California Legislative Update: An Excuse to Talk About Trusts
To be honest, I have a very hard time getting excited about California legislative updates when it comes to non-profits. I’m not sure why — I’ll get worked up about the occasional ballot initiative or state legislation when it comes to social issues I care about. For example, I have lots of only vaguely informed thoughts on SB 8 and its (in my mind, exciting) override of local zoning. (If I could afford Bay Area real estate, I’d be trying to build a 2nd unit in my backyard as we speak).
But when it comes to charities, maybe I’m just too close to it. Or maybe there are just too many discussions of potential changes that I just generally wait until things come into effect before getting too stressed about the potential effects.
For example, there is a new crowdfunding bill (AB 488), which is objectively important to the big and small players in that sector of charitable fundraising. And if you ask me, AB 488’s broad language makes it important to perhaps more players than is intended (or at least more organizations than I think they need to be subject to this bill). But, I do not have strong feelings about it yet. My guess is that I will once it goes into effect and a lot of clients have questions about it, and by the time I form opinions, there may well be a push to change it. So, for now, if you want to read about the crowdfunding bill, check out this article on For Purpose Law Group’s blog by Linda Rosenthal (whose work is consistently a great resource for the sector).
For now though, I’d rather use a far less important bill (AB 900, which, admittedly, I also only learned about from Linda’s other recent blog post) to talk about trusts as an option for charities considering what legal form to select.
*****************
Let me start by regaling you with the entire text of AB 900:
“16106(a) On and after July 1, 2022, trustee holding assets subject to a charitable trust shall give written notice to the Attorney General at least 20 days before the trustee sells, leases, conveys, exchanges, transfers, or otherwise disposes of all or substantially all of the charitable assets.
16106(b) On or after January 1, 2022, the Attorney General shall establish rules and regulations necessary to administer this section.”
That’s it. Starting on July 1 of next year 501(c)(3)’s in trust form (and other charitable trusts) will need to give 20 days’ notice to the AG before selling “substantially all” of their assets.
What is the point of this requirement? I think it’s pretty self-explanatory, but remember that the Attorney General is charged with enforcing charitable trusts and looking out for the interests of the public and donors. In the for-profit context, the Board has shareholders looking over their shoulder and shareholders are typically required to get notice and a chance to vote on transactions like this. But charitable trusts and non-profit corporations do not have shareholders. So, the AG is the one to ask questions if something about the sale does not seem right (e.g. it seems like a for-profit buying all of the assets is getting too good of a deal thereby depleting funds from the charitable sector). Considering that, it makes sense that the AG would want to know if a trust is selling off all of its assets.
Is this a revolutionary change that will shake the ground of the California nonprofit sector? Not even close.
There are not that many non-profits in trust form. There are some and they are mostly private foundations where the founders opted into the structure for particular reasons (discussed below). There are a couple of significant exceptions where there are public charities in trust form (e.g. Stanford University). But the vast majority of California charities are either California nonprofit public benefit corporations (who were already subject to this rule under CA corporate law), Delaware nonprofit corporations (who were not and STILL are not subject to this rule and DE’s AG does not have this requirement), or a nonprofit corporation in another state (whose AG may have their own notice provision or not).
There are some additional questions I have about potential unexpected impact (does it apply to charitable remainder trusts? does it apply to living trusts with some or all charitable beneficiaries?). But, I don’t think it’s worth speculating too much yet about what those answers will be until the AG releases its regulations on the topic after January 1, 2022.
Was anyone using a trust form to avoid providing the 20-day notice? Probably not. As I said, if you are setting up a charity and want to sell all of your assets without telling the AG, you could just set up a Delaware nonprofit corporation — you’ll have to file an annual report each year for a small fee and pay for an agent for service for there, but that is all Delaware asks of you (California asks considerably more of you if you incorporate, operate, or have assets here).
And unless you have very specific goals, there are some downsides to being a non-profit in trust form such that I can’t imagine you opted in just to avoid notice:
Higher Fiduciary Standards and Liability Exposure. Trustees in California are held to the highest level of fiduciary standards — meaningfully higher than the standards to which directors of nonprofit corporations are held. Directors have fiduciary duties, but generally have friendly rules that permit them to exercise that fiduciary duty primarily through reasonable reliance on experts, officers, committees, etc. When you act as trustee, there is no other legal entity — just you, acting as an individual with certain fiduciary obligations as to the property in the trust (yes, it is an entity for tax purposes, but not for state law purposes). If the “trust” causes harm to a third party or you cause harm to the trust by making a mistake, you are at a greater risk of personal liability than in the context of a corporation. (One of my prior bosses when I was a trusts and estates lawyer once referred to being a California trustee as the 2nd most dangerous job in the state, right after Sea World orca trainer — I’ve been using that to scare people away from trustee-ing their parent’s trust without professional help ever since). As a director, the entity is separate from you and, while you can be held personally liable for breaches of fiduciary duty, it is a higher bar to clear.
