Restricted Giving: The Legal Requirements Nonprofits Should Consider Before Accepting Restricted Donations
To the delight of many nonprofit professionals, the pandemic led to an increase in unrestricted giving in 2020 and 2021 for their organizations. Many people in the nonprofit world prefer unrestricted donations because they can be used for any purpose — unlike restricted donations, which can only be used in a particular way according to the donor’s wishes. Although some organizations may have experienced an uptick in unrestricted giving, restricted donations aren’t going away, and, when used effectively, they can be an important part of fundraising for a capital campaign or a new program.
When a nonprofit accepts restricted donations, a duty arises on the part of the organization to abide by any restrictions set by the donor. Failing to abide by that duty can expose the organization to enforcement actions by state charity regulators, potential lawsuits from the funder and reputational damage that erodes the donor’s trust. By fully understanding the legalities of restricted donations, nonprofits can help reduce the risks associated with accepting restricted gifts and learn to use them to their fullest potential.
Understanding Endowments Versus Other Types of Restricted Donations
Development staff need to understand exactly what is meant by the term “endowment.” A nonprofit with a true endowment is restricted from spending the principal of the donation and may only spend income earned from it. The organization also may be subject to additional donor-imposed restrictions on the use of the income earned from the principal.
An offer from a donor to “create an endowment” or “give to an endowment” should be discussed with the donor to ensure that both the donor and the organization understand:
- What type of gift the donor intends to make.
- Whether the nonprofit will be able to use the donation or will it be invested.
- If the donation will be invested, whether the nonprofit will only be able to use the income.
- Whether there are any circumstances under which the nonprofit may use the principal.
The organization should verify that the donor truly intends to create a true endowment by restricting the nonprofit to only use the income (and not the principal) of the donation if the parties plan to call the donation an “endowment.”
Nonprofit staff should be cautious not to carelessly use the term “endowment.” For example, if an employee were to send an email, saying, “Thank you for the generous endowment,” to a donor who thought they were making an unrestricted gift, that email could create confusion and tie up needed funding. The language used to describe the gift should be precise so neither party is left confused or, worse, in hot water with charity regulators.
Restrictions Can Be Altered, But Only Under Specific Circumstances
Under state laws, nonprofits generally cannot remove donor-imposed restrictions or use the principal from an endowment without significant effort. The Uniform Prudent Management of Institutional Funds Act (UPMIFA),which has been adopted in every state except Pennsylvania, only permits a nonprofit to release or modify a restriction if the donor consents in writing.
If donor consent cannot be obtained — most likely because the donor has passed away — in most cases, a nonprofit’s only other pathway to modify a restriction is to seek court approval. Organizations can initiate this process by giving notice to the state’s charitable enforcement agency and filing a petition in court. Even then, a court may only modify a restriction if a certain standard is met. For example, use or purpose restrictions may only be modified by a court if the restriction has become unlawful, impracticable, impossible to achieve or wasteful.
Court approval may not be required for very small, old funds. For example, in California, a nonprofit can release a restriction without court intervention if the restricted fund is less than $100,000 in value; more than 20 years old; and the restriction is unlawful, impracticable, impossible to achieve, or wasteful. Still, the nonprofit must give 60 days’ advance notice to the attorney general and the donor’s last known address.
Meeting the UPMIFA standards to release restricted gifts can be complicated and costly. Accordingly, nonprofit organizations should seek the guidance of experienced legal counsel before changing any restrictions or using principal from an endowment. Therefore, nonprofits will want to carefully consider donation restrictions and terms before they are accepted.
Make Restricted Donations Work for You
When a donor offers a restricted donation, both the donor and nonprofit staff should ask themselves some key questions:
- Does the restriction align with the organization’s exempt charitable purpose?
- Does it align with the strategic goals of the donor?
- Can the organization abide by the restrictions, both from a programmatic and an administrative perspective?
- Does the gift meet the criteria of the organization’s gift acceptance policy, if one exists?
- Does the organization have any additional rules, standards, procedures or limitations related to restricted giving?
When the organization and donor can answer these questions confidently and are equally satisfied with the answers, the donation is likely a good match. If there is any doubt that the donation can be put to its best possible use, that’s a sign that the donor and organization should step back and reconsider their partnership. In the long term, it’s much less costly to turn down a funding source than it is to deal with a donation that does more harm than good.
Heather DeBlanc is a partner in the Los Angeles office of Liebert Cassidy Whitmore and advises nonprofit clients on corporate governance issues, bylaws, articles of incorporation, best practices for maintaining tax-exempt status, business contracts, grant agreements, and donations, fundraising and endowments.
Casey Williams is an attorney with Liebert Cassidy Whitmore, working solely with nonprofits on employment, governance, and business matters. Based in the San Francisco office, her practice is focused on helping mission-driven organizations achieve their goals while staying compliant and working through complex disputes.
Victoria M. Gómez Philips is an associate in the Los Angeles office of Liebert Cassidy Whitmore. Victoria advises clients on business and transactional matters, including legal and business risks concerning strategic partnerships, contracts, employment, operations, and company policies.