International Encyclopedia of Public Policy and Administration - Vol. 2

By Jay M. Shafritz | Go to book overview

down in dealing with multiple local government problems. Home rule applies only to municipalities or, in a few instances, counties. Other units of local government, such as special districts, still are governed under enabling acts whose restrictions are very specific.



Advisory Commission on Intergovernmental Relations, 1981. Measuring Local Discretionary Authority. Washington, DC: Advisory Commission on Intergovernmental Relations.

Dillon, John F., 1911. Commentaries on the Law of Municipal Corporations. 5th ed. Boston:Little Brown.

ENDOWMENT . A permanent fund that distributes investment income to a beneficiary but does not distribute principal.

General Practice

Many charitable organizations seek to establish endowment funds to provide a permanent source of support to the organization. Endowments permit an organization to operate with a more stable budget than if it had to depend solely upon revenue sources that vary from year to year, such as contributions and sales revenue. As a practical matter, well-established organizations that demonstrate financial stability are in the best position to attract contributions to endowment funds. Organizations that are newly established or are in a financial crisis rarely succeed.

An endowment is sometimes confused with an operating reserve. An operating reserve provides investment income, but the charity can also withdraw principal if there is an emergency. With a true endowment the charity cannot withdraw principal even if there is an emergency.

Some charities own and invest their own endowment funds, but many others have the funds invested in a separate trust or corporation or by a local community foundation. A separate entity can increase contributions to the endowment fund because donors often want assurance that the charity will be unable to invade the principal of the fund. For example, when several symphonies became insolvent, the symphonies that controlled their own endowment funds either spent their principal or were forced to pay the amounts to creditors. Endowment funds that were invested separately, such as in a community foundation, continued to exist to support classical music after the symphony went out of existence. The funds endowed a new symphony or distributed income each year to other classical music organizations.

Legal Issues

Whether the principal of an endowment fund can be invaded depends upon the legal documents that govern the endowment fund. An important document is the "instrument of transfer" that a donor uses to make a gift to the endowment fund. Other important documents, particularly if the fund is held by a separate entity, are the fund's organizational documents: articles of incorporation (for a corporation) or the trust instrument (for a trust). These documents may contain numerous restrictions, including restrictions on the distribution of principal.

An instrument of transfer can be as complicated as a trust instrument or as simple as a letter. The donor may have imposed restrictions on the use of the assets in the endowment fund and the charity must honor them. In addition to specifying whether distributions can be made from principal, the instrument of transfer may contain specific restrictions about how the income is to be used. For example, a donor can require an endowment to be used to fund certain types of scholarships for a designated class of students (for example, graduates of a specific high school). If the instrument of transfer fails to specify what should happen if a requirement is not met or if circumstances change (for example, if the endowed charity goes out of existence), the affected parties may have to petition a court to resolve the problem. Courts often apply the legal doctrines of "cy-pres" or "equitable deviation" to modify the donor's restrictions in a manner that is consistent with the donor's intent. In extreme cases a court can order a trust to be terminated and the proceeds distributed to the donor's heirs rather than to a charity if it is impossible to carry out a donor's intentions.

The amount of the net income that should be distributed depends upon the terms of the governing document of the endowment fund and whether it is held by a trust or a corporation. In addition to administrative restrictions that may have been imposed by a charity on its endowment funds and specific restrictions that may have been imposed by a donor, there could be provisions in the organization's governing instrument (the articles of incorporation or the trust instrument) that govern the administration of the fund. For example, such documents might contain definitions of income and principal.

In the absence of specific provisions in the governing instrument, most states have laws that determine what is income and what is principal. Most trusts are governed by the Uniform Principal and Income Act. It defines income to include interest, dividends, rents, and royalties, but generally excludes capitals gains. For example, if a trust had $20,000 of interest, $10,000 of dividends, and $40,000 of gain from the sale of stock, the trust would have income of $30,000. The $40,000 of gain would be classified as principal and would be reinvested. If, however, the trust instrument has a provision that conflicts with the act (e.g., it de


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