Bankrupt But Endowed

June 12, 2012       Patrick Sullivan      

Crystal Cathedral Ministries, the megachurch started by Robert Schuller in Garden City, Calif., filed for Chapter 11 bankruptcy in 2010. A lawsuit filed late last year by creditors against the ministry’s founding members — the Schuller family — alleges that directors used more than $10 million from the ministry’s restricted endowment for operating expenses and staff salaries. Donors can restrict how en­dowment funds are spent and those restrictions are all but inviolable. Ignoring those restrictions and spending more of an endowment than the donor permits has a suitably piratical name: It’s “invading” the endowment.

Nonprofits rarely file for bankruptcy. Section 303 of the U.S. Bankruptcy Code protects nonprofits from being forced into bankruptcy. Most insolvent organizations either dissolve or work things out with their creditors. The issue is what happens to endowment money if the organization does go under.

Though he would not comment on the size of the ministry’s endowment or anything else related to ongoing litigation, Crystal Cathedral’s new President & CEO John Charles said, “Once all the creditors get paid, we hope to emerge from bankruptcy as a stronger church.” Charles did not indicate when he expected the church to emerge from bankruptcy.

Carl Grumer, the Schuller family’s lawyer, did not respond to requests for comment. According to The Christian Post’s website, $10 million was borrowed by the church be­tween 2002 and 2009. To get those restrictions lifted, a nonprofit must petition its state’s attorney general for a doctrine of “cy pres,” which is French for “as near as possible.” Cy pres is usually sought when circumstances make it illegal or impossible to administer funds in the way in which the donor intended, and therefore the gift must be distributed in a charitable manner as close to the donor’s original intention as possible. Courts occasionally grant cy pres to lift restrictions on funds so the cash can be used for operating expenses; however, it is not likely to get cy pres relief for that purpose.

“My sense is that courts, and even more-so attorneys general, are reluctant to allow cy pres relief for financial hardship,” said Patrick Sternal, a partner at the Northridge, Calif., law firm Renquist & Associates.

Restrictions on endowments extend into bankruptcy. They do not become part of a bankruptcy estate. That’s a good thing for organizations that file for bankruptcy protection (Chapter 11), because the endowment will be waiting when it emerges. And, nonprofits usually do emerge. “An organization doesn’t generally put itself in bankruptcy court if they don’t think they’re going to come out the other side,” said Sternal.

In the case of a nonprofit filing for Chapter 7 bankruptcy — which results in the liquidation of assets — or when it seeks voluntary dissolution, the organization’s endowment has to go somewhere since it won’t go to creditors. The donor often will specify in the gift agreement where the donation should go in the event of dissolution, called a “gift-over” provision. The nonprofit has to sift through each donor agreement in the endowment to find the donors’ wishes.

Many donors will have no such specifications in the agreement. In that case, the nonprofit’s board of directors, in conjunction with the state attorney general, would find another nonprofit to which to distribute the endowment. The goal is giving the endowment to an organization with programs as close to the original nonprofit’s programs as possible, according to Victoria Bjorklund, a partner at the New York City law firm Simpson Thacher & Bartlett LLP.

“These (charitable) trusts and (restricted) gifts, if they can no longer be performed as originally specified, are modified for another use by the same charity or are transferred to another charity, subject to the same or modified purpose,” according to a 2005 paper authored by Evelyn Brody, a law professor at Chicago-Kent College of Law and published in the Seton Hall Legislative Journal.

Said John Griswold, executive director for the nonprofit Commonfund Institute in Wilton, Conn., “Since no one owns a nonprofit, (its endowment) is for the beneficiaries.” He used the example of a nonprofit hospital going out of business. Its endowment would go to other area hospitals to keep with donors’ original intent of their gifts being used for healthcare. But, he said, “It depends on the state nonprofit law,” which can vary from state to state.

Sour Notes

Arts institutions often feel the burn of tough economic times more acutely than other groups. Bankruptcy proceedings for insolvent arts nonprofits seem to be more common than for other types of nonprofits. The Philadelphia Orchestra Association, the Honolulu Symphony, the San Antonio Opera, the Syracuse Symphony in upstate New York and the American Musical Theater in San Jose, Calif., have already declared or might soon declare bankruptcy.

Some, like the San Antonio Opera, will file for Chapter 7 liquidation. The organization cancelled this year’s productions and the opera’s staff has all left. Both voluntary dissolution and Chapter 7 bankruptcy amount to the same thing: an organization closing its doors, but voluntary dissolution and Chapter 7 bankruptcy differ in at least one crucial way.

“Voluntary dissolution doesn’t deal with any of the creditors,” said Randy Osherow, the San Antonio Opera’s lawyer. “To get voluntary dissolution, you have to say you’re taking care of all your bills. Certainly if (the opera) had been able to pay all their bills and still wanted to dissolve, (voluntary dissolution) would be a viable option.”

The Philadelphia Orchestra Association (POA) filed for Chapter 11 protection in April 2011. As part of the proceedings, the POA withdrew from the American Federation of Musicians and Employers’ Pension Fund (AFM-EPF). The fund initially claimed the POA owed a $23 million penalty. That number was later revised to $35 million, and the musicians’ union argued it should be paid from the orchestra association’s endowment, valued at about $120 million.

Because the AFM-EPF believed it should be paid from the endowment, the POA was compelled to produce documentation proving that the remainder of the endowment (the orchestra has already spent all of its unrestricted endowment) was restricted. The two sides came to an agreement before a lengthy court battle.

“We have had to diligently gather all of the documentation related to these gifts — many of which date back decades and some even date to the early 20th century — and we have provided that documentation, along with other requested information, to the American Federation of Musicians and Employers’ Pension Fund,” said Larry Mc­Michael of the firm Dilworth Paxson, lead counsel for the POA.

The response to the AFM-EPF’s request to be paid from the POA’s endowment normally would be no. But because the orchestra commingled unrestricted and restricted funds in the same account (although the funds were tracked separately), the idea might have been a solid argument. Like most nonprofits that enter Chapter 11 bankruptcy, the POA did so with the in­tention of emerging from it. “There was ab­solutely no expectation or notion that the orchestra would liquidate or dissolve,” said McMichael.

He said that many of the orchestra’s goals in entering bankruptcy have been accomplished. One of the last holdups is renegotiating its lease with the Kimmel Center for the Performing Arts, the orchestra’s venue. An agreement is in the works, and McMichael expects “to emerge from bankruptcy within 90 to 120 days from the time we file a Plan of Reorganization and Disclosure Statement.” He said the orchestra expects to file these documents “in the near term.”