Fund Agreements: Best Practices. Phil Purcell, JD Consultant for Philanthropy, LLC Copyright rights reserved

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1 Fund Agreements: Best Practices Phil Purcell, JD Consultant for Philanthropy, LLC Copyright rights reserved

2 Outline Fund Agreement (FA) Basics What should a FA say? Special FA issues

3 Fund Agreement Basics

4 FUND AGREEMENT BASICS Fund agreements are legal contracts between a donor and the community foundation. Must comply with applicable Federal Law such as adhering to donor advised or scholarship fund rules, requiring that the gift create a component fund, and providing that the community foundation have a variance power. Should comply with applicable State Law such as the Uniform Prudent Management of Institutional Funds Act (UPMIFA) and providing for enforcement in the resident state of the community foundation.

5 FUND AGREEMENT BASICS The donor s attorney may want to wordsmith the language of a draft you provide. Most attorneys approach this like any other contract review. Problems arise because most attorneys do not understand that some language is required such as to assure that the fund will be treated as a component fund of the community foundation and not as a separate charitable entity. You may need to remind the donor and attorney of all the benefits of being a component fund so they will accept the required language.

6 What Should Fund Agreements Say?

7 WHAT SHOULD FUND AGREEMENTS SAY? 1. NAME OF FUND AND PARTIES TO AGREEMENT Most FA s assign a name to the fund which may be the donor s name, agency name, names of loved ones and so forth. The parties to the fund are usually named in the opening paragraphs. Be sure to use correct legal names of donors and organizations. The names of the parties to the fund should match the signature lines at the end of the agreement. Why are legal names important? Using the correct legal name of the parties to a fund helps to assure that future gifts from estates are properly designated and to enforce the terms of the agreement if later challenged by heirs or others.

8 WHAT SHOULD FUND AGREEMENTS SAY? 2. FUND DESIGNATION Type of fund: unrestricted, designated, agency, field-of-interest, donor advised, scholarship, disaster relief, fiscal sponsorship, etc. Characteristic of fund: endowed or expendable (pass-through or non-permanent) What if donors make both endowed and expendable gifts? Consider separate fund agreements for endowed and pass-through funds. For example, a donor may supplement the amount available from an endowed scholarship fund with additional gifts to an expendable scholarship fund to enhance the scholarship grant amount.

9 DISCRETIONARY/UNRESTRICTED FUNDS Consider providing that after the passage of a certain number of years or on a date specified in the agreement, the named endowed discretionary fund will be terminated and the fund balance will be added to the CF s general endowed discretionary fund.

10 AGENCY FUNDS Technically Advised Funds because the CF must be free to reject any recommendations from the Agency regarding distributions from the fund. Perhaps the biggest challenge is about who owns an Agency Fund when the agency has transferred some of its own assets to the fund. Consider including additional language to make it clear that the contributed funds cannot be returned to the agency. Perhaps: All gifts shall be irrevocable once accepted by the CF and the fund assets cannot be returned to the donor, including the charitable organization benefiting from this fund.

11 AGENCY FUNDS Address common misunderstandings about these funds in an explanation document, including: Money transferred to an agency fund now belongs to the CF even though the value of the agency fund at the CF is included as an asset on the agency s financial statements. Creating a fund at a CF is not like hiring an investment advisor and future agency boards of directors cannot decide that they want their money back.

12 AGENCY FUNDS The CF can require the agency to provide current financial statements and budgets showing financial oversight and stability before distributions are made from the agency fund. Policy questions: o o o o Will /does the CF offer non-permanent agency funds? Can non-permanent agency funds participate in the endowment pool? If yes, is there a notice period required before funds can be distributed? Is there a maximum $ amount that can be distributed at one time? Is there a higher fee schedule than for endowed agency funds?

13 DESIGNATED FUNDS Consider a policy that designated funds can be created for the benefit of only one qualified public charitable organization. Ask the donor. What they would prefer if the named organization ceases to exist, changes its name or merges with another organization, or dramatically changes its charitable purpose? Would they Want the fund to continue to benefit the organization so long as there is no dramatic change in its charitable purpose, even if the legal name of the organization changes or the original organization merges with one or more other organizations in the future?

