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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, March 1, 2013

Brody Presents Corporate Change in Charitable Purpose at Brooklyn

BrodyEvelyn Brody (Chicago-Kent) presented Corporate Change in Charitable Purpose: Who Decides? at Brooklyn last week as part of its Faculty Workshop Series:

The American Law Institute is developing Principles of the Law of Charitable Organizations, for which I serve as Reporter. This workshop addresses a key question that remains unaddressed in nonprofit corporate law: How should a corporate charity be able to change its charitable purpose, and which, if any, accumulated assets can the charity use for the new purpose? A similar issue can arise in other corporate restructurings (including dissolution). In particular, what is – and should be – the role of the state, specifically the attorney general (who represents charities’ beneficiary classes) and the courts?

My current draft § 270 distinguishes between amending a charitable trust, for which the law generally requires notice to the attorney general and court approval, and amending the purposes of a corporate charity (the predominant organizational form for U.S. charities). I propose that a corporate charity need only amend its organizational documents in accordance with state law – that is, the purpose amendment is left to the charity’s board, with the approval of voting members (if any) – although the charity must separately make provision for any restricted gifts.

Moreover, unless otherwise required by state law or the organizational documents, I do not require the charity’s governing board to determine that the current purpose of the charity has failed, and the board’s determination is subject to judicial review only for abuse of discretion. This approach, however, obviously raises the question of whether the project should set forth standards for determining abuse of discretion. The classic concern is that “[t]hose who give to a home for abandoned animals do not anticipate a future board amending the charity’s purpose to become research vivisectionists.” But who decides, for example, if the decision of a woman’s college to go co-ed is an enlargement of its purpose, or a betrayal?

Separately, draft § 290 discusses the effect of a change in charitable purpose on the corporation’s existing assets. If the standard for amending purpose is the cy pres standard, then almost by definition the old assets will have to be redirected somewhere – either to the new purpose of the original charity, or transferred to another charity with the same purpose as the old one. Under a more liberal change of purpose regime, the question of appropriate uses for pre-amendment assets is more controversial. Some courts have held that even unrestricted gifts, as well as earned and investment income, are impressed with the pre-amendment purposes of a donee charity. Elsewhere, however, the Principles reject that the view that unrestricted gifts are restricted to purposes of the charity at the time the gift was made. Accordingly, my draft provides that while a restricted gift must be used only for purposes permitted by the gift instrument, the charity may generally use any other asset for any charitable purpose set forth in its current organizational documents.

Besides reflecting what I believe is already current corporate law (at least in most states), my approach reflects a general policy favoring flexibility to changes in purpose. As is true with the longstanding debate under trust law over the “dead hand” and cy pres reform, the law must balance historical purpose against current need. I worry about unduly encouraging the expectation that charity managers must honor the original purposes of the charity. Fiduciaries might reasonably believe that it is legally safer to stay the course while the organization stagnates, if not deteriorates. Elsewhere, the Principles take the position that, rather than having a “duty of obedience” to a particular purpose, the board members have a duty to keep the purpose of the charity current and useful.

I have been discussing these draft provisions (among others) with the project’s Senior Consultant, Marion Fremont-Smith, and its Associate Reporters, Dana Brakman Reiser and Jill Horwitz. Because of our differing views, the Preliminary Draft of Chapter 2 – to be presented later this year to the project’s Advisers and Members Consultative Group – could also present the argument for the alternative view that a corporate change of charitable purpose must generally follow the trust law approach of consultation with the attorney general and judicial approval.

Of course, none of this material set out below reflects the views of the Council or membership of the American Law Institute.

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