As nonprofits struggle financially during the pandemic, many may wonder if they may use endowment funds to keep them afloat. Due to their heavily regulated nature, nonprofits must be extremely careful before they use endowment funds to supplement their budget.
Even before a nonprofit can determine whether and how it may use its endowment funds, it first must identify the precise nature of its funds and determine whether they are in fact endowment funds.
What is an Endowment Fund?
An endowment fund is a gift that a donor restricts. The restrictions on an endowment fund may be permanent or temporary. If the latter, the fund is no longer an endowment fund when specified conditions are met.
The law limits how nonprofits may use endowment funds. This is the topic of the next section. First, however, it is important to contrast a true endowment with a “quasi-endowment.”
A “quasi-endowment” is board-created. Specifically, when a board sets aside funds and imposes its own restrictions on them, it creates a quasi-endowment. Unlike donor-imposed restrictions, the board can remove board-imposed restrictions at any time. (Provided that they have not co-mingled donor-restricted funds with board-restricted funds). As such, board-restricted funds are not true endowments and not subject to the rules described below.
How can nonprofits use their Endowment Funds?
Endowment funds held by nonprofits in all states other than Pennsylvania are regulated by that state’s enactment of the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”). UPMIFA provides that a nonprofit may only use its endowment funds in accordance with the donor’s restrictions as found in their gift instrument. A gift instrument may be as simple as a memo on a check or as elaborate as a gift agreement. If no gift instrument exists, then the restrictions will be the terms of the solicitation. I.e., the restriction will be the purpose that the solicitation materials indicated the nonprofit would use the funds for.
Subject to the donors’ restrictions, the board may accumulate or expend endowment funds to the extent it is considered “prudent.” UPMIFA in most states specifies that spending more than 7% of a fund’s value per year is imprudent. In some cases, a board can resolve to expend more than 7%. However, to do so, it must make a very strong showing that doing so is prudent. In determining what is prudent, a board must carefully consider several factors detailed in UPMIFA. It must also be able to show that the board acted in good faith when making that decision.
How can nonprofits modify their endowment funds?
Since a nonprofit may only expend endowment funds for the purpose for which they were restricted and in such amounts that are determined to be prudent, nonprofits occasionally may wish to modify them for more spending flexibility. This is especially true during the pandemic. Nonprofits may attempt to modify endowment restrictions through one of the following:
- Donor consent – Nonprofits may request a release or modification of restrictions on endowment funds directly from the donor.
- Court Modification – If the endowment fund no longer serves its purpose, or the restrictions on the fund are wasteful, impracticable, impossible to achieve, or unlawful, a nonprofit may petition a court for modification. (The court will make modifications in accordance with the donor’s probable intention).
- Attorney General (AG) Notice – In California, when an endowment fund is less than $100,000 in value and is greater than 20 years old, a nonprofit may modify restrictions that are unlawful, impracticable, impossible to achieve or wasteful by providing 60 days’ notice to the AG and the donor. The nonprofit must continue to use the funds in a manner consistent with the charitable purposes expressed by the donor.
Nonprofits must follow strict rules in order to modify an endowment fund using any of these procedures. Additionally, even if a nonprofit modifies its endowment fund, it still must use the fund to achieve its overall charitable purposes as enumerated in its Articles of Incorporation or similar charter document.
Can nonprofits borrow from an endowment fund?
If they cannot justify spending from an endowment fund, nonprofits may wonder if they can borrow against it. In response to the pressure the pandemic has put on nonprofits’ finances, the California AG’s office issued COVID-related guidance to charities. Among other things, the AG guidance specifically states that a nonprofit may not borrow against an endowment fund. Additionally, nonprofits must carefully consider any use of an endowment fund, as discussed above.
Nonprofits may only use their endowment funds for the purposes for which they were established and to the extent it is “prudent.” Any decision to use funds must be done with careful consideration. If a nonprofit wishes to utilize more than is allowable, it may be able to seek a modification of the restrictions on its endowment funds.
For more information regarding the proper use or modification of endowment funds, please contact The Law Firm for Non-Profits.