Practical considerations for changing a donor’s scholarship criteria

Do schools have an option to reform illegal or impractical donor terms in a scholarship without abusing their duties as trustee?

In 1989, Ms. Eris Groen Langhammer and her children donated $15,000 to the University of North Carolina at Wilmington to establish the Hans Langhammer, M.D. Memorial Scholarship Fund. Its purpose is “to assist [UNCW] in its efforts to enhance the minority presence of a black male on campus.” By 2003, the endowment was providing over $1,200 in annual interest income. UNCW staff select the recipient from a list of eligible black males provided by area high school principals. A parol agreement subsequently made in 1991 purported to modify the terms of the scholarship. Evidence of this modification consists of a typed addition to the creation document. The modification indicates Mrs. Langhammer did not want the scholarship awarded to students “whose parents were employees of the university or public school system.” The creation document did not provide for an alternate disposition of the property in the event the university could not uphold the terms of the gift.

It is likely unconstitutional for UNCW to continue its administration of the Langhammer scholarship considering Title VI of the Civil Rights Act of 1964, the Equal Protection Clause of the Fourteenth Amendment of the United States Constitution, and the North Carolina Constitution. Cf. Mark Spencer Williams, Comment, Skin Formulas Belong in a Bottle: North Carolina’s Diversity Scholarships are Unconstitutional Under Grutter and Gratz, 26 CAMPBELL L. REV. 135 (2004). The scholarship may also fail under Title IX, which prohibits the use of sex-restricted scholarships. Staff at colleges and universities are often faced with situations where scholarship award criteria need to be modified for legal, practical or political reasons. This article explores how an institution [in North Carolina] might effect necessary reform to donor terms.

Restricted charitable gifts, like that made by the Langhammer family, are “contributions conditioned on the use of the gift in accordance with the donor’s precise directions and limitations.” Michael M. Schmidt & Taylor T. Pollock Article: Modern Tomb Raiders: Nonprofit Organizations’ Impermissible Use of Restricted Funds, 31-SEP Colo. Law. 57 (2002). If the institution used the funds for a purpose other than the restricted purpose, a lawsuit may be brought seeking injunctive relief, return of the funds, or transfer to another charity to continue the primary purpose. The state Attorney General usually brings such suits. “Where property is given to a charitable corporation and it is directed by the terms of the gift to devote the property to a particular one of its purposes, it is under a duty, enforceable at the suit of the Attorney General, to devote the property to that purpose.” Restatement (Second) of Trusts, §348 cmt. f. (1959). A majority of states do not recognize the standing of a donor to bring suit. See Carl J. Herzog Found. v. Univ. of Bridgeport, 243 Conn. 1, 5 (Conn. 1997). The rejection of donor standing is supported by a public policy that encourages charitable gifts and limits negative tax implications. In contrast, a minority of states recognize a donor’s right to bring suit under the view they are more apt to be vigilant in seeking to enforce the intent of the gift. See Smithers v. St. Luke’s-Roosevelt Hosp. Ctr., 281 A.D.2d 127, 137 (N.Y. App. Div. 2001); Sierra Club Found. v. Graham, 72 Cal. App. 4th 1135, 1144 (Cal. App. 1999); Assoc. Alumni of Gen. Theological Seminary v. Gen. Theological Seminary, 163 N.Y. 417, 422 (N.Y. 1900). However, where the creation of the trust was induced by fraud, undue influence, or mistake, the donor may have standing to set aside the trust in all states. See BOGART, THE LAW OF TRUSTS & TRUSTEES §44, 211, 323. Therefore, donors will not generally have standing to sue the school.

College and university staff often believe they can change terms with donor consent. This belief, however, could be misplaced. Under the common law, a donor generally cannot alter the terms of a charitable trust unless the donor expressly reserves such power. See id. §393. Therefore mutual consent is not a valid way to resolve the problem created by impermissible terms unless the institution has statutory authority to make the change. In fact, modifications by consent may be a violation of trustee responsibilities.

