A Connecticut court issues an important ruling-Herzog Foundation v. University of Bridgeport, 699 A.2d 995 (Conn. 1997)
[Church Officers, Directors, and Trustees]
Article summary.
It is common for donors to make “designated gifts” to their church. A designated gift is one that is made for a specified purpose or project. Examples include gifts designating a missionary, a building or vehicle fund, or a benevolence need. If a church elects not to honor a particular designation, does the donor have the legal authority to enforce the gift? That was the question addressed by a court in a recent case. This feature article will review the court’s ruling and apply it to common church practices.
Do donors who make “designated gifts” to their church have a legal right to enforce their designations? This is an important question of direct relevance to every church and ministry. Consider the following examples.
• Example. In 1996 Bob donated $5,000 to his church with the stipulation that the money be used exclusively for the building program. This year the church board decides to cancel the building program. Bob demands a full refund of his contribution. If the church refuses to comply, what are Bob’s legal rights? Can he ask a court to compel the church to return his designated contribution?
• Example. A church asked its members to contribute toward a missions project with a budget of $10,000. Barb donated $1,000 to the project, but learned later that the budget had been reached before she made her contribution. She asks the church to return her contribution. If the church refuses to comply, what are Barb’s legal rights? Can she ask a court to compel the church to return her designated contribution?
• Example. A church plans to build a home for a low—income family. While much of the work is done by volunteer labor, and some of the materials are donated, the church still must raise $25,000 to complete the project. Bill does not attend the church, but he learns of the project and donates $1,000 to it. Several weeks after making his contribution Bill learns that the budget had been reached before he made his contribution. He asks the church to return his contribution. If the church refuses to comply, what are Bill’s legal rights? Can he ask a court to compel the church to return his designated contribution?
These issues were addressed directly by a recent decision of the Connecticut Supreme Court. This article will review the facts of the case, summarize the court’s ruling, and address the significance of the case to churches and religious ministries.
Facts
The facts of this case are simple. A foundation contributed $250,000 to a university with the stipulation that the funds be used to provide scholarships to needy students in the nursing program. A few years later the university closed its nursing school. The foundation sued the university, and asked a court to order the university to segregate the gift from its general fund and set it aside once again for the gift’s original purpose. If that purpose could no longer be fulfilled, then the foundation asked the court to compel the university to return the gift. A trial court and state appeals court reached conflicting decisions, and the case was appealed to the state supreme court.
The court’s decision
background
The state supreme court reached a conclusion that will come as a surprise to many church leaders-it ruled that donors who make designated gifts to charity have no legal right to enforce their designations unless they specifically reserve the right to do so. The court acknowledged that a designated contribution is held in trust by a charity for the specified purpose. And, while the donor cannot enforce a designated gift, there are others who can. These include the state attorney general, a trustee of a written trust, or anyone with a “special interest” in the enforcement of the designation. The court explained its conclusion as follows:
The theory underlying the power of the attorney general to enforce gifts for a stated purpose is that a donor who attaches conditions to his gift has a right to have his intention enforced. The donor’s right, however, is enforceable only at the instance of the attorney general … and the donor himself has no standing to enforce the terms of his gift when he has not retained a specific right to control the property, such as a right of reverter, after relinquishing physical possession of it. As a matter of common law, when a … donor of property to a charity fails specifically to provide for a reservation of rights in the trust or gift instrument, neither the donor nor his heirs have any standing in court in a proceeding to compel the proper execution of the trust …. Where the donor has effectually passed out of himself all interest in the fund devoted to a charity, neither he nor those claiming under him have any standing in a court of equity as to its disposition and control …. [W]e conclude that it is clear that the general rule at common law was that a donor had no standing to enforce the terms of a completed charitable gift unless the donor had expressly reserved a property interest in the gift.
persons who may enforce a designated gift to charity
The court concluded that the state attorney general has broad authority to enforce charitable trusts, including designated gifts to charity. Others have the same authority:
A suit can be maintained for the enforcement of a charitable trust by the attorney general or other public officer, or by a co—trustee, or by a person who has a special interest in the enforcement of the charitable trust, but not by persons who have no special interest or by the [donor] or his heirs, personal representatives or next of kin. Fiduciaries, such as trustees or co—trustees, have historically been deemed to have a “special interest” so as to possess standing [to enforce charitable trusts and designated gifts]. Still, the attorney general must be joined as a party to protect the public interest. Those with no “special interest” have no standing to bring an action to enforce the conditions of the gift. These include persons within the general class of beneficiaries of the charitable trust as well as members of the general public.
