November 27, 2012
College’s Bankruptcy Lawyers Target Endowment Money
Struggling to pay the mortgage on its dorms, Lon Morris College in Texas never tried to dip into its $11 million pool of endowment money that supported the 158-year-old United Methodist-affiliated school.
But in the hunt for money after the school’s collapse, its bankruptcy attorneys want the charitable funds to pay its final bills—an unlikely wish for those who donated to the endowments in their wills and family trusts.
The Texas Methodist Foundation, which holds the money, has filed a lawsuit to protect some of the college’s endowment money, arguing that spending it on creditors and the professionals who are now preparing to auction off the college piece-by-piece “is not consistent with the charitable intent” of the endowments, according to papers filed with the U.S. Bankruptcy Court in Tyler, Texas.
The college’s request for endowment money touched a nerve within the nonprofit community, which has struggled as much as any industry in recent years. The hardship comes as tax benefits for charitable organizations erode and as judges are less willing to grant special exceptions because of their mission, said San Diego bankruptcy attorney Paul Dostart, who has researched how bankruptcy courts treat tax-exempt organizations.
“We’re seeing a consistent move that says charities—bless them for existing—they’re businesses,” Dostart said. “You’re seeing this kind of erosion of the privileges and immunities that charities had. This isn’t overnight, but it’s a clear change that’s occurring on an incrementally basis.”
Where a charity’s endowment money goes after a bankruptcy filing is a gray area for the Bankruptcy Code, and it’s rarely explored.
This kind of conflict arose in the 1987 bankruptcy of Bishop College, another Texas college with a historically black student base and a ministerial program that taught the Revs. Martin Luther King Jr. and Jesse Jackson. (The campus, located outside Dallas, is now home to Paul Quinn College.)
In that case, the court denied a request from the college’s bankruptcy attorney to take charitable money that was set up to pay the annual income of the college, declaring that the money was not property of the bankruptcy estate.
But when Winstead Memorial Hospital in Connecticut faced a similar issue after closing its doors in 1996, bankruptcy professionals were able to use income from the endowment fund to cover the hospital’s general expenses.
Dostart said that issue can turn on an endowment’s fine print. If the donor took the extra step to put the money in the hands of an outside trustee, the money has a better chance of being withheld from a bankrupt charity’s estate than if the money was held in accounts that the college maintained itself.
“If [the donor] didn’t care enough about preserving that endowment for a long run…then that donor’s got to live with the consequences of that choice,” Dostart said.
Lon Morris filed for bankruptcy in July with $11 million in endowment money, according to court papers. College administrators intended to keep the roughly 1,000-student liberal arts school alive but were defeated by a federal rule that automatically takes federal school loans away from bankrupt colleges.
College officials blamed the school’s financial hardship on their overambitious goal to grow student enrollment during the economic recession by offering discounts on its $22,190-a-year tuition—a plan that worked starting in 2009 but left it without enough student housing and money to pay for operations.
Earlier this month, the Texas Methodist Foundation filed the lawsuit to protect roughly $265,000 in endowments that it said were “created under wills or trust instruments,” according to court papers.
“Each of the endowments was created with the intent and the purpose of furthering educational, charitable and religious endeavors of the Methodist Church and Methodism, now known as United Methodist Church,” foundation attorney Patrick Kelley said in the lawsuit.
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