Giving donors the power to restrict their gifts for a specific purpose or program or to restrict the timing and amount of expenditures can be a powerful giving incentive. Restrictions give donors comfort that their gift will be used as they envision.
Donor restricted funds are created when gifts are received subject to donor stipulations or a binding understanding with the donor. Donor restricted funds are similar to an irrevocable gift subject to conditions. By agreeing to accept the gift on the terms and conditions specified by the donor, the charity essentially enters into a contract with the donor to adhere to the stated terms and conditions of the gift. Where there is no written gift agreement, the terms of the solicitation material may serve as the gift instrument.
Most gift restrictions are on the use of the gift, the investment of the funds, or on the amount or timing of the expenditures. For example, the designation of a fund to support scholarships is a restriction on the use of the funds; whereas, a designation of a fund as an endowment fund is a restriction on the timing and amount of the expenditures from the fund.
In Arizona, the primary law that governs the expenditure of charitable assets is the Management of Charitable Funds Act (the “Act”). The Act is patterned on the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”).
The Act governs certain activities related to the management of charitable funds as follows:
- the management and investment of charitable funds;
- the investment and expenditure of endowment funds;
- the delegation of management and investment of charitable funds; and
- the release or modification of gift restrictions.
The terms of the Act are subject to the intent of the donor as expressed in a gift instrument. Thus, the Act is a default rule that is only effective when the donor has failed to express an intention in a gift instrument. However, under the Act, virtually any record can serve as a “gift instrument” that legally restricts the gift. For example according to the comments to UPMIFA, an e-mail, a jotted down note clipped to the check, a statement in the memo portion of the check or even the text of the solicitation letter can serve as part of a gift instrument that will override the Act.
In addition to the Act, certain gift restrictions can be enforced by donors on the principles of contract law. While contract actions raise questions of donor standing, many foundation grants are specifically drafted to be enforceable contracts that require a reversion of funds upon breach of the terms of the grant.
Charities that accept donor restricted gifts need to understand that they are legally required to use restricted gifts as specified by the donor. Sometimes, however, the restrictions aren’t clear or aren’t tracked over time which can lead to misunderstandings between the donor and the charity. If the violation is significant, the Attorney General may bring an action to enforce the restriction or object to an attempt to seek a court order permitting a modification of a restriction.
To avoid misunderstandings with donors and potential legal violations and to demonstrate good stewardship of its funds, charitable organizations soliciting or managing restricted gifts should take the following steps:
- Ensure there is a gift agreement or letter detailing the gift restriction for all significant restricted gifts.
- Consider including the option for the Board to modify the restriction to the closest use that achieves the donors intent in the event the stated use becomes impracticable or is no longer necessary.
- Consider drafting a more detailed agreement for gifts with significant responsibilities on the charities part such as naming rights gifts.
- For campaigns that are designed attract a large number of donations, ensure the solicitation language is clear and remains consistent throughout the campaign.
- For endowment gifts, be sure to include language that gives the charity a reasonable amount of flexibility under the law.
Finally, for dormant gifts that can no longer be used for their original purpose, the charity has the option to ask the donor to consent to a modification of the restriction. Alternatively, the charity can petition the court to approve of a modification of a restriction that no longer makes sense for the organization. In such cases, the charity is required to notice the Attorney General. If there are no objections and the charity can state a reasonable case for its request, the charity has a good case of having the modification approved.
Finally, UPMIFA has a streamlined process to modify old small restricted gifts (over 20 years old and $50,000 or less in Arizona). To take advantage of this process, the charity merely has to notify the Arizona Attorney General of its intent and wait 60 days. If the Attorney General does not object, the modification is automatically approved.
While its important to understand the legal implications of gift restrictions, the larger issues is gift stewardship. Charities that fail to adhere to the wishes of their donors will have difficult time attracting follow on gifts.
Ellis Carter is a nonprofit lawyer licensed to practice in Washington and Arizona. Ellis advises tax-exempt clients on federal tax matters nationwide. If you are seeking legal advice, contact email@example.com for information about our services.
 A.R.S. §§10-11801(3) provides as follows: “Gift Instrument” means a record or records, including an institutional solicitation, under which property is granted to, transferred to or held by an institution as an institutional fund.
 A.R.S. §§10-11801- 10-11805.
 UPMIFA is a relatively new development that replaces the similarly named previous uniform act, known as Uniform Management of Institutional Funds Act (in Arizona, the “Investments for Eleemosynary Purposes Act”).