A director of a nonprofit summer camp has been denied a claim for nearly $1 million in advances made to keep the camp operating before it went into bankruptcy.  A Bankruptcy Court in Pennsylvania has held that almost all of the transfers were donations and not loans, and that they were made without authority from the board.  (In Re: Machne Menachem, Bkrptcy. Ct., M.D. PA, No. 5-01-bk-04926, 3/4/10.)

A group of four Hasidic Jews in Brooklyn created a summer camp for boys in 1995.  In 1996, it purchased real estate in the Pocono Mountain region of Pennsylvania. Although well-attended and well received, the camp ran into financial problems from the beginning and it became apparent to Yaakov Spritzer, one of the four directors, that the only practical solution was for him to advance his personal funds to the organization. 

He advanced funds from his personal account, a wholly owned corporation, a related foundation and a joint account with his wife.  At the same time, he took over virtual control of the corporation.  Shortly before the corporation filed for bankruptcy protection in December 2001, he caused the corporation to deliver a mortgage to him to secure his advances.

Spritzer lost control over the organization when the other three directors were confirmed in office by a District Court in 2002, but as a creditor of the company he was able to propose a plan to sell the real estate to a new nonprofit that he controlled.  The proceeds would be held for distribution to the creditors.  (The Third Circuit Court of Appeals has previously held that an effort by Spritzer’s son to buy up claims of other creditors in order to assure confirmation of the plan was evidence of bad faith in an effort to “gerrymander” the vote on the plan.  (See Nonprofit Issues®, 4/1/07.))

In one of the final issues in the bankruptcy proceeding, the Court was called upon to decide whether Spritzer’s claims were valid.  The corporation objected on the grounds that they were contributions, or were not authorized.

On the first point, the Court said it had to try to determine the intent of the parties at the time the transfers were made.  It rejected any evidentiary value of the mortgage because there was no evidence that the other three directors were notified of the meeting at which it was purportedly authorized.  It said that out of 125 transactions, it found notation of a “loan” on only four checks and approximately 30 deposit slips. 

It said intent could be culled from contemporaneous resolutions of the board, but none existed. There were no contemporaneous notes, with due dates, interest rates, repayment schedules or default provisions. Two of the other directors testified that they were unaware of any loans.  The only evidence in support of the loan theory came form Spritzer himself and that testimony, the Court said, was “equivocal at best.”  Spritzer’s lawyer had said that he intended them to be loans, but that he forgave many of them depending on his tax situation at the time.

More importantly, the corporation introduced a copy of a resolution of three of the four board members dated March 17, 1997, telling Spritzer to take no further action on behalf of the corporation.  “Presumably, that would include borrowing money on behalf of” the corporation, the Court said. “A fair conclusion would be that Spritzer made those advances at his peril.  If funds were advanced to an unwilling debtor under that circumstance, then there would be a strong assumption that such advance was a gift.”

The Court also noted that the corporation was a New York Not-for-Profit corporation and that the state Not-for-Profit Corporation Law provides that a transaction between a corporation and a director can be voided if there was not good faith disclosure unless the parties can establish that it was fair to the corporation at the time it was authorized.  In this case, since the bulk of the transactions were never authorized, they should be voided.

Spritzer argued that even if the transactions were voided, he should be able to get his money back.  Although the judge said Spritzer’s point was “well taken,” “it would be inconceivable to me to be able to foist a loan on an unwilling Debtor.”  Reviewing the transfers prior to the March, 1997 resolution directing Spritzer to stop acting on behalf of the corporation, the Court found three transactions totaling $76,000 that could be considered as loans.

YOU NEED TO KNOW

This has obviously been a long and extremely contentious litigation, but it shows the critical necessity for appropriate documentation for any director who decides to advance funds to a charity in distress with the idea that the money might be repaid later.  Without such documentation, even without bad blood among the parties, it will be very hard for the person advancing the funds to prove that the advances were not donations.  The requirements of the new Form 990 tax return, that now asks whether minutes are kept of board meetings (which should show authorization of loans) and about the existence of loans from directors may provide contemporary evidence and reduce the likelihood of litigation in cases such as this.