It may be possible for an institution to transfer the property to a private entity to maintain the purpose of the scholarship. A trust does not fail for lack of a trustee. See King v. Richardson, 136 F.2d 849, 857 (4th Cir. 1943); Spring Green Church v. Thornton, 158 N.C. 119, 123, 73 S.E. 810, 812 (1912); Hobbs v. Bd. of Educ., 126 Neb. 416, 441 (Neb. 1934). See also N.C. Gen. Stat. §36A–33 (2003). A trustee may substitute himself for another to maintain the charitable purpose. This substitution may be done under the general powers of a trustee without a court’s consent or by court order. See Girard Coll. Tr’ship, 391 Pa. 434, 443 (1958). Courts have struggled with substitution in situations where the state is the trustee of an illegal trust because the substitution itself may be impermissible state action to further the discriminatory purpose. See Pennsylvania v. Brown, 392 F.2d 120, 125 (3d Cir. 1968); Reitman v. Mulkey, 387 U.S. 369, 381 (1967); Evans v. Newton, 382 U.S. 296 (1966). But see Matter of Estate of Wilson, 452 N.E.2d 1228 (N.Y. 1983). The rationale against substitution is the state becomes entangled in the private discrimination in light of the state’s history in administering the trust and its participation in its modification to a private trustee. It is questionable whether a public university could substitute itself as trustee without judicial mandate.

Courts have power to remedy the illegal trust. See N.C. GEN. STAT. §36A–52(c), 36A–53(a) (2003). Possible remedies include ordering the return of the funds to the donor, substitution of the trustee, and reform of the impermissible terms. When a non charitable trust fails for invalidity, impossibility, or other reason, courts generally require the funds be returned to the donor and his successors in interest. This remedy is not used with charitable trusts, however, unless there is a forfeiture clause in the instrument that created the trust. See Bogart, THE LAW OF TRUSTS & TRUSTEES §418; Assoc. Alumni of Gen. Theological Seminary v. Gen. Theological Seminary, 163 N.Y. 417, 422. But see Trs. of Davidson Col. v. Ex’r & Next of Kin of Chambers, 56 N.C. 253, 257 (1857). Equity requires the specific purpose be revised to meet the changed circumstances as close to the original specific purpose as possible. Similarly, when the trustee breaches their responsibilities under a charitable trust, the property does not revert to the donor. The general rule is “If the trustees of a charity abuse the trust, misemploy the charity fund, or commit a breach of the trust, the property does not revert to the heir or legal representative of the donor unless there is an express condition of the gift that it shall revert to the donor or his heirs.” See Jairus Ware Perry, A TREATISE ON THE LAW OF TRUSTS & TRUSTEES §744.

Courts may reform a trust under their equitable powers or under statutory authority. See Wachovia Bank & Trust Co. v. Morgan, 279 N.C. 265, 182 S.W.2d 3565 (1971); Trustees of the Univ. of North Carolina v. Gatling, 81 N.C. 508 (1879) (holding funds given to UNC should be reformed to remove all restrictions). Two statutes provide authority for such reform in North Carolina. One is based on the Uniform Management of Institutional Funds Act (UMIFA), see UNIF. MGMT. INST. FUNDS ACT §7 (1997) (codified at N.C. GEN. STAT. §36B–7), and the other is based upon the cy pres doctrine. See N.C. GEN. STAT. §36A–53. UMIFA enables a charitable organization to obtain a donor’s consent to modify the purpose of a restricted gift. “The donor has no right to enforce the restriction, no interest in the fund and no power to change the eleemosynary beneficiary of the fund. He may only acquiesce in a lessening of a restriction already in effect.” Id. North Carolina, however, expressly exempted the University of North Carolina System from UMIFA. See N.C. GEN. STAT §36B–8. The sixteen constituent members of the UNC System must therefore, rely upon the doctrine of cy pres but private colleges and universities could use UMIFA (Title VI applies to private institution’s receiving federal funds).

At common law, there was a royal prerogative power of cy pres as well as the judicial doctrine of cy pres. When charitable gifts did not comply with public policy, their terms could be changed regardless of the testator’s intent. North Carolina did not recognize the cy pres doctrine until 1967. See Wilson v. First Presbyterian Church, 284 N.C. 284, 299, 200 S.E.2d 769, 778 (1973). The reluctance to accept cy pres was caused by fears of potential judicial abuse that could occur by disregarding the probable wishes of the testator. The current doctrine is defined as follows:

If property is given in trust to be applied to a particular charitable purpose, and it is or becomes impossible or impracticable or illegal to carry out the particular purpose, and if the settlor manifested a more general intention to devote the property to charitable purposes, the trust will not fail but the court will direct the application of the property to some charitable purpose which falls within the general charitable intention of the settlor. Restatement (Second) of Trusts §399.

