SUMMER 2012

STUDENT UPDATE MEMORANDUM

to

NONPROFIT ORGANIZATIONS

Cases and Materials

Fourth Edition

By

JAMES J. FISHMANProfessor of Law

Pace University School of Law

STEPHEN SCHWARZProfessor Emeritus

University of California, Hastings College of the Law

With the Collaboration of

LLOYD HITOSHI MAYERProfessor of Law and Associate DeanUniversity of Notre Dame Law School

FOUNDATION PRESS2012

PREFACE

This 2012 Student Update Memorandum brings Nonprofit Organizations: Cases andMaterials up to date by summarizing major developments since publication of the FourthEdition in July of 2010. It is organized to parallel the text, with cross references to chapterand topic headings and page numbers. The Update covers developments through July 1, 2012. An Appendix includes the full text of proposed treasury regulations on program-relatedinvestments.

Instructors who have adopted the text for classroom use may copy or reproduce all orpart of the Update and distribute it to their students.

July 2012

PART ONE: INTRODUCTION

CHAPTER 1. AN OVERVIEW OF THE NONPROFIT SECTOR

B. DIMENSIONS OF THE NONPROFIT SECTOR

Page 17:

At the end of Note: Restrictions on NGO Democracies, insert:

Nongovernmental organizations (NGOs) play an important role in fostering democraticpractices. As a result they frequently come under critical scrutiny by governmental andmilitary interests, who see them as a threat to their control. This has been most evident inrecent months in the fragile democracy that emerged in Egypt after the Arab Spring.

At the end of 2011, Egyptian security forces raided the offices of seventeen humanrights and pro-democracy NGOs for evidence of illegal foreign funding. Registration tolegitimize the NGOs’ funding was ignored or delayed. At the end of January 2012 sixAmerican NGO workers including the son of a U.S. cabinet secretary were blocked fromleaving the country. In February Egyptian prosecutors charged 43 NGO workers, including 19Americans, of undermining Egyptian national interests by establishing and operating NGOswithout licenses, working for an unregistered organization and distributing foreign fundsillegally. The legal restrictions date from the Mubarak government and require licenses thatwere almost never granted, effectively precluding domestic financing and exerting governmentcontrol over foreign contributions. The six detained Americans were employed by theInternational Republican and the National Democratic Institutes. The United States threatenedto cut off its $1.3 billion in military aid. At the end of February, after negotiations and areported nearly $5 million in bail was posted, the Americans were allowed to leave, but thecharges were not dropped.

Subsequently in April, Egypt rejected license applications for eight American NGOs,because they threatened Egyptian State sovereignty and proposed new legislation which wouldfurther limit the ability of NGOs to receive funding from foreign nations. May brought apolicy reversal, and 53 NGOs including two from the United States, were granted licenses toobserve the presidential elections. Sources used for the events described above include: MattBradley & Keith Johnson, Egyptian Raids on U.S. Groups Draw Ire, Wall St. J., Dec.30,2011, at A1; Matt Bradley & Charles Levinson, In Standoff, Egypt Blocks Americans fromLeaving, Wall St. J., Jan. 31, 2012, at A1; Matt Bradley, Americans to Face Trial in Egypt,Wall St. J., Feb.6, 2012, at A1; David D. Kirkpatrick, Egypt Defies U.S. by Setting Trial for19 Americans, N.Y. Times, February 6, 2012, at A1; David D. Kirkpatrick, Egypt RejectsRegistration Bids From 8 U.S. Nonprofit Groups, N.Y. Times, Apr. 24, 2012, at A6;Observers Arrive to Monitor Egypt’s Presidential Elections, Ahram Online, May 21, 2012,available at http://english.ahram.org.eg/News/42215.aspx.

NGOs have been shuttered and harassed in other countries. An Amnesty Internationalstudy found that Ethiopian advocacy groups were forced to shut down or curtail their activitiesunder a 2009 law that bars organizations from working on human rights issues if they receivemore than a tenth of their funding from foreign sources. The law also restricts criticism of theEthiopian government. William Davison, Ethiopian Charity Law Destroys Human-RightsGroups, Amnesty Says, Bloomberg.com, Mar. 12, 2012, available at

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http://www.bloomberg.com/news/2012-03-12/ethiopian-charity-law-destroys-human-rights-groups-amnesty-says.html. In March 2012, the United Arab Emirates closed the Dubai officesof the National Democratic Institute and the Konrad-Adenauer-Stiftung, a think tank affiliatedwith the Christian Democratic Union, a political party. See Mohammed Jamjoom, Detailsemerge in UAE closing of pro-democracy groups, Cnn.com, April 06, 2012, available athttp://articles.cnn.com/2012-04-06/middleeast/world_meast_uae-organizations_1_uae-dubai-abu-dhabi?_s=PM:MIDDLEEAST. Zimbabwe banned 29 humanitarian organizations in theprovince of Masvingo, in the southern part of the country, supposedly because they failed toregister. Zimbabwe: More NGO Bannings Feared, allAfrica (Feb. 17, 2012),http://allafrica.com/stories/201202171242.html. NGOs have been threatened, raided andclosed in Uganda, Pakistan and several other countries. The best source to keep abreast ofthese of these developments is the Newsletter of the International Center for Civil SocietyLaw, available at http://www.iccsl.org/pubs/index_news.html.

At the end of Note: International Charities and Terrorist Organizations, insert:

The government continues to have mixed results in its efforts to prosecute charities’alleged terrorist and illegal activities. A federal district court judge ordered the federalgovernment to pay nearly $2.6 million to officials of the now closed Al-Haramain IslamicFoundation. Almost all of that sum represented legal fees, except for $40,800 in damages,which arose from the wiretapping of the organization’s officials without court approval under asurveillance program approved by President George W. Bush. A court previously found thatthe wiretapping was illegal. Eric Lichtblau, U.S. Ordered To Pay Group of Muslims, N.Y.Times, Dec. 22, 2010, at A23. The decision was affirmed by the Ninth Circuit, Al HaramainIslamic Foundation, Inc. v. U.S., 2012 WL 603979, ___ F.3d ___ (9th Cir. 2012). The courtupheld the government's redesignation of the organization as a specially designated globalterrorist. It affirmed that the Treasury Department’s Office of Foreign Asset Control violatedAHIF–Oregon's Fourth Amendment right to be free from unreasonable seizures when it frozethat domestic entity's assets without ever obtaining a warrant. The court remanded the case todetermine what judicial relief, if any, was available. It also found the government violated theFirst Amendment rights of another nonprofit, the Multicultural Association of SouthernOregon, when it effectively barred the organization from coordinating its advocacy with AHIF-Oregon.

The government won a major victory Holder v. Humanitarian Law Project, 130 S.Ct.2705 (2010) where the Supreme Court, in a 6-3 decision by Chief Justice Roberts, held that afederal statute prohibiting knowingly providing material support to foreign terroristorganizations, 18 U.S.C.A. § 2339B, did not violate the freedom of speech or freedom ofassociation rights of organizations and individuals, who allegedly sought to provide support todesignated foreign terrorist organizations for only lawful, nonviolent activities, such as trainingmembers on how to use humanitarian and international law to peacefully resolve disputes. TheCourt gave significant weight to the considered judgment of Congress and the Executive thatproviding material support to designated foreign terrorist organizations, even seemingly benignsupport, bolstered the terrorist activities of that organization. The case is noted in 124 Harv.L. Rev. 259 (2010).

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C. CHARITY, PHILANTHROPY AND NONPROFIT ORGANIZATIONS: AHISTORICAL INTRODUCTION

Page 30:

At the end of Note: Social Enterprise Organizations, insert:

In addition to the low-profit limited liability company (“L3C”) statutes that have beenenacted in at least nine states plus two tribal nations, two other hybrid organizational vehicles,the benefit corporation and the flexible purpose benefit corporation, have made theirappearance. The L3C is a type of limited liability company offering the limited liability andpass-through taxation of that form, but it is organized primarily for a charitable purpose andsecondarily for profit. The benefit corporation and flexible purpose corporation are new typesof business corporations that also engage in social enterprise activities.