when donors may enforce a designated gift
The court noted that donors may enforce a designated gift if they reserved the right to do so. The court observed:
By expressly reserving a property interest such as a right of reverter, the donor of the gift … may bring himself and his heirs within the “special interest” exception to the general rule that beneficiaries of a charitable trust may not bring an action to enforce the trust, but rather are represented exclusively by the attorney general.
the Uniform Management of Institutional Funds Act
The foundation insisted that the Uniform Management of Institutional Funds Act (UMIFA) gave it the authority to enforce its designated gifts to the university. The court disagreed. UMIFA is a statute that has been enacted in nearly 40 states and that addresses the management of “institutional” or endowment funds by public charities (including universities and religious organizations). UMIFA permits the governing board of a charity to seek a release of an obsolete designation in a gift without resort to the courts by obtaining the donor’s consent: “With the written consent of the donor, the governing board may release, in whole or in part, a restriction imposed by the applicable gift instrument on the use or investment of an institutional fund.” The foundation claimed that this language supported its position since it would be inconsistent “for a statute to provide for written consent by a donor to change a restriction and then deny that donor access to the courts to complain of a change without such consent.” The court disagreed, noting that such an interpretation was directly contradicted by the drafters of the statute who made the following official comments:
It is established law that the donor may place restrictions on his largesse which the donee institution must honor. Too often, the restrictions on use or investment become outmoded or wasteful or unworkable. There is a need for review of obsolete restrictions and a way of modifying or adjusting them. The Act authorizes the governing board to obtain the acquiescence of the donor to a release of restrictions and, in the absence of the donor, to petition the appropriate court for relief in appropriate cases ….
The donor has no right to enforce the restriction, no interest in the fund and no power to change the [charitable] beneficiary of the fund. He may only acquiesce in a lessening of a restriction already in effect. (Emphasis added.)
The court noted that these “clear comments regarding the power of a donor to enforce restrictions on a charitable gift” were based on a concern by the drafters of UMIFA that donors would be exposed to “potential adverse tax consequences” if UMIFA “was interpreted to provide donors with control over their gift property after the completion of the gift.” The court explained this concern as follows:
Pursuant to … the Internal Revenue Code … an income tax deduction for a charitable contribution is disallowed unless the taxpayer has permanently surrendered “dominion and control” over the property or funds in question. Where there is a possibility not “so remote as to be negligible” that the charitable gift subject to a condition might fail, the tax deduction is disallowed ….
The drafters’ principal concern in this regard was that the matter of donor restrictions not affect the donor’s charitable contribution deduction for the purposes of federal income taxation. In other words, the concern was that the donor not be so tethered to the charitable gift through the control of restrictions in the gift that the donor would not be entitled to claim a federal charitable contribution exemption for the gift.
In resolving these concerns, the drafters of UMIFA clearly stated their position as follows: “No federal tax problems for the donor are anticipated by permitting release of a restriction. The donor has no right to enforce the restriction, no interest in the fund and no power to change the [charitable] beneficiary of the fund. He may only acquiesce in a lessening of a restriction already in effect.”
The court concluded:
Although the comments and the prefatory note to UMIFA do recognize that a donor has an interest in a restriction … we find no support in any source for the proposition that the drafters of UMIFA intended that a donor or his heirs would supplant the attorney general as the designated enforcer of the terms of completed and absolute charitable gifts. Indeed, it would have been [inconsistent] for the drafters of UMIFA to strive to assist charitable institutions by creating smoother procedural avenues for the release of restrictions while simultaneously establishing standing for a new class of litigants, donors, who would defeat this very purpose by virtue of the potential of lengthy and complicated litigation ….
On the basis of our careful review of the statute itself, its legislative history, the circumstances surrounding its enactment, the policy it was intended to implement, and similar common law principles governing the same subject matter, we conclude that UMIFA does not establish a new class of litigants, namely donors, who can enforce an unreserved restriction in a completed charitable gift.
a dissenting opinion
Two of the court’s five justices dissented from the court’s opinion. They observed:
The majority here holds that the donor itself may not enforce a restriction in a gift to an educational institution when the institution had specifically agreed to that restriction. This decision is simply an approval of a donee, in the words of the donor, “double crossing the donor,” and doing it with impunity unless an elected attorney general does something about it.
This decision will not encourage donations to Connecticut colleges and universities. I fail to see why Connecticut, the home of so many respected schools that would honor their promises, should endorse such sharp practices and create a climate in this state that will have a chilling effect on gifts to its educational institutions.