14 DESIGNATED FUNDS Would they Want to name a successor charitable organization in the fund agreement to benefit from the fund if the original organization ceases to exist, or if the charitable purpose of the original organization or any successor organization is dramatically different from the charitable purpose of the original organization? Want the fund to be terminated and the fund assets to be used to create a field of interest fund? Want the community foundation to use its variance power to find a similar organization which matches the donor s original intent?

15 FIELD OF INTEREST FUNDS FOI funds are really discretionary funds that give the CF s board of directors grant making flexibility within the constraints of the description of the charitable field; can be non-permanent or endowed fund. Be cautious about how narrowly the charitable field of interest is described. If a very narrow charitable purpose is desired: o o consider naming a secondary charitable purpose, or specify what happens to the fund if it becomes impossible for the CF to identify potential charitable organizations that could receive distributions from the fund.

16 FIELD OF INTEREST FUNDS Does the donor want to include geographic limitations in terms of the service area of the charities whose charitable purpose falls within the described field of interest? If the donor wants to have an advisory role, use a DAF agreement not a FOI. If the donor wants to limit the type of charitable organizations or causes that can benefit from fund distributions, include those limitations in the DAF agreement. This may be to control what successor fund advisors or second generation fund advisors can benefit.

17 SCHOLARSHIP FUNDS Discretionary and Advised Funds: The pool of potential recipients must be large enough to be considered a charitable class. Advised Funds: All members of the committee must be appointed by the CF and not by the Donor; the Donor and his/her designees may not control or constitute a majority of the committee See separate webinar on Scholarship Funds.

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19 3. GIFTS WHAT SHOULD FUND AGREEMENTS SAY? The fund is created when the first contribution is made. The gift may described as a dollar amount, description of donated assets (appendix may be used) as well as testamentary plans for deferred gift agreements. Future gifts are allowed by same donor and/or others by outright gifts or testamentary plans. All contributions to the fund are irrevocable, assets of the Foundation and cannot be returned to the original donor. What if the donor plans a deferred gift but no lifetime giving? A deferred gift agreement states that the gift will come from a donor s estate and can describe the type of planned gift such as a bequest, life insurance or retirement plan designation. This approach minimizes the likelihood that the donor s estate documents will include language that is not acceptable such as a mandatory spending rate, prohibition of fees, etc.

20 4. PURPOSE WHAT SHOULD FUND AGREEMENTS SAY? The purpose description should support the type of fund. Funds must be subject to the ultimate legal control of the Board of Directors to be considered a component fund of the Foundation. The purpose of the fund can include: o qualified charitable purposes specified by the donor such as scholarships, charitable programs and services so long as the class of beneficiaries are large and indefinite to avoid earmarking for specific individuals o use by qualified charitable organizations or operating foundations (not private non-operating foundations) Can the donor have any control over the fund? Your board s ultimate control cannot be changed but the purpose can be tailored to the donor s interests. Be careful that the charitable purpose isn t so narrow that it could be difficult to use the fund - and to avoid earmarking.

21 WHAT SHOULD FUND AGREEMENTS SAY? 5. DISTRIBUTIONS The agreement is subject to the distribution or spending policy as established by the Foundation board of directors and can be amended at any time to reflect the current economy, best practices and other considerations. The spending policy adheres with the guidelines of UPMIFA. Grants can only be made from the fund for qualified charitable purposes and/or to qualified organizations. Can a CF refuse to make grants from a fund? The CF can refuse to make grants from the fund if in doing so the grant would not be prudent (e.g., a grant to a charity that has questionable management) or not charitable which could result in a tax penalty to the CF by the IRS on audit.

22 WHAT SHOULD FUND AGREEMENTS SAY? 6. RECOMMENDATIONS FOR DISTRIBUTION OF DONOR ADVISED FUNDS The donor/fund advisor may recommend grants from the fund to specific charitable organizations or for charitable purposes. The CF doesn t have to follow these recommendations. The Board must be sure grants are made to qualified, legitimate charitable organizations, or for legitimate charitable purposes. A surviving donor may make all recommendations regarding grants after the death of a joint donor. The agreement should also explain what happens after the death of the original donor(s)/advisor(s): successor advisors, unrestricted use, named fund, etc.