Each of these organizational forms attempts to harness the desire to accomplish socialgood while pursuing profit by weaving between the nondistribution constraint of nonprofit lawand the business corporate principal that “the fundamental objective of the business corporationis to be run for the maximization of the shareholders’ wealth.”1

Benefit corporations, currently authorized in nine states, are business corporations2

whose purposes are to be socially and environmentally conscious as well as to earn a profit. They must have a "general public benefit" purpose, defined as a material, positive impact onsociety and the environment, taken as a whole, as assessed against a third-party standard,through activities that promote a combination of specific public benefits.3

The legislation defines a "specific public benefit" to mean providing individuals orcommunities with beneficial products or services; promoting economic opportunity forindividuals or communities beyond the creation of jobs in the normal course of business;preserving the environment; improving human health; promoting the arts, sciences, oradvancement of knowledge; increasing the flow of capital to entities with a public benefit

The classic view is stated in Dodge v. Ford Motor Company, 204 Mich. 459, 507, 170 N.W.1

668, 684 (1919) “A business corporation is organized and carried on primarily for the profit of thestockholders. The powers of the directors are to be employed for that end. The discretion of thedirectors is to be exercised in the choice of means to attain that end and does not extend to a change inthe end itself, to the reduction of profits or to the nondistribution of profits among stockholders inorder to devote them to other purposes.”

As of the time this Update Memorandum went to press in July 2012, benefit corporation2

legislation has been enacted in California (Cal. Corp. Code §§14600-14631 (West 2012); Hawaii(Haw. Rev. Stat. §§420D-2 to 420D-13 (2012); Louisiana, (La. Rev. Stat. Ann. §§ 12:1801-1832(2012); Maryland (Md. Code Ann., Corps. & Ass'ns §§ 5-6C-01 to 5-6C-08 (West 2012); New Jersey(N.J. Stat. Ann. §§ 14A:18-1 to 14A:18-11 (West 2012); New York (N.Y. Bus. Corp. Law §§1701-1709 (McKinney 2012); South Carolina (S.C. Code Ann. §§33-38-110 to 33-38-600 (2012); Vermont (Vt. Stat. Ann. tit. 11A, §§21.01-21.14 (West 2012); and Virginia (Va. Code Ann §§13.1-782 to 13.1-791 (West 2012). Legislation has been introduced or passed and awaiting gubernatorial signature inColorado, Illinois, North Carolina and Pennsylvania.

The statutes are broadly similar, but with individual differences among jurisdictions. For a3

detailed discussion of the statutory provisions, see Dana Brakman Reiser, Benefit Corporations—ASustainable Form of Organization?, 46 Wake Forest L. Rev. 591 (2011).

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purpose; or the accomplishment of any other particular benefit for society or the environment.4

Benefit corporations must provide an annual benefit report to shareholders and have othertransparency obligations.5

California’s legislation has stricter requirements for corporations that adopt the benefitcorporation format including the selection of a third party standard developed by anindependent entity, that will create criteria for evaluating the overall corporate, social andenvironmental performance of the corporation. The corporation must present an annual6

benefit report to its shareholders discussing whether it met its third party standards, how thestandard was selected, and whether the corporation successfully pursued its public benefit goalsduring the year. The California statute authorizes shareholders to bring “benefit enforcement7

proceedings” directly or derivatively to enforce the obligations of the corporation to pursue itspublic benefit purposes. This provision could become known as “the crackpot’s standing8

clause.” In every decision or proposed action the directors are required to consider the impacton various constituencies ranging from shareholders, employees, customers, the local andglobal community and environment.9

The strict provisions of the California legislation encouraged a working group ofpartners in California law firms to draft a more flexible alternative, the flexible purposecorporation, which is unique to California. As one might expect from a lawyer generated10

effort, the Flexible Purpose Corporation Act is substantially longer than the social enterprisers’advocated benefit corporation. Basically, the flexible purpose corporation encourages andexpressly permits companies to be formed or converted from other organizational forms topursue one or more purposes in addition to creating economic value for shareholders, pursuantto lawful acts or activities for which a corporation may otherwise be organized under thegeneral corporate law. To some extent, entities taking this form may evince characteristics of

See N.Y. Bus. Corp. L. § 1702(E). An existing business corporation can elect to become a4

benefit corporation by amending its charter to include a statement that the corporation is a benefitcorporation. An amendment electing benefit corporation status, and the subsequent termination ofbenefit corporation status, must be approved by the shareholders. A benefit corporation can identifyand include one or more specific public benefits in its charter with the approval of the shareholders. Id.at § 1704. In California, neither directors nor officers have a fiduciary duty or are liable for the failureof the corporation to create a general or specific public benefit. Cal. Corp. Code § 14620(f).

The benefit corporation, which is a new legal form authorized by state law, should not be5

confused with the B corporation, familiarly known as “B Corp.” B Corps are for-profit companies thatdemonstrate a commitment to using the power of business to solving social problems and receive acertification from B Lab, a private nonprofit corporation that acts as an external certifier and allowscompanies that pass its standards for social responsibility to license the B Corp trademark. B Corpstatus is a sort of good housekeeping seal of approval. See http://www.bcorporation.net/.

Cal. Corp. Code §14601(c)(g).6

Id. at §14620.7

Id. at § 14623.8

Id. at § 14620(b). There are several provisions limiting directors’ and officers’ liability.9

Cal. Corp Code §§ 2500-3503.10

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both for-profit and non-profit corporations. They will, however, be subject to all provisions ofthe general corporate law, except as specifically provided in the new law.

There are fewer requirements imposed on the flexible purpose corporation than thebenefit corporation. They are not required to have as a purpose the creation of general publicbenefit. There is no need to have assessments based upon third party standards. Nor are thereprovisions authorizing benefit enforcement proceedings, or a mandate to consider anyparticular public benefit factors when making decisions.

The articles of incorporation may eliminate or limit personal liability of directors formonetary damages for breach of fiduciary duty save for intentional misconduct. A flexible11

purpose corporation may, by amendment of its articles pursuant to this section, convert to anonprofit public benefit corporation, nonprofit mutual benefit corporation, nonprofit religiouscorporation, or cooperative corporation. The board of the flexible purpose corporation must12

provide an annual report to shareholders and post on its website a management discussion andanalysis (MD&A) of its special stated purpose or purposes as set forth in its articles. Thespecial purpose MD&A shall include any information that the corporation's officers anddirectors believe to be reasonably necessary or appropriate to an understanding of the flexiblepurpose corporation's efforts in connection with its special purpose or purposes.13

To align corporate and investor interests, flexible purpose corporations will be requiredto specify in their articles of incorporation at least one “special purpose” that directors andmanagers may consider in addition to traditional shareholder economic interests whendetermining what is in the best interests of the flexible purpose corporation and its shareholderswith respect to decisions about operations, policies and transactions.

Whether these legislative efforts will lead to widespread use is uncertain, but they havegenerated an enormous academic response in the form of symposia, articles and student notes.

E. THE LEGAL FRAMEWORK

Page 40:

Tax-Exempt Organizations Registered with the IRS. The number of tax-exemptorganizations dipped sharply in 2011 after the exempt status of over 385,000 organizations wasrevoked for failing to satisfy the Form 990 information return filing requirement for threeconsecutive years. According to the latest available data, the total number of registered§ 501(c) organizations for 2011 was 1,494,882, as compared to 1,821,824 in 2010. I.R.S.Data Book, 2011, Table 25. For discussion of the new filing requirements, see infra p. 16.

Id. at § 2603.11

Id. at § 2700.12

Id. at § 3501(e).13

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PART TWO: ORGANIZATION AND OPERATION OF NONPROFIT

ORGANIZATIONS – THE STATE PERSPECTIVE

CHAPTER 2. FORMATION, DISSOLUTION AND RESTRUCTURING

D. DISSOLUTION AND DISTRIBUTION OF ASSETS

2. CHARITABLE TRUSTS: THE DOCTRINE OF CY PRES

Page 94:

Note 6. A Dog’s Life. The authors are saddened to announce the passing of LeonaHelmsley’s beloved dog Trouble in December 2010 at the age of twelve. Trouble, the world’srichest and most hated Maltese (two dozen death threats), died in Sarasota, Florida, where shelived with her guardian and security detail. Ms. Helmsley’s will requested Trouble’s remainsbe buried alongside her, but New York burial regulations prohibit interring non-humanremains at human cemeteries. A lawsuit by animal rights advocates to force the HelmsleyTrust to adhere to Ms. Helmsley’s wishes was unsuccessful and is on appeal. See CaraBuckley, Cosseted Life and Secret End of a Millionaire Maltese, N.Y. Times, June 10, 2011,at A20.

