October 2013 Professional Tax & Estate Planning Notes
Templates for Flexibility: the Variance Power & Other Alternatives
Our March 2013 issue of Professional Notes explained how donor-imposed restrictions can be lifted or modified with the consent of the donor. The June 2013 issue summarized the court proceedings available when a donor is no longer available or will not agree to modify outmoded terms of a gift. The judicial approach can take the form of a cy pres proceeding, enabling an outdated purpose to be changed in a way that falls within the donor’s more general charitable intent, or an equitable deviation proceeding to modify obsolete or counterproductive administrative or procedural restrictions. In either of those situations, a court proceeding inevitably will mean uncertainty, delay, and expense.
This issue looks at ways to change outmoded gift restrictions without seeking court intervention. Specifically, we examine the discretionary power commonly known as the “variance power,” which gives a community foundation’s governing board the ability to change a fund’s purposes in limited circumstances. We also highlight the usefulness of writing wills and gift instruments with language that can be deftly adapted to changing times while still honoring the donor’s wishes. And we note a seeming paradox: a gift instrument that allows changes over time may be the best way to ensure the donor’s core wishes are honored.
Community Foundations and Their Variance Power
The first community foundation was created in 1914, recognizing two important concerns: first, the problem of the “dead hand”1 of irrelevance reaching out beyond the grave, and second, the benefit of placing grantmaking responsibility in the hands of a charitable entity that knows the community.2 The variance power was conceived as a way to avoid costly and uncertain judicial proceedings and to put the power to modify restrictions on a charitable fund into the hands of a board and a staff with deep expertise in the needs of the community.
The 1910’s and 1920’s were chaotic: a world war; the creation of unions; the busting of monopolies; women’s suffrage; and rapid technological advancement. Charitable institutions had to adapt to fast-changing times. Older charitable trusts posed challenges when they were no longer relevant. How could a community use a charitable trust limited to funding shelter for apprentices when there were no longer apprenticeships? How could a great metropolis use resources devoted to the care of its old horses when automobiles and mass transit had largely replaced them? Cy pres and deviation proceedings were often the only solutions. Yet thoughtful philanthropists recognized there had to be a better way.
The answer lay in the crafting of the gift instrument and the way it was administered: If the instrument could anticipate the possibility of change and if the process of change could be administered by people who understood both their donors and the needs of their community, then a gift could fulfill a donor’s core vision and continue to be relevant in perpetuity. The community foundation was the means to this end and still serves this function today.
In the 2010’s and 2020’s, technological and medical advances, changing patterns of immigration, and the long-term effects of climate change are among the forces we know will test even the most advanced contemporary ideas about philanthropy. We cannot know exactly how, of course, or what other as yet unimagined forces for change will emerge. But we do know the need for flexibility is at least as great as it was when community foundations came on the scene a century ago.
The Variance Power Standard
The variance power is at the core of community foundations; the exact standards for invoking that power differ. For example, the Cleveland Foundation, the country’s first community foundation, allows its board to change a fund’s purpose if it is no longer “wise or beneficial.” The New York Community Trust’s Resolution and Declaration of Trust, written nearly 90 years ago, provides that the board (known as the Distribution Committee) may use its judgment to redirect a donation if “circumstances have so changed” that it becomes “unnecessary, undesirable, impractical, or impossible” to achieve literal compliance.
In 1976, the Internal Revenue Service issued Treasury Regulations that endorsed and codified the variance power as an essential feature of community foundations. The regulations recognized that a community foundation that is comprised of many separate trusts is a single public charity, rather than treating the trusts as separate private foundations. As a result, donors who create their own funds within a community foundation enjoy more favorable income tax deductibility than donors who give to a private foundation, and their funds escape the tax on investment income and the annual distribution requirements that would apply to assets held in a private foundation. Filing a single information return with the IRS means significantly lower administrative costs.
To qualify for single entity treatment, the community foundation must meet several requirements, including having the power to modify the terms of a component trust or fund. Treas. Reg. §1.170A-9(f)(11)(v)(B)(1) provides that the governing body must have the power to modify a restriction on the use of a fund if a restriction effectively becomes “unnecessary, incapable of fulfillment, or inconsistent with the charitable needs of the community or area served.”
In addition, the regulations require the community foundation to commit to exercise the variance power in the best interests of the community trust. The governing body will be considered “not to be so committed … where it has grounds to exercise such a power and fails to exercise it …”3
Applying the Variance Power
Simply put, The New York Community Trust has a high standard for a variance action. It requires a change of circumstances since the execution of the gift instrument, as well as a finding that the change has made literal compliance with the original terms unnecessary, undesirable, impractical, or impossible.
Donors take comfort in knowing that the community foundation board, charged with decisions about the variance power, is a group of individuals with deep knowledge of the community and a commitment to fulfill donors’ desires. In the case of The New York Community Trust, six of the twelve Distribution Committee members are nominated by people holding various public or quasi-public positions: The chairman of the New York City Partnership; the Mayor of New York City; the president of the New York Academy of Medicine; the president of the Association of the Bar of the City of New York; the chairman of Lincoln Center; and the Chief Judge of the Second Circuit.
