Bequests in wills and trusts can be a considerable source of income for charitable organizations.  Such organizations and their counsel, while remaining sensitive to the concerns of donors’ families, are well advised to pursue and protect their interests in any estate or trust proceeding involving a charitable bequest.  I describe here some important considerations on how best to protect the charitable interests in trusts and estates.

Review the instrument, such as the will or trust document, which provides for a bequest or payment to a charity.¹
If a charity learns that it has an interest in an estate or trust, someone should review the actual instrument in which such interest is set forth.  This should include ascertaining the amount or nature of the interest (including whether it is an outright payment of a specific amount, or a portion of the residuary), as well as any restriction imposed on the charitable gift being provided.  The charity and its counsel should not simply rely on a representation by counsel for the estate or trust, but ask to at least review the relevant language in the instrument.

If a specific amount is being given to a charity, it should make sure that the full amount is received. 
Outright payments should ordinarily be paid in full, and not subject to reductions for fees or taxes, which are not ordinarily the responsibility of charities that receive outright bequests or payments.  If a charity is asked to sign a receipt and release in order to receive the payment, it should make sure it receives the full amount.²

If a charitable gift or bequest is subject to a restriction (such as requiring it to be used for a particular purpose, and/or putting the monies into an endowment), the charity should determine that it is prepared to honor the restriction before accepting the gift. 
If for any reason a charity determines that a restriction is onerous (such as for a use which would be difficult to carry out) or inappropriate (such as for a purpose which is not part of its mission or is otherwise problematic), it should not accept the gift or bequest.  A charity should be prepared to honor scrupulously any restriction which is imposed, including any naming or honor which it is required to bestow.

If the beneficiary of a will or trust is named in the residuary (that is, the assets in a deceased person’s estate after all gifts are bequeathed and debts, taxes, administrative costs, probate fees and court costs are paid), the residuary beneficiary will be impacted by those fees and expenses.  It should therefore consider the conduct of the executor(s) or trustee(s) and the reasonableness of the fees and expenses of administering the estate or trust before signing off on an accounting by the fiduciary. 
An executor’s management of estate assets might improperly reduce the total value of the estate or trust (such as through imprudent investments or inappropriate expenditures).  The legal fees charged by the attorney representing the estate or trust could also impact the estate’s beneficiaries.  In both scenarios, assuming the charity has an interest in the residuary (as a recipient of an outright bequest should not be impacted by these considerations), charitable organizations have a right to challenge the accounting submitted by the executor (whether it is a judicial accounting submitted to the court or an informal accounting submitted to the interested parties.)

A will or trust instrument might be challenged by a family member who would benefit from the instrument being declared invalid.
When an individual chooses to leave substantial sums to charity in his or her will or trust instrument, such a bequest is often made to the detriment of the decedent’s family.  A relative of a decedent who is a “distributee” (that is, who would inherit from an estate by virtue of the relationship with the decedent in the absence of a will or trust), has legal standing to challenge the validity of the instrument.  The rules governing intestacy in New York are set forth in New York Estates, Powers and Trusts Law (EPTL) §4-1.1. Similar statutes exist in other states. The estate of a decedent who dies without a will is distributed among the distributees in a manner and order prescribed by the applicable state statute.

There are a variety of reasons why a will or trust might be challenged. 
They could include: (a) the lack of testamentary capacity of a decedent; (b) undue influence exerted on a decedent; or (c) an improperly prepared or witnessed instrument.  The technical rules on properly preparing and witnessing a will or trust are governed by state law.

Testamentary capacity and undue influence are related concepts which often form a basis for challenging the validity of a will or trust instrument. 
The testamentary capacity of the decedent can sometimes be a crucial issue, particularly when a decedent has executed multiple wills or trust instruments, has executed a codicil to a will or an amendment to a trust, has revoked a will, or has executed a document at a point in time where cognitive ability might be called into question. Since any amendments might prejudice the interest of at least one party to the original instrument, it is common for the party whose interests are impaired to raise concerns regarding the capacity of the testator or grantor.

When the testamentary capacity of a decedent is challenged, questions might be raised as to whether a beneficiary exerted undue influence to induce the allegedly vulnerable decedent to transfer or bequeath money to that beneficiary.  Charitable organizations can face both sides of these issues of capacity and undue influence, depending on whether their interests are best served by an earlier or the most recent instrument.