3. THE DOCTRINE OF DEVIATION

Page 101:

Barnes Redux. As the Barnes collection prepared to move to its new home inPhiladelphia, Friends of the Barnes, who opposed the move, requested the judge in the 2004decision to reconsider his decision, because of new evidence that the Foundation’s direeconomic situation had been overstated. In the film, The Art of the Steal, the Pennsylvaniaattorney general stated that he pressured Lincoln University to ensure the move by threateningto sue to change the composition of Lincoln's board. The plaintiffs alleged the attorney generalviolated his fiduciary responsibilities. See Randy Kennedy, Barnes' Dispute Continues, N.Y.Times, March 30, 2011, at C3. The court not only rejected the petition but required the group,its counsel and another attorney, who filed a separate petition, to reimburse the BarnesFoundation $40,000 to cover legal fees. See Joanne Loviglio, Judge: Barnes Move Foes MustReimburse Legal Fees, Wash. Times, March 12, 2012 available athttp://www.washingtontimes.com/news/2012/mar/12/judge-barnes-move-foes-must-reimburse-legal-fees/. Friends of the Barnes refuses to give up. It has asked the court to reopen the casebased on a blog post by the museum’s former CEO in which she wrote that the BarnesFoundation was not on the verge of bankruptcy when it sought to break the trust indenture andmove the museum to Philadelphia. This revelation seemingly contradicted key testimonypresented at the trial about the Foundation’s precarious finances. See Randy Kennedy, FormerHead of Barnes Foundation Says Its Move Was Not Forced by Bankruptcy, N.Y. Times, July3, 2012, available at http://artsbeat.blogs.nytimes.com/2012/07/03/former-head-of-barnes-foundation-says-its-move-was-not-forced-by-bankruptcy/.

Despite this lingering controversy, the “new Barnes” – an opulent campus on BenjaminFranklin Parkway in Philadelphia – opened on May 19, 2012. The early reviews have beenmostly favorable. See Ada Louise Huxtable, The New Barnes Shouldn’t Work – But Does,

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Wall St. J., May 24, 2012, at D4; Eric Gibson, Saving Dr. Barnes’s Vision, Wall St. J., May24, 2012, at D4.

F. OTHER NONPROFIT RESTRUCTURING

Page 121:

Note 3. Charities in Bankruptcy. The persistence of the recession has created enormousfinancial stress on the nonprofit sector. The 2008 market drop preceded a tsunami of otherproblems: overexpansion during times of prosperity, leading to an inability to pay mortgageand other commitments, reduced donor generosity, cutbacks in governmental support, declinesin patronage and for social services organizations, increasing demands from beneficiaries. Organizations have been forced to merge, downsize, tap into their endowments, or temporarilycease operations. An increasing number have entered bankruptcy. Perhaps the most recognizedorganization to collapse so far in 2012 was the 123 year old Jane Addams Hull HouseAssociation in Chicago.

Although the headlines have focused on bankruptcies of eight Catholic dioceses (out of195) because of the child abuse scandals, other churches, estimated in the hundreds, havesought or will seek bankruptcy protection. Shelly Banjo, Churches Find End is Nigh, TheNumber of Religious Facilities Unable to Pay Their Mortgage Is Surging, Wall St. J., Jan. 25,2011, at A3; Carolyn Said, Churches see surge in foreclosures, S.F. Chron. Mar. 25, 2012,available at http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2012/03/25/MNQ81NO9TB.DTL&ao=all. One of the more prominent church bankruptcies was that of Reverend RobertSchuller’s Crystal Cathedral in Garden Grove California. Insiders and members of theSchuller family received more than $1.8 million in the year preceding the bankruptcy filing.See Abby Sewell & Nicole Santa Cruz, L.A. Times, Dec. 3, 2010, available athttp://articles.latimes.com/2010/dec/03/local/la-me-crystal-cathedral-20101203.

Arts and cultural organizations seem most severely affected. The Delaware Symphonysuspended its season. The St. Paul Chamber Orchestra moved to a part time status. TheHonolulu, Louisville, New Mexico and Syracuse Symphonies are in bankruptcy proceedingsand uncertain to emerge. The Philadelphia Orchestra, one of the nation’s most esteemedmusical institutions with an endowment of $140 million, entered bankruptcy in April 2011, toavoid pension obligations. It is scheduled to emerge from bankruptcy this year. The SanFernando Children’s Museum and the Fresno Museum declared bankruptcy. The SeaportMuseum in New York City survived by entering into a shotgun marriage with the Museum ofthe City of New York, thereby saving the organization. See Robin Pogrebin, Seaport MuseumTakeover Planned, N.Y. Times, Sept. 8, 2011, at C1. The Florida Stage of Palm BeachFlorida became a delayed victim of Bernard Madoff as many of its patrons had invested in hisPonzi scheme.

The Asian Art Museum of San Francisco narrowly avoided bankruptcy after JP MorganChase agreed to restructure repayment of $120 million in bonds it held and the City guaranteedthe loans. Other institutions at risk may not have such a happy ending. The well-regardedIntiman Theater of Seattle cancelled its 2011 season but was able to return in 2012. The NewYork City Opera has been forced to move out of Lincoln Center and has postponed its seasonuntil it gets its finances in shape.

Most organizations that enter bankruptcy elect Chapter 11 of the Bankruptcy Code,which permits organizations to restructure and eliminate debt, terminate labor agreements,

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change pension obligations, thereby emerging from bankruptcy as a leaner and, hopefully,stronger institution. If restructuring is not an option, the organization will enter Chapter 7 andbe wound up.

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CHAPTER 3. OPERATION AND GOVERNANCE

C. FIDUCIARY OBLIGATIONS

5. INVESTMENT RESPONSIBILITY

b. The Uniform Prudent Management of Institutional Funds Act

Page 208:

UPMIFA Update. Forty-nine states and the District of Columbia have now adoptedUPMIFA. The only holdout is Pennsylvania, which has taken no legislative action.

A report issued by the Association of Governing Boards of Universities and Colleges,in conjunction with the Commonfund Institute, demonstrates the impact of UPMIFA onendowment expenditure policies. On average, funds below their historic dollar value accountedfor 22.4% of the total value of endowment funds held by colleges and universities at the end ofthe fiscal year ending June 30, 2009. Nearly 47% percent are continuing distributions inkeeping with their normal spending rule, an increase of 8.7 percentage points over practiceprior to the enactment of UPMIFA; 25.1% discontinued all distributions from underwaterfunds, a decrease of 16.4 percentage points from practice prior to UPMIFA; 9.7% aredistributing only interest and dividends, a decrease of 7.2 percentage points from the practiceprior to UPMIFA. After the enactment of UPMIFA; 47.1% of institutions and foundationswhich previously discontinued all distributions or distributed only interest and dividends fromunderwater endowments adopted a new spending approach likely to yield greater ongoingdistributions supporting endowment purposes. See David Bass, Spending and Management ofEndowments under UPMIFA (2010), available athttp://agb.org/reports/2010/spending-and-management-endowments-under-upmifa.

New York adopted UPMIFA (NYUPMIFA) in 2010 but added several uniqueprovisions and procedures that undermine the flexibility of the uniform act. NYUPMIFA has abroader definition of "institution" by including nonprofit social clubs, trade associations andsocial welfare organizations formed under the New York Not-for-Profit Corporation Law.(NYUPMIFA § 551). Similarly, "institutional fund" does not include the requirement that thefund be held exclusively for charitable purposes. (Id. §531(e)).

NYUPMIFA adopts UPMIFA's requirement that an institution shall diversifyinvestments of an institutional fund unless it prudently determines that because of specialcircumstances the purposes of the fund are better served without diversification. However,New York also adds that "an institution shall review a decision not to diversify an institutionalfund as frequently as circumstances require, but at least annually." (Id. §552(e)(4).) NewYork also requires nonprofit corporations to adopt a written investment policy. (Id. §552(f)).

NYUPMIFA creates three categories of endowment funds, each with different spendingrules. The first category is for endowment funds established by gift instrument beforeSeptember 17, 2010 (the date NYUPMIFA became effective) by a donor who is no longeravailable nor can be found or a fund established as part of an institutional solicitation. In thisclass the organization can appropriate a prudent portion of the endowment based on theNYUPMIFA standard of prudence, absent an express limitation in the gift instrument.

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The second category is for endowments established before the date of the legislation butthe donor is "available" and was not solicited as part of institutional solicitation. NYUPMIFArequires the organization to send a notice to a donor in this category at least 90 days in advanceasking whether the institution may spend as much of the gift as prudent or not. If the donoragrees or does not respond within 90 days, the institution can avail itself of NYUPMIFA’srules for making appropriations.

