Quatloos!

Subject:

Ray Styles v. Friends of Fiji: Big Winner at Slots a Big Loser with Nevada Charity

Richard L. Fox describes for LISI subscribers an intriguing and cautionary tale, which is believed to be a case of first impression regarding the legal obligations under a donor-advised fund agreement of a charity sponsoring donor-advised funds.

The case involves an individual from Wichita Falls, Texas. He had the good fortune of winning $8 million at a slot machine in Lake Tahoe, Nevada.

Then, on the advice of a now infamous tax planning advisor, he contributed $2.5 million of his winnings to a charity incorporated under Nevada law (but operating out of Danville, CA) to establish a donor-advised fund account pursuant to a donor-advised fund agreement. The $2.5 million contribution, as it turns out, was the only contribution ever received by the charity.

Unfortunately for the donor, the directors and officers of the charity, consisting of only two individuals, ignored the donor-advised fund agreement in its entirety, opting instead to use the donor's $2.5 million contribution for their own purposes, rather than to further the charitable purposes of the donor.

Despite the Nevada District Court holding that the charity breached the express terms of the donor-advised fund agreement and breached its duty of good faith and fair dealing by failing to attempt in any way to achieve the donor's charitable goals, the court awarded no remedy or damages to the donor, thereby allowing the charity to ignore the donor and the donor-advised fund agreement with absolute impunity.

An appeal was recently filed on February 23, 2009 with the Nevada Supreme Court, asserting that, in light of the breaches found by the trial court, the trial court erred in not providing any remedy or damages to the donor.

Richard L. Fox is an attorney and a partner in the law firm of Dilworth Paxson LLP, in Philadelphia, where he heads the Philanthropic and Nonprofit Group. He represents a multitude of charitable organizations, including some of the largest private foundations in the country. He is a member of the editorial board of Estate Planning and BNA Tax Management, and writes and speaks frequently on issues pertaining to philanthropy.

Richard was also recently named by Worth Magazine as one of the Top 100 Attorneys in the country representing affluent families and individuals, including in the areas of private foundations and philanthropy, as well as a Pennsylvania Super Lawyer in these areas. We reviewed Richard's latest book, Charitable Giving: Taxation, Planning and Strategies in LISI Charitable Planning Newsletter # 139.

EXECUTIVE SUMMARY:

In 2002, an individual from Wichita Falls, Texas won $8 million at a slot machine in Lake Tahoe, Nevada.

Upon receiving and relying on the advice of a now infamous tax planning advisor, Jerome Schneider, who subsequently spent six months in federal prison after pleading guilty in February 2004 to the charge of conspiracy to defraud the Internal Revenue Service (in a matter unrelated to this case), the individual contributed $2.5 million of his winnings to a charity incorporated in Nevada, now operating out of Danville, California.

The contribution was made to establish a donor-advised fund account with the charity pursuant to a donor-advised fund agreement, to be used to make distributions to other charities recommended by the donor. The $2.5 million contribution turned out to be the only contribution ever received by the charity.

Rather than using the donor-advised fund account to further the donor's charitable purposes, the directors and officers of the charity, consisting of only two individuals, ultimately ignored the donor and the donor-advised fund agreement in its entirety.

The directors and officers of the charity, instead, opted to use the donor's $2.5 million contribution for their own purposes, which, as it turned out, consisted principally of paying themselves substantial annual salaries, transferring hundreds of thousands of dollars to another organization they created almost immediately after becoming directors and officers of the charity, paying hundreds of thousands of dollars to sponsor celebrity golf events at lavish resorts, purchasing penny stock (in a company in which one of the directors and officers of the charity held an interest) later sold at a 90% loss, paying hundreds of thousands of dollars in fundraising expenses without the charity receiving any fundraising proceeds, and paying over $500,000 in legal fees, the vast majority of which were incurred to defend the charity in the Nevada litigation brought by its sole donor, whose only goal was to have his contribution transferred to a bona fide charity pursuant to the terms of his donor-advised fund agreement. In the end, not one dollar of the donor's donor-advised fund account was ever used by the charity to further the donor's charitable purposes.

In the suit brought by the donor against the charity in the State of Nevada, the Nevada District Court held that the charity breached the express provisions of the donor-advised fund agreement and that the failure of the charity to attempt in any way to satisfy the donor's charitable goals was contrary to the intention and spirit of the donor-advised fund agreement and, thus, in violation of the implied covenant of good faith and fair dealing.

Surprisingly, notwithstanding this determination, the Nevada District Court did not award any remedy or damages to the donor. Thus, a charity receiving $2.5 million from a donor was allowed to ignore the donor-advised fund agreement in its entirety, fail in any way to satisfy the donor's charitable goals and charitable intent, fail to act in good faith and fair dealing, and use the donor's $2.5 million contribution for the sole purposes of its two directors and officers, all with absolute impunity.

Substantial and repeated attempts have been made to enlist the assistance of the State Attorney General in California and Nevada, as well as the Internal Revenue Service, in an effort to ensure that funds dedicated to charitable purposes have not been wasted or misused and to recover any funds not used for charitable purposes.

Apparently, however, no action has ever been taken by either of these states or by the Internal Revenue Service.

Currently, the case in Nevada is on appeal with the Nevada Supreme Court pursuant to an appeal just recently filed on February 23, 2009.

FACTS:

GOOD NEWS:

In 2002, Ray Styles, the owner of a local barbeque restaurant from Wichita Falls, Texas, had the good fortune of winning $8 million at a slot machine in Lake Tahoe, Nevada.

BAD NEWS:

Unfortunately, Styles then had the misfortune of receiving and relying on the advice of the now infamous Jerome Schneider who, at the time, was widely known and well-regarded by many as a tax planning expert, including having appeared on CNN and CNBC and ABC Radio and the Business Radio Network.

