New law eases endowment fund spending restrictions

By Steven L.F. Ho

This past year has been difficult for schools and other charitable organizations that have endowment funds. While the declining economy has increased the demand for endowment fund distributions, significant losses in fund portfolios have limited distributions. A new Hawaii law now gives charitable organizations greater flexibility in dealing with endowment funds.

On July 1, the Uniform Prudent Management of Institutional Funds Act , or Act 135, will go into effect in Hawaii. UPMIFA replaces the Uniform Management of Institutional Funds Act. It provides modern standards for management and investment decisions, loosens limitations on spending and makes it easier to modify or release fund restrictions.

The most significant change made by UPMIFA is in the area of spending from endowment funds. Previously, a charitable organization was permitted to make prudent distributions of any endowment fund income and net appreciation, but only to the extent that they exceeded the fund’s historic dollar value, that is, the dollar amount of contributions made to the fund. If the value of an endowment fund fell below its historic dollar value because of a declining market and the fund was “underwater,” the charity was prohibited from making further distributions until the fund’s current value again exceeded its historic dollar value.

Because of the changes made by UPMIFA, charities are no longer subject to rigid restrictions on spending tied to the fund’s historic dollar value, but are now guided by a prudence standard in making spending decisions. UPMIFA loosens spending restrictions by eliminating the concept of historic dollar value. Under UPMIFA, a nonprofit may spend the amount that it deems prudent, subject to the terms of any gift instrument. It must, however, consider a variety of factors, including the duration and preservation of the fund, the purposes of the organization and the fund, general economic conditions, the possible effect of inflation or deflation, the expected total return from income and appreciation of investments, other resources of the organization and the organization’s investment policy.

UPMIFA also changes management and investment decision making. Before, a charitable organization was required to exercise ordinary business care and prudence in making investment decisions. UPMIFA replaces this vague standard with specific factors to be considered in management and investment decisions, which are similar to the factors listed above when making spending decisions.

Finally, UPMIFA allows a nonprofit to modify or release donor-imposed restrictions in situations where a restriction has become unlawful, impracticable, impossible to achieve or wasteful. This can be done by obtaining the consent of the donor, the approval of the court or the approval of the attorney general if the value of the fund is less than $250,000, or if the fund is more than 20 years old and has a value less than $50,000, upon notice to the attorney general.

UPMIFA will apply to both new and existing endowment funds. Accordingly, a charitable organization should review its investment policy to ensure that it is consistent with the factors that must be considered in making investment decisions. Similarly, an organization’s spending policy should be updated to incorporate the factors to be considered when making spending decisions.

Attorney Steven L.F. Ho is with the Honolulu firm Torkildson Katz Fonseca Moore & Hetherington and is a member of the HANO board of directors.