Amy Hereford - Charitable Trusts

In recent years certain FASB statements [1] has prompted auditors of the civil corporations of religious institutes [2] to propose consolidation of financial statements of the institute’s charitable trust with those of the donor corporation, or to include a beneficial interest in the charitable trust in the donor corporation’s statements. [3] Consolidation of the financial statements of a trust with those of the donor corporation of the religious institute is disadvantageous to the Order because 1) it gives the appearance on the audit statement that the donor has control of the trust monies, and 2) the trust may lose some of its ability to protect assets because its assets do not appear to be separate from those of the Order. In other words, consolidation works to negate the very benefit that the trust was set up to obtain.

The FASB development and several decades of experience with charitable trusts have led to a rethinking of the use of this device to protect retirement assets. In the light of this, institutes are encouraged to review the purposes for which they set up these trusts, consider the nature of charitable trusts and their ability to carry out the institute’s purposes, evaluate the practice of the institute in the actual administration of the trust, and take appropriate action to ensure the institute achieves the purposes for which the trust was established.

A. Applicable FASB Statements

Two FASB statements raise questions about the treatment of trusts within the audit of the donor corporation. The Statement of Position 94-3 (SOP 94-3) gives guidance for consolidating financial statements when the corporation being audited has a controlling interest or an economic interest in another organization. Paragraphs 13 and 15 of FASB 136, define a specified beneficiary as having rights to the assets of the trust. Should the auditors of the donor corporation choose to use either of these statements as a basis for inclusion of the trust in the audit of the corporation, the separation between the trust and the donor corporation may be weakened. In either case, if the auditor consolidates the financial statements or identifies the corporation as having a beneficial interest in the trust, the relationship evidenced on the audited statements is inconsistent with the legal reality that a donor can have no financial interest in an irrevocable charitable trust. This is particularly true if there is a faithful implementation of the trust document in distributing funds to beneficiaries.

As a result, 1) this treatment of the trust gives the appearance on the audit that the donor has control of or an economic interest in the trust, and 2) the corporation will carry the beneficial interest from the trust as an asset, which doesn't reflect the legal reality of the separation of the trust from the corporation. While accounting treatment cannot determine the legal reality, it works against the legal structures set up to protect the assets.

1. SOP 94-3

The consolidation of statements called for by SOP 94-3 is premised on two factors:

· An economic interest and control through a majority voting interest in the organization’s board.

In the charitable retirement trusts of religious institutes the controlling interest may be exercised through a number of devices. These include: appointment of the trustees by the donor corporation, donor corporation directing disbursement, corporate finance committee oversight of investments, corporate finance officer providing information on needed disbursements, disbursements made by the corporate finance officer, disbursements made to the corporate checking accounts, corporate finance officer actions with regard to trust subject to corporate auditor.

If several of these controls are in place, through the documents, or in actual practice, consolidation may be appropriate. However, if the trust is actually independent of the control of the donor corporation, consolidation is not appropriate.

The auditor of the financial statements of the civil corporation views those statements from the perspective of that corporation. The beneficiaries of the trust are members of the congregation, but they are generally not members of the corporation and have no civil law relationship to that corporation. Separation of the donor (civil corporation) from the beneficiaries (unincorporated association of the congregation), and separation of these two from the trust supports non-consolidation of financial statements. However, there are many practical obstacles to maintaining separation between these parties.

Consider for example a scenario in which the officers of the donor corporation, the trustees of the trust and the beneficiaries of the trust overlap, each group being comprised of some members of the other two groups. This scenario would be further complicated if the finance office of the institute was responsible for the accounting for the corporation and trust and the beneficiary association. Some overlap of roles and responsibilities can be maintained successfully, however it requires a precise understanding of the operative rules of law and principles of accounting and the necessary sophistication to maintain clarity in documents and in practice.

While consolidation of financial statements would not automatically make the assets of the trust available to the donor’s creditors, it could weaken the donor’s argument that trust assets are separate and expose these assets to attack.

2. FASB 136, Paragraph 13

Auditors have used FASB 136, Paragraph 13 to support the consolidation of the financial statements of the trust and the donor corporation. Paragraph 13 establishes conditions for consolidation of financial statements between a trust and its beneficiaries.

“The recipient organization (the trust) and the specified beneficiary are financially interrelated organizations if the relationship between them has both of the following characteristics: One organization has the ability to influence the operating and financial decisions of the other, and one organization has an ongoing economic interest in the net assets of the other.” Emphasis added.

Paragraph 13 defines the characteristics of a relationship between the trust and the beneficiaries. It does not apply in any way to the consolidation of financial statements of the trust with those of the corporation. Since the donor corporation is not a party in the relationship described in this Paragraph, it does not apply.