The third category is for endowments established after legislation’s enactment. NewYork eliminated historic dollar value but requires consideration of eight factors (instead ofUPMIFA’s seven). The additional factor requires the board to consider "where appropriate andcircumstances would otherwise warrant, alternatives to expenditure of the endowment fund,giving due consideration to the effect that such attitudes may have on the institution”. (Id.§ 553(a)(8)). This may serve as a brake on appropriations from funds below their historicdollar value. NYUPMIFA also requires an institution to keep a contemporaneous recorddescribing the consideration given by the governing board or committee to each of the factors.(Id. §553(a)).

New York is one of the 14 states that have adopted the rebuttable presumption ofimprudence, if the appropriation for expenditure in any one year is over 7%. For calculationpurposes the 7% figure requires a five-year look back, rather than three years under the uniform act. The 7% presumption only applies to appropriations from gift instruments after thelegislation’s enactment.

Both UPMIFA and New York's version allow an institution to apply cy pres orequitable deviation without application to a court to release an endowment restriction, if thefund's value is less than $100,000, more than 20 years have elapsed since its establishment andthe property will be used consistently with the gift’s charitable purposes. In addition to thenormal attorney general notification, institutions must notify donors. (Id. §555(d)). This couldcreate a real burden on institutions.

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CHAPTER 4. REGULATION OF CHARITABLE SOLICITATION

B. CONSTITUTIONAL RESTRICTIONS ON REGULATION

Page 272:

Note 1. Cost of Fundraising Ratios. An analysis by the Scripps Howard News Serviceof the most recent Form 990 returns of 37,987 charities and other nonprofits that raised at least$1 million through fundraising reaffirmed the Urban Institute’s conclusions in its 2000 studythat a substantial number of charities report no fundraising expenses. Forty-one percent of thecharities (15,389) that raised a total of $116.7 billion stated they spent nothing for advertising,telephone solicitations, mailed appeals, professionally prepared grant applications or staff timefor face-to-face solicitations. For example, 48 of Goodwill Industries 127 major affiliatesreported raising $387 million at no cost. Of the 22,598 organizations that did reportfundraising expenses, the cost of fundraising was but seven cents for every dollar raised.

Robert Ottenhoff, CEO of GuideStar and former COO of the Public BroadcastingService, said: "It is ridiculous to think an organization could raise significant amounts ofmoney without spending money to do it. I must be doing something wrong. I've never seen itgrowing on trees." Thomas Hargrove & Waqas Naeem, Thousands of Nonprofits MisreportFundraising Costs, Scripps Howard News Service, May 21, 2012, available athttp://public.shns.com/content/thousands-nonprofits-misreport-fundraising-costs.

Page 273:

Note 2. Post-Riley Cases. Oregon attempted a new approach to states’ repeated effortsto control the high administrative and fundraising costs of charities. A bill approved by thestate’s senate but rejected by its house of representatives would have allowed the attorneygeneral to disqualify charities from receiving tax-deductible contributions for Oregon state taxpurposes if the charity failed to expend at least 30% of the organization’s “total annualfunctional expenses” on program services as that phrase is used on IRS Form 990. Exemptedfrom the proposed legislation were private foundations, community trusts or foundations,qualified charitable remainder trusts, charities that didn’t have to file the Form 990 andcharities that operated for less than four years.

Additionally, the attorney general could have exempted organizations that wereaccumulating money for a specific purpose such as a capital campaign or presented “othermitigating circumstances.” Charities would have to disclose to donors that they could notdeduct their contributions for state tax purposes. Unlike the Supreme Court cases that struckdown attempts to limit solicitation, this bill regulated the availability of charities to use thestate subsidy provided by tax exemption and the charitable deduction, an approach that wasupheld in Regan v. Taxation with Representation (casebook p. 489). However, Riley v.National Federation of the Blind (casebook p. 263) held the state’s power to licenseprofessional fundraisers was subject to First Amendment scrutiny to ensure that the licensor’sdiscretion was suitably confined. Here the Oregon attorney general’s discretion under the billmay come under similar scrutiny.

Using the Guidestar data base, the Chronicle of Philanthropy scanned the Form 990s ofmore than 100,000 nonprofits and found that more than one-fifth would not have met theguidelines of the Oregon bill. Of that group, nearly 96% would have failed the 30%requirement because they left blank or filled in zero on the line where they were to report how

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much they spent on programs. Lisa Chiu, Many Charities Don’t Tell IRS How Much TheySpend on Programs, Chron. Philanthropy, May 1, 2011, available (with subscription) at http://philanthropy.com/article/Many-Charities-Don-t-Tell/127302/.

The bill is available at http://www.leg.state.or.us/11reg/measpdf/sb0001.dir/sb0040.intro.pdf . See also Suzanne Perry, Oregon Puts the Spotlight on How Charities SpendTheir Money, Chron. Philanthropy, May 1, 2011 available (with subscription) athttp://philanthropy.com/article/Ore-Crafts-Novel-Way-to-Crack/127339/.

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PART THREE: TAXATION OF CHARITABLE ORGANIZATIONS

CHAPTER 5. TAX EXEMPTION: CHARITABLE ORGANIZATIONS

B. THE RATIONALE FOR CHARITABLE TAX EXEMPTIONS

Page 298:

Footnote 1. See also Memorandum from Erika Lunder, Congressional ResearchService, to Joint Committee on Taxation re: Non-Tax Benefits Provided to OrganizationsDescribed in IRC § 501(c)(3), Feb. 16, 2005, in Joint Committee on Taxation, HistoricalDevelopment and Present Law of the Federal Tax Exemption for Charities and Other Tax-exempt Organizations (JCX-29-05), April 19, 2005, at 195.

C. AFFIRMATIVE REQUIREMENTS FOR CHARITABLE TAX EXEMPTION

3. THE MEANING AND SCOPE OF CHARITY

Page 319:

Free Fertility Foundation is a California nonprofit public benefit corporation foundedby William Naylor, a software engineer and inventor. Its purpose was to provide sperm freeof charge to women seeking to become pregnant. Naylor was the only sperm donor, and heand his father were the sole board members and officers of the organization. In Free FertilityFoundation v. Commissioner, 135 T.C. 21 (2010), the Tax Court upheld the IRS’s denial of§ 501(c)(3) exemption. The court acknowledged that the free provision of sperm might qualifyas “charitable,” but in this case the class of beneficiaries was not sufficiently large to benefitthe community as a whole. The “smoking pistol,” as it were, was that Mr. Naylor was theonly donor and his personal preferences (he preferred women “from families whose membershave a track record of contributing to their communities” and who had “better education”)narrowed the class of eligible recipients.

6. RELIGIOUS ORGANIZATIONS

Page 427:

Note 1. Religious Distinctions – What’s a Church? In Foundation of HumanUnderstanding v. United States, 614 F.3d 1383 (Fed. Cir. 2010), the court affirmed a Court ofFederal Claims decision holding that a § 501(c)(3) religions organization did not qualify as a“church.” The Foundation of Human Understanding was formed in 1963 and achieved churchstatus after prevailing in a 1987 Tax Court case. Foundation of Human Understanding v.Commissioner, 88 T.C. 1341 (1987). It underwent several changes following the Tax Courtdecision, causing the IRS to conduct an inquiry and eventually revoke the Foundation’s churchclassification primarily because the organization no longer conducted regular worship servicesat any particular location but instead disseminated its message through broadcast, print media,and the Internet.

Both the Claims Court and the Federal Circuit referred to the fourteen church criteriaoften utilized by the IRS but ultimately applied an “associational test,” which defines a church“as an organization that includes a body of believers who assemble regularly for communcal

13

worship.” The Foundation failed to qualify under this standard because it did not provideregular religious services to an established congregation and the extent to which it broughtpeople together to worship was incidental to its main function of spreading its message throughpublication and broadcasting.

