In a soon-to-be-released article, Charities in Financial Distress: The Impact of Bankruptcy on Donor-Restricted Funds, Richard Fox, Jonathan Blattmachr, and Benjamin Bolas explore one aspect of bankruptcy filings by charitable organizations. Specifically, the authors discuss the vulnerability of some charitable contributions to creditor claims of the bankruptcy estate.
In a bankruptcy proceeding, it is possible that your donation could be lost to creditors of the charity even when the contribution is to a donor advised fund.
As noted in the article, the charitable sector is growing. So too are the number of charities looking for bankruptcy protection. This happens because some charities are ill-conceived and poorly run, and fail, but also because some large, successful nonprofits falter due to unforeseen events. Fortune turns for both the for- and nonprofit alike. Indeed, in recent years, high profile charities such as the New York City Opera and the National Heritage Foundation have filed for protection. In other words, size and legacy are no safeguard.
It is important to know that a charity you are contributing to could potentially file for bankruptcy protection in the future. In the event of such a bankruptcy, you too should know that if you contribute funds which are not scheduled for immediate use or which are not restricted in their use, those funds could become eventually become subject to creditors such as service providers and judgment winners.
Relatedly, existing charities operate to serve their stated mission. Protecting donative intent helps them achieve that mission by attracting more donors. Therefore, knowing what restrictions to suggest to donors can be a differentiator for a charity soliciting donations.
The “bankruptcy estate” is established upon the bankruptcy filing and includes all legal or equitable interests of the debtor-charity. A determination of what property the debtor-charity has a legal or equitable interest in turns on the applicable state property laws. In certain circumstances, the estate can include charitable gifts which were made years ago, which were intended to last for many years, or which were intended to fund certain programs. Needless to say, the charitable gift being used to pay general creditors is rarely what the donor envisioned.
To determine whether an existing charitable gift is at risk takes an analysis of the terms and conditions (if any) placed on the use of the assets by the donor and the applicable state property rights law. Or if contemplating a new gift, it takes an analysis of state law and the implementation of careful, appropriate terms and conditions on the gift. Even then, the most restrictive, protected-against-bankruptcy gift might not be appropriate for all donors or for all charities. Determining what appropriate conditions and restrictions should be placed on a donation takes consultation between all involved parties.
In sum, proper planning is necessary to make sure that charitable donors can have the comfort that they will achieve their charitable goals.
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