It can further be noted that in a charitable trust, by definition the beneficiary class must be indefinite. The beneficiaries of the trust are the qualified members of the congregation, so that no single beneficiary has an enforceable right to specific assets. Paragraph 13 refers to a “specified beneficiary”, thus excluding charitable trusts in which by definition, the beneficiaries are unspecified members of the class.

3. FASB 136, Paragraph 15

FASB 136, Paragraph 15 states that a specified beneficiary shall recognize its rights to the assets held by a trust as an asset unless the trust is explicitly granted variance power. “Those rights are either an interest in the net assets of the recipient organization, a beneficial interest, or a receivable.”

This paragraph is about the trust. Like Paragraph 13 above, it describes the characteristics of a relationship between the trust and the beneficiaries. It does not apply in any way to the relationship between the trust and the corporation or to the consolidation of financial statements of the trust and the corporation. Since the donor corporation is not a party in this relationship described in this Paragraph, it does not apply. In a charitable trust, no assets can run back to the donor. Since the donor corporation being audited has no rights to trust assets, there is no beneficial interest to be reported.

4. Audits

The key to the proper handling of an audit is to make sure the auditor understands the structure of the trust. The donor, the trust and the beneficiaries are three legally separate entities. If the trust is properly established and properly administered, the distinction between these parties is sufficiently maintained, and the audit should reflect that legal distinction among the parties. The next section will explain the legal principles underlying charitable retirement trusts of religious institutes.

B. Legal Background and Theory

Two classes of reasons have been advanced for the establishment of charitable trusts by religious institutes:

2. Protection from External Challenge: Shielding assets from use to satisfy potential adverse legal judgments against the corporation.

Charitable trusts are one of many tools that have been advanced for accomplishing these goals. Other tools exist. For example, education of leadership and of membership to responsible use of assets is an important tool in protecting them from internal challenge. Risk management also provides an array of tools that an institute could employ to provide protection from external challenge. These tools include insurance and/or elimination of risk through modification or avoidance of high-risk activities. In addition, an institute may use a variety of other entities such as a separate corporation or foundation, or a restricted account for the protection of assets.

In addition to these protective purposes, a charitable trust may be set up primarily as a tool for the administration and management of the retirement assets of an institute, without a specific protective purpose in mind. The protective uses of the trust, and avoidance of consolidation of financial statements discussed herein may be less relevant for trusts established merely for administrative purposes.

This document will primarily address the use of the charitable trusts only for protection from external challenge. However, before turning to that topic, some mention should be made of the use of a charitable retirement trust for protection from internal challenge.

1. Shielding Assets from Leadership and Membership

Shielding retirement assets from leadership and membership may be accomplished by creation of a charitable trust that effectively shields the assets from a third party. However, it will be difficult to completely shield retirement trust assets from internal challenge if the trust purposes are sufficiently broad and the trustees are drawn from leadership and membership.
The purpose of this instrument is to entrust the management and disbursement of assets to a third party who is given a certain flexibility of action. The trustees must be given discretion in this regard, though their discretion is limited in the trust document.[4]
On the one hand, trustees, acting within the scope of their fiduciary responsibility, may be very generous with disbursement for retirement needs of the members, thus drawing down the trust assets, and lessening the financial burden on the institute's operations budget. For example trustees may vote to finance needed renovation or construction of an institute's retirement facility. As long as the use is within the scope of the purposes set forth in the trust documents, the trustees could lawfully make this disbursement, presuming that there were still sufficient assets for the ongoing care of the members' retirement needs.

On the other hand, the trustees, still acting within the scope of the same fiduciary responsibilities, may narrowly interpret the retirement needs and make only limited disbursements for retirement needs of the members. These trustees may elect not to finance the renovation or construction of the retirement facility. In this case, the institute will be left to draw on its operating funds to supplement the retirement needs of members.

If leadership and membership understand the nature of the trust, they will realize that trustee discretion is flexible and can be used indirectly to increase or decrease funds available for ministry projects. Creation of a charitable trust places real limits on the use of the funds, and protects them from reckless diversion to operations. However, it does not set them completely beyond the reaches of those who would seek to drain the trust in the interest of enhancing funds available for ministry choices or other activities. It is important therefore for leadership and membership to appreciate the appropriate balance between using the charitable trust for retirement needs, and using its assets responsibly without undue regard for other needs of the institute.

2. Case Study:

In order to understand the proper operation of a trust as a tool to protect from external challenge, it is important to view it from a defensive stance. Although charitable trusts have a 500-year history, it is important to note that the charitable retirement trust specifically as used by religious orders has never been tested in court. This section will briefly set out the posture of a legal challenge to the trust by using a fictitious case study.