Based on Mr. Styles' philanthropic goals and his desire to secure an income tax deduction in 2002, Mr. Schneider advised Mr. Styles to make a $2.5 million contribution to establish a donor-advised fund account at a charity, known as "Friends of Fiji" (EIN: 98-0191060), which was incorporated in the State of Nevada but currently operates out of Danville, California.

Unbeknownst to Mr. Styles at the time he was receiving advice from Mr. Schneider, however, it was actually Mr. Schneider who had created Friends of Fiji and Mr. Schneider was also an officer and director of Friends of Fiji.

Also unbeknownst to Mr. Styles was that his $2.5 million contribution was the only contribution that Friends of Fiji had ever received (thus making Mr. Styles the sole donor to Friends of Fiji) and that, although Friends of Fiji was incorporated in Nevada on July 28, 1998, it had never engaged in any activities, involving a donor-advised fund or otherwise, essentially rendering it a dormant and empty shell corporation, although, in response to its Form 1023, Application for Recognition of Exemption, it had previously received an IRS determination letter on October 30, 1998, classifying it as Section 501(c)(3) tax-exempt entity and a public charity.

Apparently, Mr. Schneider had initially established Friends of Fiji to solicit funds for charities located in the Republic of the Fiji Islands, a purpose that never came to fruition, leaving Friends of Fiji as a dormant empty shell from the day it was created on July 28, 1998 until Mr. Styles' $2.5 million contribution in 2002, the first year in which Friends of Fiji actually filed a Form 990 with the IRS.

Also unknown to Mr. Styles was that Friends of Fiji, which was originally determined by the IRS to be a public charity based on representations made in its Form 1023, Application for Recognition of Exemption, lost its public charity status shortly following Mr. Styles' contribution, officially being converted by the IRS from a public charity to a private foundation on September 18, 2003, despite representations by Friends of Fiji in the donor-advised fund agreement that it would "take all actions necessary to maintain [that] qualification at all times."

Finally, unbeknownst to Mr. Styles, at the time he was being advised by Mr. Schneider, Mr. Schneider was apparently under investigation by the U.S. Justice Department.

On December 19, 2002, Mr. Schneider was indicted by a federal grand jury on one count of conspiracy to defraud the Internal Revenue Service, 14 counts of wire fraud and eight counts of mail fraud (in a matter unrelated to this case). After pleading guilty in February 2004 to the count of conspiracy to defraud the Internal Revenue Service, Mr. Schneider subsequently spent six months in federal prison (http://www.quatlosers.com/jerome_schneider.htm).

THE DONOR-ADVISED FUND AGREEMENT AND THE DIRECTORS AND OFFICERS OF FRIENDS OF FIJI

In connection with his $2.5 million contribution to Friends of Fiji, Mr. Styles signed an 11-page, single-spaced donor-advised fund agreement dated October 14, 2002, that, typical of donor-advised fund agreements used across the country,

 * * * gave Mr. Styles advisory privileges to make recommendations for distributions to other charities,

 * * * required Friends of Fiji to hold the contribution in a separately accounted-for donor-advised fund account, and

 * * * imposed a host of other requirements that are typically imposed on a sponsoring charity under a donor-advised fund agreement.

The donor-advised fund agreement also specifically required Friends of Fiji to take all actions necessary to maintain its public charity status although, as indicated above, shortly after Mr. Styles' $2.5 million contribution in 2002, Friends of Fiji became a private foundation on September 18, 2003. That meant it became subject to the much stricter tax regime of Chapter 42 of the Internal Revenue Code applicable to private foundations, including the imposition of an excise tax on investment income that is not imposed on public charities.

At some point prior to Mr. Styles' contribution in 2002, Mr. Schneider resigned his positions with Friends of Fiji and, apparently, "through" Mr. Schneider's attorney at the time, had two individuals, Gary Nerison and James Bickel, brought on as the sole directors and officers of Friends of Fiji.

Interestingly, in the Deposition of Gary Nerison on Tuesday, May 17, 2005 in connection with the Nevada litigation brought by Mr. Styles, Mr. Nerison's answers to a number of questions provide invaluable insight as to how Mr. Nerison became involved with Friends of Fiji, a charity that, although incorporated on July 28, 1998, had never engaged in any charitable activities and prior to Mr. Styles' contribution in 2002, had never received any contribution of any kind:

 * * * When asked "How did you become associated with Friends of Fiji?", Mr. Nerison responded "Through Dan Herling."

 * * * In response to the question "And who is Dan Herling?", Mr. Nerison stated "Dan Herling is an attorney for Duane Morris."

 * * * When Mr. Nerison was asked "And how it is that [Mr. Herling] got you involved with [Friends of Fiji]?", Mr. Nerison responded "He approached me one day and asked if I would be interested in running a foundation."

 * * * When asked "How is it that [Mr. Herling] knew about Friends of Fiji?", Mr. Nerison stated that "He at the time was representing Jerome Schneider on some business."

 * * * When Mr. Nerison was asked "Do you know Jerome Schneider?", he responded "I do."

 * * * When asked "And how did you meet [Mr. Schneider]?", Mr. Nerison stated "Through Dan Herling."

 * * * In response to the question about "What made you decide to get involved with Friends of Fiji?", Mr. Nerison responded "I thought it was a very interesting challenge and was interested."

 * * * In response to the question "Have you ever been involved in a nonprofit corporation before?", Mr. Nerison stated "No … nothing direct."

In the Deposition of James Bickel on Tuesday, May 17, 2005 in connection with the Nevada litigation brought by Mr. Styles, Mr. Bickel's answers are consistent with those of Mr. Nerison, as follows:

 * * * In response to the question, "How did you become familiar with Friends of Fiji?", Mr. Bickel stated "I was introduced to it by Gary Nerison."

 * * * In response to the question "And do you know how [Mr. Nerison] became aware of Friends of Fiji?", Mr. Bickel sated "He was introduced by Dan Herling."

 * * * And, in response to the question "Why did you get involved with Friends of Fiji?", Mr. Bickel stated "Because Mr. Nerison asked me to."

