Fiscal sponsorship exits can be very complex and at times contentious. In this series of posts, we’ll identify issues that may provide some guidance in structuring the initial fiscal sponsorship agreement, terminating that agreement, and transferring a project’s assets and liabilities to a successor fiscal sponsor or other nonprofit. For purposes of this series, we’ll just focus on comprehensive (Model A) fiscal sponsorships of charitable projects.
Finding a Successor
Where a termination of the fiscal sponsorship relationship is desired but there remain funds/assets in the project’s restricted fund, the parties must find a willing and able successor fiscal sponsor or other charity. The selection of a successor typically requires the mutual approval of the parties to the fiscal sponsorship agreement.
The fiscal sponsor must assure that the successor is a reasonable recipient of the fiscal sponsor’s assets, which may minimally mean that the successor is, at the time of the transfer, (1) exempt under IRC §501(c)(3), (2) properly qualified to operate the project in any applicable states/jurisdictions, (3) an entity whose governing documents and mission are consistent with the project’s charitable purposes, (4) willing and able to house the project, and (5) reasonably trustworthy.
The project’s leadership (assuming it is the other party to the fiscal sponsorship agreement) should be looking for the same assurances but may also be looking at other factors, including cultural fit, administrative support, insurance, and administrative fees (though this should never be the principal factor). See How to Find a Fiscal Sponsor.
There are times when the fiscal sponsor and the project’s leadership are not in agreement upon the latter’s selection of a fiscal sponsor. This sometimes occurs when the project’s leadership is not vetting the successor for all of the factors noted above. In such case, the fiscal sponsor may not be willing to make the transfer because of its exposure to liability and reputational harm since the project’s assets are legally the fiscal sponsor’s assets. However, the fiscal sponsor may have some room to give. For example, it may be willing to transfer assets to a successor that has applied for, but not yet received, recognition of 501(c)(3) status. This may require extra due diligence and protective provisions in any transfer agreement so should probably be an exception made only with the assistance of knowledgeable counsel.
Project Leadership’s Formation of a ‘Questionable’ Successor
Fiscal sponsors may market their ability to serve as an incubator of a charitable project while the project’s leadership causes the formation of a new nonprofit intended to be the successor. But if the fiscal sponsor discovers strong indicators of the project’s leadership diverting charitable assets for their private benefit, the fiscal sponsor appropriately may not be willing to transfer the project’s assets to a nonprofit created and governed by the project’s leadership.
No Termination Provision
Termination of a fiscal sponsorship relationship may be particularly difficult where the fiscal sponsorship agreement does not provide for a termination and transfer of remaining project assets or where no written fiscal sponsorship agreement exists. Because the project’s assets all belong to the fiscal sponsor, the project’s leadership may have little recourse if they want to terminate the relationship but the fiscal sponsor does not.
It may also be possible for the fiscal sponsor to terminate the project leaders as employees, volunteers, or other agents of the fiscal sponsor, leaving them unable to fundraise for the project or manage it. In such event, the project’s leadership (typically, an unincorporated association), as the other party to the fiscal sponsorship agreement, may still have rights under the agreement. But if the agreement doesn’t provide for its termination, the project’s leadership may have few rights to enforce so long as the fiscal sponsor appropriately uses funds raised for the project’s purposes. On the other hand, the fiscal sponsor may find it difficult to operate programs advancing the project’s purposes without the original project leaders and could be exposed to diverting restricted funds if they fail to do so. One alternative for the fiscal sponsor is to grant any remaining project funds to another organization that can use those funds to support a compatible project. Such outcomes are relatively rare and often not contemplated when fiscal sponsorship relationships are initially created, but they represent one of the significant risks with fiscal sponsorship.
You can find Part 2 here.
Fiscal Sponsorship (NEO Law Group)