Sister X has had eye trouble for some years, and has difficulty with her vision. Nevertheless, she is still able to pass the driver’s vision test, and still drives the community’s car. Sister has had some minor automotive mishaps but to date there have been no serious accidents. The sisters in her community know of Sister’s trouble, and several report that they are afraid to ride in the car when she is driving. The leadership has approached Sister and requested that she discontinue driving, citing her failing vision and the series of incidents that have occurred. Sister appreciates their concern, but states that their fears are misplaced. She insists that she has always been a good driver and her vision is still good enough for driving, after all, she continues to pass the vision test. The ‘little incidents’ that have occurred have been entirely the fault of others, and furthermore she continues to be active and needs to drive to carry on her ministry.

In the case of a serious accident and subsequent lawsuit against Sister X, the plaintiff will attempt to join the order’s corporation and/or the unincorporated association as co-defendants. Liability running to the institute would be first premised on the member’s action that caused injury to the plaintiff. [5]

Second, the plaintiff would have to establish that there was a positive legal duty of the corporation to supervise the member’s driving since she was driving a car that was a corporate asset. [6]

Then the plaintiff would attempt to show that the order neglected this legal duty. They knew of the member’s vision problems, and other members of the community were afraid to ride with her. They had actually addressed the issue with the member. Had they properly supervised the member, she would not have been driving. Since they neglected their duty, the member was driving. The order’s neglect of its duty to supervise thus contributed to the plaintiff’s injury.

The plaintiff would attempt to show that based on a theory of vicarious liability, the order should be held legally responsible for the malfeasance of the member and that it should pay for the damages sustained by the plaintiff and caused by the member.

If the plaintiff were successful in the underlying claim, and further successful in pressing the claim of negligence and vicarious liability against the order, the plaintiff would then attempt to attach the assets of the trust by claiming that these assets were in fact the assets of the donor corporation that should be used to satisfy the plaintiff’s judgment.

Attacking the trust is a formidable challenge. The trust would be defended not only by the trustees and the beneficiaries, but by the state Attorney General as well. In a charitable trust, the state Attorney General is charged with enforcing the trust, and by extension with defending the trust from attack. There are several reasons for this. First, a charitable trust is established for the benefit of society as a whole, through a specific purpose of benefiting one segment of society. Therefore society as a whole has an interest in the ongoing benefit of the trust. The second reason is that the class of beneficiaries in a charitable trust is indefinite and uncertain, therefore single beneficiary or group of beneficiaries may not adequately represent the interests of all potential beneficiaries. Furthermore, assets from a 501(c)(3) trust may not inure to the benefit of any private individual. [7]

This example presents a risk that is very common in religious communities and in society at large. US streets and roads are populated with people of varying levels of competence. Even when this competence falls below a certain minimum, many people are reluctant to surrender driving privileges.

As was demonstrated above, there are many links in the chain stretching from the plaintiff, to the member, then to the institute and finally to the trust. Each link represents a legal hurdle for the potential plaintiff, and an opportunity for risk management for the religious institute and its corporation. While a trust may provide protection of assets, it should not be relied upon to get the institute off the hook from doing its homework in managing its assets.

In this case, the first and most obvious protection is identifying risks and sources of potential lawsuits. Here, the member’s driving is a source of risk. The leadership knew of the series of minor accidents and of the member’s vision problems. Although they attempted to address the issue, they did not go far enough to prevent the hazard from continuing. In this case, a community driving policy [8] could help. The policy should establish both positive driver education standards [9] and negative factors that would trigger loss of driving privileges including disability, accident record and traffic violations. The policy should then be followed, and drivers must be ‘retired’ from driving when the policy indicates they can no longer drive safely. In addition to eliminating risk, the policy could be a defense by showing that the order is supervising drivers responsibly. [10] It should be noted that the purpose of the policy is to promote responsible use of corporate assets. It must be applied effectively to accomplish this goal. From a liability point of view, a policy that is not followed is worse than no policy at all.

Basic automobile insurance could be purchased to address this type of liability. However, there are other types of liability, e.g. sexual abuse, where damages can be extremely high, and insurance may be missing or inadequate. In these rare, but catastrophic cases, a well drawn and well run trust will provide an added layer of protection.

3. Shielding Assets from Adverse Legal Judgments

Each institute is unique in the types of exposure it has, and the probability that it will sustain a significant legal challenge. In addition each institute is unique in its ability to sustain such a challenge legally and financially. Finally, each institute has a unique level of risk tolerance. After evaluating its strength and weakness in each of these areas, an institute should determine the appropriateness of the use of the trust as a protection from external legal challenge.

If an institute chooses to use a charitable trust to shield its assets from adverse legal judgments such as that discussed above, it should first consider the nature of a charitable trust and its ability to protect assets, then take appropriate action to ensure the trust is organized and administered in such a way that it will provide the required protection.

