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Higher Education Endowments: How To Access When Needed Most – Education

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Many colleges and universities have endowments. In the last few
years, institutions of higher education have had more questions
about how to access their endowments – between the COVID-19
pandemic and periods of significant market volatility, the need for
cash has been acute at times. This brief piece addresses legal
questions related to endowments and how colleges and universities
can work with counsel to have greater access to their endowments
when needed most.

What is an “Endowment?”

Though “endowment” is colloquially used to mean any
assets that are held for the long-term, an “endowment
fund” is a legal, defined term of art under the Uniform
Prudent Management of Institutional Funds Act (UPMIFA), which has
been adopted in some form in forty-nine (49) states — only
Pennsylvania has not adopted in any form and the District of
Columbia. Specifically, an “endowment fund” is “an
institutional fund or any part thereof that, under the terms of a
gift instrument, is not wholly expendable by the [nonprofit
organization holding the fund] on a current basis.” In other
words, if a donor restricts the timing during which a fund may be
used – often by restricting the organization’s use to the
“income” of the fund each year, or requiring that the
fund be held “in perpetuity,” or with words of similar
importance, then the fund is an endowed fund.

Alternatively, funds that the board of a college or university
designates to be held long-term or restricts so that the only
assets available to be spent each year are limited to an
organization’s spending policy — typically expressed as a
percentage of a fund — are not considered endowment funds
under UPMIFA. Sometimes organizations refer to these funds as
“board-designated funds” or
“quasi-endowments.”

Why Does It Matter if a Fund Is an Endowment Fund?

A college or university may only spend endowment funds in
accordance with the terms of the gift instrument through which the
donor made the gift to the college or university. Gift instruments
can be documents that take effect at death like wills, living
trusts, or beneficiary designations, or agreements negotiated with
donors during their lives. Donor restrictions are not optional, nor
can they be ignored, even if they are impossible to follow. In
other words, if a donor sets a spending rate or annual amount, that
rate or amount must be followed. If the donor has not set an annual
spending amount but has indicated that the fund is to be treated as
an endowment, then the fund should be spent in accordance with the
terms of the college or university’s spending policy. Spending
policies vary, but organizations typically adopt an annual spending
rate between 3% and 5% of the average endowment fund balance over a
historical period for the specific fund (e.g. the past 12 quarters
– it is worth noting that although Pennsylvania has not
adopted UPMIFA, it has provided for a similar calculation as a safe
harbor in PA Act 141). The percentage adopted in the spending
policy is expendable by the college or university each year for the
purposes specified by the donor.

The spending policy rate is adopted by a college or
university’s board of directors, and the presumption of
prudence with respect to the spending rate varies based on the
state in which the organization is located. The UPMIFA model act
provides an optional provision that a greater than 7% spending rate
is rebuttably presumed to be imprudent. However, Ohio, for example,
took a divergent approach, providing that an annual spending rate
of 5% or less is presumed to be prudent — without creating a
presumption for higher spending rates. Many states are silent on a
presumption of prudence, so a college or university should consult
its counsel and the version of UPMIFA applicable — or in
Pennsylvania, PA Act 141 — to the college or university when
developing or amending its spending policy.

What if a College or University Needs More From Its Endowment
Than Spending Policy Allows?

In challenging economic times, many charitable organizations,
including colleges and universities, often find it challenging to
raise funds at the same rate as during “normal” times. As
we saw during the COVID-19 pandemic, organizations that rely on
revenue from operating activities can be in especially difficult
positions, particularly when operating activities are inhibited by
restrictions through state or local laws or regulations. During
such times, the usual spending policy draw from a college or
university’s endowment may not be enough to close a budgetary
gap. Fortunately, colleges and universities have options to
increase access to their endowment funds.

