endowments: loans and pledges
TRANSCRIPT
Endowments: Loans and PledgesChicagoBarAssociation
FederalTaxation– (H)ExemptOrganizationsDivision
October13,2016
Presented by:
Norah L. Jones & Corbin J. MorrisQuarles & Brady LLP
• Post‐recession increase in attempts to access and leverage endowment funds
• Greater attention on historical donor records as well as current campaign literature
• Focus is on both “true” endowments as well as board‐designated or “quasi” endowments
• Special considerations with respect to true endowments
Introduction
• Uniform Prudent Management of Institutional Funds Act
– Enacted in 49 states, including Illinois (760 ILCS 51/1 et seq.)
– Governs “institutional funds” and “endowment funds”
– Governs investment, spending, and release of restrictions
– Replaces the Uniform Management of Institutional Funds Act (“UMIFA”)
– UPMIFA, among other things, expands the factors to be considered in making “prudent” investment decisions, removes the “historic dollar value” concept of UMIFA, and more comprehensively addresses modifications of restrictions on charitable funds.
– Compliance with UPMIFA is determined in light of the facts and circumstances at the time a decision is made or action is taken, and not by hindsight
UPMIFA– Background
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• Institutional Fund – a fund held by an institution exclusively for charitable purposes. 760 ILCS 51/2(5).
– Includes nearly all assets of a charitable organization, including operating bank accounts, investment assets (other than program‐related assets), endowment for specific purposes (e.g., scholarship funds), and set‐aside funds.
• Endowment Fund – an institutional fund or part thereof that, under the terms of a gift instrument, is not wholly expendable by the institution on a current basis. The term does not include assets that an institution designates as an endowment fund for its own use. 760 ILCS 51/2(2).
UPMIFA‐ Definitions
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• Gift Instrument – 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. 760 ILCS 51/2(3).‐ Specific terms in a gift instrument may override the flexibility and guidance otherwise provided by UPMIFA.
UPMIFA– Definitions(cont.)
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• Many organizations use the term “endowment fund” informally to refer to the organization’s income‐producing investment assets (i.e., those not spent currently for operations).
• “Endowment fund” under UPMIFA has a narrower meaning.
• Organizations may create unwanted or unnecessary spending restrictions when referring to “endowment funds” in donor literature
UPMIFA– Institutionalvs.EndowmentFunds
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• UPMIFA’S provisions relating to spending apply only to “true” endowment funds.
• UPMIFA’s provisions relating to investment apply to all institutional funds, not just “true” endowment.
• The distinction between a spending and investment decision may not always be clear.
UPMIFA– Spendingvs.Investment
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UPMIFA requires that all institutional funds be managed and invested in good faith with the care an ordinarily prudent person in like position would exercise in similar circumstances (760 ILCS 51/3(b))
Investment decisions about an individual asset may not be made in isolation but rather in the context of the fund’s portfolio and as part of an overall investment strategy having risk and return objectives reasonably suited to the fund and the institution (760 ILCS 51/3(e)(2))
UPMIFAInvestmentDecisions
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The institution may invest in any kind of property or type of investment consistent with UPMIFA (760 ILCS 51/3(e)(3))
An institution shall diversify the investments of an institutional fund unless it reasonably determines that, because of special circumstances, the purposes of the fund are better served without diversification (760 ILCS 51/3(e)(4))
UPMIFAInvestmentDecisions(cont.)
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• What is it? An “interfund” loan from an organization’s “endowment” to an operating fund (i.e., to itself)
• Why? May be driven by cash‐flow needs, to pay down higher rate debt, to avoid undesirable obligations imposed by third‐party lenders, or for capital investment
• How is it treated? Likely as an “investment” under UPMIFA• What to consider? UPMIFA investment factors, specific donor
restrictions, potential donor/public relations issues• What about pledges? UPMIFA drafting notes specifically comment
that, if otherwise consistent with UPMIFA, pledging endowment assets as collateral may be permissible.
EndowmentFundLoans
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• DONOR INTENT• Charitable purposes of the fund and the institution• General economic conditions• Inflation / deflation• Expected tax consequences• Role of the investment within the overall portfolio
760 ILCS 51/3(a), (e)
UPMIFAInvestmentFactors
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• Expected total return from income and appreciation• Other resources of the institution• Needs of the institution and the fund to make distributions and
preserve capital • The loan’s special relationship or special value, if any, to the
charitable purposes of the institution
760 ILCS 51/3(e)
UPMIFAInvestmentFactors(cont.)
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Practical considerations: – Interfund loans generally must have market terms– Institution must consider its own creditworthiness – The terms of the loan should be clearly documented,
including interest rate, repayment terms, debt covenants, events of default, reporting requirements, etc.
– The extent to which the “charitable purposes” of the fund or institution, or the loan’s “special relationship” to those purposes, may override the other factors is unclear
EndowmentFundLoans
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Practical considerations (cont.)– Donor relations and the reaction of donors to an
endowment loan should be considered.– Documentation is key– Seeking donor consent may be advisable even if not
required– When does the investment in the interfund loan look more
like an expenditure?– How will the loan be accounted for and reflected on the
institution’s financial statements and tax returns?
EndowmentFundLoans(cont.)
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Considerations relating to purpose‐restricted funds:• Will an interfund loan from purpose‐restricted assets
adversely affect the institution’s ability to fulfill the purposes of the fund?
• Connected to overall prudence determination• Recall that prudence is not determined with the benefit of
hindsight
EndowmentFundLoans(cont.)
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© 2015 Quarles & Brady LLP ‐ This document provides information of a general nature. None of the information contained herein is intended as legal advice or opinion relative to specific matters, facts, situations or issues. Additional facts and information or future developments may affect the subjects addressed in this document. You should consult with a lawyer about your particular circumstances before acting on any of this information because it may not be applicable to you or your situation.
Questions?
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Norah L. Jones / [email protected] N. LaSalle Street, Suite 4000 / Chicago, IL 60654‐3406Office 312‐715‐5052 / quarles.comAssistant Frieda Schuch 312‐715‐2752
Corbin J. Morris / [email protected] N. LaSalle Street, Suite 4000 / Chicago, IL 60654‐3406Office 312‐715‐5066 / quarles.comAssistant Frieda Schuch 312‐715‐2752