Significance of the case to churches and ministries
What is the relevance of this ruling to other churches? Obviously, a decision by the Connecticut Supreme Court is of limited significance since it has no direct or binding effect in any other state. Nevertheless, there are a number of aspects to the ruling that will be instructive to church leaders in every state. Consider the following:
1. The general rule-donors cannot enforce designated gifts. According to the Connecticut Supreme Court, a donor has no legal “standing” to enforce a designated gift to charity. There is no doubt that courts in many other states will concur with this result. The reason for this rule is simple-charitable contribution is a gift, and a gift is a transfer of all of a donor’s “dominion and control” over the donated property. Allowing a donor to enforce a designated gift is not legally possible because the donor has no remaining interest in the gift. This is true even if the gift was “designated”-that is, the donor specified the purpose for which the gift was given. The fact remains that a designated gift is held by a church or charity “in trust” for the specified purpose. The trust may be expressed in a written trust instrument, but more often no instrument exists and the trust is implied. While the donor cannot enforce such a “trust,” this does not mean that a church or charity can ignore it. As the court observed in this case, the state attorney general can enforce a trust created by a designated gift, and so can any other person with a “special interest” in the trust. While this does not include donors, their families or heirs, or even beneficiaries of the gift or trust, it may include “fiduciaries” (such as a trustee of a written trust).
2. Tax considerations. The court noted that the general rule is supported by federal tax law which provides donors with a charitable contribution deduction only if they have permanently surrendered “dominion and control” over the donated property or funds. If donors were allowed to enforce the purposes of their designated contributions, then this would jeopardize their eligibility for a charitable contribution deduction since they may have retained too much control over the donated property or funds.
• Key point. The court concluded that the tax deductibility of designated charitable contributions would be jeopardized if a church or charity allowed donors to “enforce” such gifts.
3. An exception to the general rule-a reservation of rights. The court mentioned one important exception to the general rule-donors can legally enforce a trust created by a designated gift if they have reserved the right to do so. One way this can be done, according to the court, is if a donor “expressly reserves a property interest such as a right of reverter.” A “right of reverter” is an interest that donors can create by appropriate wording in a legal instrument. For example, assume that Bob wants to give 5 acres of land to a church for religious purposes. He executes a deed conveying the property with a “reversion clause” specifying that title to the land will “revert” to Bob in the event that the church ever quits using the property for religious purposes. If the church violates this restriction, then Bob or his heirs will have a legal right to enforce it or demand a return of the property.
• Key point. Deeds to church property often contain reversionary clauses specifying that legal title to the property shall revert to the previous owner (or his or her heirs) if a stated condition occurs. Such conditions often include an attempted sale of the church property, or use of the property for non—religious purposes. It is important for church leaders to be familiar with the deed or deeds to church property so they are aware of any such conditions.
4. An exception to the general rule-persons with a “special interest.” The court concluded that persons with a “special interest” in the enforcement of a designated gift have a legal right to enforce it. The court mentioned “fiduciaries” (such as the trustee of a trust instrument) as an example of a person having a special interest. However, the court cautioned that donors or their heirs have no such interest, nor do beneficiaries of a designated gift.
5. An exception to the general rule-ethical principles. Donors may not have the legal right to enforce a purpose specified in a designated gift, but this does not mean that a church should ignore requests by donors to honor their designations. After all, there is an ethical component that must be considered. As the dissenting justices of the Connecticut Supreme Court observed, “[t]his decision is simply an approval of a [charity] double crossing the donor, and doing it with impunity unless an elected attorney general does something about it.” Do church leaders want to be perceived as “double crossing” members who make designated gifts?
Further, the dissenting justices noted that the court’s decision “will not encourage donations to [charities].” What did they mean? Simply this-many donors are prompted to make a charitable contribution because of a desire to further a specific purpose or project. If donors realize that they have no legal right to enforce a designated gift then many of them may decide not to give.
CHECKLIST. While the court concluded that donors have no legal right to enforce a designated gift, there are a number of reasons why church leaders may want to voluntarily honor designated gifts. Consider the following:
- While the donor ordinarily cannot enforce designated gifts, the state attorney general can. They are not unenforceable. They are simply not enforceable by the donor.
- In some cases donors reserve a legal right to enforce a designated gift. This often happens when such a gift is expressed in a written instrument.
- Persons with a “special interest” in the designated gift may have a legal right to enforce it. This would include a trustee (if a designated gift is reflected in a written trust instrument).
- Church leaders may want to avoid any suggestion of “unethical” behavior. Often, church leaders who ignore the purpose specified in a donor’s designated gift are accused by the donor of unethical behavior.