23 DONOR ADVICE VS. DONOR CONTROL Donor control means donor can direct grants, investments, spending, etc. Donor control would be stipulated in the agreement with words like control, right and direct associated with the donor s powers Donor control violates variance power and is prohibited - will disqualify tax benefits for gift Donor advice means that the community foundation board has absolute and final control Conduct due diligence (copy of confirming legal documentation) if a Power of Attorney or Guardian requests to advise if donor is incompetent but still living 23

24 ADVISED FUNDS Consider language in the fund agreement that provides: For build-up funds, if the fund value on the date stated in the fund agreement does not equal or exceed a stated $ amount, then the endowed advised fund will be terminated and the fund balance will be used to create a pass-through advised fund with the same original and successor fund advisors. Is there a minimum fund value necessary for an endowed advised fund to continue for a second generation? For a third generation?

25 ADVISED FUNDS Consider language in the fund agreement that addresses who serves as Fund Advisor if someone is acting on behalf of a named Fund Advisor under a Power of Attorney or a Guardianship. Restrict DAF successor advisors perhaps one subsequent generation only if fund is large enough to justify (e.g., $100,000+)

26 FUND POLICIES AND PRACTICES FOR THE LONG GAME DAF Successor Advisors Can DAFs continue for more than the lifetime of the founding donor(s)? Is a higher minimum fund balance at the time of the death or resignation of the founding donor required to continue for a second generation? a third generation? Policy should include whether the advisory function can continue for second/third generations and state the minimum fund balance needed at the death of the founding donor(s) and that the minimums can be amended from time to time. Policy should state what happens if the then applicable fund balance is not met, i.e., the fund is terminated and the fund assets are transferred to the community endowment fund? some other fund?

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28 WHAT SHOULD FUND AGREEMENTS SAY? 7. ADMINISTRATIVE PROVISIONS AND CONDITIONS FOR ACCEPTANCE OF FUNDS The CF board is the final decision maker in all aspects of the fund operation and the CF Articles of Incorporation and By-laws. Federal and state laws control the operation of the fund. The CF can change the charitable purposes of the fund under specific conditions if needed in the future. This is the variance power under the cited US Treasury regulation. The Foundation s understanding of the Donor s intent when the fund was established, its policies regarding exercising its powers of modification and removal, and its policies regarding amending the fund agreement all apply to the management of the fund once established.

29 WHAT SHOULD FUND AGREEMENTS SAY? 8. CONTINUITY The Fund will continue so long as there are assets in the Fund and the charitable purposes of the Fund can continue. If the fund is terminated and no recommendations for distribution are included in this paragraph, the Board will use the remaining assets for charitable purposes as defined in the Foundation's Articles of Incorporation and By-Laws which most nearly approximate the Donor's original wishes. Can We Edit this Paragraph? Yes, language can be added to state the donor s preference of how the remaining assets are to be used if the fund is terminated, subject to the CF s right to determine how to use the remaining assets for purposes within the CF s mission and which are closest to the original purpose of the fund.

30 WHAT SHOULD FUND AGREEMENTS SAY? 9. NOT A SEPARATE TRUST, ACCOUNTING, STATE LAW The funds will be part of the general assets of the Foundation. The fund agreement does not create a separate legal entity or trust. Earnings, fees, grants and other distributions will be tracked separately from the other funds held by the CF. Subject to the laws of the state where the CF is incorporated.

31 WHAT SHOULD FUND AGREEMENTS SAY? 10. INVESTMENT OF FUNDS All investment decisions will be made by the Foundation and the assets of this Fund may be invested together with assets from other Funds held by the Foundation. Must comply with standards of UPMIFA. Can donors advise on investments? A CF may allow donors to advise on investments but ultimate legal control rests with the CF board. If advising on investments is allowed, be certain that donors understand the limits of their advising subject to CF control.

32 DONOR ADVICE ON INVESTMENTS Outside Manager May want to consider allowing a donor to request that the CF hire the donor s investment professional to manage the assets held in a specific fund if the original contribution is $ or more. $250,000 minimum contribution is common. The contributed assets are no longer held in the donor s name, but in the name of the CF and are the irrevocable assets of the CF. The CF hires the investment professional to manage the assets in compliance with the CF s investment policy and reviews the performance of all managers investing the CF s assets.

33 DONOR ADVICE ON INVESTMENTS Outside Manager There is no guarantee that the donor s investment professional will be retained in the future. The donor does not give investment directions regarding the fund to the investment professional after the contribution is made to the CF. Separate Investment Pools Some CFs allow the donor to allocate the original contribution among several investment pools depending on the fund type. Most do not allow for reallocation after the initial allocation.