In general, a trust is a legal mechanism by which a donor, the “Settlor” separates the legal interest in property from the equitable interest. The legal interest is the bare title to the property while the equitable interest is benefit deriving from ownership of the property. In establishing a trust, the donor transfers the legal interest to the trustee/s and the equitable interest to the beneficiaries. In a non-charitable trust, the donor can be either the trustee or the beneficiary of the trust, but not both. The trustee and beneficiary cannot be the identical person or entity, because then the legal and equitable interests would merge and the trust would fail. The trustee/s must exercise some discretion as to the management of the assets and distribution to the beneficiaries.

There are further particular requirements for charitable trusts. First is the requirement that the donor cannot be a member of the beneficiary class, and that none of the assets of the trust can run to the benefit of the donor. Second, the beneficiary class must be sufficiently broad that the trust is not set up for the benefit of a certain nameable group. [11] Third, if the trust is to enjoy the benefits of tax exemption, the charitable purpose must fit within the IRS requirements for a 501(c)3 entity. [12]

The trust is set up through a trust document in which the donor sets aside assets for the trust, names the initial trustees and the beneficiaries and provides clear instructions as to how the trustees are to administer the trust and distribute its income. In addition it identifies the governing law, and for a charitable trust, it establishes the tax-exempt nature of the trust. The document may contain a spendthrift clause, designed to protect assets of the trust from distribution for the benefit of creditors of the beneficiaries particularly from judgment creditors.

In the case of a religious institute’s charitable trust, the trust works in theory because the donor is the institute’s civil corporation, the trustees are independent, though they are often drawn from the leadership and membership, and the beneficiary is the unincorporated association of the members of the institute. These three parties, the donor, the trustees and the beneficiaries must be clear and distinct. When it is properly drawn, the trust is another entity separate from the donor. The trustee/s control the trust, and must be allowed discretion in both the investment and the disbursement of trust assets. They must at least have the power to ensure that the assets are managed, and disbursements are made according to the purposes established for the trust. This highlights the need for clear and careful drafting of the trust.

The trust must be sufficiently distanced from the donor’s control if it is to be protected from an adverse judgment against the donor. If the donor has retained sufficient control to appoint succeeding trustees the FASB statement may require consolidation of statements. In addition, it will be more difficult to argue that the assets should be protected from a potential adverse judgment in a lawsuit against the donor. If the donor has retained sufficient control, a successful plaintiff may be able show that the trust is a sham and that the donor is still in control of the assets.

If the trustee is identical to the beneficiary the trust will fail through a merger of the legal and equitable interests. However, as long as there is at least some difference between trustees and Beneficiaries, there will not be a merger. [13] Even if there are several Beneficiaries serving as trustees, the courts have found that merger will not occur. Therefore, in a charitable trust for the retirement needs of a religious institute, members of the institute, or even retired members can serve as trustees.

For the creation of a charitable trust, there must be an indefinite class of beneficiaries. [14] It is not inconceivable that the members of a beneficiary class of the aged/infirm members of an institute may disappear. In this case, if there is no other charitable class provided in the trust document, the Attorney General who is charged with enforcing charitable trusts may urge the court to carry out the general charitable intent of the donor, through application of the cy pres doctrine. [15] However before this happens the trust may be amended by the party who is given this power in the trust documents. The beneficiary clause could conceivably be broadened or a secondary purpose could be added. The clause may be extended to include the aged and/or infirm members of XXX institute as the primary class, and members of other religious institutes similarly situated as a secondary beneficiary class. The secondary purpose will keep the class from being impermissibly narrow. [16] Alternatively the trust purpose could be broadened to include care and support of all members of the institute or it could be for the mission of the institute. However, as this purpose broadens, the vulnerability of the assets increases, particularly if one of the purposes of the trust is to shield the assets from members and leadership who seek to divert the assets precisely to these other purposes of the institute. It is important to balance the freedom of use of the assets with the need to protect them from incursion from third parties.

Institutes may also be restructured, merging or dissolving provinces, regions or institutes. The amendment and dissolution clauses of the trust should be drawn in such a way that the trust can be adapted to these changing circumstances of the donor and beneficiary. A specific clause could provide that in the event that the donor corporation or the primary beneficiary class is merged or restructured, the trust may be amended, restructured, or dissolved, with the assets being distributed for the benefit of the remaining members or identifiable potential members of the beneficiary class. Any such amendment of a charitable trust may be subject to the approval of the state Attorney General and the courts.

C. Administration of the Trust

Many institutes have established charitable trusts as a tool for shielding retirement assets from adverse legal judgments. The documents have been drawn in an attempt to appropriately insulate the assets. However, in addition to carefully structuring the trust and properly drawing the trust document, a trust must be administered in accordance with its document and the purposes for which it was established.

