An appellate court in New York has held that donor-restricted gifts to a museum are not generally available to pay creditors upon dissolution of the corporation.  It has required an endowment to be kept intact to support an historic village, but has permitted a ceramics collection to be sold, if possible, subject to the terms and conditions of a loan and gift agreement with the original donors. (In the Matter of Friends for Long Island’s Heritage, Supreme Ct. of NY, App. Div., Second Dept., 11/16/10.)

The Friends for Long Island’s Heritage was formed in 1964 to operate the Nassau County Historical Museum and acquired about 35,000 objects for the museum collection between its founding and 2002.  Among the restricted assets were a $250,000 endowment to preserve historic buildings and a ceramics collection. The collection was to be displayed, but selected pieces could be sold if the proceeds were placed in a restricted fund to establish a center for the study of English ceramics and to maintain the rest of the collection.

At some point, the county became dissatisfied with the Friends’ performance and terminated its agreement for use of the building in 2002.  The Friends subsequently decided to dissolve.  At the time of dissolution, it had obligations far in excess of its assets.  As part of a “settlement” with creditors, the Friends asked a trial court for permission to sell the collection and use the proceeds, along with the endowment funds, to pay claims of creditors.  The trial court approved the settlement.  The Attorney General and the Wedgwood Society, which had been permitted to intervene, appealed.

The case was complicated because Friends was incorporated under the state’s Education Law, which utilized the provisions of the state’s Not-for-Profit Corporation Law unless there was a conflict with the Education Law. 

The state’s Court of Appeals (its highest court) had long ago ruled that restricted charitable assets of a nonprofit corporation could not be used to pay claims of creditors on dissolution.  The Education Law provided, however, that upon dissolution, the court “shall direct the sale of sufficient designated assets to pay any outstanding debts and the costs of dissolution.”  The statute also provided that the court should “make all such orders as it may deem appropriate” but in the case of restricted charitable assets, distribution should be to another entity “engaged in activities substantially similar to those of the dissolved corporation.” 

The Court held that the sale of assets to pay debts was not a “distribution” and that the restricted assets had to be disposed of under the “quasi cy pres doctrine.”

“The tension here…is between two legitimate interests – the rights of creditors and the limitations imposed by donors under which the NFP holds certain assets,” the Court wrote. “And, both sides warn of dire consequences flowing from the rejection of their position.  The appellants warn of a ‘chilling effect’ on charitable giving if prospective donors cannot be confident that their charitable purposes will be honored. Various parties on the other side warn of the difficulty struggling charities may have in obtaining credit during times of economic stress if the prospective creditors cannot be certain that they will be repaid out of the valuable assets of the NFP.”

The Court held that “New York’s long-standing policy honoring donors’ restrictions on the use of property they donate has greater weight than the claims of creditors.”  Citing several statutory provisions protecting such gifts, including cy pres provisions where an organization can’t use the assets as directed, the Court said “the public places greater importance on the limitations on the use of the asset than on which entity actually holds it.”

It held that the endowment fund could not be liquidated because to do so “would be to extinguish the purpose behind the fund.”

Its view of the collection was “somewhat different.”  The trial court had to decide what to do with it.  Although the Attorney General and the Society argued that it had to be given to a similar organization and could not be sold at all, the Court said a sale was not completely precluded.  “Nothing in the law requires distribution without charge,” it said.  The pieces could be sold as a single collection to a similar entity pursuant to the terms and restrictions of the original gift.  The sale might bring less than an unrestricted sale but “the policy behind the protection of restricted assets is strong enough to require such a result.”

YOU NEED TO KNOW

Protecting donor-restricted assets from the claims of creditors is the general rule and the Court, correctly in our opinion, applies the general rule in this case.  The idea of selling the collection subject to the donor-imposed restrictions is an unusual extension of the doctrine, but not inconsistent with protection of the donor.  As long as the conditions don’t prevent the sale, something is better than nothing for the creditors, and the donor is still protected.