34 WHAT SHOULD FUND AGREEMENTS SAY? 11. COSTS OF THE FUND This fund will pay an administrative fee charged to funds of this type. This fund will be charged with a share of the CF s investment costs. The fee schedule may be amended from time to time by the Foundation. Costs of accepting, transferring, selling, or managing the contributed property will also be charged to the Fund, including attorney s fees. Can the current fee schedule be referenced? The current fee schedule charged to funds of this type can be described in an attached exhibit. But it must be stated that the fees can be changed over time and are subject to the control of the CF board.

35 WHAT SHOULD FUND AGREEMENTS SAY? 12. Variance Power The power of the governing body to modify any restriction or condition on the distribution of funds for any specified charitable purpose or to any specified organization, if in the sole judgment of the governing body, such restriction becomes unnecessary, incapable of fulfillment, illegal or inconsistent with the needs of the community. Treas. Reg. Sec A-9(e)(11)(v)(B)(1). What if a donor disagrees with variance power? You must explain to the donor that the variance power is required by federal. It does not mean that a CF can act in bad faith and later choosing to ignore a donor s preferences. Rather, the CF must prudently follow donor intent subject to Attorney General review.

36 AUTHORIZATION TO EXECUTE FUND AGREEMENTS The Gift Acceptance policy should include: A statement that authorizes the CEO of the CF to execute fund agreements that are in compliance with CF policies. A statement that requires board approval of fund agreements that are not in compliance with CF policies prior to execution of the FA by the CEO.

37 Amending Fund Agreements They can be amended: When all of the original donors are living and all agree plus the community foundation agrees to amend the fund agreement. When the donor is deceased or disagrees - amend pursuant to UPMIFA and state law. When required by changes in state or federal law such as the Pension Protection Act when passed.

38 AMENDING FUND AGREEMENTS If a fund agreement is amended, then include in the This Agreement opening paragraph that the fund agreement supersedes and replaces the fund agreement executed on [DATE].

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40 Special Issues for Fund Agreements and Management

41 MINIMUM AMOUNT What is the minimum amount needed to create a fund? Can the fund be started with less than the minimum with the fund balance required to reach a stated minimum amount by a date stated in the fund agreement?

42 SMALL FUNDS Should cover all fund types but the definition of a small fund can be different for different fund types. Should state if and what types of funds can be created with less than the usual fund minimum so long as the fund balance equals the fund minimum that existed when the fund was created by not later than a specific date. Should require that FAs include the date on which the fund balance must equal or exceed a stated dollar amount to continue as a separate fund.

43 SMALL FUNDS Should include a process to terminate small funds, including those with silent FAs regarding required minimum fund balance. Should include what happens with the fund assets when the fund is terminated; added to a community endowment fund? a non-permanent discretionary fund? a appropriate FOI fund?

44 INACTIVE FUND POLICY Should cover all fund types; may want to include This fund is subject to the Foundation s policy on Inactive Funds, which may change from time to time. in the Administrative Provisions paragraph. Should define what inactive means. Usually a stated period of time with no disbursements from the fund. Should include an exceptions policy to allow for the accumulation of funds for a large distribution from the fund in the future. Documentation can include a written request from the fund advisor or the agency benefiting from the fund that explains the long-term distribution goal and the expected timeline to reach the goal.

45 INACTIVE FUND POLICY Should include a process to terminate inactive funds when no communication with the fund advisor or fund representative over a # of years; with a response requested by a stated date and evidence of delivery of a letter by certified US mail. Should include what happens with the fund assets when the fund is terminated; added to a community endowment fund? a non-permanent discretionary fund? an appropriate FOI fund?

46 CONFUSED OR HYBRID PURPOSE STATEMENTS Should cover all fund types. Should detail the process for reviewing and resolving existing confused or hybrid purpose funds in compliance with the CFs process for exercising the variance power. Should provide that effective on a stated date and thereafter: o Designated funds may not be created to benefit more than one publicly-supported charitable organization. o FOI funds may not include an advisory function. o Funds that make scholarship awards cannot be DAFs, agency, designated, FOI, or discretionary funds.