Not a Good Fit for “Corporate” Governance. Trusts work well enough when there is one or two trustees (typically a wealthy individual or married couple) running their family foundation. Once you start adding directors and trying to act like a proper board, however, there is really nothing to guide you other than the provisions you put in the trust. California’s Corporation Code provides a number of rule that tells you how to operate the organization. If you look in the Probate Code (which governs trusts), you will not find any reference to meeting minutes, or committees, or officers. Trusts can be run like corporations if that is what you want to do, but you will need to establish your own rules and be thorough if you want to function just like a “typical” non-profit.
People Do Not Understand Trusts. This might seem like a bad reason but trusts sometimes throw people for a loop. For example, the “ABC Foundation, a nonprofit corporation” can just sign contracts in its own name as an entity separate from its directors. If it were in trust forms, it might be something like: “A, B, and C, in their capacity trustees of the ABC Foundation, a charitable trust formed under the trust agreement dated ____ hereby agree….”. Doesn’t exactly roll off the tongue. Hardly a significant problem, but there are similar hiccups like this that pop up. Sometimes, it is helpful to use the exact same form as everyone else so you do not have to explain yourselves.
So, why are you even talking about this? Well, as a public service because this is the kind of thing that practitioners could easily miss. Charitable trusts have been operating since the Magna Carta (don’t fact-check me) without filing any 20-day notices to the California Attorney General. Now they have to do so. So, keep an eye out.
But mostly just as an excuse to give the pros and cons of operating in trust form.
OK, you mentioned the cons, what about the pros? There are some miscellaneous benefits I could get into (perhaps a little additional privacy because you don’t register with the Secretary of State, some unrelated business income tax planning opportunities, some room to get creative with the governance structure), but I think there is one reason that people set up foundations and charities in trust form: people want to live forever. And by “live”, I mean ensure the foundation or charity does exactly what they want until the end of time, regardless of what their children, grandchildren, or anyone else has to say about it.
Want to make sure the trust lasts forever and only does the specific charitable program you want? Want to make sure that only your lineal descendants can be trustees of the trust? Want to make sure that one lineal descendant is never a trustee? Want to require that, at your death, the assets of the trust go to specific charities or sub-divided into a foundation or donor-advised funds for each of your children? All these options and more await you in a trust — just lock it in, say the trustee can’t amend the trust, and that restriction will generally last as long as your money does. (There are ways to modify a trust, but it requires going to court and satisfying a pretty high bar, such as that the charitable purpose has become impossible to achieve, all with the AG looking over your shoulder to protect the settlor’s intent).
For some, this “dead hand” control is sufficiently desirable to opt into the trust form. After all, just because life ends, that does not mean that micromanaging your children has to end too.
More seriously, these “dead hand” restrictions can be desirable in certain situations to prevent mission drift (compare a trust to a corporation, where a new Board can generally undo any of the actions of a prior Board, subject to donor-imposed restrictions).
For example, there are people that think that it’s a good thing to prevent family foundations from “losing their way” over the course of generations (for what it’s worth, I am not one of those people when it comes to private foundations — for example, I am VERY happy that the Ford Foundation is doing the work that it is doing and not supporting the work that Henry Ford would actually support if he was still alive).
To be fair, it is not just philanthropists looking to protect their egos that care about mission drift. There are also progressive ways to use trusts too to effect positive and permanent change. For example, trusts can be used to permanently dedicate land or other assets to be managed by carefully selected stewards (e.g. experts, community members, or tribal representatives) for a defined purpose or targeted to support a particular underserved community or other charitable purpose (e.g. to always be used to provide affordable housing in X community, to always be used for environmental purposes and not sold to businesses). A corporation could hold land for that purpose too but, unless the donor put the restriction in a gift agreement, the corporation could generally change its mind. So perhaps you’ve preserved that land for housing now, but what if two generations from now, the directors want to sell the land to luxury condo developers and use the proceeds for buying an art collection?
In conclusion: Like many other things, trusts are not good or bad in and of themselves, just a tool that can be used. I hope this blog, stemming from a relatively trivial new law provides some insight on them. After all of it, maybe you want to form a charitable trust, maybe you don’t. If you do, make sure you register with the AG just like any other 501(c)(3) and provide them 20 day notice if you are selling all of your assets.