A donor should allow the trustee/s to administer the trust according to the trust document or investment guidelines as best determined in their discretion. Trustees must be allowed to manage the investments although the donor may give advice in this process. General guidance for investment management should be in the trust document. Trustees must be allowed to determine whether or not requests for disbursement are in keeping with the charitable purposes of the trust.

The disbursement of trust assets must run to the beneficiary, [17] not to the donor. For example, if a trust disbursement ostensibly made to the beneficiary is made out to the institute's corporation (the donor) and is deposited in the corporation's bank account, it will be difficult to assert and defend the notion that the assets are not running back to the donor. Simplicity of administration often requires this practice, but it puts the trust at risk of being declared a sham and failing if it is ever challenged. In addition, a judgment creditor may attach trust assets that come to the donor as they are paid out by the trust. Often the beneficiary, an unincorporated association, has no bank account of its own. The best practice in this case is for the trust to pay third party creditors of the beneficiary directly.

Charitable retirement trusts are often administered by the institute's financial office that also administers the corporation's funds. In this case, care must be taken that the finance functions of the trust are sufficiently insulated from other functions of the office. The office may be hired by the trust to administer these funds, but this should be clearly documented, and the practice requires clear accounting.

Documentation of trustee actions is also important. There must be minutes and records of the decisions and actions of the trustees. In addition, there must be records documenting the fact that the administration of the trust is separate from the administration of the corporation.

It can be burdensome to adequately insulate the trust from the beneficiary and the donor so that it is protected from adverse legal action. The trust must be organized correctly, and it must be operated according to the organizing documents without blurring of the parties that the trust was established to distinguish.

D. Responses

1. Documents

An institute may choose to establish or retain a trust for the benefits that it can provide. In this case, the documents should be closely reviewed with the help of competent counsel, so that the trust will indeed provide the desired protection. The trust document clauses governing amendment will dictate who may amend the document if this is required, and will indicate the extent of their power to amend.

Insulation of the trust would be enhanced by the following elements in the documents: 1) a self-perpetuating board of trustees, [18] 2) direct payment of third party bills by the trust, 3) a clear purpose clause, making sure the definition of the beneficiary class is sufficiently broad and/or includes a secondary purpose or beneficiary class; 4) termination clauses and amendment clauses that provide flexibility, yet keep the assets of the trust out of the control of the donor.

If the trust is no longer seen as providing the intended benefits, there are several possible devices that may be used to undo them. Before any of these actions are taken, the trust documents must be reviewed carefully, and their provisions followed exactly in every detail. State law governs trusts and it varies from one jurisdiction to another. While the donor cannot control the investment or disbursement of trust assets, it should review its policy on depositing additional funds into the trust. [19] Often the trusts are set up to be indissoluble, and/ or irrevocable. In this case, the only recourse may be for the trustees to pay out the maximum possible under the trust document so that the assets of the trusts are liquidated. These payments however, must be made according to the trust purposes and made to the proper trust beneficiaries.

It may be possible under the trust document, and under state law to completely reform the trust by creating a new trust that is more properly structured, and pouring the assets of the original trust into the new trust. Trustees are charged with managing trust assets and using the income and assets for the benefit of a named beneficiary class. The trustees may elect to fulfill the trust purposes by contributing the assets of the original trust to a second trust set up for the same purpose.

Alternatively, an institute may decide that the trust is no longer necessary or adequate to shield its assets. If the documents and local law allow, the trust may be liquidated and the assets distributed according to the trust provisions. The assets cannot then run back to the donor, so an alternative recipient would have to be determined in accordance with the dissolution clause of the trust document.

2. Administration

In addition to proper documents, proper management of the trust is crucial. The institute that chooses to use this tool to shield assets must be willing to bear the administrative burden of proper management.

Insulation of the trust would also be advanced by the following practices in the administration of the trust: 1) Clarifying the distinction between the donor and the beneficiary. 2) Allowing trustees to exercise their fiduciary responsibility in determining that investment and disbursement decisions are in keeping with trust purposes. Trustees must meet as required by the trust documents to consider investment choices and requests for disbursement. These decisions cannot be completely controlled or mandated by the donor. 3) Clearly separating all accounting, investment and management of the trust from the similar activities of the donor corporation. [20] This adds an administrative burden but is required for the proper operation of the trust. The trust or religious institute as beneficiary must make direct payment to creditors, unless it hires someone else to administer the funds paid out. If however it hires the donor, i.e. the financial office of the corporation, this must be administered very clearly or it will lead to questions about trust insulation and open the trust to the same exposure it was created to avoid.

Another device that may be effective is to have a third party, e.g. members of another institute serve as trustees. These trustees can bear the burden of administration and clarify the distinction between the parties. The time may be ripe for the establishment of third party administrators who can administer trusts of religious institutes.