8. STATE AND LOCAL TAX EXEMPTIONS

Page 444:

After the carryover paragraph, insert:

In Mesivtah Eitz Chaim v. Pike County Board of Assessment Appeals, 44 A.3d 3 (Pa.2012), the Pennsylvania Supreme Court in a 4-3 decision overturned the more expansiveapproach to property tax exemption of Act 55 and reinstated its more restrictive five point testin the 1985 Hospital Utilization Project (“HUP”) decision (see casebook pp. 442-443). Asummer camp owned by a religious organization was denied property tax exemption as apurely public charity because it did not meet one of the five HUP tests – relieving thegovernment of some of its burden. Although the camp’s facilities were open to the public, noPike County resident utilized its amenities. The legal issue was whether the criteria enacted bythe legislature in Act 55 for determining whether an organization qualified as a purely publiccharity under Pennsylvania’s Constitution was deserving of deference, or whether the testprovided by the court in the HUP decision was controlling, leaving no room for legislativeinfluence and input. The court concluded that legislation could not displace a judicialinterpretation of the Constitution and thus, if an organization fails to qualify under the HUPtest, that ends the inquiry. This case demonstrates that in these cash-strapped times for stateand local governments, the bar for property tax exemption is being raised.

D. INUREMENT, PRIVATE BENEFIT AND INTERMEDIATE SANCTIONS

1. INUREMENT OF PRIVATE GAIN

Page 454:

Note: Executive and Trustee Compensation. Nonprofit hospitals are under financial andpolitical pressure. Perhaps nothing has raised the ire of the public and their electedrepresentatives more than the level of compensation of senior executives and board members ofnonprofit blue cross plans and hospitals. At a time when health care premiums are rising andsome hospitals are merging, converting to for-profit status or entering bankruptcy, seven figuresalaries, rich severance arrangements, perquisites such as country club dues and other fringesmore typical of corporate CEOs are bound to arouse criticism. For a good overview, seeStephanie Strom, Lawmakers, Tightening Belts, Question Nonprofit Salaries, N.Y. Times,July 27, 2010, at A12.

In Massachusetts there has been a public dispute over whether directors of nonprofithospitals and insurance companies should receive compensation, which in the case of largerinstitutions ranges from $72,000 to $85,000. In response to criticism in the press and from theattorney general, Harvard Pilgrim Health Care and Tufts Health Plan temporarily suspendedboard compensation, but then reversed their positions. Massachusetts attorney general MarthaCoakley supported a bill that would have prohibited director compensation without attorneygeneral approval and permitted her to issue regulations relating to exemptions from the

14

compensation ban. In May 2011, the bill was approved by the state senate as part of a budgetbill but in early July it failed in the house.

2. PRIVATE BENEFIT

Page 458:

In the suggested assignment, the Treasury Regulations cite should be: § 1.501(c)(3)-1(d)(1)(iii).

3. INTERMEDIATE SANCTIONS ON EXCESS BENEFIT TRANSACTIONS

Page 469:

Penalties on Organization Managers. The first sentence should be clarified to read:“Although exempt organizations are not penalized (except for loss of exemption in the mostegregious cases) for participating in excess benefit transactions, organization managers aresubject to tax equal to 10 percent of the excess benefit if their participation was knowing,willful, and not due to reasonable cause (with the tax capped at $20,000).”

E. LIMITATIONS ON LOBBYING AND POLITICAL ACTIVITIES

5. POLITICAL CAMPAIGN LIMITATIONS

Page 526:

Note: Branch Ministries v. Rossotti. The court of appeals in Branch Ministriesmisstates the rule for intervening in political campaigns by § 501(c)(4) organizations. Whilethe court says that such organizations are “subject to the ban on intervening in politicalcampaigns (see text p. 524), the regulation it cites instead provides that such organizationsmust be “primarily engaged” in promoting social welfare and that the promotion of socialwelfare does not include intervention in political campaigns. Section 501(c)(4) organizationstherefore may intervene in political campaigns as long as they are primarily engaged in otheractivity that promotes social welfare (see text p. 532).

7. SECTION 527 POLITICAL ORGANIZATIONS: REPORTING AND DISCLOSURE REQUIREMENTs

Page 537:

Form 990 Filing Requirements. The statement in the text that § 527 organizations arenot required to file Form 990 information returns is overbroad. In general, tax-exemptpolitical organizations with annual gross receipts of $25,000 or more must file Form 990 (or,for smaller organizations, Form 990-EZ) unless they qualify for an exemption. Certainqualified state or local political organizations only must file Form 990 if they have annualgross receipts of $100,000 or more and a political organization that is a caucus or associationof state or local officials is exempt from filing.

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8. OTHER REGULATION OF POLITICAL ACTIVITIES OF NONPROFIT ORGANIZATIONS

Page 542:

Disclosure of Donors. The extent to which § 501(c)(4), 501(c)(5), and 501(c)(6)organizations must publicly disclose the identities of their contributors if they engage in certainelection-related activities continues to be a moving target, as illustrated by a federal districtcourt decision rejecting a Federal Election Commission regulation that limits such disclosures. Van Hollen v. FEC, 2012 WL 1066717 (D.D.C. 2012), motion for stay pending appealdenied, 2012 WL 1758569 (D.C. Cir. 2012).

F. PROCEDURAL ISSUES

2. INFORMATION RETURN AND DISCLOSURE REQUIREMENTS

Page 548:

Information Returns. In Rev. Proc. 2011-15, 2011-3 I.R.B. 322, the IRS updated therules providing relief from the annual Form 990 filing requirement. Effective for tax yearsbeginning on or after January 1, 2010, organizations (other than private foundations and TypeIII supporting organizations, which must file in all events) that normally have annual grossreceipts of not more than $50,000 (up from $25,000) are not required to file a Form 990. These small organizations, however, must submit annually the Form 990-N “e-Postcard”described at page 549 of the casebook. Failure to file this notice for three consecutive yearswill result in revocation of the organization’s tax exemption on or after the due date for filingthe third annual notice unless the organization can show reasonable cause for its failure. I.R.C. § 6033(j)(1).

The first trigger date for loss of exemption under the new notice requirement for smallexempt organizations was May 15, 2010 (for calendar year filers), but the IRS extended thedeadline to October 15, 2010. Once that date passed, the IRS carefully scrutinized its MasterFile and in June 2011 it announced the automatic revocation of exemptions of approximately275,000 organizations. By early 2012, the list of automatic revocations had swelled to433,000 organizations, of which slightly more than 14,000 had reapplied for exemption. Many of these non-filers probably no longer exist and never bothered to inform the IRS. TheIRS conceded that the list as first displayed contained errors, some caused by space limitationsthat prevented including an organization’s entire name. For example, George WashingtonUniversity and the University of Michigan appeared on the revocation but the real non-filersmost likely were affiliates, such as a fraternity or other separate entity, that includes theschool’s name in its own.

Under a special transitional relief rule, small organizations that were not required to fileannual information returns for pre-2007 tax years and were eligible to file the e-Postcard for2007, 2008 and 2009 may apply for reinstatement of tax-exempt status by December 31, 2012and pay a reduced user fee of $100. If the application is granted, the organization will betreated as having established reasonable cause for the non-filing and its tax-exempt status willbe reinstated retroactive to the date it was revoked. Notice 2011-43, 2011-25 I.R.B. 882. Forguidance on reinstatement of tax exemptions for organizations that had their tax exemptionsautomatically revoked but do not qualify for the special transitional relief, see Notice 2011-44,2011-25 I.R.B. 883.

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3. STANDING BY THIRD PARTIES TO CHALLENGE EXEMPT STATUS

Page 566:

Note 1A. Recent Standing Developments. In Arizona Christian School TuitionOrganization v. Winn, 131 S.Ct. 1436 (2011), the Supreme Court denied Article III standingto a group of Arizona taxpayers who challenged a state law giving tax credits for contributionsto “school tuition organizations” that used the donated funds to provide scholarships tostudents attending private (mostly religious) schools. The Court found that any damages orharm to the plaintiffs was purely speculative because the law being challenged used themechanism of a tax credit rather than direct government spending. Four dissenting justices, inan opinion authored by Justice Kagan, would have conferred standing. Citing cases such asRegan v. Taxation With Representation of Washington (see casebook p. 489), they viewed theArizona tax credits as equivalent to cash subsidies to the benefitted organizations andindividuals.

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CHAPTER 6. COMMERCIAL ACTIVITIES AND UNRELATED BUSINESS

INCOME

G. UNRELATED DEBT-FINANCED INCOME

Page 659:

Note 1 – Strike Three. The litigious Bartels struck out swinging in their endless butfutile effort to persuade a court that the debt-financed income rules do not apply to incomederived from securities purchased on margin. Henry E. & Nancy Horton Bartels Trust ex rel.Cornell University v. United States, 617 F.3d 1357 (Fed. Cir. 2010). Affirming the Court ofFederal Claims decision cited in the casebook, the court applied the unambiguous language ofthe statute and in so doing rejected the taxpayer’s argument that imposition of the UBITrequires a showing of unfair competition. It also held that whether or not the taxpayer’sinvestment activities were a “trade or business,” income from its debt-financed securities stillmust be included in UBTI under §§ 512(b)(4) and 514.