6. The Uniform Management of Institutional Funds Act. Most states have enacted the Uniform Management of Institutional Funds Act (UMIFA). The court in this case acknowledged that UMIFA provides that “with the written consent of the donor, the governing board may release, in whole or in part, a restriction imposed by the applicable gift instrument on the use or investment of an institutional fund.” In other words, the board of a charity can ask persons who donated to an “institutional” or endowment fund for their written consent to release the charity from a designation or restriction. However, the court insisted that this provision did not give donors a legal right to enforce designated gifts. Quite to the contrary, the drafters of UMIFA stated (in their official interpretation of the statute) that a donor “has no right to enforce the restriction, no interest in the fund and no power to change the [charitable] beneficiary of the fund. He may only acquiesce in a lessening of a restriction already in effect.”
In summary, even if your state has enacted UMIFA, it is doubtful that this will give donors a legal right to enforce designated gifts.
7. Honoring designated gifts when the designated purpose is abandoned. Assume that church leaders decide to abandon a project, such as a building program. Further assume that they do not want to unilaterally apply donors’ designated building fund contributions to some other purpose. They want to honor the donors’ intent. How do they do so? There are a number of possibilities, including the following:
Donors can be identified. If donors can be identified, they should be asked if they want their contributions returned or retained by the church and used for some other purpose. Ideally, donors should communicate their decision in writing to avoid any misunderstandings. Of course, churches should advise these donors that they will need to file amended tax returns if they claimed a charitable contribution deduction for their contributions in a prior year.
• Key Point. Often, donors prefer to let the church retain their designated contributions rather than go through the inconvenience of filing an amended tax return.
Donors cannot be identified. A church may not be able to identify some donors who contributed to the building fund. This is often true of donors who contributed small amounts, or donors who made anonymous cash offerings to the building fund. In some cases, designated contributions were made many years before the church abandoned its building plans, and there are no records that identify donors. Under these circumstances the church has a variety of options. One option would be to address the matter in a meeting of church members. Inform the membership of the amount of designated contributions in the church building fund that cannot be associated with individual donors, and ask the church members to take an official action with regard to the disposition of the building fund. In most cases, the church membership will authorize the transfer of the funds to the general fund. Note that this procedure is appropriate only for that portion of the building fund that cannot be traced to specific donors. If donors can be identified, then use the procedure described in the previous paragraph. Another option is to ask a court for authorization to transfer the building fund to another church fund. Such a procedure is authorized by UMIFA.
Other options are available. Churches should be sure to consult with a local attorney when deciding how to dispose of designated funds if the specified purpose has been abandoned.
Some donors can be identified, and some cannot. In most cases, some of the building fund can be traced to specific donors, but some of it cannot. Both of the procedures summarized above would have to be used.
8. Courts in other states. Few courts have addressed the legal authority of a donor to enforce a designated gift. As a result, it is essential for church leaders to consult with a local attorney before using a donor’s designated funds for some other purpose.
9. Examples. Let’s apply these principles to the three examples at the beginning of this chapter, along with several additional examples:
• Example. In 1996 Bob donated $5,000 to his church with the stipulation that the money be used exclusively for the building program. This year the church board decides to cancel the building program. Bob demands a full refund of his contribution. The church held Bob’s designated contribution “in trust” for the specified purpose. However, according to the case addressed in this article, Bob has no legal standing to challenge the church’s decision to use his designated contribution for other purposes. He cannot ask a court to compel the church to return his designated contribution. However, he can urge the state attorney general to enforce the trust.
• Example. Same facts as the previous example. Assume that church leaders decide to return Bob’s designated gift to him. They base this decision on two grounds. First, the possibility that Bob may ask the attorney general to enforce the trust; and second, a feeling of moral obligation. They may return the $5,000 to Bob, but before doing so they should advise Bob that he will need to file an amended tax return for 1996 if he claimed a charitable contribution deduction for the contribution.
• Example. A church asked its members in 1998 to contribute toward a missions project with a budget of $10,000. Barb donated $1,000 to the project, but learned later that the budget had been reached before she made her contribution. She asks the church to return her contribution. If the church refuses to comply, Barb cannot ask a court to compel the church to return her designated contribution (in any state following the court ruling addressed in this article). However, there are compelling reasons why church leaders should consider voluntarily honoring her request, including the following: (1) the attorney general is authorized to enforce the designation even though Barb is not, and (2) moral obligation. If church leaders decide to return Barb’s contribution, they should amend Barb’s contribution records to delete the $1,000 contribution.