Once assets are declared in trust, or transferred to a trust, the donor no longer has ownership or control of them. It is essential for the donor corporation to respect this limitation if it expects others, including third party creditors to respect the integrity of trust. Using trust assets, taking them on loan or using them as collateral for other transactions will compromise the integrity of the trust and thus work to undermine the purpose for which the trust was established. The trustees may decide to give a loan to the donor, but this must be done as an arm’s length transaction and only if it is in keeping with trust purposes and represents a good investment and furthers the best interests of the beneficiaries. It must also be an investment allowable to charitable trusts under state law [21] and federal requirements for tax-exempt organizations.

Trustees bear the primary responsibility in the administration of the charitable trust. In the trust document, they are given directives about the management and distribution of trust assets. The document also spells out their powers, and the limits of those powers. They are charged with managing the assets in the best interests of the beneficiary class. Trustees have a fiduciary responsibility to carry out this role. Efforts to maintain control of congregational assets through limiting trustee discretion or use of passive trustees undermines the integrity of the trust as a tool to insulate assets.

E. Conclusion

In developing the structure of a charitable trust, and in its practical management, there are many choices to be made in balancing competing interests: protection of assets, ease of management, retention of control, etc. For example, donor appointment of trustee/s and administration of the trust through the order's finance office allow for ease of administration, however, they will likely raise questions of consolidation. Broad purpose clauses or multiple purpose clauses provide flexibility, however, they may open the door for the diversion of retirement assets imprudently to ministry operations. In balancing these interests a religious institute should consider its specific situation, its structure and the various needs that compete for its limited resources, the risks it faces, and the laws of the local jurisdiction that color the legal environment.

An institute using a trust as a tool to accomplish its goals should take care that the organization and administration of the trust meet the institute's goals and that the trust operates within both state trust law and federal tax-exempt requirements for charitable trusts.

Trust Document Checklist:

Purpose	E.g. To promote, support and advance the religious and charitable works of the Congregation, especially, but not exclusively, to provide for the needs of the aged, infirmed and/or disabled members of the institute. It is a good idea to provide a secondary purpose or a purpose broad enough that there is some discretion on disbursement. However, the broader the purpose and beneficiary clauses, the more likely persons within the institute can argue that the assets can be diverted to their purposes. If the purpose gets broad enough even third party judgment creditors may be able to demand disbursement.
Donor	The donor cannot receive any assets from the trust. While the donor may retain some control, the more control they retain, the more vulnerable the trust is to attack. A controlling financial interest may also lead to consolidation of statements under SOP 94-3.
Trustee	Trustees manage the assets and make disbursements. In general, the more limits placed on the trustees’ fiduciary responsibility, the more vulnerable the trust is to attack. The donor should provide adequate guidance in the trust document for trustees to manage and disburse the assets. On the other hand, the more continuing control the donor exercises over the trustees and their appointment and removal, the more vulnerable they will be to consolidation of statements.
Beneficiary	Beneficiary class should be indefinite in number, [22] but should be described clearly enough that the trustees have clear guidance on distribution of the assets. Beneficiary must be distinct from donor in the documents as well as in practice. If the beneficiary class is broadened to include other activities of the institute, the trust will not be effective in shielding assets from other uses by leadership and membership.
Amendment	There should be provision for amendment. This is an important power and the clause should be drawn in such a way as to strike a proper balance between donor control, and protection of the assets. The document should spell out how the purpose can be amended, by whom, under what circumstances and within what limits.
Dissolution	Dissolution is another important power. Circumstances and manner of dissolution, as well as who holds the power to dissolve should be outlined. Generally the trust can only be dissolved if the charitable purpose is fulfilled or if the assets are depleted. Distribution of the remaining assets should be in keeping with the purpose clause and requirements for tax exemption. Provision should also be made here or elsewhere for the disposition of the trust in the event canonical restructuring of the institute or province, e.g. merger, union, division. The dissolution clause should provide that on dissolution the remaining assets of the trust must be distributed to another 501(c)(3) entity. Even on dissolution of the trust, the assets may never run back to the donor.
Tax Exemption	To ensure the tax exempt status of the charitable trust, the documents must provide for · a religious, charitable purpose, · no private inurement or private benefit, · no political campaigning, · no more than insubstantial lobbying, · the dissolution of assets to similar 501(c)(3) organizations. Operation of the trust should also be in accordance with these principles.
Practical Reminders	· Trusts are governed by state law that varies by jurisdiction. · Trust documents vary widely in the allocation of authority and responsibilities of the donor and the trustees. · Trust documents may define one or more classes of Beneficiaries. · Administration of a trust should not contravene the protection the trust documents were designed to establish. · Trust documents should be tailored to a specific institute in its actual situation; these documents should not be simply passed from one institute to another without careful review and adaptation.

[1] Statement of Position 94-3 and FASB 136, Paragraphs 13 and 15

[2] What is said of religious institutes in this article also generally applies to societies of apostolic life.