Cy pres is a judicial rule of construction, which has as its paramount aim to effectuate the general charitable purpose of a donor when his specific intention cannot be carried out. North Carolina requires three elements in order to apply the doctrine: (1) the donor had a general charitable intent; (2) the trust has become illegal, impossible, or impracticable of fulfillment; and (3) the donor made no alternative disposition. See Bd. of Tr. of Univ. of North Carolina at Chapel Hill v. Unknown and Unascertained Heirs of Prince, 311 N.C. 644, 647, 319 S.E.2d 239, 242 (1984). The doctrine is governed by state statute, which allows reformation of a charitable trust when the purpose becomes illegal or impracticable. See N.C. GEN. STAT. §36A–53.

To use cy pres, an institution files an action in superior court to determine the disposition of the scholarship fund. The institution will generally request reform of the fund to lessen restrictions arguing the donor had a general charitable intent to benefit the school. In such an action, the Attorney General may elect to represent the public’s interest. If the donor is still living, the court may consider their views but they are not conclusive on the issue of general charitable intent. See Bogart, THE LAW OF TRUSTS & TRUSTEES §441; Richards v. Wilson, 112 N.E. 780, 794 (Ind. 1916); Commonwealth v. Home, 21 A. 661 (Pa. 1891).

The cy pres doctrine has been applied to reform scholarship programs such as the Langhammer Scholarship. See In re Certain Scholarship Funds, 575 A.2d 1325 (N.H. 1990) (holding scholarships administered by public officials which discriminated on the basis of gender and religion could be reformed); Barclay Estate, 18 Pa. D. & C.2d 489 (Pa. Orph. 1959) (holding funds devised to a German college to make scholarships to females could be reformed); Howard Sav. Inst. of Newark v. Peep, 170 A.2d 39 (N.J. 1961) (holding a scholarship fund could be reformed to strike religious and ethnic restrictions). But see Estate of Johnson, 13 Phila. Co. Rptr. at 592 (Pa. Orph. 1985) (holding a testators devise of funds to two universities with a preference for Jewish students could not be reformed); Weaver Trust, 43 Pa. D. & C.2d 245, 254 (Pa. D & C2d. 1967) (holding a racial restriction would not be removed under cy pres).

If the conditions exist to allow a court to apply cy pres, it will generally do so. The rationale is that public policy favors gifts and trusts for charities and therefore, the most liberal rules of construction are permitted to ascertain the donor’s intent. It has been suggested that because courts have consistently used cy pres to reform charitable trusts, the de facto rule is once given for charity; it is forever dedicated to charity. See Edith L. Fisch, Article: Changing Concepts and Cy Pres, 44 CORNELL L Q 382, 388 (1959). Timing impacts whether a court will apply the doctrine. See Bd. of Tr. of Univ. of North Carolina at Chapel Hill, 311 N.C. at 648, 319 S.E.2d at 242–43.

Courts are more likely to apply the doctrine of cy pres after property is given and a trust established than when a particular purpose fails at the outset. “Courts have less difficulty finding a general charitable intent where the particular object fails after the charitable disposition has taken effect than when it ceased to exist before the gift took effect.” See id (quoting Fisch, D. Freed, and E. Schachter, CHARITIES AND CHARITABLE FOUNDATIONS §561 [1974]). The rationale is that courts infer an expectation in the donor that changing conditions resulting from the passage of time are likely to make the effectuation of a particular purpose impossible or impracticable and therefore, the donor would prefer modification than reversion. “The longer the period between the creation of the charitable trust and the failure of the particular purpose, the more undesirable it is that the property should revert to the [donor’s] estate.” Id. Some have suggested public policy should require cy pres always apply.

Schools have an option to reform illegal or impractical donor terms without abusing their duties as trustee. Private institutions may do so under UMIFA with the donor’s consent and North Carolina public universities may do so under cy pres. The doctrine of cy pres may also be used by private institutions when consent cannot be obtained. Both may substitute themselves for a new trustee but this action is questionable for state actors. If Langhammer’s terms are illegal and UNCW has not yet removed them, it may likely do so under cy pres.

Originally published as a two-part series in the January and February 2005 issues of the Campbell Law Observer. (Reprinted with permission.)

Authored by Mark Spencer Williams, Esq. and Managing Member, Rice Law, PLLC