Friday, April 17, 2009

Underwater Funds and Endowment Spending

The press has been reporting about underwater endowment funds and the problems for charities that cannot spend endowment money due to state laws.  The information often is not quite right.

UMIFA, still the law in fewer than 20 states, provides a default rule that governs endowment spending.  If a charity and a donor did not agree otherwise when the donor made the gift, then UMIFA says that the charity can spend from the endowment the amount of appreciation (the amount above the original gift value - termed historic dollar value in UMIFA) that the charity determines to be prudent.  UMIFA does not address the spending of income, and the assumption is (without case law but with guidance posted on the NY AG's website supporting this understanding) that a charity can continue to spend "income" (interest and dividends but not capital gains) even if the fund is underwater.  Thus, the statements in the press that a charity cannot spend from an underwater fund are wrong.  In most cases the charity would not spend in those circumstances, but the legal rule is not quite the way it is usually described.

Thirty states plus the District of Columbia have adopted UPMIFA, and that new statute is effective in some states and will become effective in others this year or next.  In addition to the 31 enactments, bills are still pending in a number of states.  UPMIFA permits a charity to spend from an endowment fund the amount it determines to be prudent, keeping in mind the long-term nature of the fund.  Historic dollar value no longer provides a sort of guidance, but the absence of historic dollar value from the law may not mean that charities will be eager to spend if funds drop too far below their recent values.

The difficulty from the charity's standpoint is a practical one as well as a legal one.  What amount can a board prudently authorize for spending when a fund is down 30% - or more?  Some charities may find it prudent to increase spending, so that important programs and services will not be cut.  Others may curtail spending until the funds' values rebound.  Spending now means that getting the fund back to a value that it had as recently as last year will take longer.  But deciding not to spend may mean that scholarships are not paid or programs are cut.  The choice is not an easy one for charities, and each charity must examine its own needs and make its own prudent decision.


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