• Example. A church plans to build a home for a low—income family. While much of the work is done by volunteer labor, and some of the materials are donated, the church still must raise $25,000 to complete the project. Bill does not attend the church, but he learns of the project and donates $1,000 to it in 1998. Several weeks after making his contribution Bill learns that the budget had been reached before he made his contribution. He asks the church to return his contribution. If the church refuses to comply, see the analysis in the previous example.
• Example. Bill contributes $2,000 to his church’s benevolence fund in 1998, with the stipulation that the gift be used for the medical expenses of Jane, a member of the congregation. The church board elects to use this gift for another benevolence need. Bill does not object to this diversion, but Jane does. She threatens to “see an attorney” if the church does not distribute Bill’s $2,000 gift to her. Jane has no legal basis for challenging the church’s action in any state that follows the court ruling addressed in this article. The court noted that only persons with a “special interest” in the enforcement of a designated gift have a legal right to enforce it. The court mentioned “fiduciaries” (such as the trustee of a trust instrument) as an example of a person having a special interest. However, the court cautioned that donors or their heirs have no such interest, nor do beneficiaries of a designated gift.
• Example. Example. In 1960 Charles donated ten acres to his church. The deed contained a “reverter clause” specifying that title to the property would “revert” to Charles, or his heirs, “if the property ever ceases to be used for church purposes.” In 1998 the church decides to relocate to a new facility if it can sell its current property. A developer (who wants to demolish the church and construct a commercial building on the site) offers to buy the property. The church board learns of the “reverter clause” from a local title company. The board is not certain what to do. Charles died in 1970, and no one is aware of any heirs. According to the court ruling addressed in this article, a donor may enforce a “reverter clause.” This is an exception to the general rule that donors cannot enforce designated gifts. This right passed to Charles’ heirs at his death. Any of them would have the right to enforce the “reverter clause” that would be triggered by the church’s attempt to sell the property. This assumes, of course, that the buyer would not use the property for church purposes.
10. The court’s reliance on another case. The court based its ruling in part on an earlier decision by the Maine Supreme Court. Attorney General v. First United Baptist Church, 601 A.2d 96 (Me. 1992). In this earlier case the question was whether a state has the authority to demand an accounting of church trust funds. The court concluded that it did. The facts of the case are easily stated. In 1939, a wealthy individual made a gift of a substantial amount of stock to a church, subject to the following two conditions: (1) the church was to use the trust fund for “charitable uses and purposes,” and (2) the church was not to sell or transfer the stock for a period of fifty years. In 1983, after faithfully observing the terms of the trust for forty—four years, the church sought court permission to sell the stock. It noted that the value of the stock had fallen sharply and the rate of return was substantially less than could be achieved with other investments. The court permitted the church to sell the stock (then valued at $733,000) in order to protect the trust fund.
In 1987, the state attorney general received information suggesting that the church was not carrying out the terms of the trust. The attorney general asked the church for an accounting of the trust fund. When the church refused to comply, the attorney general sought a court order compelling the church to provide an accounting. The church argued that expiration of the fifty—year restriction on sale of stock expired in 1989, and this gave the church full legal title to the trust. The church also argued that the first amendment guaranty of religious freedom protected the church from complying with the demand for an accounting. The trial court rejected the church’s arguments, and ordered the church to provide the attorney general with an accounting. The church appealed, and a state appeals court agreed with the trial court’s ruling. The appeals court noted that the fundamental purpose of the trust continued to be for “charitable uses and purposes.” This purpose was not affected by the expiration of the fifty—year ban on sales of stock. The court then observed:
Where property is given to a charitable corporation and it is directed by the terms of the gift to devote the property to a particular one of its purposes, it is under a duty, enforceable by the attorney general, to devote the property to that purpose.
As a result, the church was not free to spend trust funds in any manner it chose. It had to spend them consistently with the trust purpose (“charitable uses and purposes”). And, the attorney general had the legal authority to ensure that the church was complying with the trust purpose, and this authority included the right to demand an accounting of trust funds.
The court rejected the church’s claim that requiring it to prepare an accounting would violate the constitutional guaranty of religious freedom. It observed:
Civil courts can constitutionally adjudicate property disputes involving religious organizations if they can be resolved in accordance with neutral principles of law and without interpretation of, or reference to, religious doctrine. We have held that a suit for an accounting of church funds is a property dispute capable of resolution by application of neutral principles of law …. The attorney general is not attempting to inquire into the financial affairs of the church, or impose a regulatory scheme, but only to obtain the information necessary for him to fulfill his statutory obligation to the public. Because we find that the trust is a public trust, separate and distinct from the church, the court ordered accounting can be accomplished by application of neutral principles of law and therefore, does not impinge upon the church’s first amendment freedoms.
