Here is a question I posed to some colleagues recently regarding the low-profit limited liability company (L3C) and charitable trust laws:
Is it clear whether or not an L3C that receives a PRI is holding property for charitable purposes subject to charitable trust restrictions and Attorney General jurisdiction? While the L3C is not subject to the same operational test as a 501(c)(3), I wonder if the L3C's mandate to significantly further a charitable or educational purpose within the meaning of IRC Section 170(c)(2)(B) combined with the PRI's primary purpose to further one or more exempt purposes under 170(c)(2)(B) is enough to create an issue.
In Illinois, the L3C legislation requires an L3C to register with the Attorney General. The four other states with L3C statutes (Michigan, Utah, Vermont, and Wyoming) presently do not. However, Vermont's Office of the Attorney General has sent out letters to all Vermont L3Cs requesting information, including the approximate percentage of annual gross revenues represented by the L3C's charitable and educational activities, and whether the L3C has transferred any interests or assets to non-501(c)(3) organizations.
It is clear that the Attorneys General of various states and the National Association of State Charity Officials (NASCO) have been looking at the L3C with interest and considering whether L3Cs fall under their jurisdiction under charitable trust laws. Robert Lang, CEO of The Mary Elizabeth and Gordon B. Mannweiler Foundation, sent this letter to NASCO, dated April 17, 2009, containing responses to NASCO's questions drafted by the Foundation's attorneys, including former director of the IRS exempt organizations division, Marcus Owens.
I believe that there's a sound argument that an L3C does not necessarily hold assets imposed with a charitable trust when such assets originated from a PRI, at least no more than an LLC whose articles of organization provide that it shall "significantly further the accomplishment of one or more charitable or educational purposes."
1. The PRI can be directed to commercial entities that do not hold any assets in charitable trust; and
2. The L3C is not required to have only 170(c)(2)(B) charitable and/or educational purposes; it can have other purposes so long as a significant purpose is not the production of income or the appreciation of property.
- then, there's no way to know what portion of a PRI (and its proceeds), if any, would be bound by charitable trust unless the PRI documents stated that the PRI (or some portion) was to be held in charitable trust.
But I can imagine that an argument could be made that given that the primary purpose of a PRI must be to accomplish "a charitable (or other 170(c)(2)(B)) purpose," and the L3C's purpose must be to significantly further "a charitable or educational purpose," then at least some portion of the PRI must be bound by charitable trust.
"Significantly" is the word causing the problem for me. If it were "exclusively" (which admittedly might defeat the purpose of an L3C), then certainly the AG would have jurisdiction. For 501(c)(3) entities, the operational test requires that the organization operate "primarily" for an exempt purpose, and that alone would likely give the AG jurisdiction. So, is "significantly" different enough from "primarily" to keep the AG out? Attorney Allen Bromberger predicts that AG jurisdiction will soon become the norm as the AGs become more aware of the issue. While this is not the hope of Robert Lang and many other advocates of the L3C, I tend to agree (but I remain optimistic about the future impact of the L3C).
So, what happens if the AG has jurisdiction under charitable trust laws? Well, to start, the L3C will be required to register, and likely will be required to file annual reports, with the AG. In addition, the L3C may be faced with certain restrictions on the use of its charitable assets. The PRI documentation should already contain such restrictions, but a violation would become not just a breach of contract, but also a breach of state charitable trust law. Because of such restrictions on its assets, the AG may also require that an L3C either give notice or obtain AG approval for major corporate changes such as a merger, sale of substantially all of its assets, or dissolution. What impact will this have on the liquidity and value of L3C membership interests? And how will this impact joint ventures between L3Cs and other commercial entities? There are still myriad issues to consider.
Read attorney Mark J. Lane's booklet on Illinois L3Cs (including a description of the applicability of the Charitable Trust Act) here.