Apparently, neither Mr. Nerison nor Mr. Bickel had any direct experience running or operating a charity or a foundation, but, for whatever reason, they were put in the position, which they apparently willingly accepted, of being in charge of a dormant empty shell "charity" that suddenly found itself holding $2.5 million in cash, subject to a donor-advised fund agreement with Mr. Styles, a high-school educated barbeque restaurateur from Wichita Falls, Texas.

FRIENDS OF FIJI AND THE WORLD HEALTH AND EDUCATION FOUNDATION

Almost immediately following Mr. Styles' $2.5 million contribution pursuant to his donor-advised fund agreement dated October 14, 2002, Friends of Fiji took actions that were inconsistent with the donor-advised fund agreement, in that the directors and officers of Friends of Fiji used Mr. Styles' contribution for their own purposes, rather than using his contribution to further his charitable goals. This included creating the "World Health and Education Foundation" (EIN: 04-3766459), an entity controlled by Mr. Nerison and Mr. Bickel which was incorporated in the State of California on February 7, 2003 (almost immediately after they became directors and officers of Friends of Fiji), to which hundreds of thousands of dollars were subsequently transferred from Friends of Fiji, all attributable to the $2.5 million contribution by Mr. Styles to Friends of Fiji. Based on its Forms 990, the only "contributions" ever received by World Health and Education Foundation have come from Friends of Fiji.

In the end, not one dollar of Mr. Styles' $2.5 million contribution, which was required to be held in his donor-advised fund account pursuant to his donor-advised fund agreement, was ever used by Friends of Fiji to further his charitable purposes. This includes a recommendation made by Mr. Styles to Friends of Fiji on January 30, 2007, stating:

"I am hereby recommending that the entire balance of my donor-advised fund be distributed to the NEVADA COMMUNITY FOUNDATION," which was accompanied by a letter from the Nevada Community Foundation to Mr. Styles, which acknowledged and expressed "our deepest thanks and gratitude for your recommendation."

This recommendation was rejected by Friends of Fiji, as Friends of Fiji made no transfer of any kind to the Nevada Community Foundation or to any other charity recommended by Mr. Styles.

Instead, Mr. Styles' $2.5 million contribution to Friends of Fiji, representing the only contribution it ever has received, was used solely for the purposes of its directors and officers, Mr. Nerison and Mr. Bickel, without regard to Mr. Styles or his donor-advised fund agreement. It was also recently learned that the lead litigator for Friends of Fiji in the Nevada litigation subsequently joined the board of directors of the Nevada Community Foundation, the very charity to which Mr. Styles has recommended his donor-advised fund be transferred.

As further discussed below, the Nevada District Court held that Friends of Fiji breached the express provisions of Mr. Styles' donor-advised fund agreement and that its failure to attempt in any way to satisfy Mr. Styles' charitable goals was contrary to the intention and spirit of the donor-advised fund agreement and thus in violation of the implied covenant of good faith and fair dealing. (To read a copy of the court's decision, click here.)

FORM 990 DISCLOSURES BY FRIENDS OF FIJI AND WORLD HEALTH AND EDUCATION FOUNDATION

Starting with its 2002 Form 990-PF, which included an attached statement indicating that Friends of Fiji received its first contribution in December 2002 (of course, this was Mr. Styles' $2.5 million contribution) and that the focus of the charity was changing (notwithstanding that Mr. Styles was the sole donor and Mr. Styles had a donor-advised fund agreement with Friends of Fiji), Friends of Fiji acted in a manner wholly inconsistent with Mr. Styles' donor-advised fund agreement by failing to attempt in any way to satisfy Mr. Styles' charitable goals.

As reflected on its 2003 Form 990-PF, Friends of Fiji starting paying annual compensation to Mr. Nerison and Mr. Bickel, and on behalf of the World Health and Education Foundation, paid $100,000 for World Health and Education Foundation to be the Tour and Tournament Principal Sponsor of the "Cody Unser Celebrity Golf Fiesta" (a two-day event held "at the five-star Hyatt Tamay Resort in Albuquerque, New Mexico"), paid $100,000 for the World Health and Education Foundation to be the Title Sponsor of the "Joe Montana Legends of Golf Tournament" (a two-day event held at Edgewood Golf Course, Lake Tahoe, Nevada, hosted by Harrah's-Harvey's Casino Resort), and paid $25,000 for the World Health and Education Foundation to be the lead sponsor of the "Kid's Turn Golf Classic 2003."

The expenditures made in 2003 set the pattern for future expenditures by Friends of Fiji being made solely as determined by Mr. Nerison and Mr. Bickel, without regard to Mr. Styles and his donor-advised fund agreement. Because the only contribution Friends of Fiji ever received was Mr. Styles' $2.5 million contribution in 2002, each and every expenditure made by Friends of Fiji, as determined by Mr. Nerison and Mr. Bickel, was necessarily attributable to Mr. Styles' contribution to Friends of Fiji.

The information contained in the Forms 990 filed with the IRS by Friends of Fiji and the World Health and Education Foundation clearly reflects that Mr. Styles' contribution was not used to further his charitable purposes, but was used for the purposes of Mr. Nerison and Mr. Bickel, its sole directors and officers. Such information provided on the Forms 990 also raises some very important issues about the use of Mr. Styles' contribution. For example:

1) * * * Since 2003, Mr. Nerison and Mr. Bickel have paid themselves nearly $600,000 in compensation (generally $108,000 each year) for an * * * organization that merely makes a nominal number of disbursements each year and engages in no direct charitable activities of any kind. For example, for the years 2006 and 2007, respectively, Mr. Nerison and Mr. Bickel * * * received combined annual compensation of $108,000 (for such years, Mr. * * * Nerison received $84,000 and Mr. Bickel received $24,000) when Friends of Fiji, in each of these years, showed one "charitable disbursement," of $25,000 and $20,000, respectively, which went to the World Health and Education Foundation, the very organization controlled by Mr. Nerison and Mr. Bickel.