H. COMPLEX STRUCTURES AND OTHER SPECIAL PROBLEMS

1. THE USE OF CONTROLLED SUBSIDIARIES

b. Payments from Controlled Organizations

Page 666:

Section 512(b)(13) Fair Market Value Exception. The “fair market value” exception in§ 512(b)(13) expired at the end of 2011. It remains on a long list of provisions that could bereinstated if and when Congress considers an “extenders” bill, most likely after the 2012elections.

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CHAPTER 7. PRIVATE FOUNDATIONS

C. AVOIDING PRIVATE FOUNDATION STATUS: THE DETAILS

2. TRADITIONAL PUBLIC CHARITIES: § 509(a)(1)

Page 742:

Footnote 1. Proposed and Temporary Regulations. The temporary and proposedregulations issued in 2008 and in discussed in the text are now final, effective on September 8,2011. They are similar in all material respects to the earlier versions.

4. SUPPORTING ORGANIZATIONS: § 509(a)(3)

Page 753:

Footnote 3. Supporting Organization Regulations. The supporting organizationregulations referred to in the text are still proposed.

D. PRIVATE FOUNDATION EXCISE TAXES

5. JEOPARDY INVESTMENTS: § 4944

Page 795:

Program-Related Investments. The Treasury has released proposed regulationsclarifying the types of private foundation investments that qualify as “program-related.” REG-144267-11 (April 18, 2012), adding Prop. Treas. Reg. § 53.4944-3(b) Examples 11-19. Forthe full text, see the Appendix to this Update, infra, at pp. 28-31. Although the regulationswill not be effective until they are adopted in final form, taxpayers may rely on them until theyare finalized. Prop. Treas. Reg. § 53.4944-3(c).

The proposed regulations do not make new law but they do add nine examplesillustrating a broader range of qualifying investments commonly employed by privatefoundations to advance their charitable purposes. The regulations articulate several importantprinciples:

• PRIs may accomplish a variety of charitable purposes – e.g., advancing science,promotion of the arts, combating environmental deterioration, and aiding thepoor and underprivileged.

• PRIs may fund activities in a foreign country.

• The possibility that a PRI may earn a potentially high rate of return will not, initself, be a disqualifying factor.

• Loan guarantees can qualify as PRIs.

• The acceptance of an equity position in conjunction with making a loan does notnecessarily disqualify an investment as a PRI.

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• PRIs can provide capital to individuals and entities who are not within acharitable class if those recipients are the instruments through which a privatefoundation accomplishes its charitable purposes.

20

CHAPTER 8. CHARITABLE CONTRIBUTIONS

A. INTRODUCTION

2. POLICY ISSUES

Page 825:

Note 4. Itemized Deductions Floor. Congress extended the complete phase-out of the§ 68 limit on itemized deductions through the end of 2012. Section 68 is now scheduled toreappear in 2013 unless Congress takes further action.

Page 826:

Note 5. Limiting the Tax Benefit of the Charitable Deduction for Wealthy Donors. Inhis fiscal 2013 budget message to Congress, President Obama once again resurrected hisproposal to limit income tax benefits for high-income taxpayers from certain itemizeddeductions, including the charitable deduction. General Explanation of the Administration’sFiscal Year 2013 Revenue Proposals 73 (Dept. of the Treasury, Feb. 2012), available athttp://www.treasury.gov/resource-center/tax-policy/Documents/General-Explanations-FY2013.pdf.

Note 6. Impact of Estate Tax Repeal on Philanthropy. Estate tax repeal was shortlived but the ultimate resolution of several important wealth transfer tax issues was still in playas this Update went to press in July 2012. In the Tax Relief, Unemployment Insurance andJobs Creation Act of 2010, Congress reinstated the estate and generation-skipping taxes, with ahigher exemption ($5 million) and lower maximum rate (35%) for 2010, 2011 and 2012. Italso repealed the modified carryover basis rules in § 1022, except executors of estates ofdecedents dying in 2010 could elect out of the estate tax and be subject to the modifiedcarryover basis regime. Unless Congress acts again, however, the wealth transfer taxes willrevert back to the lower exemptions and higher rates that were in effect prior to 2002.

Note 6A. More Threats to the Charitable Deduction. In February 2010, PresidentObama created the National Commission on Fiscal Responsibility and Reform and appointedErskine Bowles and Alan Simpson as co-chairs. The Commission’s task was to formulate aproposal to balance the federal budget by 2015, improve the long-term fiscal outlook, andaddress the growth of entitlement spending and the tax gap. On November 10, 2010,Commission co-chairs Bowles and Simpson released a draft proposal presenting three taxreforms options. The emphasis was on rate reductions (individual and corporate), eliminationof tax expenditures to broaden the base, repeal of the alternative minimum tax, simplification,improvement of compliance, and “making America the best place in the world to start andgrow a business.” One option (the Zero plan) would consolidate the tax code into threeindividual rates and one corporate rate, eliminate the AMT, eliminate $1.1 trillion of taxexpenditures, and dedicate a portion of the savings to deficit reduction and apply the rest toreduce all marginal tax rates. Tax expenditures up for discussion include the usual suspects,such as the home mortgage interest and charitable deductions. Specifically, the Commissionproposed to replace the charitable deduction for taxpayers who itemize deductions with a 12%non-refundable credit available to all taxpayers subject to a 2% AGI floor – i.e., onlycharitable gifts in excess of 2% of the taxpayer’s AGI would be eligible for the credit.

21

The Commission issued its final report in December 2010. It is available athttp://www.fiscalcommission.gov/sites/fiscalcommission.gov/files/documents/TheMomentofTruth12_1_2010.pdf. The recommendations at pages 28-33 of the report are a useful startingpoint for a national debate about deficit reduction and comprehensive tax reform.

B. CHARITABLE CONTRIBUTIONS: BASIC PRINCIPLES

1. QUALIFIED DONEES

a. In General

Page 829:

Rev. Proc. 82-39, cited at the end of the first full paragraph on p. 829, has beenmodified and superseded by Rev. Proc. 2011-33, 2011-25 I.R.B. 887.

b. International Giving

Page 834:

Note 4. For Further Reading. Eric M. Zolt, Tax Deductions for CharitableContributions: Domestic Activities, Foreign Activities or None of the Above, 63 Hastings L.J. 361 (2012).

3. WHAT IS A CHARITABLE GIFT?

a. Return Benefits: In General

Page 843:

Note 2. Administrative Guidelines: Benefits with Insubstantial Value. For 2012, thelow-cost article limit is $9.90. The $25 and $50 amounts, as indexed for 2012, are $49.50 and$99.

C. NONCASH CONTRIBUTIONS

2. ORDINARY INCOME PROPERTY

Page 875:

Note 1. IRA Rollovers. The IRA charitable rollover exclusion was restoredretroactively for 2010 and extended through 2011 by the Tax Relief Act of 2010, but it expiredas of January 1, 2012, and Congress is not expected to consider a further extension until afterthe 2012 elections, if then.

Page 876:

Note 2. Gifts of Food and Book Inventory. The Tax Relief Act of 2010 also restoredthe enhanced the deduction for certain contributions of food and book inventory for 2010 andextended it through 2011, but these provisions also have expired and it is uncertain whetherthey will extended again.

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6. QUALIFIED CONSERVATION CONTRIBUTIONS

Page 884:

Conservation Easements. The Tax Relief Act of 2010 reinstated the increasedpercentage limitations (from 30% to 50%) and contributions carryover period (to 15 year) forconservation easement gifts and the 100% percentage limit for certain farmers and ranchersand extended these benefits through 2011 but not beyond. Like the other expired provisions,the it is uncertain whether Congress will resurrect these provisions.

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PART FOUR: MUTUAL BENEFIT AND PRIVATE MEMBERSHIP

ORGANIZATIONS

CHAPTER 9. TAX EXEMPTION: MUTUAL BENEFIT AND OTHER

NONCHARITABLE ORGANIZATIONS

D. TRADE ASSOCIATIONS AND OTHER BUSINESS LEAGUES

1. THE LINE OF BUSINESS REQUIREMENT

Page 919:

Note. The district court’s decision upholding revocation of exemption to Bluetooth Sigwas affirmed by the Ninth Circuit in Bluetooth Sig, Inc. v. United States, 611 F.3d 617(2010). The court of appeals found that the organization failed two of the tests in Treas. Reg.§ 1.501(c)(6)-1 by engaging in a business of the sort ordinarily engaged in for profit andproviding non-incidental services for particular members.

