College expense loan

Borrowing Restricted Net Assets to Fund Unrestricted Expense

Last week I received a call from two very concerned church members. They said they had learned that the church had borrowed some money from the building fund to cover an operational' shortage. They wanted to know if it is illegal to do this. In other words, how concerned should they be?

Especially after 9/11 and the dip in the economy, the cash reserves of some churches has been below levels previously experienced. When a church's finances are tight, it is possible to deplete liquid (cash, cash equivalents, and investments) unrestricted net assets. At that point, churches may be tempted to borrow donor-restricted net assets to cover operating expenses.

To avoid violating the terms of any restricted gifts, churches must exercise caution. Churches are legally required to spend restricted net assets to further the intent and purposes expressed by the donor. Therefore, borrowing donor-restricted funds raises red flags and is appropriate only in limited circumstances.

Should a church fail to obtain the donors consent releasing the restricted net assets, or should the donors refuse to give consent and the church use the restricted net assets anyway, the church may face a demand letter or court action seeking to enforce the terms of the gift. A lawsuit could seek injunctive relief, a return of the restricted gift, or a transfer of the restricted net assets to another charity.

Churches have a duty to use restricted net assets only in accordance with the intent and purposes established by the donor at the time of the gift. This is particularly true of funds raised for capital campaigns or for endowment. A church should critically evaluate whether it can survive the possible negative publicity of a media inquiry or even an unsuccessful lawsuit regarding the use of restricted net assets.

Before a church borrows from restricted net assets, it should carefully consider alternative sources. For example, the church may be able to obtain a loan from a financial institution without collateralizing or impairing the church's restricted funds.

Although not preferred, borrowing donor-restricted net assets may be prudent only if the donor has not restricted how the church may invest the funds, and only when the church is able to pay these funds back within a short period of time. If the church believes short-term repayment of borrowed restricted funds is highly improbable, the church should not borrow them. If churches are unable to repay amounts they have already borrowed from their restricted funds in a timely manner, they should create a reasonable repayment plan.

There are limited circumstances under which borrowing may be appropriate. If a church has an immediate need for funds but reasonably expects to receive the contributions to cover the immediate expenses in the next several months, it may borrow from its restricted assets, rather than borrow the money from a bank and incur interest expenses. Then, as the contributions are received, the church can repay the borrowed restricted funds.

Temporarily and permanently restricted net assets are typically invested in cash and investments.

The simplest way to determine if a church is borrowing from restricted net assets is to compare temporarily and permanently restricted net assets to total cash, marketable securities, and any other restricted assets. If restricted net assets exceed total cash, marketable securities, and any other restricted net assets, the determination is that borrowing has occurred.

A recent court case serves as an example of the best way to go about borrowing restricted net assets in severe financial distress circumstances. Hood College of Frederick, Maryland, filed a court petition in late July 2003 to gain approval of a plan to borrow funds from its endowment. The college had defaulted on several bank loans earlier that year and threatened foreclosure would require Hood to close its doors. The Frederick Circuit Court approved the loan from the endowment at an annual interest rate of 6.25% over ten years.

This scenario serves as an ideal example of borrowing restricted assets because they informed their constituents, received court approval before taking any action, and borrowed only in desperate circumstances.

by Dan Busby, CPA