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Chapter 3 – Special Considerations for NonprofitsTreatment of Unrestricted and Restricted DonationsAuthored by: Michael Mosher, Avery S. Buffa and Alex Campbell, Mosher & Associates LLCOnce a nonprofit organization begins to consider bankruptcy or alternatives to bankruptcy, theorganization should evaluate all its restricted and unrestricted donations and grants. The issueof restricted charitable endowments in the context of nonprofit bankruptcy is not fully exploredin this section. But in general, bankruptcy law prevents unpaid creditors from receivingpayment from the corpus of a restricted charitable endowment. (Corpus is a term used to referto the principal of a trust, as distinguished from the interest earned on that principal.)Nonprofit organizations often receive a combination of restricted and unrestricted donations, aswell as grants from public or private entities that are program or event specific. For example, anonprofit may run several different programs, such as youth afterschool programs, eveningadult GED courses, and evening health and nutrition classes. Donors to the organization mayrequest that their donation be restricted to support the afterschool program or the eveninghealth and nutrition classes. Other donors to the organization may support the generaloperation of the organization without restricting how the nonprofit uses the donation.Grants to nonprofits, whether from government or private sources are often restricted tospecific programs—restricted grants are more often being used. Whether restricted orunrestricted, most grants may require the nonprofit to submit complete detailed and sometimescomplex reports to the funder. Grant reporting requirements are particularly rigorous forgovernment grants, some of which require the nonprofit to submit multiple reports each year.A nonprofit’s failure to complete reporting requirements for government grants may result ingrant funds being suspended, additional monitoring and oversight by the government, orcancellation of the grant. Finally, the government grantor can demand a refund of certain grantfunds, which may adversely affect the personal standing of the directors responsible for thegrant’s administration.As discussed in Chapter 1 of this Guide, when a nonprofit is considering bankruptcy or anyform of dissolution, the nonprofit must conduct a thorough review of its assets and liabilities.(All the while, the nonprofit must be diligent in completing and submitting all required grantreports. Failure to submit a required grant report may cause a grant to be revoked, and result ina demand for grant funds to be returned to the grantor, which creates an unfortunate situationwhere a grantor becomes a creditor, and what was once an asset is now a liability. It should benoted that in some grant agreements, certain individuals are required to make a reportirrespective of the fiscal status of the organization.)A thorough review should also be applied to the nonprofit’s restricted and unrestricteddonations or grants. More specifically, the nonprofit should isolate those liabilities associatedwith programs or services that have received restricted donations or grants, and then examinewhether the restricted grants or donations can be used to cover those liabilities. In addition, thenonprofit must carefully examine the terms and conditions of the restricted donations and44
grants to assess whether or not the restricted funds may be used to pay liabilities tangential tothe restricted nature of the donation or grant.One example is whether or not restricted donations to a nonprofit’s after-school program maybe used to pay the nonprofit’s liability for past due rent for the facility where the afterschoolprogram, among many other programs, is run. Nonprofits often make the mistake of simplyreturning restricted donations before carefully analyzing where and how restricted funds can beused to pay outstanding liabilities or creditors. If a nonprofit has questions regarding therestricted nature of a donation or grant, it should examine the terms and conditions of the grantor donation, preferably with its legal counsel. Nonprofits should be aware that the intention ofcertain restricted donations and grants may be so narrowly focused that the nonprofit will havean obligation to expend those funds only for the specified activity or project.A nonprofit considering bankruptcy should also discuss how it plans to handle on-goingdonations. If the bankruptcy discussions are in the early stages, a nonprofit may continue toreceive and apply donations and grants, whether restricted or unrestricted, to cover currentprogram and operating expenses. Once a nonprofit begins to seriously move towards Chapter 7liquidation, it should consider sending its donors a letter informing them that the nonprofit isconsidering liquidation, which is the precursor to a nonprofit’s dissolution. While such notice isnot required under the Bankruptcy Code, it may bode well from a relationship standpoint tokeep donors, especially significant and longstanding ones, informed of the nonprofit’s fiscalhealth and future.Further, by developing an effective communication plan for donors and funders, a nonprofitmay receive direction on how it may use restricted and unrestricted donations or grants. Whencommunicating to donors and funders, nonprofits should clearly articulate whether it isconsidering bankruptcy, moving towards bankruptcy, committed to filing a Chapter 11reorganization with the court, or committed to liquidating under Chapter 7. Nonprofits mayconsider asking those donors permission to use restricted funds to pay creditors that are outsidethe restricted scope of the specific donation or grant. Of course, whether or not to ask anydonors and grantors for permission to unchain their restrictions is a complicated question andmay not be a suitable or preferred strategy for all situations, and nonprofits are wise to consultlegal counsel before doing so. Regardless, it is essential that nonprofits have a clearunderstanding regarding when and for what unrestricted donations and grants may be used tocover its liabilities or pay creditors.When a nonprofit decides to petition for liquidation under Chapter 7, the nonprofit must, in thevery least, stop asking for donations and inform all of its funders of its plan to file for Chapter 7.In a Chapter 7 scenario, once a nonprofit has made its filing with the bankruptcy court, allreceived donations and grants received before the date of filing are considered assets of thebankruptcy estate. If there are unrestricted grants or donations, the Trustee can use those topay any creditors. In regard to restricted donations and grants, the Trustee should review theterms and conditions of each and determine whether or not they can be used to pay outstandingcreditors. Another complication can arise with bequests from the estates of deceased donors.For example, what happens if a nonprofit files for Chapter 7 and two weeks later it receives a$50,000.00 bequest from a donor who died three months before the Chapter 7 filing date. Is thebequest considered an asset of the estate? Does it make a difference if the donor died after the45
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