Fiscal Sponsorship & Dormant Projects – Part I: Liability Risks

Man and mousetrapAt the recent “Understanding Fiscal Sponsorship in the Arts" workshop sponsored by the Creative Capacity Fund, an audience member in our legal issues workshop asked about the appropriate length of time to keep dormant projects on the fiscal sponsor’s books. While there is no legally mandated timeline, boards of fiscal sponsors should at a minimum discuss this common problem, which does carry liability risks.

It can be fairly easy for an organization to “forget” about projects for many reasons including, but not limited to, the large number of projects being sponsored, the varying timelines of each project, and the different ways and reasons that defunct projects fly under the radar with their fiscal sponsors.

Number of Projects

Fiscal sponsorship is often discussed in isolation, looking at a single agreement or arrangement. But for many fiscal sponsors, there is more than one ball in the air. For example, the Tides Center Whitepaper “Fiscal Sponsorship Field Scan: Understanding Current Needs and Practices” from 2006, which is the most comprehensive study on fiscal sponsorship to date, reported that the median number of projects sponsored by the surveyed organizations engaged in fiscal sponsorship was eight and at the highest end of the range was an organization that sponsored 400 projects. This can be quite a handful to juggle especially when taking into consideration that many organizations are sponsoring these projects in addition to running their own distinct programs. 

Timeline of Projects

In addition to the sheer number of projects being fiscally sponsored by an organization, a sponsor’s responsibilities can be complicated by the fact that projects have different timelines. Although a key difference between absorbing a project and setting up a fiscal sponsorship relationship is the potential exit of the project that is contemplated from the start, this exit is neither guaranteed nor that common.

The Tides Center Whitepaper also revealed that 20% of fiscal sponsors indicated none of their projects eventually became independent 501(c)(3) entities; another 50% indicated that less than a quarter of their projects became independent; and only 22% indicated half or more of their projects eventually became independent nonprofits. Interestingly, sponsors with fewer projects had a higher percentage of projects eventually become 501(c)(3) organizations, suggesting that sponsors with larger numbers of projects are less likely to be only temporary incubators to their projects.

Additionally, the trends at that time also showed that the majority of fiscal sponsors (56%) were taking in more projects than they were ending each year. Thus, not only does the fiscal sponsor role as a temporary incubator vary on a project-by-project basis, the number of projects to monitor is also constantly increasing for most organizations.

Flying Under the Radar

A dormant project is generally understood as a project that is simply not operating (i.e., inactive). However, what may appear to be dormancy may also be a project that is still operating at some level but failing to report its operations. If the recent tax-exempt status revocation of 275,000 nonprofit organizations is any indication about the problems generally with respect to knowing what is required to properly operate or properly shut down shop when necessary, it is probably in line to assume the parties to fiscally sponsor relationships are not immune from the same problems. 

Liabilities can exist in either situation. For example, just because an organization has closed shop operationally doesn’t mean they have properly wound up their affairs in paying their debts, discharging any contractual obligations, and settling other claims. Additionally, just because a project is not sending reports or keeping in contact with its sponsor doesn’t mean it isn’t actually doing things that have legal implications such as soliciting donations, disseminating information (including on social media platforms), and entering into contracts.

Allowing projects to fall “under the radar” can be particularly troublesome for the fiscal sponsor in a Model A comprehensive fiscal sponsorship relationship because the fiscal sponsor and the project are one and the same for legal purposes. Therefore, the project is subject to same 501(c)(3) restrictions as the fiscal sponsor and to the extent that the project has outstanding debts or claims or has engaged in unlawful conduct (e.g., infringing on a copyright, defaming an individual, violating the 501(c)(3) prohibition on electioneering), the fiscal sponsor must take responsibility.

In a Model C pre-approved grant fiscal sponsorship relationship, there is potentially less exposure to liability for the fiscal sponsor because the project is a separate legal entity and much of the liability for the project sits with that entity. However, as most experts know, Model C is the most susceptible to “conduit” issues when the relationship is mismanaged, and as a result, what parties intended to be a Model C relationship can actually start to look like something else such as a Model A that exposes the fiscal sponsor to more liability.

Additionally, keeping an inactive project on the books has costs, even if there are no outstanding affairs to be settled or unlawful acts committed. For example, in a Model A relationship, the fiscal sponsor generally charges a fee to render agreed upon services (e.g., payroll, insurance coverage). A project that is not bringing in any funding, even if not operating, is likely a deficit to the organization. Fiscal sponsorship is sometimes not a net revenue-generating operation for the fiscal sponsor, especially for first-time fiscal sponsors or other organizations that need to invest in setting up the infrastructure to operate as a fiscal sponsor. Rendering services to an inactive shell project, even if it is minimal monitoring just to confirm no operations are occurring, costs the fiscal sponsor resources (e.g., time, energy, money). With enough dormant projects, this could result in a significant drain of the sponsor’s resources that would be better spent in furtherance of the sponsor’s exempt purpose. 

In a Model C relationship, the project should be aware that it may be a taxable entity subject to a minimum state tax that applies so long as the entity exists, regardless of whether it carries on operations or receives any income (e.g., California’s minimum $800 franchise tax).

The Tides Center Whitepaper “Fiscal Sponsorship Field Scan: Understanding Current Needs and Practices” can be downloaded here.

For more information on Model A and Model C fiscal sponsorship, please view our previous posts, Fiscal Sponsorship Basics and Fiscal Sponsorship: 6 Ways to Do It Wrong. A comprehensive list of our posts on fiscal sponorship is available here.

Part II coming soon!