The standard allows substituting any purpose within the general purposes of the foundation, not merely the next closest purpose. In choosing the community foundation, a donor shows support for the foundation’s goals; thus the variance standard is similar to the modern cy pres standard which permits substituting a charitable purpose “which falls within the more general charitable intent of the settlor.”4 The New York Community Trust’s board, however, generally has sought to identify interests close to the donor’s original intentions—rather than switching, for example, to support of the arts when the donor’s intention was to advance medical research.
The Trust realizes that a donor may be uncomfortable with the remote possibility that the board might substitute a purpose inconsistent with his or her interests. The Trust staff is available to help craft language that will provide for alternative purpose if a particular restriction becomes problematic. For example, a donor interested in funding music education in public elementary schools might provide that, if music education is eliminated in public elementary schools, the fund should be used to support music education, wherever provided, that is made available to public school elementary students. That way, the board of The Trust wouldn’t have to use the variance power unless public school itself or the concept of public elementary education were eliminated.
Donors also take comfort in the fact that the variance power is infrequently used. In fact, The New York Community Trust and other community foundations have a record of going to great lengths to honor donor-imposed restrictions, even decades after a fund is created. Consider The Trust’s first fund, created in 1924. It continues to provide a cash award to P.S. 9 in New York City for the female student who “has earned the highest respect of her teachers.” P.S. 9 has changed locations during those nine decades, but the cash award continues.
Three examples where The Trust has exercised the variance power:
- A fund established under a will dating to the 1930s to help keep “aged and needy married persons” together so they would not be separated when they went into nursing homes. By the late 1980s, The Trust found that agencies did not track the marital status of the elders they served and that older couples frequently chose not to marry for family or financial reasons. The Trust concluded that circumstances had so changed that it was impractical to assist only married elderly couples. In exercising the variance power, The Trust was able to fulfill the donor’s core intent in a contemporary context and use the fund to help keep couples, married or not, from being separated in nursing homes.
- A scholarship fund with a $500 award cap. Inflation had made the $500 limit undesirable, and the pool of potential scholarship recipients was declining. The exercise of the variance power enabled the Trust to award scholarships of a more appropriate amount and, by doing this, fulfill the essence of the donor’s intention, which was to spend the entire fund on scholarships for a certain population.
- A fund for research in bacteriology and filterable viruses. In 1939, when the donor’s will was written, the term “filterable virus” referred to any of an array of disease-causing agents whose nature was not yet understood. Over time, as the nature of viruses was better understood, the filterable restriction became unnecessary and, to best carry out the donor’s intent, the variance power was invoked to delete the “filterable” reference.
As donors and their advisors hear of more and more cases of overly narrow gift restrictions that become problematic, they frequently consider and build flexibility into their gift instruments, even when the recipient is not a community foundation. This could be in the form of an expiration clause (so that the restriction falls away after a specified number of years), a discretionary power similar to the variance power, or a cascading series of alternative purposes, perhaps with a variance-type power if all of those fail. This negotiated flexibility is an excellent way to ensure that a gift can continue to meet the needs of an organization and the community it serves. Some organizations insist on such provisions, and lawyers and other advisors should urge their clients to weigh the benefits of restrictions that are flexible enough to reflect personal wishes while allowing efficient adaptation to change.
For many donors, their interest in a specific purpose, or a specific way of fulfilling a purpose, is the manifestation of a larger charitable intent. They have very little interest in seeing their donation eroded by the costs of a legal proceeding necessitated by changed circumstances that they did not, or could not, foresee. They also do not want their philanthropy to become marginal or quaint. They do, on the other hand, have a strong interest in doing good in their community and seeing that their philanthropy remains relevant in a world that, inevitably, will change. Paradoxically, the best way to ensure that their core wishes are followed may be a gift instrument that is clear about core purposes, but flexible enough to allow for thoughtful changes over time.
The community foundation movement recognized the value of this approach in the early 20th century, and the community foundation variance power is one way a donor can balance the desire for specificity and the desire for thoughtful flexibility over time. For donors who choose charities that are not community foundations, those goals may be achievable through gift instruments that permit the purposes of a gift to change in certain circumstances.
Narrow restrictions on the purpose and administration of a charitable gift increase the likelihood that the recipient organization will eventually have to take steps to change the terms. It is crucial that lawyers and their clients speak candidly with one another, and with charities, about the ways a particular restriction might become troublesome. Sometimes, donors who start with a very specific purpose are surprised to discern a broader purpose to their philanthropy and to discover that there may be a way to meet their immediate goals while paving the way for the inevitable changed circumstances of the future.
For further reference, see:
Christopher R. Hoyt, Legal Compendium for Community Foundations, 2d ed. (Council on Foundations, 1996).
Other issues in this series:
1Sir Arthur Hobhouse is credited with coining the “dead hand” term, asserting “The grip of the dead hand shall be shaken off absolutely and finally; in other words that there shall always be a living and reasonable owner of property, to manage it according to the wants of mankind.” Nathaniel R. Howard, Trust for All Time (1963).
2 Today, many community foundations are organized in corporate form, without trustee banks.
3 Treas. Reg. §1.170A-9(f)(11)(v)(E)
4 Restatement (2d) of Trusts, Section 399 (1959)
© Copyright 2013.
By Jane L. Wilton, general counsel, with special thanks to John Sare of Patterson Belknap Webb & Tyler LLP.
This material was developed for The New York Community Trust. We publish it with the understanding that neither the publisher nor the author is engaged in rendering legal, accounting, or other professional advice. If you require legal advice or other expert assistance, consult a professional.