Legal Brief

Good relationships between grantmakers and grantees promote more effective philanthropy. But there's nothing that can mess up a good partnership faster than an overzealous lawyer. In seeking to protect their foundation clients, lawyers can sometimes impose excessive requirements on grantees, forcing them to spend unnecessary time and money. While grantmakers should always pay attention to their lawyers' advice, here are some legal recommendations you might want to question.

Requiring grantees to "re-certify" tax-exempt status.

Most grantmakers wisely ask potential grantees to provide a copy of their determination letter from the Internal Revenue Service (IRS). The letter, sometimes called "the 501(c)(3) letter," states the IRS has determined that the organization is exempt from federal income tax under Section 501(c)(3) of the Tax Code.

Some attorneys unwisely suggest that if a grantee's determination letter is more than a few years old, the foundation should require the organization to request an updated letter from the IRS. But in addition to being a time-consuming and expensive undertaking, in most cases, it is absolutely unnecessary. Generally, determination letters are valid until the IRS acts to revoke them. This is true whether the letter is from 1992, 1952 or even 1922. And it's true even if the Tax Code section referred to in the determination letter is Section 101(6), the predecessor to Section 501(c)(3).

A more thoughtful approach is to insert a provision in any grant agreement that the grantee (1) affirms its tax status is as set forth in its determination letter, and (2) pledges to notify the grantmaker if there is a change in this status.

That being said, there are a few circumstances when a foundation should demand that a grantee contact the IRS for an updated letter. For example, when a new publicly supported charity submits an application for exemption to the IRS, it will—if approved—receive an "advance ruling." Generally, this letter is valid from the organization's inception until the last day of its fifth tax year.

Within 90 days after the end of this advance ruling period, the organization must submit materials to the IRS showing that it meets one of the public support tests that allow it to qualify as a public charity. If the organization can demonstrate it is publicly supported, it should receive a final determination letter that is valid until revoked. When a grantee is within this 90-day period, a foundation should request the grantee provide evidence that it has initiated efforts to secure a final determination letter.

If the grantee is beyond this 90-day period and has not attempted to secure its final determination letter, a grantmaker may not rely on the grantee's advance ruling determination letter. For a private foundation, this means that any grant to such an entity may be considered a grant to a non-501(c)(3) organization and will require the exercise of expenditure responsibility. In that case, the grantee should contact the IRS immediately and clarify its tax status.

Requiring grantees to sign lengthy grant agreements for small, general purpose grants

Not all grants require extensive documentation. A small, general purpose grant to an established 501(c)(3) organization probably does not require much more than a cover letter that sets out, for public acknowledgement purposes, (1) the grant amount, (2) the purpose of the grant, and (3) the name of the grantmaker. However, public charities report that they often receive dense, multipage agreements in connection with such grants.

And while there may be nothing objectionable in these agreements, the grantee's managers may not wish to commit to the terms of the agreement without checking with a lawyer, because such a consultation may cost more than the grant itself! Foundation managers, in turn, report that their lawyers demand they use these complicated forms.

Foundations that regularly use grant agreements should have their counsel review those agreements periodically and should seek legal advice when a particular proposed grant raises complicated issues (ownership of intellectual property, for example).

Part of the advice that foundation counsel can—and should—provide is guidance on when extensive grant agreements are not necessary.

Requiring grantees to sign overly restrictive "no lobbying" grant agreements

Too often, grant agreements that accompany private foundation grants to 501(c)(3) public charities bar recipients from using any of the funds to lobby government officials. In most cases, this restriction is not necessary and creates an accounting headache for the grantee.

While foundations are quite restricted in the types of lobbying they can do and the subjects on which they may try to "influence legislation," public charities are much more free to communicate their positions on a variety of issues. A private foundation may not earmark a grant for lobbying efforts, but it certainly may provide a general support grant to a public charity that lobbies. Generally, these grant funds may be used for lobbying without the foundation being penalized. A foundation may even make a special purpose grant to a public charity for a project that involves lobbying, so long as the foundation's funding does not exceed the nonlobbying portion of the proposed activity's budget.

When a grant agreement forbids the recipient from using any funds for lobbying, the grantee must carefully segregate the foundation dollars in order to comply with the terms of the grant. The result may be that such a restriction can discourage a charity from getting involved in public policy debates on issues relevant to its charitable mission.

There is one circumstance in which a grant agreement must deny lobbying with grant funds. This occurs when a private foundation makes a grant to an organization that is not a 501(c)(3) public charity.

