Court decision regarding DAFs gives pause to charitable donors

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You’ve sold your business, reaped the reward of a great investment, or received an inheritance. Now you want to donate $1 million to a worthy cause.

Where to start? Whether you focus on education, poverty relief, health care or the arts, which institution should you choose – hospital, university, museum, etc.? Should you donate the money upfront into one project? What if the project fails early and there are funds left over? Is it wise to put all the eggs in one basket? Perhaps it is better to have the charity invest the $1 million and then disburse the income perpetually so you will have a legacy.

A donor can contribute the $1 million to a donor advised fund (DAF) and get the best of both worlds: a) an immediate tax deduction for the full $1 million (because the DAF is operated by a registered charity); and b) flexibility, in case your recommendations change.

For instance, one year you can recommend that the DAF give income earned on the $1 million to United Way. Next year, you can recommend a different charity or a different project within the original charity, and a different amount – a donation so large that it eats into capital, for instance, or so small that it uses only part of the growth – so long as CRA’s minimum disbursement percentages are met (currently 3.5 per cent, rising shortly to 5 per cent).

The catch

The donor can only make recommendations to the DAF regarding disbursements. If the DAF administrator follows the donor’s advice, despite not being legally obligated to do so, its a “win-win-win.” The donor gets the full deduction in year one. The charity receives the money. Operating charities to which the DAF charity disburses have a pool of funds that will be disbursed to them (at worst, over time).

This understanding has allowed for significant growth of charitable funds held in DAFs. But it is predicated on DAF administrators listening to and implementing donor recommendations despite not being legally bound to do so.

A DAF is highly incented to honour donor recommendations. DAF administrators who ignore donor recommendations will repel the particular donor (foreclosing future donations). The negative publicity will likely dissuade other donors from donating to that charity (or to any DAF) – they may make direct donations, cutting out DAFs, or they may decide to dribble out funds annually, to maintain control.

But as every fundraiser/salesperson knows, time kills all deals. If the charity blows an opportunity to close a large donation now, there is a risk that the deal may never close. A donor’s passions change. Donor fortunes change. Donors become incapacitated or pass away and their spouses/children/executors have other ideas for deployment of the money.

What were they thinking?

A recently reported Ontario case brought this issue into focus:

The Joseph Lebovic Charitable Foundation (“Donor”) made a large donation to the Jewish Foundation of Greater Toronto (“Foundation”). The monies went into a DAF, and for several years the Foundation made grants in accordance with Joseph’s recommendations (with regard to the charities and the projects within those charities that would benefit, and with regard to the amounts of the particular disbursements each year).

Then Joseph died. His brother and estate executor – who was not specifically named in the DAF agreement as an alternate to provide recommendations when Joseph passed – instructed the Foundation to make certain grants to operating charities that: a) materially differed from prior recipients; and b) were in amounts that would have disbursed the entire capital. The Foundation declined. The brother/executor sued for an order requiring the Foundation to disburse funds as instructed.

DAF litigation is rare because DAFs strive to honour the vision of their donors.

The court held that “in order for charitable gifts to be valid, donors must divest themselves of all power and control over the property and transfer such control to the donee.” The Foundation had no obligation to implement the instructions of Joseph’s brother, or to follow recommendations.

Lessons for donors

Having suffered devastating losses in his victories over the Romans, King Pyrrhus said that “one other such victory would utterly undo me.” Is the Foundation expressing the same concern after its court “victory”?

Each DAF has complete legal power to ignore donor recommendations, but paradoxically, existential reasons impel DAFs to avoid using that power. No charity wishes to fight with a donor, which could result in losing that relationship, frightening away other donors and wasting money on litigation.

Here, the Foundation was the defendant. It did not initiate litigation to prove that it had power over donors. The effective plaintiff was not Joseph (the person behind the original large donation) but his brother/estate executor. While declining to honour the recommendations of the executor, the Foundation’s defence of the principle of independence was exercised so that it could continue to honour Joseph’s philanthropic vision (an ongoing legacy to provide support to various charities long term vs large one-time gifts to a small number of charities), as evidenced in several successive years of recommendations while he was alive.