2) * * * According to its 2005 Form 990-PF, Friends of Fiji incurred over $200,000 in fundraising expenses in 2005, but received absolutely no fundraising proceeds of any kind in that year or any other year.

3) * * * Friends of Fiji transferred hundreds of thousands of dollars to World Health and Education Foundation, an entity controlled by Mr. Nerison and Mr. Bickel, which generally used such funds to be a principal sponsor at celebrity golf tournaments, including a transfer of $311,836 made from Friends of Fiji in 2005, as reflected on Schedule B ("Schedule of Contributors") of the 2005 Form 990 for World Health and Education Foundation.

4) * * * As reported on it 2006 Form 990-PF, Friends of Fiji paid $50,000 for a "penny stock," YaSheng Group (YHGG.PK), which it purchased for $50,000 and sold for $5,175, resulting in a 90% loss. Interestingly, in a Deposition of James Bickel dated May 30, 2008 in the case of Joe Martin v. World Health and Education Foundation (in the Superior Court of the State of California), in response to the question to Mr. Bickel, "Do you hold any financial interest in YaSheng, direct or indirect?", Mr. Bickel responded by stating "I own shares – public shares."

5) * * * Since 2003, Friends of Fiji has paid more than $500,000 in legal fees, including $318,529 in 2007 alone, the vast majority of which was used to fight Mr. Styles, its sole donor, in the Nevada litigation, just so the directors and officers of Friends of Fiji could continue to use Mr. Styles contribution for their own purposes, notwithstanding that, in the end, the Nevada District Court held that Friends of Fiji had a legal duty to use Mr. Styles contribution for his charitable purposes and that, in failing to do so, Friends of Fiji breached its duty of good faith and fair dealing to Mr. Styles. This costly Nevada litigation continued even after Mr. Styles made a recommendation to Friends of Fiji on January 30, 2007 that his donor-advised fund account be transferred to the Nevada Community Foundation, a recommendation that was rejected by Friends of Fiji. Apparently, at some time after January 30, 2007, the lead litigator for Friends of Fiji apparently joined the board of directors of the Nevada Community Foundation.

6) * * * World Health and Education Foundation, whose only contributions have come from Friends of Fiji, loaned Gary Nerison, a director and officer, $20,000 in 2007, as reflected on the 2007 Form 990 for World Health and Education Foundation. Specifically, an attachment to the Form 990 provides that "During the 2007 calendar year, The World Health and Education Foundation loaned Gary Nerison, President, $20,000 … due by March 15, 2009." Consistent with California law (California Corporations Code 5236), the Bylaws of World Health and Education Foundation provide it may not loan money to any director or officer "without the approval of the California Attorney General."

7) On its 2005 Form 990, World Health and Education Foundation indicated that it conducted a "Celebrity Golf Fundraiser." This celebrity golf event was, according to a June 5, 2005 article in the San Francisco Chronicle (entitled "Catching Up With Kenny Stabler"), the "second annual Ken Stabler Celebrity Golf tournament … benefiting the World Health & Education Foundation." Accordingly to the article, the tournament was to be held at the Arrowcreek Course in Reno, Nevada, and "The idea for the tournament came from Gary Nerison, president of the WHEF." The 2005 Form 990 for World Health and Education Foundation reflects the following issues in connection this tournament, which indicate that this celebrity golf tournament ended up losing nearly $150,000 of funds of Friends of Fiji otherwise dedicated to charitable purposes and the financial results of this tournament were not properly reported on the 2005 Form 990 of World Health and Education Foundation:

 * * * The fundraising proceeds and expenses were not reported on lines 9a and 9b of Part I of page 1 of the 2005 Form 990, as required for fundraising events, such that the gross revenue and direct expenses of the tournament were not properly reflected on the Form 990.

 * * * The Form 990 reflects that the tournament raised gross revenue of $58,763; however, this amount was reflected as "program service revenue," rather than what it really was, proceeds from a celebrity golf tournament. A golf tournament is not considered a program service of a Section 501(c)(3) tax-exempt entity. Notwithstanding, the $58,763 amount is reflected as "program service revenue" on Part 1, line 2 and Part VII, line 93a, of the 2005 Form 990. As indicated above, fundraising proceeds should be reported on line 9a of Part I of page 1 of the 2005 Form 990.

 * * * The expenses in connection with the tournament were included in Part III of the 2005 Form 990 as "Program Services Expenses," when, in fact, they were nothing more than fundraising expenses in connection with a celebrity golf tournament, having nothing to do with any program. Thus, as indicated above, these fundraising expenses should have been reported line 9b of Part I of page 1 of the 2005 Form 990. World Health and Education Foundation incurred $205,659 in fundraising expenses for the tournament, as delineated in Statement 1 attached to the Form 990, under the heading "Golf Outing Fundraiser Fees and Costs," as follows:

 Security * * * * $ 1,000

 Travel Expenses for Celebrities * * * 31,597

 Appearance Fees * * * 55,326

 Entertainment * * * * 41,472

 Prizes, Awards, Trophies * * * * 31,827

 Insurance * * * 7,322

 Photography * * * * 4,586

 Rent * * * 488

 Advertising * * * 2,958

 Miscellaneous * * * * 2,957

 Facility Expense * * * 11,837

 Printing * * * * 14,289

* * * Total * * * * $205,659

* * * ======

 * * * Thus, because the gross fundraising revenue from the tournament was $58,763 and the fundraising expenses of the tournament were $205,659, the tournament actually lost $146,896. Because the revenue and expenses were treated as part of a program service, rather than the proper treatment as fundraising revenue and expenses, this $146,896 loss was not reflected on the front page of the 2005 Form 990, where it belonged (on line 9c). Thus, on the face of the return, the IRS, a State Attorney General, and the public could not readily determine that this tournament lost $146,896 and, the revenue and expenses were basically "buried" by treating the golf tournament as a program service, which it clearly is not.