[3] The donor/settlor is generally the civil corporation of the religious institute, but may also include other contributors.

[4] Some trust documents attempt to completely eliminate trustee discretion by directing trustees to make all disbursements requested by the donor without question. A trust with this clause would not protect trust assets from diversion by leadership. In addition, such a trust would probably not provide legal protection if challenged in a lawsuit.

[5] Even if Sister is a Trustee of the Trust, a beneficiary of the Trust, and a member of the civil corporation, each role is separate and the distinction must be asserted clearly in any legal action.

[6] Some courts have developed an “intentional failure to supervise” tort which includes four elements: an actual supervisor exists; the supervisor knew of the risk of harm; the supervisor intentionally disregarded the known risk; the supervisor’s inaction lead to the plaintiff’s harm. Weaver v. African Methodist Episcopal Church 2001 WL 303056 (WD Mo. App. Ct. Mar 30, 2001). Upheld punitive damages against a minister for sexual harassment while reversing the trial court’s decision against the church, relying on a four element “intentional failure to supervise” tort outlined by the Missouri Supreme Court in Gibson v. Brewer.

[8] A community policy may however be a two edged sword. It will help to prevent accidents from occurring. However, it tends to demonstrate a duty to supervise, and if not followed, it could be used against the community.

[9] E.g. Driver re-education programs that are available for older adults. When the policy is initiated, an order may require all drivers 55 years and older to attend this course and forward a certificate of attendance to the finance office. Thereafter drivers must re-certify every 5-10 years, and younger drivers must take the course when they reach 55 years of age.

[10] The case presumes that Sister possesses a valid, current driver’s license. The fact that the state licensed Sister to operate a motor vehicle can be used as a defense. It will make it harder for a plaintiff to claim that the corporation had a further duty to supervise.

Some courts have developed an “intentional failure to supervise” tort which includes four elements: an actual supervisor exists; the supervisor knew of the risk of harm; the supervisor intentionally disregarded the known risk; the supervisor’s inaction lead to the plaintiff’s harm. Weaver v. African Methodist Episcopal Church 2001 WL 303056 (WD Mo. App. Ct. Mar 30, 2001). Upheld punitive damages against a minister for sexual harassment while reversing the trial court’s decision against the church, relying on a four element “intentional failure to supervise” tort outlined by the Missouri Supreme Court in Gibson v. Brewer.

[11] To allow the institute to use assets, there should be a primary and secondary purpose to payout. Trusts set up for the retired members of the institute should have a secondary purpose. All of these purposes should be drafted so as to maintain the tax-exempt status of the trust.

[12] Tax exemption for the trust must be established and may be obtained through listing in the OCD and inclusion in the annual USCCB group ruling.

[13] “The doctrine of merger is only applicable when the same person is both the sole trustee and sole beneficiary of the same interest.” Estate of Kagan, 118 Misc.2d 1084, 462 N.Y.S.2d 128 (1983)

“Further, the Restatement (Second) of Trusts § 99 discusses the ramifications of having a primary beneficiary also act as the trustee of a trust. It states:

There can be a trust in which one of several beneficiaries is the sole trustee. The trustee holds the legal title to the trust property, and the beneficiaries, including the beneficiary who is also the trustee, have equitable interests the extent of which is determined by the terms of the trust. There is no partial merger of the legal interest and the equitable interest. The beneficiary who is also trustee does not hold any part of the property free of trust. A creditor of this beneficiary can reach his interest only by a proceeding appropriate for reaching an equitable interest, and, if it is a spendthrift trust, a creditor cannot reach his interest.

Restatement (Second) of Trusts § 99, cmt. (2) (1959) (emphasis added).” Doyle v. Morrison 582 N.W.2d 237 (1998).

[14] See City of Palm Springs v. Living Desert Reserve, 70 Cal.App.4th 613, 82 Cal.Rptr.2d 859, 865-66 (1999) "The elements essential to [the creation of a charitable trust include] ... a charitable purpose promoting the welfare of mankind or the public at large, of a community, or of some other class of persons which is indefinite as to numbers and individual identities.”

“In order to qualify as a charitable trust, the trust instrument must indicate that "the persons who are to benefit are ... of a sufficiently large or indefinite class so that the community is interested in the enforcement of the trust."” Restatement (Second) of Trusts § 375.

State ex rel. Champion v. Holden, 953 S.W.2d 151 (Mo.App. S.D., Sep 29, 1997) “The central nature of a charitable trust is that the objects of the trust are uncertain or indefinite, and there are innumerable.”

Martinez v. State, 753 S.W.2d 165 (Tex.App.-Beaumont, May 31, 1988) “It is settled law that one of the characteristics of a religious trust or charitable trust is that the trust is for the benefit of an indefinite, changing number of persons.”

