26 November 2008

Art and cultural assets news - autumn: promises broken

Making a charitable pledge or promised gift has long been a popular way to satisfy requests for donations from charitable institutions as there is no immediate need to transfer funds or turn over assets.  When making a pledge, a donor makes a promise to make a gift of cash or specified assets at some future time or by will.  There are many reasons for agreeing to a deferred gift rather than an immediate gift.  The pledged assets may not currently be liquid, the donor may wish to invest funds to secure a higher rate of return than that available to the charity, or the donor may be trying to arrange for more beneficial tax treatment for a gift completed in a future year.  In the case of artwork or collectibles, a promised gift may simply reflect the donor's desire for his or her continued use and enjoyment of the works a while longer before turning them over to charity.  

Although it is relatively uncommon, a number of donors may become unwilling or unable to fulfil  their pledges. This may be due to a divorce or other change in the donor's economic circumstances or simply a change of mind. In a number of cases, the heirs of a pledgor become unwilling to honour a pledge made during the pledgor's lifetime, particularly in the case of artwork, when the value of the artwork may have skyrocketed between the date the pledge was originally made and the scheduled date of the gift. Many people who make a pledge consider the pledge as a mere hope or expectation that a gift will be made in the future and assume that a charity will not seek to enforce the pledge. However such pledges have generally been enforced by the US courts when a charity has chosen to litigate. 

It is a general rule of contract law that a mere promise is not legally enforceable if there is no consideration given in exchange for the promise.  In many cases courts have found consideration and have therefore enforced the pledge as a standard contract.  A seminal New York case Allegheny College v. Nat'l Chautauqua County Bank [1927] involved Mary Yates Johnson, who in 1921 signed a pledge to leave $5,000 at her death to Allegheny College for a fund in her memory to be known as the “Mary Yates Johnson Memorial Fund.”  Mary made one payment of $1,000 but then changed her mind and, in 1924, notified the school that she was revoking her pledge.  Upon her death, Allegheny College sued her estate to enforce the pledge.  Mary's estate argued that the college had given Mary nothing in return for her pledge, and thus there was no consideration.  Judge Cardozo, in ruling in favor of Allegheny College found consideration in the college's “implied promise” to “do whatever acts were customary or reasonably necessary to maintain the memorial fund “.  

Other US courts have upheld the enforceability of pledges under the theory of “promissory estoppel.”  In such cases pledges were upheld when an institution had “reasonably relied on the promise” of the future gift and would suffer a hardship if the gift was not ultimately made.  The courts are very liberal in finding that institutions have relied upon gifts, such as in cases where there were specific fundraising goals prompting pledges, capital campaign drives and building naming opportunities.  In cases where art has been pledged, pledges have been enforced when museums have agreed to build or renovate space to display such artwork, or have undertaken acquisition programs based on the promise that a work would be left to them. In such cases courts have been willing to order “specific performance” of the pledge, that is, a completed gift of the artwork itself rather than the gift of the cash equivalent. 

Even where there was no consideration and an institution has not relied on a promised gift under the theory of promissory estoppel, courts have been willing to enforce pledges on public policy grounds.   In the case of Jewish Federation of Cent. New Jersey v. Barondess [1989] a New Jersey man made an oral pledge to donate $2,000 to a charity that he thereafter refused to pay.  The New Jersey court found that there was no contract to make the pledge and that the charity did not rely on the promise of $2,000.  Nonetheless, the court found for the charity on the ground that enforcement of charitable pledges is a desirable social goal and therefore public policy supports the upholding of charitable pledges.  

Many charities are reluctant to sue pledgors for fear that they will lose donors due to bad publicity.  In one survey, a review of reported cases to enforce pledges shows that a majority of such actions were brought only after the death of the pledgor, indicating that the charity was more inclined to enter into a dispute with heirs of the pledgor than with the pledgor. On the other hand, pledges constitute assets of the charity and are reported as such on the charities balance sheet in accordance with accepted US accounting principles. It is generally accepted that trustees and directors of charities owe a duty of care to an organization which generally includes the duty to safeguard assets.  The directors and trustees are often faced with a difficult balancing of the possible loss of future donors or other bad publicity associated with a battle over a pledge against their duty to protect charitable assets.  If the pledge is small or the debtor is in financial difficulty, prudence may dictate that a charity abandon a pledge. Similarly, if a pledge becomes tainted as ill-gotten gains or is received from a person who later falls into disrepute, the proper business judgment may be to forego enforcement of the pledge. In a purely commercial setting there is opportunity for compromise and settlement of disputes and often a charity will accept a reduced pledge or a longer payment schedule or perhaps the substitution of different artwork for the works originally promised. 

It is important for prospective donors to understand that their promised gifts have legal consequences for them and possibly their heirs and that they should seek advice before entering into a pledge. Such pledges may have immediate tax consequences in addition to consequences at the time of completion. The renegotiation of pledges and particularly the substitution of artwork in a renegotiation can also present difficult tax issues and these tax issues must be carefully explored in connection with the revision of the pledge. 

Charities should exercise care in the acceptance of pledges by fully informing the donor that they expect the pledge to be legally binding and have a pledge agreement in place in writing.  With respect to significant pledges charities must also investigate whether the donor has the finances to complete the pledge and determine whether there are any factors which may lead to a challenge of the pledge later on. With respect to a pledge of artwork the charity must obviously be concerned with authenticity and that the pledgor has good title.