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CHAPTER 10. SPECIAL PROBLEMS OF PRIVATE MEMBERSHIP

ASSOCIATIONS

F. PRIVATE ASSOCIATIONS AND THE CONSTITUTION

Page 1002:

Note: University Nondiscrimination Policies and Student Religious Organizations. In a5-4 opinion, the Supreme Court upheld Hastings College of the Law’s “all comers”nondiscrimination policy as it applied to registered student organizations (“RSOs”). ChristianLegal Society v. Martinez, 130 S.Ct. 2971 (2010). As interpreted by Hastings and stipulatedby the parties during the litigation, the policy required RSOs to allow any student toparticipate, become a member, and seek a leadership position in a student organizationregardless of the student’s status or beliefs. The Court held that because this policy was areasonable viewpoint-neutral condition on access to a limited public forum, it did not violatethe Christian Legal Society’s free speech and associational rights. The Court’s limited publicforum precedents permit a governmental entity, such as a public law school, to imposerestrictions on speech in light of the purposes of the forum if the restrictions are viewpointneutral. The Court ruled that this less restrictive level of scrutiny applied not only to speechbut also to expressive association occurring in a limited public forum. It distinguished freedomof association holdings such as Boy Scouts of America v. Dale because they involved statelaws compelling a group to include unwanted members. In contrast, Hastings’ RSO program,in the words of Justice Ginsburg in her majority opinion, is “dangling the carrot of subsidy,not wielding the stick of prohibition.”

Justice Ginsburg emphasized the function of a limited forum and the traditionaldeference to public school administrators to formulate educational policy. In this case, the all-comers policy ensured that the leadership, educational and social opportunities afforded byRSOs were available to all students. RSOs were eligible for financial assistance drawn frommandatory student activity fees, and the policy ensured that no student would be forced to funda group that would reject her as a member. Favorable facts were that Hastings could enforceits nondiscrimination policy without inquiring into a student organization’s motivation formembership restrictions, and the policy brought together individuals with diverse backgroundsand beliefs, and encouraged tolerance, cooperation and learning. Another positive was that thepolicy incorporated state nondiscrimination laws, thereby conveying the law school’s decisionto decline to subsidize content disapproved by the state of California.

The Court found the all-comers policy was viewpoint-neutral because it applied to allstudent groups seeking to become RSOs. For example, to answer the question raised at page1003 of the text, the policy would require the Jewish Law Students to admit Muslims andHolocaust deniers, and the Student Democrats to admit Republicans. (In an interview onNational Public Radio, the law school’s then acting dean said the policy even would require ablack student organization to admit white supremacists such as members of the Ku Klux Klan.) CLS also argued that Hastings selectively enforced its policy with the intention ofexcluding CLS but not other student groups that restricted their membership. The Courtdismissed this argument because it had not been addressed by the lower courts but remandedthe case to enable the Ninth Circuit to address to CLS’s selective enforcement challenge “if,and to the extent, it is preserved.”

25

Justice Alito’s dissent, joined by Justices Roberts, Scalia and Thomas, said the decisionmarked a “dark day” and was a triumph for the principle that there is no freedom ofexpression for groups that “offend prevailing standards of political correctness in our country’sinstitutions of higher learning.” He noted that some religious groups cannot in goodconscience agree to admit persons who do not share their beliefs and, for such groups, theconsequence of an all-comers policy is marginalization. Justice Alito went so far as tocharacterize the Hastings all-comers policy as “absurd” and a pretext for exclusion of CLSbecause of its controversial religious beliefs.

On remand, the Ninth Circuit held that CLS did not raise the selective enforcementargument until the case had reached the Supreme Court and thus did not preserve it forappellate review. Christian Legal Society v. Wu, 626 F.3d 483 (9 Cir. 2010).th

In Alpha Delta Chi-Delta v. Reed, 648 F.3d 790 (9 Cir.2011), cert. denied, 132 S.th

Ct. 1743 (2012), the first appellate decision applying Christian Legal Society v. Martinez, theNinth Circuit upheld San Diego State University’s nondiscrimination policy for studentorganizations. Unlike the Hastings “all comers” policy approved in Christian Legal Society,the narrower San Diego State nondiscrimination regulation only prohibited membershiprequirements based on gender, race, religion and sexual orientation. The plaintiffs were aChristian fraternity and a sorority that were denied recognition by the school because theirmembership requirements included beliefs and practices consistent with orthodox Christianbeliefs.

Applying the limited public forum doctrine, the court held that the restrictions werereasonable in light of the purpose of the forum. The plaintiffs argued Christian Legal Societydid not apply when a school’s policy prohibited only certain membership requirements. Thediscrimination they claimed went to viewpoint because it allowed secular discrimination, butnot religious discrimination. A Republican organization could exclude Democrats, but aChristian group could not exclude Muslims.

The court accepted that the nondiscrimination policy incidentally burdened groups thatexcluded on the basis of religion, but found there was no evidence the universitynondiscrimination policy purposely restricted plaintiff’s viewpoint. It was neutral as to contentand viewpoint. The court reaffirmed the distinction in Christian Legal Society betweenpolicies that require action and those that withhold benefits.

The case was remanded to determine whether the university failed to grant plaintiffs anexemption from the nondiscrimination policy because of their religious viewpoint, and whetherit had granted official recognition to some religious groups that had restricted membership,such as the Catholic Newman Center, which provides that its officers must be members ingood standing within the Catholic Church, and the African Student Dance Association’sconstitution, which limited its leadership positions to students from Africa.

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CHAPTER 11. ANTITRUST AND NONPROFITS

B. HEALTH CARE

Page 1029:

Note 3A. In Girl Scouts of Manitou Council v. Girl Scouts of the United States, 646 F.3d 983 (7 Cir. 2011), the Seventh Circuit in a decision by Judge Richard Posner held thatth

despite the fact it was a nonprofit organization, a local Girl Scout Council was a dealershipunder the Wisconsin Fair Dealership Law (WFDL). The local council qualified as a dealershipbecause it managed a rolling inventory of Girl Scout branded cookies, operated campsidentified as Girl Scout camps and proselytized for the Girl Scouts in the communities that itserved, building up good will for both the local council and the national brand. Therefore, aneffort by the National Girl Scouts to alter the local council’s territory changed the localcouncil’s competitive circumstances and violated the WFDL.

The district court had reasoned that applying the WFDL would violate the nationalorganization’s rights of expressive association a la Boy Scouts of America v. Dale (seecasebook, p. 987). The national organization embraced this argument on appeal, but this wasmet with classic Posnerian scorn. 646 F. 3d at 985-986. And in a dagger to the heart of anyparent who has hawked Girl Scout cookies for a daughter, the Court stated: “From acommercial standpoint, the Girl Scouts are not readily distinguishable from Dunkin’ Donuts.”Id. at 987.

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APPENDIX

§ 53.4944-3 Exception for program-related investments.

* * * * *

(b) * * *

Example 11. X is a business enterprise that researches and develops new drugs. X'sresearch demonstrates that a vaccine can be developed within ten years to prevent a disease thatpredominantly affects poor individuals in developing countries. However, neither X nor othercommercial enterprises like X will devote their resources to develop the vaccine because thepotential return on investment is significantly less than required by X or other commercialenterprises to undertake a project to develop new drugs. Y, a private foundation, enters into aninvestment agreement with X in order to induce X to develop the vaccine. Pursuant to theinvestment agreement, Y purchases shares of the common stock of S, a subsidiary corporationthat X establishes to research and develop the vaccine. The agreement requires S to distributethe vaccine to poor individuals in developing countries at a price that is affordable to theaffected population. The agreement also requires S to publish the research results, disclosingsubstantially all information about the results that would be useful to the interested public. Sagrees that the publication of its research results will be made as promptly after the completionof the research as is reasonably possible without jeopardizing S's right to secure patentsnecessary to protect its ownership or control of the results of the research. The expected rate ofreturn on Y's investment in S is less than the expected market rate of return for an investmentof similar risk. Y's primary purpose in making the investment is to advance science. Nosignificant purpose of the investment involves the production of income or the appreciation ofproperty. The investment significantly furthers the accomplishment of Y's exempt activitiesand would not have been made but for such relationship between the investment and Y'sexempt activities. Accordingly, the purchase of the common stock of S is a program-relatedinvestment.