 * * * Notwithstanding that the celebrity golf "fundraising" tournament lost $146,896, as demonstrated above, Part VIII of the 2005 Form 990 for World Health and Education Foundation states that "Proceeds from celebrity golf fundraiser were used to make charitable donations to 501(c)(3) organizations." Query how one could assert on a Form 990 that proceeds of a celebrity golf tournament that lost $146,896 were used to fund anything, as the tournament resulted in World Health and Education Foundation not ending up with a penny of net proceeds, but instead ending upon using $146,896 of funds otherwise dedicated to charitable purposes (i.e., the net loss for the tournament) for people to play golf at a lavish golf club in Reno, Nevada with celebrities. Clearly, no proceeds from the tournament were used to make charitable donations, as the tournament produced no net proceeds, but, in fact, lost $146,896.

 * * * The only reason that World Health and Education Foundation could have conducted the Ken Stabler Celebrity Golf Tournament in 2005 was because, as reflected on Schedule B ("Schedule of Contributors") of the 2005 Form 990 for World Health and Education Foundation, it received $311,836 of funds from Friends of Fiji during 2005, thereby allowing the World Health and Education Foundation to utilize $146,896 of Friends of Fiji funds so that World Health and Education Foundation could conduct a money-losing celebrity golf tournament at a lush country club in Reno, Nevada (http://www.arrowcreekcc.com/). Thus, it was only on Friends of Fiji's dime (actually $146,896) that the World Health and Education Foundation could have conducted a celebrity golf tournament having a price tag of in excess of $200,000. Thus, the $146,896 loss incurred by World Health and Education Foundation from conducting the Ken Stabler Celebrity Golf Tournament was funded entirely by Friends of Fiji, and, as a result, was directly attributable to Mr. Styles $2.5 million contribution to Friends of Fiji.

 * * * Interestingly, and consistent with the propensity to use the funds of Friends of Fiji to fund celebrity golf tournaments, the World Health and Education Foundation, also in 2005, was apparently the "2005 Title Sponsor" of the "Legends Celebrity Golf Tournament 2005 with Joe Montana," held at Harrah's Havey's Casino Resort in Lake Tahoe, again funded with transfers of funds from Friends of Fiji to the World Health and Education Foundation.

8) Despite the fact that the only contributions ever received by World Health and Education Foundation were from Friends of Fiji, a private foundation, onsistent with its previously filed Forms 990, Part IV-A of the 2007 Form 990 for World Health and Education Foundation indicates on line 26f that the "public support percentage" for World Health and Education Foundation is 99.9908%, thus, in effect, treating all of its receipts of funds from Friends of Fiji as being public support. There are no grounds for this treatment and, as a result, rather than the treatment of itself as a public charity on its Forms 990, the World Health and Education Foundation should now actually be a * * * private foundation and should be subject to the private foundation excise tax rules of Chapter 42 of the Internal Revenue Code and file Form a 990-PF, not Form 990. World Health and Education Foundation received its IRS determination regarding its Section 501(c)(3) tax-exempt status and its public charity status on August 18, 2003, with its advance ruling period ending December 31, 2007. It received its public charity status determination based on representations in its Form 1023, Application for Recognition of Exemption, that it would receive contributions from the general public, sufficient for it to be classified as a public charity under Section 170(b)(1)(A)(vi) of the Internal Revenue Code. Such application, however, made no mention of Friends of Fiji, although the only contributions ever reported on Forms 990 as being received by World Health and Education Foundation came from Friends of Fiji. Given the representations made on the Forms 1023 of World Health and Education Foundation, in contrast to the reality of its only contributor being Friends of Fiji, it would appear that the World Health and Education Foundation should be considered a private foundation as of February 7, 2003, the date of its incorporation.

Notwithstanding that all of the contributions received by World Health and Education Foundation have come from Friends of Fiji, and all of the contributions received by Friends of Fiji have come from Mr. Styles, both Mr. Nerison and Mr. Bickel widely tout their role with the World Health and Education Foundation, i.e., as being the co-founders and officers of the World Health and Education Foundation, a charitable organization. (Examples of this can be found by "Googling": (1) "World Health and Education Foundation" and "Gary Nerison" and (2) "World Health and Education Foundation" and "James Bickel".)

THE LAWSUIT

Being totally dissatisfied, to the point of being distraught, with the way he was being treated by Friends of Fiji from the start and the manner in which his $2.5 million contribution was being used by Friends of Fiji, Mr. Styles brought suit against Friends of Fiji on August 31, 2004, Ray Styles v. Friends of Fiji, A Nevada Corporation; Gary Nerison, James S. Bickel, in District Court, Clark County, Nevada, No. 51642, asserting, among other things, that it failed to comply with the terms of his donor-advised fund agreement by, in effect, ignoring him and the terms of the agreement, and using his contribution for the purposes of Mr. Nerison and Mr. Bickel, the sole officers and directors of Friends of Fiji.

For the Nevada litigation, Mr. Styles engaged local Las Vegas counsel, with Richard L. Fox, Esq., of the law firm Dilworth Paxson LLP, who is licensed only in Pennsylvania and New York, serving as an adviser and Mr. Styles' personal lawyer. Given the prohibitive costs involved in pursuing this case further, Mr. Styles is no longer using Nevada counsel. However, with the assistance of Mr. Fox (without charge), Mr. Styles just recently filed, on February 23, 2009, a pro se appeal with the Nevada Supreme Court under its "Civil Proper Personal Appeal" procedure, where a litigant is not represented by Nevada counsel.

