The Charity in Bankruptcy and Ghosts of Donors Past, Present, and Future
60 Pages Posted: 19 Jul 2006
The bankruptcy of a charity represents the clash of two policy regimes: charity law's willingness to preserve assets for the public purpose determined by the donor as against bankruptcy law's desire to maximize assets for distribution to creditors. As a general rule, assets will be distributed to creditors; as the courts say, 'a man must be just before he is generous.' However, when a charitable donee goes out of existence or otherwise becomes unable to perform a charitable trust or restricted gift, the courts will try to identify those charitable assets that are restricted in such a manner that they survive the bankruptcy proceeding. These assets excluded from the bankruptcy estate are instead subject to the venerable doctrine of cy pres, regardless of whether the charity is a charitable trust or a corporate charity. Charitable trusts and restricted gifts, if they can no longer be performed as originally specified, are modified for another use by the same charity or are transferred to another charity, subject to the same or modified purpose. It is common for the cy pres proceeding to occur in state court, rather than in the federal bankruptcy proceeding.
This approach views any particular charity holding a restricted gift as distinct from the contemplated beneficiaries of that gift. Despite its benefits to society, such a policy also carries negative implications for the governance of individual nonprofit organizations. Sympathy for charitable beneficiaries in bankruptcy can make it harder for all charities - including those not in financial distress - to obtain needed financing. Less obviously, but perhaps more seriously, over accommodating courts that wall off charity assets from bankruptcy creditors can further an already pervasive view that charitable property is 'public' to an inappropriate degree.
Keywords: Bankruptcy, charitable assets, charity law, restricted gifts, trusts
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