Example 12. Q, a developing country, produces a substantial amount of recyclablesolid waste materials that are currently disposed of in landfills and by incineration,contributing significantly to environmental deterioration in Q. X is a new business enterpriselocated in Q. X's only activity will be collecting recyclable solid waste materials in Q anddelivering those materials to recycling centers that are inaccessible to a majority of thepopulation. If successful, the recycling collection business would prevent pollution in Q causedby the usual disposition of solid waste materials. X has obtained funding from only a fewcommercial investors who are concerned about the environmental impact of solid wastedisposal. Although X made substantial efforts to procure additional funding, X has not beenable to obtain sufficient funding because the expected rate of return is significantly less thanthe acceptable rate of return on an investment of this type. Because X has been unable to attractadditional investors on the same terms as the initial investors, Y, a private foundation, entersinto an investment agreement with X to purchase shares of X's common stock on the sameterms as X's initial investors. Although there is a high risk associated with the investment inX, there is also the potential for a high rate of return if X is successful in the recyclingbusiness in Q. Y's primary purpose in making the investment is to combat environmentaldeterioration. No significant purpose of the investment involves the production of income orthe appreciation of property. The investment significantly furthers the accomplishment of Y'sexempt activities and would not have been made but for such relationship between the

28

investment and Y's exempt activities. Accordingly, the purchase of the common stock is aprogram-related investment.

Example 13. Assume the facts as stated in Example 12, except that X offers Y sharesof X's common stock in order to induce Y to make a below-market rate loan to X. Xpreviously made the same offer to a number of commercial investors. These investors wereunwilling to provide loans to X on such terms because the expected return on the combinedpackage of stock and debt was below the expected market return for such an investment basedon the level of risk involved, and they were also unwilling to provide loans on other terms Xconsiders economically feasible. Y accepts the stock and makes the loan on the same terms thatX offered to the commercial investors. Y plans to liquidate its stock in X as soon as therecycling collection business in Q is profitable or it is established that the business will neverbecome profitable. Y's primary purpose in making the investment is to combat environmentaldeterioration. No significant purpose of the investment involves the production of income orthe appreciation of property. The investment significantly furthers the accomplishment of Y'sexempt activities and would not have been made but for such relationship between theinvestment and Y's exempt activities. Accordingly, the loan accompanied by the acceptance ofcommon stock is a program-related investment.

Example 14. X is a business enterprise located in V, a rural area in State Z. X employsa large number of poor individuals in V. A natural disaster occurs in V, causing significantdamage to the area. The business operations of X are harmed because of damage to X'sequipment and buildings. X has insufficient funds to continue its business operations andconventional sources of funds are unwilling or unable to provide loans to X on terms itconsiders economically feasible. In order to enable X to continue its business operations, Y, aprivate foundation, makes a loan to X bearing interest below the market rate for commercialloans of comparable risk. Y's primary purpose in making the loan is to provide relief to thepoor and distressed. No significant purpose of the loan involves the production of income orthe appreciation of property. The loan significantly furthers the accomplishment of Y's exemptactivities and would not have been made but for such relationship between the loan and Y'sexempt activities. Accordingly, the loan is a program-related investment.

Example 15. A natural disaster occurs in W, a developing country, causing significantdamage to W's infrastructure. Y, a private foundation, makes loans bearing interest below themarket rate for commercial loans of comparable risk to H and K, poor individuals who live inW, to enable each of them to start a small business. H will open a roadside fruit stand. K willstart a weaving business. Conventional sources of funds were unwilling or unable to provideloans to H or K on terms they consider economically feasible. Y's primary purpose in makingthe loans is to provide relief to the poor and distressed. No significant purpose of the loansinvolves the production of income or the appreciation of property. The loans significantlyfurther the accomplishment of Y's exempt activities and would not have been made but forsuch relationship between the loans and Y's exempt activities. Accordingly, the loans to H andK are program-related investments.

Example 16. X is a limited liability company treated as a partnership for federalincome tax purposes. X purchases coffee from poor farmers residing in a developing country,either directly or through farmer-owned cooperatives. To fund the provision of efficient watermanagement, crop cultivation, pest management, and farm management training to the poorfarmers by X, Y, a private foundation, makes a loan to X bearing interest below the marketrate for commercial loans of comparable risk. The loan agreement requires X to use theproceeds from the loan to provide the training to the poor farmers. X would not provide suchtraining to the poor farmers absent the loan. Y's primary purpose in making the loan is to

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educate poor farmers about advanced agricultural methods. No significant purpose of the loaninvolves the production of income or the appreciation of property. The loan significantlyfurthers the accomplishment of Y's exempt activities and would not have been made but forsuch relationship between the loan and Y's exempt activities. Accordingly, the loan is aprogram-related investment.

Example 17. X is a social welfare organization that is recognized as an organizationdescribed in section 501(c)(4). X was formed to develop and encourage interest in painting,sculpture and other art forms by, among other things, conducting weekly community artexhibits. X needs to purchase a large exhibition space to accommodate the demand forexhibition space within the community. Conventional sources of funds are unwilling or unableto provide funds to X on terms it considers economically feasible. Y, a private foundation,makes a loan to X at an interest rate below the market rate for commercial loans of comparablerisk to fund the purchase of the new space. Y's primary purpose in making the loan is topromote the arts. No significant purpose of the loan involves the production of income or theappreciation of property. The loan significantly furthers the accomplishment of Y's exemptactivities and would not have been made but for such relationship between the loan and Y'sexempt activities. Accordingly, the loan is a program-related investment.

Example 18. X is a non-profit corporation that provides child care services in alow-income neighborhood, enabling many residents of the neighborhood to be gainfullyemployed. X meets the requirements of section 501(k) and is recognized as an organizationdescribed in section 501(c)(3). X's current child care facility has reached capacity and has along waiting list. X has determined that the demand for its services warrants the constructionof a new child care facility in the same neighborhood. X is unable to obtain a loan fromconventional sources of funds including B, a commercial bank, because X lacks sufficientcredit to support the financing of a new facility. Pursuant to a deposit agreement, Y, a privatefoundation, deposits $h in B, and B lends an identical amount to X to construct the new childcare facility. The deposit agreement requires Y to keep $h on deposit with B during the term ofX's loan and provides that if X defaults on the loan, B may deduct the amount of the defaultfrom the deposit. To facilitate B's access to the funds in the event of default, the agreementrequires that the funds be invested in instruments that allow B to access them readily. Thedeposit agreement also provides that Y will earn interest at a rate of t% on the deposit. The t%rate is substantially less than Y could otherwise earn on this sum of money, if Y invested itelsewhere. The loan agreement between B and X requires X to use the proceeds from the loanto construct the new child care facility. Y's primary purpose in making the deposit is to furtherits educational purposes by enabling X to provide child care services within the meaning ofsection 501(k). No significant purpose of the deposit involves the production of income or theappreciation of property. The deposit significantly furthers the accomplishment of Y's exemptactivities and would not have been made but for such relationship between the deposit and Y'sexempt activities. Accordingly, the deposit is a program-related investment.

Example 19. Assume the same facts as stated in Example 18, except that instead ofmaking a deposit of $h into B, Y enters into a guarantee agreement with B. The guaranteeagreement provides that if X defaults on the loan, Y will repay the balance due on the loan toB. B was unwilling to make the loan to X in the absence of Y's guarantee. X must use theproceeds from the loan to construct the new child care facility. At the same time, X and Yenter into a reimbursement agreement whereby X agrees to reimburse Y for any and allamounts paid to B under the guarantee agreement. The signed guarantee and reimbursementagreements together constitute a “guarantee and reimbursement arrangement.” Y's primarypurpose in entering into the guarantee and reimbursement arrangement is to further Y'seducational purposes. No significant purpose of the guarantee and reimbursement arrangement

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involves the production of income or the appreciation of property. The guarantee andreimbursement arrangement significantly furthers the accomplishment of Y's exempt activitiesand would not have been made but for such relationship between the guarantee andreimbursement arrangement and Y's exempt activities. Accordingly, the guarantee andreimbursement arrangement is a program-related investment.

(c) Effective/applicability date. Paragraph (b), Examples 11 through 19 of this sectionwill be effective on the date of publication of the Treasury decision adopting these examples asfinal regulations in the Federal Register. Taxpayers may rely on paragraph (b), Examples 11through 19 of this section before these proposed regulations are finalized.

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