THE OPINION OF THE NEVADA DISTRICT COURT

Among the specific express breaches of the donor-advised fund agreement by Friends of Fiji, as determined by the Nevada District Court in its Findings of Fact and Conclusions of Law dated December 11, 2007, included the following:

 * * * Friends of Fiji failed to provide Mr. Styles with quarterly reports following the receipt of his contribution indicating, among other things, the balance in his donor-advised fund;

 * * * Friends of Fiji failed to disseminate to Mr. Styles fund reports, special mailings, annual reports, information on special events or have any personal contact with Mr. Styles;

 * * * Friends of Fiji used Mr. Styles' contribution "for charitable purposes unrelated to those recommended by [Mr. Styles] and without consulting [Mr. Styles];" and

 * * * Although the donor-advised fund agreement required Friends of Fiji to take all actions which are necessary to maintain it public charity status, "Friends of Fiji decided not to take those actions and instead the IRS determined that it was a private foundation."

In addition to these express breaches by Friends of Fiji, the Nevada District Court found "that the failure [of Friends of Fiji] to attempt in any way to satisfy [Mr. Styles'] charitable goals is contrary to the intention and spirit of the [Donor-Advised Fund] Agreement and thus in violation of the implied covenant of good faith and fair dealing."

Despite its findings of express breaches of the donor-advised fund agreement by Friends of Fiji and its failure to act in good faith and fair dealing by failing in any way to use Mr. Styles' contribution to further his charitable goals, the court did not award any remedy or damages to Mr. Styles. In the end, therefore, the Nevada District Court held that a sponsoring charity can breach the express terms of a donor-advised fund agreement, fail in any way to satisfy the donor's charitable goals and intent, fail to act in good faith and fair dealing with the donor, and use the donor's contribution for the sole purposes of its directors and officers, all with absolute impunity, a truly frightening decision, which is currently under appeal with the Nevada Supreme Court. (For a copy of the appeal, click here)

ATTEMPTS TO ENLIST THE ASSISTANCE OF ATTORNEYS GENERAL IN CALIFORNIA AND NEVADA

Interestingly, substantial and repeated efforts were made on behalf of Mr. Styles to enlist the assistance of the State Attorney General in California and Nevada (in the case of the California Attorney General, as far back as June 8, 2007), so as to ensure that contributed funds to Friends of Fiji that were dedicated to charitable purposes have not been wasted or misused and to recover, on behalf of Friends of Fiji, any funds expended that may not have been used for bona fide charitable purposes.

This was not done to necessarily seek assistance for Mr. Styles, but to ensure that, in light of the financial disclosures made on the Forms 990 filed by Friends of Fiji and the World Health and Education Foundation, charitable assets contributed to Friends of Fiji were being preserved for the good of the public, the ultimate beneficiaries of charitable assets. To date, however, based on the available public information, no action has ever been taken by the Attorney General in California or Nevada against Friends of Fiji or its directors or officers.

Unlike California and many other states, the Nevada Attorney General does not have its own division specializing in regulating charities and overseeing charitable assets, and regulating charities and charitable assets does not appear to be anywhere a priority of the Nevada Attorney General's Office. Further, while California generally does take an active role in regulating charities and Friends of Fiji operates in California, the California Attorney General does not have the same degree of statutory power over a nonprofit corporation incorporated in another state as it has over a nonprofit corporation incorporated in California. (World Health and Education Foundation was, however, incorporated in California and operates in California.)

Although Mr. Styles has appealed the trial court's denial of any remedy or damages to the Nevada Supreme Court, as a practical matter, Mr. Styles' entire $2.5 million contribution will likely have been dissipated by the time any possible relief could be obtained in the Nevada Supreme Court. Without the help of a State Attorney General, therefore, Mr. Styles could ultimately prevail in the Nevada Supreme Court, but be left holding a judgment against a charity that no longer has any funds, thus providing a hollow victory.

Further, unlike a State Attorney General, who has "parens patriae" authority over a charity, a donor lacks authority and jurisdiction over a donee charity, lacks the power to enjoin the use of a charity's assets, lacks the power to take any actions to challenge the use of a charity's funds for noncharitable purposes, lacks the authority to remove the directors and officers of a charity for not acting in the charity's best interests, and has no power to recover funds on behalf of a charity that were not expended for bona fide charitable purposes.

Mr. Styles time and time again, demanded that Friends of Fiji discontinue spending any more of his contribution, pending the ultimate outcome of the Nevada litigation, but it refused to do this. Mr. Styles also previously sought to freeze the assets of Friends of Fiji in a motion made in the Nevada courts, but that motion was denied. Moreover, despite repeatedly notifying the IRS regarding certain concerns about this matter (as far back as June 18, 2007), the IRS, to this point, has not taken any action in this case that has been announced publicly.

COMMENT:

This is an important case, and apparently one of first impression.

If the decision of the Nevada District Court is allowed to stand by the Nevada Supreme Court, it essentially means (at least under one State Supreme Court's opinion) that charities across America holding billions of dollars in donor-advised funds have no legal obligation to carry out the terms of donor-advised fund agreements or fulfill the spirit and intention of such agreements, as even if they totally ignore a donor and a donor-advised fund agreement, the donor will not be entitled to damages or any other remedy.

WARNINGS FOR DONORS

This case presents a cautionary tale for donors contemplating contributions to charity on a number of fronts.

First, it is imperative that the donor conduct due diligence on potential charitable tax planning advisors, including getting references and referrals. A donor should ensure, to the extent possible, that a potential advisor has a proven track record, is ethical and trustworthy, renders reliable advice, and, perhaps most importantly, is not in a position of having a conflict of interest whereby his interests may outweigh those of the donor's.

Second, a donor must know the prospective donee charity, its board of directors, its financial status, the nature of its activities, its history, and its reputation for dealing with donors, particularly when large dollars are at stake. It is critical to seek the advice of others who have dealt with the charity and get their input as to how the charity deals with its donors and the extent to which it is inclined to follow donor intent and engage in litigation with donors.

Third, consider the state in which the charity is incorporated and be leery of a charity that is incorporated in, for example, Nevada, but does absolutely no activities in that state. Question, for example, why a charity, not having any contact with Nevada, would opt to incorporate in Nevada and be subject to the laws of that State and be subject to the jurisdiction of the Nevada Attorney General.

