Your 501(c)(3) organization or church is in the midst of a large building campaign. Someone approaches you about making a large gift to the campaign. You don’t know the person, but he says that his grandparents were long-time members and supporters of your organization and he would like to honor them with a donation in their names. Sound too good to be true? Well, rein in your enthusiasm. That may just be the case. Before accepting any large gift, particularly one from someone you don’t know, you should exercise some due diligence.

Fraudulent Transfer may Result in a Clawback

A gift that is given to an organization or to individuals may be required to be returned if it can be shown that the transfer to your organization could be termed a fraudulent transfer under federal bankruptcy law or applicable state law. This is known as a clawback. If the donor obtained the funds in an ill-gotten manner such as a Ponzi scheme, a bankruptcy trustee, creditor, donor, or law enforcement authorities can maintain that the contributions made to the nonprofit organization were fraudulent transfers and must be returned to pay creditors or for other purposes.

Protecting the Organization

Unfortunately, there is no sure-fire way to protect yourself from such contributions. One can exercise a measure of due diligence. This should include:

• An initial screening of the potential donor based on publicly-available information and third party sources.
• A focus on the potential donor’s financial profile. Check sources of income, investment portfolios, closely held companies, and personal residences. Questions about the source of the funds for the donation could provide clues.
• Learning about the potential donor. Check for criminal prosecutions or investigations, assessing the potential donor’s reputation for integrity in the business and philanthropic community.

A good policy, if the funds are accepted, would be to consider holding the assets until it is deemed safe to spend them. This would involve not spending the funds until the applicable statute of limitations has expired.

The organization should also consider any damage to its reputation should it become associated with a clawback of funds from a donor.

Statutes of Limitations

The federal bankruptcy law allows a bankruptcy trustee to void and undo a gratuitous transfer if the transfer involved an actual intent of the debtor to hinder, delay, or defraud or if the debtor received less than a reasonably equivalent value in exchange for such transfer or obligation. Most states have similar laws. However, the statute of limitations varies significantly. Under Federal law, there is a two-year period in which the courts can go back and void the transfer. States vary from two to six years.

A shorter statute of limitations is advocated to provide charitable organizations better protection and predictability in its operations. Having to repay funds via a clawback could inflict significant damage to the organization’s finances. Imagine receiving a multi-million dollar gift, spending it, then learning that it must be returned. Most organizations would not have the resources to do so.

Others argue for a longer statute of limitations to give the trustee a greater possibility of recovering funds that were illegally taken from unsuspecting investors or others under a Ponzi or other fraudulent scheme. After all, these innocent investors were wronged, just as the charitable organization was wronged. It is a delicate balance to weigh the rights and interests of all parties involved.

In short, an organization should take all reasonable steps before accepting a large gift. If accepted, it would be wise not to spend the funds until the statute of limitations has run out.

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Church & Clergy Tax Issues