The circumstances with respect to a dispute involving an estate or trust, including whether a charity supports or opposes the disputed instrument, will impact the manner in which the attorney might best represent a charity.
If, for example, the charity supports the validity of the will or trust, the defense will ordinarily be led by counsel for the executor or trustee, and the charity’s attorney can minimize expenses by cooperating with or supplementing the actions of the estate or trust counsel.  If, on the other hand, a charity challenges a will or trust which might supersede a prior instrument in which the charity had a greater interest, its counsel would often have to play a more active role, perhaps in cooperation with other similarly aggrieved parties.

In New York, the Attorney General is a necessary party in proceedings where a charity has a residuary interest.
In New York and any other state where the Attorney General might have such authority, cooperation and coordination with the AG’s office in instances of disputes or questions can often enhance the likelihood that a charity will achieve a more favorable result. This could include a charity joining the Attorney General in defending or challenging a will or trust in which the charity has an interest, or disputing excessive legal fees or expenses or imprudent conduct by fiduciaries. The result can be achieved through either litigation or settlement.

Conclusion: Charitable organizations should be aware of the various issues that can arise in estate and trust matters, many of which can potentially affect the benefit ultimately received by charitable beneficiaries.
Organizations should work with their legal counsel to conduct appropriate due diligence and ensure that the organization’s interests have been protected before consenting to probate of a will or to the fees and expenses reflected in an accounting.

The post Protecting Charitable Interests in Trusts and Estates appeared first on Perlman & Perlman.

Total compensation must be reasonable under federal law such that the organization complies with the private inurement doctrine. 
A 501(c)(3) organization must be organized and operated so that no part of its net earnings inures to the benefit of any private shareholder or individual.  It has long been held by the federal courts that “the payment of reasonable salaries by an allegedly tax-exempt organization does not result in the inurement of net earnings to the benefit of private individuals.”[1]

Assessing the reasonableness of compensation is largely a market driven analysis. 
An executive’s compensation is properly compared to individuals in similar positions at organizations of a similar size, in the same or a comparable geographical area, performing similar services.  The experience, expertise, and accomplishments of the individual are also taken into consideration.  It is appropriate to hire a qualified independent consultant to conduct a market analysis to ensure that compensation is reasonable.

The total compensation of an executive, and not merely the base salary or cash compensation, must be considered in determining whether compensation is reasonable. 
All compensation and benefits, including bonuses, deferred compensation, pension payments, and other perks not provided for legitimate business purposes are to be considered in calculating the total compensation at issue.

In the event that an executive is paid severance upon termination, any severance payments must be reasonable to assure compliance with applicable laws. 
The payment of excessive severance can itself be deemed excess compensation in violation of state and federal laws. An exception, for example, might be in connection with the reasonable settlement of a claim against the organization for improper termination.

Entering into a formal written contract with a senior executive can be advantageous for both the organization and the executive to ensure compliance with the laws governing executive compensation. 
Such a contract should set forth the duties and responsibilities of the executive, and thereby set standards for evaluating the executive.  It should also establish appropriate severance in the event of termination without cause.

Board members of charitable organizations in the various states have a fiduciary duty to preserve the organizations’ charitable assets, to supervise and oversee the administration of the organization’s’ assets, and to establish mechanisms designed to protect against the squandering or misuse of such assets.
This includes the authorization and payment of reasonable compensation and benefits to executives, and establishing mechanisms and internal controls to protect the organization’s expenditures.  Some states have specific laws requiring that compensation be reasonable.

The federal “intermediate sanctions” law, enacted by Congress in 1996, permits the IRS to impose excise tax penalties on charities executives who receive excess compensation (an “excess benefit transaction”) and on an organization manager or other person who is in a position to exercise substantial influence over the affairs of the organization.[2] 
In addition to paying a 25% excise tax on any excess compensation received, the executive must also make a correction and return the excess amount to the organization or face a confiscatory second tier tax.  The executive can be assessed the tax even if he or she acted in good faith and without knowledge that the compensation was excessive.

An organization manager can be assessed an excise tax only when he or she participated in an excess benefit transaction “knowing that it is such a transaction, … unless such participation is not willful and is due to reasonable cause.” 
If a board member or other organization manager has relied in good faith on professional advice that the compensation paid is reasonable, this would provide a strong defense against any IRS claim that excise taxes should be imposed.

It is significant to note that, under formal IRS rules, an executive is entitled to a rebuttable presumption that his or her compensation is reasonable if a three-step test has been satisfied.  