As a Nevada corporation, Friends of Fiji is primarily subject to the jurisdiction of the Nevada Attorney General, which apparently doesn't take a great interest in regulating charities incorporated in that state or overseeing charitable assets, notwithstanding the statutory authority given to it by Nevada legislature. Nevada legislature gives the Nevada Attorney General authority and jurisdiction over charities incorporated in Nevada.

Specifically, NRS 82.536, "Attorney general: Examination of corporate affairs; powers of enforcement," provides as follows:

1) A corporation for public benefit and a corporation holding assets in charitable trust is subject at all times to examination by the attorney general, on behalf of the state, to ascertain the condition of its affairs and to what extent, if at all, it fails to comply with trusts it has assumed or has departed from the purposes for which it is formed. In case of any such a failure or departure, the attorney general may institute, in the name of the state, the proceeding necessary to correct the noncompliance or departure.

2) The attorney general, or any person given the status of relator by the attorney general, may bring an action to enjoin, correct, obtain damages for or otherwise to remedy a breach of a charitable trust or departure from the purposes for which it is formed. (Added to NRS by 1991, 1263).

Notwithstanding the powers vested in it under Nevada law, the Nevada Attorney General simply doesn't appear to get involved in matters involving the regulation of charities or their assets.

Fourth, be aware that even in a state where the Attorney General is active in regulating charities and overseeing charitable assets, the State Attorney General will not take on a role in every case to ensure that donor intent is followed or take action to avoid the possible misuse of assets dedicated to charitable purposes or seek to recover assets that have not been used for charitable purposes.

Even where the State Attorney General takes an active role in monitoring charities, it has limited resources and a limited staff, so the Attorney General will not always be there to "come to the rescue" of a donor that has bona fide issues with a charity or where a charity appears to be wasting its assets, and the same holds true with the IRS.

This fact makes it all more important that donors get to know the charities that they intend to contribute beforehand, so as to avoid potential disputes and arguments after the contribution has been made and the charity already has the donor's contribution in hand.

APPEAL PENDING BEFORE THE NEVADA SUPREME COURT

Although it determined that Friends of Fiji breached express provisions of the donor-advised fund agreement and violated its duty of good faith and fair dealing to Mr. Styles, the Nevada District Court apparently believed that no damages could be awarded in this case because consistent with federal tax law, the express terms of the donor-advised fund agreement provide Friends of Fiji with ultimate control, authority and discretion over Mr. Style's contribution.

As argued in Mr. Styles' appeal filed with the Nevada Supreme Court on February 23, 2009, however, this appears to be contrary to the law. Rather, where a party that is provided with control under a contract does not exercise such control in good faith, the "dependent party" is, in fact, entitled to a remedy. Thus, contract damages must be awarded where a controlling party's actions fall outside the reasonable expectations of the dependent party.

Indeed, it has been specifically recognized in Nevada that contract damages are available where the party to a contract who has discretionary control over certain aspects of the contract wrongfully and deliberately takes advantage of the other dependent party. See also Cal. Lettuce Growers v. Union Sugar Co, 45 Cal.2d 474, 289 P.2d 785 (1955), where the court stated that "where a contract confers on one party a discretionary power affecting the rights of the other, a duty is imposed to exercise that discretion in good faith and in accordance with fair dealing."

Thus, where one of the contracting parties is in a position to either approve or disapprove a request made by the other contracting party made pursuant to the terms of the contract, "in deciding whether to exercise its approval or disapproval," the controlling party is "required to do so within the parameters of good faith." Mattel v. Hopper, 51 Cal.2d 119, 330 P.2d 625 (1958); Rodriguez v. Barnett, 52 Cal.2d 154, 338 P.2d 907 (1959).

Notwithstanding Friends of Fiji's ultimate control of the contributed funds, therefore, Friends of Fiji was not permitted to exercise such control in a way that wrongfully and deliberately took unfair advantage over Mr. Styles. Rather, Friends of Fiji was required to exercise such control in good faith, so as to be faithful to the purpose of the donor-advised fund agreement in a manner reasonably contemplated by the parties. And, what was contemplated by the parties was clearly spelled out in the donor-advised fund agreement, which was to use Mr. Styles' contribution to achieve his charitable goals. What was not contemplated was Friends of Fiji simply using Mr. Styles' contribution exclusively for those purposes determined by its directors and officers, although this is exactly what actually transpired.

Of course, the foregoing are only the positions taken in Mr. Styles' appeal, with the ultimate determination to be made by the Nevada Supreme Court. By that time, however, absent action of a State Attorney General (or possibly the IRS), it is likely that the remaining funds currently held by Friends of Fiji will have been fully dissipated.

As indicated above, however, this is a case of utmost importance, because if the decision of the Nevada District Court is not reversed by the Nevada Supreme Court, it essentially means that (at least under one State Supreme Court's opinion) charities across America holding billions of dollars in donor-advised funds have no obligation to carry out the terms of donor-advised fund agreements or fulfill the spirit and intention of such agreements, as even if they ignore a donor and a donor-advised fund agreement, the donor will not be entitled to damages or any other remedy.

Nevada is one of just 11 states in the country that does not have an intermediate appellate court, placing the burden on the Nevada Supreme Court to resolve all appeals. Currently, the seven-member Court must address more than 2,000 matters annually - one of the heaviest caseloads in the nation.

Editor's Note:

Richard Fox became professionally involved in the case when Ray Styles, the donor, sought out his legal advice after reading one of Richard's articles over the Internet, entitled "Planning for Donor Control and Other Strings Attached to Charitable Contributions," first published by Estate Planning, which was reprinted (Link) by the Nevada Lawyer in July 2004.

This same article was cited by the Tennessee Appeals Court for support in its January 5, 2005 decision in a highly publicized case involving donor intent, Tennessee Division of the United Daughters of the Confederacy v. Vanderbilt University (Link ).

