> Endowment Fund (and UPMIFA) Reminders for Colleges, Universities, and Other 501(c)(3) Organizations
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Endowment funds held by educational institutions often have considerable value and represent the generosity and goodwill of countless alumni and other donors. Over time, however, an institution’s financial needs and purposes may change, causing a board of directors to take a close look at assets designated as an “endowment fund” on its books and records.
In this FAQ style article, our goal is to (1) provide a high-level overview of endowment funds for colleges, universities, and other charitable organizations; and (2) discuss the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”), a uniform law that governs the management of endowment funds, highlighting certain important definitions, concepts, and common questions.
Nearly every state has adopted a version of UPMIFA. When presented with an endowment issue, the best place to start is your state’s version of UPMIFA. For purposes of this discussion, all references to “UPMIFA” in this article are to the version enacted in Wisconsin (Wis. Stat. § 112.11).
Q: What is an endowment fund? Are there different types of endowment funds?
- An “endowment fund” is defined in UPMIFA as “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.” “Institutional fund” means “a fund held by an institution exclusively for charitable purposes” and primarily for investment. “Gift instrument” is defined below.
- Importantly, the statute clarifies that an endowment fund “does not include assets that an institution designates as an endowment fund for its own use.” In other words, a fund is not treated as an endowment fund under UPMIFA where a board (instead of a donor) has restricted certain funds for a particular purpose. Board-restricted funds often are called a “board-designated endowment” or a “quasi-endowment,” because the same board that self-imposed the restrictions could change its mind and release them.
Q: What is a “gift instrument”?
- A “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.” “Record” is defined as “information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.”
- In short, the definition of “gift instrument” and “record” require a writing of some kind (e.g., electronic, paper, etc.) to create an endowment fund subject to UPMIFA.
Q: How is an endowment fund created?
- An endowment fund is created pursuant to the terms of a gift instrument if the instrument indicates that the fund: (1) must be held exclusively for charitable purposes, and (2) is not wholly expendable by an institution on a current basis. An endowment fund could be restricted temporarily or restricted permanently, depending on the language in the gift instrument.
- The gift instrument does not need to specifically identify the gift as an “endowment” to create an endowment. At times, this can result in unintentional endowment treatment under UPMIFA. For example, because “gift instrument” is defined to include an “institutional solicitation” (e.g., a solicitation prepared and sent by the charity and received by the donor), gifts made pursuant to a capital campaign to build and maintain a new student center or to fund a department chair could create an endowment, even if the donor never signs a traditional gift agreement, as the money raised is expressly or implicitly intended for long-term use. Another example of an unintentional endowment may arise by email exchange with a donor where the donor indicates an intention for his or her gift to be used in the future or over the course of several years. The email and solicitation material in these examples may qualify as a “gift instruments” under the UPMIFA.
Q: Is it possible to modify restrictions on the management, investment, or purposes of an endowment fund?
- The release or modification of restrictions may be possible (1) with written consent from the donor(s); (2) upon court approval and notice to the attorney general in certain circumstances; or (3) upon notice to the attorney general if certain conditions are met.
- If the donor or donors are still living, the easiest approach often is to obtain each donor’s written permission. Even this approach, however, can get complicated. For example, there may be dozens (or more!) donors to a specific endowment. If that’s the case, donor consent may not be practical. A modification by any means other than by written agreement of the donor generally requires a showing that the restriction has become unlawful, impracticable, impossible to achieve, or wasteful, and any repurpose of the fund generally must be as consistent as possible with the charitable purposes expressed in the gift instrument.
Q: What standard of conduct applies to an organization’s directors when managing and investing an institutional fund?
- In addition to complying with the duty of loyalty, UPMIFA requires that “each person responsible for managing and investing an institutional fund shall manage and invest the fund in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances.”
- UPMIFA provides eight factors for directors to consider (if relevant) when making management and investment decisions affecting endowment funds, including:
- General economic conditions.
- The possible effect of inflation or deflation.
- The expected tax consequences, if any, of investment decisions or strategies.
- The role that each investment or course of action plays within the overall investment portfolio of the fund.
- The expected total return from income and the appreciation of investments.
- Other resources of the institution.
- The needs of the institution and the fund to make distributions and to preserve capital.
- An asset’s special relationship or special value, if any, to the charitable purposes of the institution.
Q: Are there limits on the amount an organization can spend from an endowment?
- Subject to the intent of the donor expressed in a gift instrument, “an institution may appropriate for expenditure or accumulate so much of an endowment fund as the institution determines is prudent for the uses, benefits, purposes, and duration for which the endowment fund is established.” Like with investment decisions, directors are required to act in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances when making spending decisions. UPMIFA provides seven factors for directors to consider when determining whether to appropriate or accumulate endowment funds.
- As mentioned earlier, UPMIFA statutes vary from state to state. In New York, for example, (1) an institution must keep a contemporaneous record describing consideration that was given by the governing board to each of the factors and (2) a rebuttable presumption of imprudence generally applies to spending above 7% of a fund’s fair market value.
Q: My organization is interested in modifying a restriction on an existing endowment fund. Where do we start?
- Identify each donor to the endowment fund in question. Next, locate the gift instrument and/or solicitation that accompanied each donor’s gift.
- Questions to ask: (1) Is this really an endowment fund under UPMIFA? (2) Does the gift instrument permit the change we’re seeking? If not, does it outline a procedure for modifying restrictions? (3) Is the donor(s) still living, and can we reach the donor(s)? (4) What is the size of the endowment fund, and when was it established? (5) Why do we want to modify the restriction, and what do we propose to do with the fund instead of its current use? The answers to these questions will illuminate whether modification of the restriction is possible and, if so, the procedure for doing so based on the state’s version of UPMIFA.
- It is advisable to have legal counsel assist with this review process and guide institutions through the proper procedure for releasing restrictions, where possible.
Q: I’ve heard of organizations borrowing from an endowment fund. Is that permitted under UPMIFA?
- This is a difficult question and will depend on the facts and circumstances. Borrowing from an endowment likely would be characterized as an appropriation for spending (instead of an “investment”) and, thus, would be evaluated under UPMIFA’s seven factor “prudence” standard. Practically, an organization that borrows from its endowment may jeopardize the trust of donors and the general public and also risk scrutiny from the state attorney general.
- Before moving forward, a board of directors should explore all alternatives, meticulously document its decision-making process, and ultimately make a determination that borrowing restricted funds is prudent based on the factors set forth in the statute. We recommend that an organization involve legal counsel early in the process before borrowing from endowment funds.
Please don’t hesitate to reach out to your Michael Best attorney if you need assistance with any of the issues raised in this article.
 Under Wisconsin law, if an institution determines that a restriction contained in a gift instrument on the management, investment, or purpose of an institutional fund is unlawful, impracticable, impossible to achieve, or wasteful, then the institution, 60 days after notification to the attorney general, may release or modify the restriction, in whole or part, if: (1) the endowment fund has a total value of less than $75,000; (2) more than 20 years have elapsed since the fund was established; and (3) the institution uses the property in a manner consistent with the charitable purposes expressed in the gift instrument. Wis. Stat. § 112.11(6)(d). If all three conditions are not present, then court approval is required to modify the restriction. State laws differ with respect to the thresholds for size and age of the fund for modification by notice to the attorney general, rather than court approval, to be an option when donor consent is not possible.
 In addition to UPMIFA, most states have charitable solicitation laws, typically enforced by the attorney general or equivalent regulatory body, requiring that contributions be used for the purpose for which they were solicited. Such laws might be implicated when using endowment funds for other than their intended purpose.