First Requirement: Compensation Fixed by An Independent Board
Board members must act independently and at arm’s length, and relatives and business associates of an executive should be excluded from any participation in fixing such individual’s compensation and benefits.

Second Requirement: Reliance on Appropriate Data as to Comparability
The IRS Regulations specify that the relevant information upon which the authorized body may rely “includes, but is not limited to, compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; the availability of similar services in the geographic area of the applicable tax-exempt organization; current compensation surveys compiled by independent firms; and actual written offers from similar institutions competing for the services of the disqualified person.”

Third Requirement: Adequately Document Basis for Determination of Compensation
The board of a charity should, through formal board minutes, a written employment contract, an independent compensation survey, and/or other relevant documentation demonstrate the basis for the compensation paid.

Improper excess benefits can be quite varied. 
Areas which might be scrutinized by government regulators could include: purchases or leases of automobiles; payments of country-club dues; use of apartments, interest-free loans; travel expenses; use of charity credit cards without documentation; and blanket amounts to spend on expenses.

Summary: General Considerations in Fixing Compensation

• Decisions should be made by an independent board of directors at arm’s length.
• There should be Board minutes and/or other documents reflecting the criteria and basis for fixing compensation.
• Total compensation should reflect the fair market value of the executive’s services.
• Where appropriate, there should be reliance on an independent compensation survey.

[1] Founding Church of Scientology v. U.S., 412 F.2d 1197, 1200 (Ct. Claims, 1969), cert. denied, 397 U.S. 1099 (1970).

[2] The intermediate sanctions rules apply to both 501(c)(3) and 501(c)(4) organizations.  They do not apply to private foundations, as the well-established self-dealing rules in the Internal Revenue Code already barred payment of excessive compensation to executives of private foundations.

The post What Can They Be Paid? Advising Charitable Organizations on Executive Compensation appeared first on Perlman & Perlman.

Attorneys for nonprofits are ultimately responsible to their boards.

Since there are no owners or shareholders of a nonprofit organization, they are supervised by their boards in accordance with the directors’ fiduciary duties.  This means that boards must be informed of any problems or possible issues by senior staff and/or by the organization’s attorneys.  It is incumbent upon legal counsel to ensure that the board is notified of such problems in a timely manner and engaged in their resolution.

Depending on the circumstances, attorneys should maintain communication with the Board Chair, and with the entire board when appropriate. 

This is particularly important if there are problems meriting board knowledge and involvement.  Attorneys should ensure that board members are informed and engaged and act in an independent manner.

There are no specific ethical rules governing representation of nonprofit organizations.

The rules and cases construing professional responsibility in the for-profit context offer significant guidance.  Certainly, court decisions that apply the attorney ethics rules to situations involving nonprofit clients can be of particular assistance.

An attorney representing an organization owes a duty to the organization rather than any persons employed by or associated with the organization. (See ABA Model Rule 1.13)

When an attorney who is employed or retained by an organization is dealing with its directors, officers, or employees, if it appears that the organization’s interests may differ from the individual’s interests, the attorney is obligated to explain to the individual that he or she represents the organization and not the individual.  NYRPC 1.13(a).

If the attorney knows that a person involved with the organization is acting in a manner that violates, or is likely to violate, the legal obligations of the organization, and the attorney determines that this violation is likely to result in substantial injury to the organization, the attorney is obligated to proceed as is “reasonably necessary in the best interests of the organization.”  NYRPC 1.13(b).

If an issue arises whereby the attorney may have a conflict of interest as a result of prior representation of the organization, the attorney should consider advising the organization to retain other counsel.  For example, if an attorney has handled a transaction for a client that later winds up in litigation, the client should retain an attorney for the litigation who was not involved in the initial transaction.

Examples of where an attorney should ensure that nonprofit boards act appropriately and independently from senior leadership include:

• Setting compensation for top executives
• Overseeing conduct and performance of executives
• Addressing complaints or problems involving executives, including allegations of discrimination or harassment
• Addressing allegedly inappropriate or illegal conduct within the organization
• Responding properly to whistleblower complaints
• Complying with conflict of interest and related party rules and law

Summary:

In the practice of representing a nonprofit organization, attorneys must consider their ethical obligations to ensure that the organization will be well-served and in compliance with legal requirements.

The information provided in this article does not constitute legal advice, and is not intended to substitute for legal counsel.

The post Ethical Considerations in Providing Legal Advice to Nonprofits and their Boards appeared first on Perlman & Perlman.