Richard did not become involved in this case until December 2006, when he was first contacted by Mr. Styles and, therefore, had no involvement in any of the planning stages that occurred back in 2002.

Anyone wishing to file an Amicus Curiae Brief in this case can submit it to: Nevada Supreme Court, 201 South Carson Street, Carson City NV 89701-4702, referring to "Ray Styles, Individually, Appellant, v. Friends of Fiji, A Nevada Corporation; Gary Nerison; James Bickel, Respondents, No. 51642."

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Richard Fox

CITE AS:

LISI Charitable Planning Newsletter # 142 (March 19, 2009) at http://www.leimbergservices.com/ Copyright 2009 Leimberg Information Services, Inc. (LISI). Reprinted with permission.

CITES:

Ray Styles v. Friends of Fiji, A Nevada Corporation; Gary Nerison, James S. Bickel, District Court, Clark County, Nevada, No. 51642. IRC § 4966(d)(2) (definition of donor-advised fund); NRS 82.536, "Attorney general: Examination of corporate affairs; powers of enforcement;" Cal. Lettuce Growers v. Union Sugar Co, 45 Cal.2d 474, 289 P.2d 785 (1955); Mattel v. Hopper, 51 Cal.2d 119, 330 P.2d 625 (1958); Rodriguez v. Barnett, 52 Cal.2d 154, 338 P.2d 907 (1959).

Richard L. Fox

Richard L. Fox, Esq. is a partner in the Philadelphia-based law firm of Dilworth Paxson LLP, where he chairs the Philanthropic and Nonprofit Group. He concentrates his practice in the areas of charitable giving, private foundations, tax-exempt organizations, family planning, and trusts and estates. Mr. Fox is the author of the treatise, Charitable Giving; Taxation, Planning and Strategies, a Warren, Gorham and Lamont publication, writes a national bulletin on charitable giving and nonprofit topics, and writes and speaks frequently on issues pertaining to estate planning and philanthropy. He is a member of the advisory board of the Estate Planning Journal and BNA Tax Management. He is also currently an Adjunct Professor of Philanthropy at the American College in Bryn Mawr, Pennsylvania, in its Chartered Advisor in Philanthropy Program. Mr. Fox, who holds an LL.M. degree in taxation from New York University School of Law, is also the author of two tax management portfolios published by BNA Tax Management, and is a frequent contributor to the Estate Planning Journal. He represents a multitude of charitable organizations, including some of the largest private foundations in the United States. He was recently named by Worth Magazine as one of the Top 100 Attorneys in the country representing affluent families and individuals, including in the areas of private foundations and philanthropy, as well as a Pennsylvania Super Lawyer in these areas.

Recent Speeches by Richard L. Fox

Private Foundations: Governance, Duration and Other Hot Topics, Not for Profit Organization Symposium, Washington D.C., November 2008.

Nonprofit Governance and NFP Professionals Serving on Boards, Not For Profit Organization Symposium, Washington D.C., November 2008.

The Art of Philanthropy - Do You Know What You and Your Clients Don't Know: Tools & Techniques for Advisors and Their Clients, Central Indiana Community Foundation, March 2008.

Gifts of Property - Do You Know What You Don't Know?, Current Topics: Private Foundations and Supporting Organizations, Planned Giving Council of Houston, September 2007.

Using Philanthropy to Add Value to Your Clients Relationships, Presentation at the American College, Professional Advisors' Seminar, June 2007.

Luncheon Speech Regarding the Sallie B. and William B. Wallace Chair in Philanthropy at the American College, Advisors in Philanthropy Conference, Chicago, Illinois, April 2007.

Private Foundation Workshop, The Annenberg Foundation, Annual Retreat, November 2006.

Charitable Planning Ideas, Temple University School of Medicine Reunion Day, October 2006.

Donor-Created Entities to Support Public Charities Planned Giving Council of Greater Philadelphia, 2006 Planned Giving Day Conference, Greater Philadelphia Planned Giving Council, October 2006.

Gifts of Property - Do You Know What You Don't Know, Planned Giving Council of Greater Philadelphia, September 2006.

Getting to the Heart of Charitable Giving, Temple University Planned Giving Day, April 2006.

Donor-Created Entities to Support Public Charities, Lorman Educational Services and Penn State University 60th Annual Tax Conference, March and May 2006.

Hot Topics for Academic and Nonprofit Institutions: Essential Issues in Executive Compensation, Dilworth Paxson LLP Seminar, February 2005.

Recent Publications by Richard L. Fox

Charitable Giving: Taxation, Planning and Strategies, a Warren, a Warren, Gorham & Lamont (Loose Leaf) Publication on Charitable Giving, Monthly Bulletins For Same Publication.

A Guide to the IRS Sample Charitable Lead Trust Forms, Estate Planning, [to be published March and April 2009, Estate Planning]

Charitable Limitations and Reforms of the Pension Protection Act, Part 2, Estate Planning, December 2006.

Charitable Limitations and Reforms of the Pension Protection Act, Part 1, Estate Planning, November 2006.

A Guide to the IRS Sample Charitable Remainder Trust Forms, Estate Planning, January 2006.

Planning for Contributions to Foreign Charities by Individuals and Foundations, Estate Planning, July 2005.

Practical Charitable Planning for Employee Stock Options, Estate Planning, May 2005.

New Prop. Regs. On Distributions From CRTs Provide Opportunity, Estate Planning, April 2004.

Is a Basis Step-Up Available On Foundation Founder's Death?, Estate Planning, February 2004.

Planning for Donor Control and Other Strings Attached to Charitable Contributions, Estate Planning, September 2003.

Restrictions on Charitable Bequests of Art: Recent Ltr. Rul. Paints a Picture, Estate Planning, September 2002.

Responsible Person and Lender Liability for Trust Fund Taxes - Sections 6672 and 3505, BNA Tax Management, Inc., Portfolio No. 639

Compelled Production of Documents and Testimony in Tax Examinations, BNA Tax Management, Inc., Portfolio No. 123.

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