Bakos v. Kryder, 260 Ark. 621, 543 S.W.2d 216 (Ark., Nov 08, 1976) (NO. 76-103) “As long ago as McDonald v. Shaw, 81 Ark. 235, 98 S.W.2d 952 (1906), this Court in speaking of charitable trusts, quoting from the case of Russell v. Allen, 107 U.S. 163, 2 S.Ct. 327, 27 L.Ed. 397 (1882), said: . . . 'They may, and indeed must, be for the benefit of an indefinite number of persons, for if all the beneficiaries are designated, the trust lacks the essential element of indefiniteness, which is one characteristic of a legal charity.'”

In re Kidd's Estate, 12 Ariz.App. 58, 467 P.2d 770 (Ariz.App. Div. 1, Apr 14, 1970) “…a charitable trust has as a beneficiary a definite class and indefinite beneficiaries within the definite class….”

Eldridge v. Marshall Nat. Bank, 527 S.W.2d 222 (TexCivApp-Hous (14 Dist.), Jul 30, 1975) “In order to create a valid public charitable trust, the beneficiaries must be indefinite in number. Otherwise, the trust will be a private one. Russell v. Allen, supra, 107 U.S. at 167, 2 S.Ct. 327; Powers v. First Nat. Bank of Corsicana, supra, 161 S.W.2d at 283; Taysum v. El Paso Nat. Bank, supra, 256 S.W.2d at 175.”

Staman v. Board of Assessors of Chatham, 351 Mass. 479, 221 N.E.2d 861 (Mass., Dec 12, 1966) “It is characteristic of a valid charitable trust that the designated beneficiaries constitute an indefinite class described reasonably.”

Goetz v. Old Nat. Bank of Martinsburg, 140 W.Va. 422, 84 S.E.2d 759 (W.Va., Nov 23, 1954) “One requisite of a charitable trust is that the beneficiaries of the trust as distinguished from the object or purpose of the trust must be indefinite. Shenandoah Valley Nat. Bank v. Taylor, supra; Hays v. Harris, 73 W.Va. 17, 23, 80 S.E. 827; Ritter v. Couch, 71 W.Va. 221, 76 S.E. 428, 42 L.R.A.,N.S., 1216.”

[15] This legal doctrine provides that if the stated purposes of a charitable trust can no longer be carried out, or if the beneficiary class no longer exists, the trust may be broadened to accomplish a similar purpose that the original settlor may have intended.

[16] The beneficiary class must be sufficiently broad when the trust is established. The beneficiary class may shrink and even disappear after that time, without affecting the validity of the charitable trust. This case would however highlight the need for secondary beneficiaries, secondary purposes, and an adequate dissolution clause.

[17] Assets may run to a third party on behalf of the beneficiary, e.g. to pay medical costs.

[18] Care must be taken to avoid any alienation of congregational assets. Since the assets are being set aside for congregational purposes no alienation occurs, however it is important to ensure that they not be diverted from congregational purposes. Reserve powers, especially with regard to amendment of purposes, beneficiary class and dissolution clause, can be used to ensure appropriate ongoing control.

In general assets put into a trust are liquid assets that are not subject to alienation rules. However putting them in trust for a set purpose may establish them as fixed capital that is then subject to limits on alienation. If the trust is properly drawn and the assets are clearly and effectively limited to specific congregational purposes, they may become stable patrimony, subject to rules on alienation; however, the trust document will prohibit their alienation. If the trust assets are not effectively limited to congregational purposes they never become stable patrimony, so the alienation rules never apply.

[19] The Congregation develops its funding policy based on a variety of factors including present and future retirement needs and other congregational needs. The donor corporation is the tool of the congregation in carrying out this policy.

[20] Some have suggested the establishment of a separate corporation for the management of the trust. This seems to add an extra layer of administration without proportionate benefit. The trust should administer the assets independently from the donor corporation, either through its own personnel, or through services it retains. A service corporation might be established for the purposes of administering the charitable trusts of a diversity of religious institutes. However, such a corporation may have difficulty articulating a tax-exempt purpose.

[21] The 1990’s have seen a change in fiduciary investment rules in a majority of jurisdictions, due to the modest returns allowed under the old ‘prudent investor rules’. Most jurisdictions have enacted some version of the 1994 Uniform Prudent Investor Act that embodies the modern concepts of total return investing, investment diversification and prudent asset allocation among a broad range of investments carrying varying levels of risk.

[22] E.g. the sisters of XYZ congregation would be sufficiently indefinite. Generally the class should be larger than 12 persons. It is helpful if the group is larger, and if new persons can come into the group – e.g. more sisters retire, or more candidates enter the institute. However, the indefiniteness of the class is determined when the trust in established. An established trust may continue operate even if the beneficiary class subsequently becomes very small.

Introduction