Accessing restricted funds amidst the COVID-19 crisis

The COVID-19 pandemic and resulting measures to encourage and enforce social distancing have resulted in a severe economic slowdown that is widely expected to lead to a deep recession, if not worse.  This downturn has hit charities hard.  Foundations have seen the value of their endowments plummet and investment income is likely to diminish significantly.  The economic downturn has also adversely affected donors’ ability to give, putting further downward pressure on revenue in the sector.  For charities that rely on in-person giving (e.g., plate collections by religious congregations), social distancing has had disastrous effects on fundraising.  How long this will continue is unknown, but charities are already struggling to support their charitable programs and meet their ongoing operating costs at a time when need in the community for their services has never been greater.

For charities that hold endowment or other restricted funds, a natural question arises: can we access these funds to support our programs, meet our expenses and enable us to continue operating during this time of crisis?

Restricted Funds

“Restricted funds” refer to funds given to charity subject to specific terms limiting how the charity is permitted to hold, invest or spend the funds.  These restrictions may be imposed by the terms set out in a gift agreement or other gift instrument (e.g., a Will).  They may also arise where a donor makes a gift in response to a specific donation appeal setting out how the funds would be held or used.  Common forms of restricted funds include “capital hold” restrictions in which the capital of the gift is required to be held in perpetuity or for some other time period, with only the investment income generated by the fund available to be spent.  Funds of this nature are often referred to as “endowment funds”.  Restricted funds also include funds that have been given by the donor for a specific charitable program or project of the charity.

Charities are legally required to adhere to the terms of any gift restrictions that apply to their funds.  Unless a court order has authorized a charity to vary the restrictions that apply to the funds, a charity and its board risk being found to be in breach of trust if funds are expended in a manner that contravenes the applicable gift restrictions.

Accessing Restricted Funds

There are numerous reasons why a charity may wish to access restricted funds, even in normal times.  Funds may have been given for programs or uses that are no longer practicable.  Funds may have been raised for particular programs that exceed the amount needed to carry out the program, resulting in a restricted surplus that cannot be used for the intended program.  In times of low investment returns, it may also be necessary to access the capital of endowment funds in order to meet a charity’s annual disbursement quota spending obligation under the Income Tax Act R.S.C., 1985, c.1.

In the current COVID-19 crisis, charities may need to access restricted funds simply to enable the charity to continue operating and avoid having to massively scale back operations, incur ruinous debt, or face insolvency.

In determining whether restricted funds can be accessed, the first step is to consider the terms of the applicable restrictions carefully.  Where the funds were given pursuant to a written gift instrument, the written instrument is the first place to look in determining the terms that apply to the funds.  It may be that the terms of the gift are less restrictive than the organization initially thought, giving greater flexibility to encroach on capital or otherwise use these funds.  Some funds also come with terms permitting the charity to vary the restrictions in circumstances where the original restrictions have become unworkable.  There may also be terms in a charity’s constating documents (i.e., letters patent, articles of incorporation, etc.) that speak to this issue and so they should be considered.

Where the terms of the gift do not give the charity flexibility to apply the funds as needed, it is possible to apply to court for a cy-près order varying the terms that apply to the funds.  The cy-près doctrine allows a court to vary the terms of a charitable gift where the original gift terms have become impossible or impracticable to carry out.

In Ontario, a special streamlined procedure exists under section 13 of the Charities Accounting Act, R.S.O. 1990, c. C.10 which enables a charity to apply to the Public Guardian and Trustee (PGT) for an order allowing the charity to vary the terms of restricted charitable funds.  The PGT can consent to such an order, which has the same effect as an order issued by a court.

Ontario Public Guardian and Trustee Temporary Guidelines

The Ontario PGT has recognized that the difficulties wrought by the COVID-19 crisis require increased flexibility in enabling charities in Ontario to access restricted funds.  On March 30, 2020, the PGT issued temporary guidelines to allow charities in danger of closing to access income and capital of restricted funds when necessary in order to continue operating during the COVID-19 pandemic.

These guidelines confirm that charities may access restricted funds prior to being granted a court order or section 13 order, provided that the following conditions are met:

• The organization is in danger of closing, which includes becoming insolvent or filing for bankruptcy or receivership, unless it can access the funds;
• The organization may only access the funds as a last resort. Non-restricted funds, including reserve funds, should be used first;
• The organization must first notify the PGT. Notification should include the name and address of the organization; the name of the perpetual endowment fund or the restricted purpose trust fund; and the name, address and telephone number of a contact person for the organization. The PGT will accept notification via email to cynthia.spencer@ontario.ca;
• All board members must approve the decision to use or encroach upon the funds and the decision should be documented contemporaneously. (The documentation will be required for the section 13 application referred to below;)
• Subject to the next bullet point, the funds must be used only for operating expenses and the contractual obligations of the charity and only to the extent necessary to maintain solvency. Operating expenses include: salaries, building expenses, utilities;
• If a charity’s purposes enable it to provide services in response to the COVID-19 pandemic, the funds may be used for such services;
• The organization must keep an accounting of the use of the funds;
• The organization shall apply for an order approving the encroachment under section 13 of the Charities Accounting Act R.S.O. 1990, c. C.10 within a reasonable time after the pandemic has subsided;
• The funds must not be transferred to another organization except in compliance with previously existing contractual obligations;
• The amounts withdrawn should be reasonable given the circumstances of the organization; and
• If it is necessary to sell stocks, bonds or other securities, the PGT will consider the sale reasonable even if there is a loss of capital, provided such investments are sold to an arms-length third party on the open market.

A copy of the guidelines is available here.

These guidelines provide welcome relief for charities that must access restricted funds in order to continue operating during the COVID-19 pandemic.  It is noteworthy that in addition to enabling charities to access restricted funds to continue operating generally, the guidelines specifically authorize charities to use restricted funds to carry out COVID-19 relief work, provided that this is not inconsistent with the charity’s general purposes.

It should also be noted that it will still be necessary to apply for a section 13 order approving the encroachment once the pandemic has subsided.

Salvage Doctrine

Charities outside Ontario may also be able to rely upon the trust law concept known as the “salvage doctrine.”  This doctrine provides, in essence, that where a charity faces a situation that is sufficiently dire that it will be unable to continue to operate unless it encroaches on its restricted funds (thus threatening the charity’s ability to carry out the more limited purpose of those funds), it may be possible for the charity to borrow from or encroach on its restricted funds in order to survive, notwithstanding the conditions.  This doctrine largely informs the approach taken by the Ontario PGT in the guidelines described above, and has been applied by courts to enable trustees to encroach on restricted trust funds in particularly exigent circumstances.

Relying on this doctrine in the absence of court approval does carry risk and it is strongly advised that charities obtain legal advice before encroaching on or otherwise borrowing from restricted funds in this manner.  However, given the circumstances faced by many charities in this difficult time, it may be appropriate to investigate whether this doctrine may apply and whether it provides a basis to encroach on restricted funds.

Conclusion

It is vital in this time of crisis that charities continue to deliver needed services in the community and around the world.  Charities should consider whether they may be able to rely on any of the approaches above to access restricted funds to assist them in carrying out their mission.  Miller Thomson’s Social Impact Group is available to help any charities with questions about their restricted funds.

 

Miller Thomson is closely monitoring the situation around the COVID-19 pandemic to ensure that we provide our clients with the appropriate support in this rapidly changing environment. For additional information, please see our COVID-19 resources page.