by Victoria B. Bjorklund and Jennifer I. Goldberg
Simpson Thacher & Bartlett

U.S. private foundations are increasingly involved in international grantmaking. One way for a private foundation to give overseas is to make direct grants to foreign charities. Many U.S. private foundations, however, may want to consider giving overseas indirectly through a "Friends of" organization.

What is a "Friends of" organization?

The term "Friends of" derives from the fact that the names of so many organizations that support foreign charities begin with these two words. They include organizations such as American Friends of the Canadian Centre for Architecture and Friends of China Heritage Fund, as well as hundreds of other organizations which do not have names beginning with these two words, such as Doctors Without Borders/Medecins Sans Frontieres. The "Friends of" organization is almost always a U.S. nonprofit corporation. It can be classified as a public charity or as a private foundation. A private foundation donor will prefer to give to a "Friends of" organization classified as a public charity in order to avoid having to perform expenditure responsibility (which is required for grants to other private foundations).

The "Friends of" organization generally exists to provide federal tax deductibility for charitable contributions to support a named foreign charity by breaking a "conduit" flow of funds to the foreign charity. While a private foundation has no need of tax deductibility, it may wish to work with a "Friends of" organization to make international grants without extensive documentation. Private foundations must also avoid earmarking of grants and are thus interested in the proper functioning of a "Friends of" organization.

The Internal Revenue Service has approved two structures, which provide models for two distinct types of "Friends of" organizations. The first type of organization makes grants to a foreign charity, and the second actually controls the operations of the foreign charity. In either case, the structure will succeed or fail on the U.S. charity's exercise and documentation of "discretion and control."

Discretion and Control

Directors
The IRS has noted the importance of the "Friends of" organization having a significant number of directors who are U.S. citizens and who are not acting on behalf of the supported foreign charity. This issue is usually handled by negotiation with the IRS after the organization files its application for tax exemption. Board composition may be one of the most difficult issues in setting up a "Friends of" organization unless the foreign charity understands U.S. law. Counsel will likely need to disclose in the application for tax exemption (i) the number of directors that are U.S. citizens or residents and their percentage of the entire Board of Directors, (ii) whether the directors are subject to voting or other restrictions, and (iii) whether the directors are also directors, officers, or employees of the foreign charity. It is also important to take into account state conflict-of-interest rules and watchdog agencies' rules about disclosure and eligibility to vote on grants to an organization of which a director is a director, officer, or employee. In particular, representatives of the foreign charity receiving grants may, for various reasons, take offense at being asked to leave the board room during a discussion or vote. This can be one of the most divisive issues faced by a "Friends of" Board.

Grants for Specific Projects
The models approved by the IRS fund specific projects of the foreign charity. Disapproved models remit net proceeds of fundraising campaigns or "receive contributions and send them at convenient intervals to the foreign organization," which could be interpreted to prohibit general operating support grantmaking. The IRS has held that a charity had to know, in advance of making a grant, what the foreign charity would do with the funds. The problem with general operating support grants is that the "Friends of" organization cedes expenditure control to the foreign charity.

Promises that Kill Discretion and Control
The donor private foundation should not request, and the "Friends of" organization must not make, promises that the contribution will absolutely, positively be used overseas as the donor requires. The "Friends of" Board must have the option to say "No" if, for example, the "Friends of" organization becomes aware that the foreign charity is diverting funds or failing to account for funds. An alternative is that a donor could pledge a contribution to the "Friends of" organization contingent upon that organization's pre-approval of a specific project. In this way, the contingency would not be satisfied and the funds not due unless the project is approved. While the pledge model comes in several varieties and may not be fail-safe, it can be a useful alternative for a donor who wants some level of assurance but wants to avoid earmarking.

Pre-approve Projects Before Soliciting Funds
In the model approved by the IRS, the "Friends of" organization solicited funds "pursuant to grants previously reviewed and approved by the Board of Directors." This fact pattern has generally been read to create a pre-approval requirement before solicitation begins in the United States. This requirement can be met by using the pledge option described above. An alternative is to ask the foreign charity annually to submit its "wish list" of projects for the following fiscal year. The Board of Directors of the "Friends of" organization can then review and "pre-approve" those projects that they believe will be of greatest interest to U.S. donors. The Board can also authorize and conduct fundraising for these projects in cooperation with the foreign charity. Note that the "Friends of" organization should be the solicitor as it, and not the foreign charity, is likely registered to solicit in the many states that require registration.

Recordkeeping
The "Friends of" organization should prepare form proposals, form resolutions, form grant contracts, and form reports if necessary to create the required records that discretion and control have been exercised by the U.S. Board of Directors in proper sequence. Creating a package of form documents also helps the foreign charity better to understand what is expected of it and to avoid misunderstandings or resentment about paperwork. The "Friends of" organization should also create a file for each grant that includes a copy of the board resolution authorizing solicitation, a copy of the resolution authorizing payment of the grant, the grant application and budget from the foreign charity, the grant-award contract, and the annual and/or wrap-up reports.

A grant to a well-run "Friends of" organization can be an efficient means for funding overseas projects without having to conduct expenditure responsibility. In addition, the donor private foundation has no affirmative legal obligation to investigate a "Friends of" organization's anti-conduit procedures. It will however want to refrain from overriding those procedures, such as by earmarking grants. A better course is to fund pre-approved projects of the "Friends of" organization. Finally, a donor private foundation should avoid making grants to those few "Friends of" organizations that the IRS has explicitly ruled to be conduits.

About the Authors

Victoria B. Bjorklund is a partner at Simpson Thacher & Bartlett, where she heads the firm's Exempt Organizations Group. She is the co-author of "New York Nonprofit Law and Practice" (Lexis Publishing 1997). Jennifer I. Goldberg is an associate in the Simpson Exempt Organizations Group and a graduate of New York University (J.D.) and the University of Michigan (B.A.).

For copies of this article with citations to legal authority, please contact Ms. Goldberg at 212/455-2000. "Legal Dimensions" articles are edited by an editorial board in which the following firms are represented: International Center for Not-for-Profit Law; Silk, Adler & Colvin; Day, Berry & Howard; and Caplin & Drysdale.