In this case, the private foundation, generally, must exercise expenditure responsibility in connection with the grant. Part of this process is executing a grant agreement that bars the recipient from using grant funds for a number of noncharitable purposes as well as influencing legislation. In general, however, there's no reason to import this prohibition on lobbying into a general purpose (non-expenditure-responsibility) grant agreement.

Ensuring that grantees are freed from unnecessary administrative burdens is a first step in establishing a good working partnership between grantmakers and grantees. The foundation's legal counsel can play an important, positive role in making this happen.

Grant Agreements—the Basics

In most cases, it would be perfectly legal for a foundation to put a check into an envelope and send it off to a charitable 501(c)(3) organization without any further paperwork. But sending a check by itself is not necessarily a good idea. Here are some thoughts on what a minimal cover letter should contain and suggestions on what a well-drafted grant agreement will address.

The Bare Bones Approach

At the very least, a foundation should include, with its check, a cover note that identifies the foundation, notes the amount of the check and specifies the purposes for which the grant is made (general support, scholarships, etc.). If there are any simple grant conditions in the letter (for example, that the grantee must inform the foundation if there are any changes in its tax-exempt status or that the grantee must return any funds that are not spent for the purposes of the grant), the letter may state explicitly that by cashing the check the grantee agrees to such conditions. Generally, this will eliminate the need for the grantee to countersign and return a copy of the letter. Such a transmittal letter might be all that is required for a general support grant to a long-established, publicly supported charity.

A More Expansive Approach

Other grants may benefit from more extensive documentation that clarifies the terms of the relationship between the grantmaker and grantee. While every grantmaking situation will be different, it is possible to generalize about the areas that a well-drafted grant agreement will cover. The basic goal is to describe the extent of the grantmaker's commitment and inform the grantee of its responsibilities. Following is a listing of essential provisions that a grant agreement should almost certainly contain as well as some provisions that may be appropriate depending on the situation.

Essential Elements

• A description of the purposes for which the grant funds are to be spent, including a reference to all or part of the grant proposal (activities, budgets, timetables), if appropriate. May explicitly limit use of funds to charitable purposes. May also bar use for carrying on propaganda and influencing the outcome of any specific public election (note that as a general rule and in connection with general support grants, lobbying—influencing legislation—need not be barred).     
• Provisions that state the amount and timing of payments.     
• A clear description of any conditions that need to be met to secure the entire amount of funding under this agreement.     
• Provisions relating to repayment of unexpended or misdirected funds.     
• A summary of reporting requirements, including financial accounting provisions. If necessary, attach a model report and specify that reporting must be substantially in this format.     
• Description of conditions under which the grant may be terminated and the consequences of such termination.     
• Designation of responsible individuals at grantmaker and grantee organizations.     
• A statement in which the grantee affirms that its tax status is as set forth in its determination letter from the IRS and pledges to notify the grantmaker if there is a change in this tax status.     
• Language that provides that by signing the agreement, grantee agrees to be bound by its terms. May also add that the agreement represents the entire understanding between grantmaker and grantee and supersedes all prior writings and understandings.

Provisions that May be Desirable Depending on the Situation

• Restrictions on re-granting, including grants to individuals.     
• Information about the grantmaker's own evaluation process.     
• Discussion of how the grantmaker wishes press releases or other publicity about the grant to be handled.     
• Treatment of copyrights and other rights in materials produced as a result of the grant.     
• Information about the grantmaker's expectations regarding grantee's organizational behavior—commitment to inclusiveness/nondiscrimination in employment and/or provision of services.

—J.C.N

Additional Resources

• On the details of tax exemption: 
  Tax-Exempt Status for Your Organization. (IRS Publication 557, available for download in pdf format on the IRS Web site, www.irs.gov/pub/irs-pdf/p557.pdf)     
• On grant agreements: 
  The Handbook on Private Foundations contains a sample grant agreement. David F. Freeman. (Council on Foundations, 1991) Order online at www.cof.org/applications/publications/index.cfm. Item #401, $29.95.     
• On grantmaking generally: 
  Grantmaking Basics: A Field Guide for Funders. Barbara D. Kibbe, Fred Setterberg and Colburn S. Wilbur. (Council on Foundations, 1999) Order online at www.cof.org/applications/publications/index.cfm. Item #508. Members $35/Nonmembers $55.     
• On lobbying:
  Foundations and Lobbying: Safe Ways to Affect Public Policy. John A. Edie. (Council on Foundations, 1991) Order online at www.cof.org/applications/publications/index.cfm. Item #701. Members $20/Nonmembers $30.
  Myth v. Fact: Foundation Support of Advocacy. T. Asher. (Alliance for Justice, 1995) Order online at www.afj.org. $20.