The Pennsylvania Supreme Court has affirmed a decision by a state trial court holding that a charitable trust providing support of Virginia Military Institute should not be terminated because the additional burdens of operating as a separate private foundation were not “unreasonably out of proportion to the charitable benefits” of the trust.

Richard H. Wells, a Class of 1924 graduate of Virginia Military Institute who was president of the Oil City Trust Company, had created a trust designating the residue for the benefit of VMI in 1956.  Over the years, he had amended the Trust several times, to provide that the trustees give favorable consideration to providing the income to VMI, and in 1965 provided that the residue would remain in a perpetual charitable trust with the VMI Foundation as the sole income beneficiary.

Wells died in 1968.  In 1969, Congress passed the Tax Reform Act that imposed new private foundation rules on trusts like the Wells Trust, including an annual distribution requirement of 5% of the net investment asset value each year and an excise tax on net investment income that is now 1.39% of such income annually.  The Trust provided compensation to the corporate trustee at its standard schedule of published rates.  The value of the Trust grew under the corporate trustee’s management from $1.5 million in 2010 to over $2.1 million in 2020.

In 2019, the VMI Foundation filed a petition to terminate the Trust under the Pennsylvania version of the Uniform Trust Code.  Section 7740.3(e) of the Uniform Trust Act enacted in Pennsylvania, permits a court to terminate a charitable trust if “the separate existence of a trust…results or will result in administrative expense or other burdens unreasonably out of proportion to the charitable benefits.”  The Foundation argued that the corporate trustee was taking a fee of $18,500 a year or about 28% of the income.  The Trust also paid about $750 a year for a tax return and about $4300 a year in the investment income tax.

The trial court, with the concurrence of the state Attorney General, held that the administrative burden was not unreasonably out of proportion to the benefits.  The Superior Court, the intermediate appellate court, affirmed.  (See Nonprofit Issues®, Vol. XXXII, No. 4.). In a lengthy opinion, the Supreme Court has also affirmed.

The Supreme Court noted that at common law, beneficiaries of a trust had no right to terminate a trust to obtain the assets outright except in cases involving cy pres or equitable deviation where the purpose of the trust was no longer legal or practical.  But the rules were changed by the Uniform Trust Act and the provisions enacted by the General Assembly.  The Court said that the new provision of the Uniform Trust Act leaves no room for consideration of settlor intent “by imposing a heightened standard that must be met in order to abrogate this intent.”  The Court said it was the Foundation’s burden, as the moving party, to establish that the trial court abused its discretion in weighing the burdens and benefits and denying termination.

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The Foundation argued not only that the investment income tax was burdensome, but also that because of the 5% minimum distribution requirement under the private foundation rules, the Trust was not able to utilize the state’s unique 2-7% income rule under which a charitable trustee can determine income to be a percentage of the value of the fund averaged over at least three prior years.  In a significant understatement, the Court said “it is not clear” that the Trust was barred from utilizing the 2-7% rule and also noted that if income fell below 5% the statute allows the trustee to comply with the federal 5% distribution requirement.

Because the Foundation had agreed that the corporate trustee’s fees were reasonable, the Court said the Foundation could not argue that they were out of proportion to the benefits the Trust provides.  The Court did not give much credence to the burden of the investment income tax.

On the benefit side, the Court said the separate trust would allow the use of cy pres if the Foundation were to go out of existence.  The Court also noted that the Foundation had received an average annual distribution of $71,500, which was nearly six times the amount paid by the Trust in fees and taxes.  “The size of the trust indicates that it ought to be self-sustaining and productive for many years to come.  The charitable benefits to the Foundation are substantial.”

The Court went on to say that even if the Foundation had shown that the burdens were unreasonably out of proportion to the charitable benefits, the General Assembly vested the trial court with the discretion not to terminate the trust, which had to be evaluated against an “abuse of discretion standard in light of the record.”  It said that the record here “demonstrates compellingly” that the costs are not unreasonably out of proportion to the benefits.  It also said that termination “merely because it would be more advantageous to the beneficiaries is inappropriate.”  (In Re: Trust B Under Agreement of Richard H. Wells, Supreme Ct., PA, No. 5 WAP 2023, 3/21/24.)

YOU NEED TO KNOW

The Foundation lost me when it tried to argue that the private foundation rules prevent the trust from following Pennsylvania’s law authorizing charitable trustees to determine that income is an amount determined to be 2-7% of the value of the trust averaged over at least three years.  The Supreme Court was generous in saying “it is not clear” that the argument was correct.  Private foundations as well as public charities in Pennsylvania regularly utilize that rule to determine income so that they can invest in a total return basis that is much more likely to increase and maintain the value of the fund over time than investing in traditional fixed income investments.

The real question is how much extra cost resulting from the separate trust is “unreasonably out of proportion.”  This court said that standard bank fees and a 1.39% investment income tax were not enough.  It is not particularly hard to imagine, however, where standard fees and separate costs could add up to a significant loss of asset value over time because of the separate administration of the private foundation.  Exactly where the line gets crossed will have to be decided separately in every case.