To that extent, this case should bring comfort to original donors. It doesn’t expand DAF power. It confirms what most people already believed was the law. It does not illustrate that DAF administrators will exercise their discretion to ignore donors.

DAF litigation is rare because DAFs strive to honour the vision of their donors. Here, the Foundation risked the cost, stress and potential negative publicity so it could continue to honour Joseph’s wishes. For instance, it was not a situation of a donor providing funding for bursaries for poor students suddenly finding the DAF had decided to give the money to purchase medical equipment because the DAF decided that was a more worthy cause.

However, the judgment has come at a time of increasingly vigorous debate between donors who want to ensure their donations are used the way they were intended to be used, and donees, who want to use the donations as they see fit. These often result in tussles over transparency, accountability and influence.

The question of whether Joseph’s brother/executor was the rightful successor to provide recommendations was argued before, but not decided by, the court. Logically, it is irrelevant. If the DAF has the right to decline a recommendation, it doesn’t matter who the recommendation is from. However, from the original donor’s perspective – and from a wise DAF administrator’s perspective – the question is crucial.

Thoughtful donors fear their wishes won’t be honoured. Imagine a donor funding a business school professorship to study entrepreneurship who finds that the university appoints a sociology professor who teaches that capitalism is evil.

Therefore, when the Foundation effectively declined to honour the demands of the apparent replacement decision maker for the donor, it understandably gives pause to potential donors that want to ensure the funds are used for their intended purpose. A deeper understanding of the case illustrates that the DAF acted to honour the original donor’s vision.

Likely responses of thoughtful donors

In the circumstances:

• A) Larger donors will consider: 1) reducing DAF donations and 2) creating their own private foundations (or special purpose charitable trusts) to get the same or similar tax benefit, and obtain greater control for longer, to ensure money will be disbursed when they want, in the amounts they want, to the charitable projects they want;
• B) Smaller donors using DAFs (in order to avoid the setup and ongoing administrative costs of a private foundation, or the uncertainties and cost of a special purpose charitable trust) or larger donors using DAFs for specific relatively smaller projects will consider dribbling in donations over time, or making a large donation in the year they need the tax deduction, but spreading the money among multiple DAFs to mitigate the risk of any one DAF administrator ignoring recommendations;
• C) Choose a DAF wisely. A larger DAF, with a longer history and higher public visibility, is perhaps more likely to adhere to donor wishes because the institutional risk of bad publicity would be enormous;
• D) Ensure DAF agreements clearly specify the donor’s vision. For disbursements, that might include the types of charities it wants to benefit, the goals it is trying to accomplish, whether it wishes only income to be disbursed so that there is a perpetual legacy, or whether it wishes that all capital be disbursed quickly after a trigger event, such as the passing of the individual behind the donor, etc. This provides colour and guidance to DAF administrators as individual staff members or volunteers change over time; and
• E) Finally, and very relevant to the Lebovic case, ensure DAF agreements clearly specify successor advisors, either by name or by a clear succession mechanism, to increase the probability that the successor will honour the donor’s vision. Joseph chose his brother as his estate executor, but did not specifically choose him as the replacement advisor to the DAF.

One suspects that the sorry litigation was the result of Joseph not naming a successor advisor who would honour his vision, or not making clear to the Foundation that whatever Joseph’s vision was prior to his passing, he trusted his brother/executor sufficiently, so that if he had a different vision, Joseph was willing to have his brother’s vision supersede his own after he died.

Absent that clarity, the Foundation was in the extremely difficult position of having to exercise its discretion based on its understanding of Joseph’s vision as evidenced by his years of choices while he was alive. The Foundation ignored the brother/executor’s instructions, in order to honour what it understood to be Joseph’s vision.

David Latner is a partner at Toronto-based Advocan Law LLP, a boutique law firm focused on assisting family offices and technology companies.

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