity in the gift instrument, UPMIFA provides default rules for both the investment and expenditure of endowment funds. UPMIFA also provides means by which gift restrictions can be removed or modified which is discussed below. With respect to the amount from an endowment fund that is to be appropriated or accumulated, UPMIFA provides: “(1) Subject to the intent of a donor expressed in the gift instrument, an institution may appropriate for expenditure or accumulate so much of an endowment fund as the institution determines is prudent for the uses, benefits, purposes, and duration for which the endowment fund is established. Unless stated otherwise in the gift instrument, the assets in an endowment fund are donor-restricted assets until appropriated for expenditure by the institution. In making a determination to appropriate or accumulate, the institution shall act in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances, and shall consider, if relevant, all of the following factors:(a) The duration and preservation of the endowment fund.(b) The purposes of the institution and the endowment fund.(c) General economic conditions.(d) The possible effect of inflation or deflation.(e) The expected total return from income and the appreciation of investments.(f) Other resources of the institution.(g) The investment policy of the institution.(2) To limit the authority to appropriate for expenditure or accumulate under subsection (1), a gift instrument must specifically state the limitation. . . “ MCL 451.924 [emphasis added] Therefore, charitable organizations like community foundations holding endowment funds must consider several factors in determining the amount of their endowments funds to appropriate or accumulate. Those considerations include both current and long-term purposes of the endowment, economic conditions and expected total income and appreciation. Increasing spending currently may be appropriate to address current demands for charitable services. However, that appropriation should be tempered by projected needs from the endowment in future years. The Council of Michigan Foundations commissioned a study in 2000 with Cambridge Associates regarding payout rates. That study concluded that a payout rate of more than 5% was unsustainable over time. This is not to say that payouts should be limited to this percentage in the current circumstances. Rather, this information is provided to help guide discussions in the setting of endowment payouts to meet both short- and long-term goals. UPMIFA provides flexibility that allows for an increase in current spending rates in light of the current COVID-19 national emergency. Foundations should consider the impact of setting a higher current spending rate on the future growth of those endowments and the amount that will be available from those endowments to support future needs in the communities they serve. Removing and Modifying Endowment and Charitable Purpose RestrictionsCharities and foundations wanting to remove or modify gift restrictions in response to the COVID-19 pandemic should first review the gift instruments that established those gifts to see if the gift instrument provides any means for such changes. Sometimes those gift instruments will reference the governing documents and policies of the charity or foundation holding the restricted gift necessitating a review of the referenced documents. Lastly, Federal and Michigan legislation and regulations may provide processes through which these restrictions may be modified or removed. Community FoundationsCommunity foundations have what is commonly referred to as the “variance power” over its funds. This power originates in Treas. Reg. 1.170A-9(f)(11)(v)(B) that provides:“. . . the governing body must have the power in the governing instrument, the instrument of transfer, the resolutions or by-laws of the governing body, a written agreement, or otherwise –(1)To modify any restriction or condition on the distribution of funds for any specified charitable purposes or to specified organizations if in the sole judgment of the governing body (without the necessity of the approval of any participating trustee, custodian, or agent), such restriction or condition becomes, in effect, unnecessary, incapable of fulfillment, or inconsistent with the charitable needs of the community or area served;(2) To replace any participating trustee, custodian, or agent for breach of fiduciary duty under State law; and (3) To replace any participating trustee, custodian, or agent for failure to produce a reasonable (as determined by the governing body) return of net income (within the meaning of paragraph (f)(11)(v)(F) of this section) over a reasonable period of time (as determined by the governing body).” [emphasis added]When considering the application of variance power, a community foundation should consider both the current and long-term needs of the community or area it serves. A community foundation should also review the variance provision specifically provided for in its articles, bylaws, gift agreements or otherwise to determine the application of that provision to any given fund.Example: A community foundation may use its variance power to modify a fund established to provide relief in the event of a natural disaster to provide relief in connection with the COVID-19 pandemic concluding the restriction is inconsistent with the charitable needs of the community or region served. Michigan foundations and nonprofitsMichigan charities and foundations have avenues by which to remove gift purpose and use restrictions. In the case of a charitable trust, those restrictions could be removed or altered by means of a cy pres preceding if the charitable purpose of the fund is “unlawful, impracticable, or impossible to achieve” under a provision of the Michigan Estates and Protected Individuals Code. See MCL 700.7413The use of cy pres may not be practical in the short-term however as access to the courts has been strictly limited under administrative orders issued by the Michigan Supreme Court in response to the pandemic. A charity or foundation wanting to proceed with a cy pres proceeding should seek the guidance of its legal counsel as to the applicability of the proceeding and the likely time needed to complete the required court proceeding. As to institutional funds held at a Michigan charity or foundation, UPMIFA provides:“(1) If the donor consents in a record, an institution may release or modify, in whole or in part, a restriction contained in a gift instrument on the management, investment, or purpose of an institutional fund. A donor may give prior consent to an institution for release or modification of a restriction or charitable purpose in a gift instrument that also includes a restriction or stated charitable purpose subject to this section. A release or modification shall not allow a fund to be used for a purpose other than a charitable purpose of the institution.” MCL 451.926(1) [emphasis added]Example: A donor established an endowment fund at the end of 2019 that has had a significant drop in market value. On the initiative of the charity or foundation, the donor could be approached to provide consent to remove or modify the endowment restriction. Or, the donor may have already given that consent in the original gift agreement.This section of UPMIFA also reflects that a donor can give prior consent to a community foundation to exercise its variance power. Prior consent and the variance power are further reinforced by the UPMIFA provision that provides:“(5) This section does not affect the right of a governing body of an institution to exercise the power to modify restrictions contained in a gift instrument as conferred by the institution's governing instruments or by a gift instrument.” MCL 451.926(5) Several additional provisions of UPMIFA allow for a court to modify a restriction on the management, investment or purpose of an institutional fund on application of the charity or nonprofit holding the fund. See MCLA 451.926(2) and (3). Similarly, there is a process in UPMIFA to remove an endowment restriction on funds that are below $25,000 in value and that were established more than 25 year ago without court involvement after providing 60 days of notice to the Michigan Attorney General. See MCLA 451.926(4) As mentioned above, access to the courts and the Michigan Attorney General are limited at present making these provisions impractical in the short-term. A charity or foundation wanting to proceed with a court proceeding or engaging the Attorney General under these provisions of UPMIFA should seek the guidance of its legal counsel as to how best to proceed and the likely time needed to complete those proceedings. Please note that in the above referenced statutes and regulations that there must be some finding of illegality, impracticability, impossibility, or waste before a modification can take place. Only the variance power (as provided in the Treasury Regulation) adds the possible trigger of being “inconsistent with the charitable needs of the community or area served.”Further ConsiderationsFoundations and charities holding endowments should consult with their legal counsel to discuss the management of those endowments, and especially in the case of any attempt to modify or remove gift restrictions, in response to the COVID-19 pandemic. ................
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