47 MANAGING MEMORIAL FUNDS Should allow for the creation of named funds memorializing the life of one or more deceased individuals. Should state that the minimum amount needed to create the desired type of fund must be met in order to create the named fund. Should require that contributions received in memory of one or more deceased individuals will be held in a temporary fund for a minimum period of time before the permanent fund is created and the FA executed.

48 MANAGING MEMORIAL FUNDS Should prohibit accepting contributions designed to create funds that will provide a personal benefit to family members of the deceased individual, i.e. a college fund for the deceased person s children, payment of the funeral and burial expenses, payment of medical expenses, providing living expenses to the family. These are personal gifts, not charitable contributions.

49 COMMUNITY PROJECT FUNDS: DONOR INITIATED FUNDRAISING Should state under what conditions that CF will allow donorinitiated fundraising, if at all. Should include an advance approval process, including period of time for CF to consider the request and what information must be included in the request. Should include what types of fundraising activities are prohibited. Should include who has the authority to enter into contracts.

50 COMMUNITY PROJECTS: FISCAL SPONSORSHIP AGREEMENT Should include need for and payment of insurance coverage and whether waivers are needed from event participants. Should include an advance approval process for use of the CF s name/logo and approval of digital and printed promotional materials. Should state what types of contributions will be accepted (cash, checks, credit cards) and how gift acknowledgements in compliance with IRS quid-pro-quo rules will be issued. Should include a statement about how expenses will be handled, i.e., no reimbursement of expenses to individuals, only direct payment from the fund to pre-approved vendors.

51 NON-PERMANENT FUNDS PARTICIPATING IN THE ENDOWMENT POOL Should state that allowing non-permanent funds to be invested in the endowment pool does not change nonpermanent funds to endowed funds (spending policy, fee schedule, etc.). May want to allow this with some fund types, but not all, or with different minimum fund balances and fee schedule. Do not allow community project or fiscal sponsorship funds to be invested in the endowment pool.

52 NON-PERMANENT FUNDS PARTICIPATING IN THE ENDOWMENT POOL Generally not a good idea for non-permanent agency funds due to changes in agency leadership and expectations. Better to encourage creation of two funds, endowment fund and a nonpermanent fund invested in the short-term pool if the ability to request distribution of 100% of fund balance is important. Require a minimum time period between creating the fund and making the first grant to avoid having to liquidate in a down market. Include an acknowledgement in the FA by the donor that they understand the risks of having the fund invested in the endowment pool and the limitations on timing of grants.

53 TRANSFER FUNDS TO ANOTHER FOUNDATION Transfer allowed to another tax exempt organization qualified as 501(c)(3) Always abide by terms of gift agreements Honor donor restrictions and intent Document due diligence prior to transfer Transfer agreement with recipient Report on

54 TRANSFER OF FUND TO ANOTHER FOUNDATION The board of directors of a CF cannot be forced to transfer the assets held in a fund to another foundation, but can choose to do so if the fund agreement allows distribution of the principal and the transferring CF exercises its due diligence in determining that the proposed recipient foundation is a publicly-supported 501(c)(3) charitable organization that accepts and manages funds of the type being transferred. The recipient foundation should acknowledge in writing that is accepting the transferred fund and will operate and manage it in accordance with the terms of the original fund agreement.

55 CORPORATE FUNDS Types of corporate funds: Scholarships, Advised, Other Scholarships require special federal rules if for employees or family of employees Scholarships must follow PPA requirements if corporation is represented on committee Corporate advised funds must follow same due diligence as DAFs created by persons 55

56 CORPORATE FUNDS Corporate funds can include named DAFs, designated funds, named FOI funds, scholarship funds and named community funds. Corporate scholarship funds that are designed to benefit only current or former employees and/or their children are subject to special rules. CF policy should state which type of corporate funds will be accepted and managed. Corporate funds are usually non-permanent funds, but can be endowed funds.

57 CORPORATE FUNDS Fund agreements should identify the staff position that is the official representative of the corporation or business in all dealings with the CF regarding the fund and the fund agreement should be executed by the incumbent in that position. Fund agreement may provide for the recommendation of a new corporate advisor in the event that the original is sold or goes out of business. Another alternative would be to create a new fund for a charitable purpose such as field-of-interest.

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59 Available Webinars Community Project Funds Staying Legal with Donor Advised Funds and Scholarships Available at: