Fiscal Sponsors and COVID-19

You’ll find a wealth of information provided by numerous organizations and law firms regarding COVID-19-related issues facing nonprofits, including this page from the NEO Law Group. Such issues include those related to new laws providing for paid employee leave, small business (and nonprofit) loans, and enhanced charitable contribution deductions. However, these new laws, understandably created in great haste, leave open many questions that will require regulations and follow-up laws to answer. Fiscal sponsors, like other nonprofits, should be aware of these new laws and other COVID-19-related issues, but they should also be aware of how they may impact fiscal sponsors in different ways.

Governance and Oversight

The board of directors of a fiscal sponsor (“Sponsor”) is ultimately responsible for all of the comprehensive (Model A) fiscally sponsored projects (“FSPs”) of the Sponsor and the exercise of all corporate powers. A board may delegate management of the day-to-day operations to project directors, project committees, employees, or a management company, but it may not delegate its oversight responsibility or its function to govern. And when it delegates authority and power, the board must do so with reasonable care.

The general roles of the Sponsor’s board are to direct, oversee, and protect. Direction is provided through mission, vision, and values statements; plans; policies; budgets; specific directives; and responsible leadership. Oversight involves reviews of executive performance, financials, audits, programmatic impact, and compliance. And protection of charitable assets is accomplished by appropriate risk management, including internal controls and insurance, and strategic decision-making.

With respect to the Sponsor’s FSPs, the board typically relies heavily on staff and policies to provide information and assurance that each FSP is operating in compliance with applicable laws and prudent practices that mitigate unreasonable risks. Because the leaders of an FSP are responsible for fundraising for such FSP, and policies customarily provide that the FSP will be terminated where there are insufficient resources, the board generally does not intervene as it might when the Sponsor itself has a solvency problem.

However, when a disaster like the COVID-19 pandemic jeopardizes multiple FSPs and consequently also the Sponsor, the board must recognize its duty to act. The board should immediately take steps to reasonably ensure that its employees, volunteers, clients, customers, beneficiaries, and visitors associated with each FSP are in a safe work environment. If existing policies do not address urgent needs and issues, the board needs to make sure they are created, implemented, and enforced. And if the Sponsor can reasonably access governmental aid for Sponsor, the board should determine how to allocate such aid, including whether and how it might be distributed or shared with some or all of the FSPs.

CARES Act Loans

Sponsors that apply for, and particularly those that receive, loans made available to small businesses and most nonprofits through the CARES Act will likely be viewed favorably by leaders of current and prospective FSPs. Conversely, Sponsors that do not apply for such loans, particularly the Paycheck Protection Program (PPP) forgivable loans, may be viewed unfavorably for not taking reasonable steps to allow all of Sponsor’s employees, including those working for the FSPs, to continue being employed. Whether the PPP loans are still available is unclear due to the rush of applicants when they were first made available, the limited amount of funds available for the program, and the preference of lenders to work with certain types of clients. Whether Sponsor should apply for other loans may be a more difficult decision as Sponsors typically do not allow FSPs to take loans that could place Sponsor’s other assets at risk.

Contracts

During periods of crisis, a Sponsor must consider how its contracts may be impacted. Sponsor may determine that it cannot perform and meet its obligations under some contracts, but it may need to consider this holistically and not just based on an individual FSP’s resources and capacity. Breaching a contract may have serious consequences, including damages owed to the other party. In some cases, Sponsor may have a defense against a breach of contract claim, such as application of a force majeure clause in the contract, impracticability/impossibility, and frustration of purpose. See Update: Force Majeure Under the Coronavirus (COVID-19) Pandemic from Paul Weiss. But it may be best, where possible, to negotiate with the other party to avoid a potentially very costly legal dispute.

Sponsor may also discover that one or more other parties to contracts with Sponsor cannot perform and meet their contractual obligations. Sponsor will need to determine whether to negotiate and modify the contracts or pursue a breach of contract claim. Just as Sponsor may have a defense against such a claim, so may another party. And while we expect to see a flood of claims in the coming months, Sponsor needs to consider the public relations implications of pursuing a breach of contract claim against an adversely impacted party.

Unlike most charities, Sponsor must also consider the opinions of its FSP on whether it can meet its contractual obligations and how the FSP can manage the relationship with the other party if it cannot. If Sponsor does not have confidence in the legal acumen or negotiation skills of its FSP leaders (who would be considered agents of Sponsor), Sponsor may need to intervene. In any case, it may be wise for Sponsor engage an attorney, regardless of whether the FSP asks for such support.

Project Financial Solvency

FSP solvency issues are an ordinary management concern for Sponsors. But these are extraordinary times and rather than experiencing one or two FSPs struggling with solvency at a given time, some Sponsors may be facing a much larger number of FSPs bordering on insolvency.

Customarily, Sponsors do not lend money from their general operations to FSPs except perhaps in circumstances where repayment within a short time frame is a near certainty (e.g., a payment owed, or grant awarded, to the FSP is expected shortly). But with the CARES Act, a Sponsor has the opportunity to apply for and possibly receive forgivable PPP loan (that may effectively turn into a grant) to retain its employees and/or an Economic Injury Disaster Loan (EIDL) that provides for a 2.75 percent interest rate and deferred payment for 12 months. I can imagine that a Sponsor might apply for the forgivable PPP loan and allocate the proceeds across FSPs (though the allocation formula may be unique to each Sponsor based on numerous considerations besides payroll costs since up to 25 percent of the PPP loan can also be used for rent, mortgage interest, and/or utilities). However, a Sponsor must consider the loss of flexibility regarding staffing decisions if it wants the loan to be forgivable (which is determined in part by employee retention). I think it’s less likely a Sponsor will allocate any EIDL proceeds to its FSPs as such loans may still be enforced against the Sponsor’s general assets if the restricted funds for the FSPs are not sufficient to cover repayment.

The Employee Retention Payroll Tax Credit may also be worth considering but it may be difficult to calculate whether a Sponsor qualifies and the amount of the credit as the calculations must be done on a whole entity basis and not on an FSP basis. The amount of the credit is 50% of qualifying wages paid up to $10,000 in total, so Sponsor must determine whether it would still need to determine the FSPs individual solvency if Sponsor received such credit.

Employees and Independent Contractors

Sponsors need to be very careful about proper classification of their workers, including workers for all of their comprehensive FSPs. Both federal tax law and state laws will apply. Adding to the complication, these laws do not necessarily conform with each other, particularly with respect to California where AB 5 went into effect at the start of this year.

The classification of workers will apply to the amount of any PPP loan a Sponsor may be eligible to receive. A Sponsor’s “payroll costs” as defined in the CARES Act do not include amounts paid to an independent contractor. If such independent contractor’s agreement with the Sponsor is terminated, they may look to see if they were improperly classified and legally should have been considered an employee entitled to the rights, protections, and benefits given to other employees of Sponsor. If this is true, it may also impact the PPP loan calculations and qualifications. For Sponsors who have FSPs that have heavily relied upon independent contractors, this may be a very important issue to discuss with an employment attorney and a tax attorney.