  1. Modify Spending Policy Rate. Depending on the
    circumstances a college or university may be able to increase the
    spending policy rate fairly dramatically for a short period of
    time. For example, a college with a standard spending policy of 4%
    may be able to increase its spending policy to 7% or higher for a
    year or two. A college or university with a conservative spending
    policy – generally 3% or less – may wish to take the
    opportunity to revisit its spending policy more generally and
    increase it more modestly with the intention that the new spending
    policy will be in place for as long as makes sense to the
    organization’s board. Any adjustment to the spending policy
    should be done based on careful consideration of the factors
    required under UPMIFA by the college or university’s
    board.

  2. Seek To Modify or Release Fund-Specific
    Restrictions
    . As indicated above, donor restrictions are
    not optional. In addition to stipulating that gifts are to be
    treated as endowed funds (a timing restriction on spending), donors
    also may require that funds may be spent only for specified
    purposes (a purpose restriction on spending, for example, the gift
    may only be used for scholarships, a specified program, or capital
    project). Funds also can be both timing and purpose restricted (for
    example, a donor may create a fund with a college or university to
    provide scholarships (a purpose restriction) from which only the
    income may be spent each year (a timing restriction)). There is a
    strong policy concern under UPMIFA that organizations comply with a
    donor’s intent when making a charitable gift, including both
    timing and purpose restrictions. Colleges and universities must
    honor donor restrictions unless the requirements of UPMIFA to
    modify or release a restriction are met.

One common example of a fund that a college or university may
seek to modify relates to programs that a college or university no
longer offers. For example, ABC College was established in 1800 for
women. During the nineteen century, ABC College offered a number of
courses of study in home economics. Donor Smith left $5,000 to ABC
College in 1920 to be used in perpetuity for scholarships for women
studying home economics under her will. ABC College used the income
from the Smith Fund to provide scholarships as required under the
will. In 1965, ABC College became coeducational, but scholarship
awards continued to be awarded to women. In 1975, the home
economics course of study was discontinued. No distributions from
the Smith Fund have been made after the discontinuation of home
economics. The current value of the Smith Fund is $25,000. What
should ABC College do? Because ABC College cannot administer the
Smith Fund in accordance with the donor restrictions, it should
look to the applicable statute in the state where ABC College is
located to determine the process to seek modification or release of
the home economics restriction.

The process for seeking modification or release of a restriction
depends on a number of factors. If a donor is living, an
organization generally should seek the donor’s consent to
modify the restriction. If a donor is not living, UPMIFA provides a
process for modification or release of restrictions provided that
the fund is old enough (this threshold varies by state and can be
as little as ten years and as many as twenty-five), small enough
(again, varies by state and can be as low as $25,000 or up to
$250,000), and the organization believes that the restriction is
“impracticable or wasteful,” “impairs the management
or investment of the fund,” or that a modification “will
further the purposes of the . . . fund.” If a fund is eligible
under the UPMIFA process, the organization generally must notify
the state attorney general of its intention to modify or release
the restriction and wait the proscribed period of time (e.g., 60
days) before the organization is able to do so. The state attorney
general may object to the modification or release or request
additional information. Finally, if a donor is not living and a
fund does not qualify for the UPMIFA small, old fund process, an
organization may seek a court modification of the restriction.

Donor Smith is no longer living, so Donor Smith cannot be
consulted to modify the restriction. The age of the Smith Fund is
old enough (more than 100 years) and the value of the Smith Fund is
small enough ($25,000) under most, if not all, versions of UPMIFA
to seek a modification. ABC College should work with its counsel to
give notice to the state attorney general in accordance with the
statute. ABC College could request a modification of the
restriction to instead offer scholarships to women in a different
specified course of study or it could seek to have all restrictions
removed. The state attorney general will decide whether the
modification or release sought is acceptable. Once ABC College has
received notice of objection or has waited the proscribed period,
ABC College may move forward accordingly.

Looking Forward

Many of the problems that colleges or universities encounter
with respect to their endowments can be addressed proactively
through a clear and flexible gift agreement with donors. A gift
agreement that clearly sets out the donor’s intentions both at
the time of the gift and should unexpected circumstances arise in
the future is helpful for both the donor and the college or
university receiving the gift.

The content of this article is intended to provide a general guide
to the subject matter. Specialist advice should be sought about your
specific circumstances.

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