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Fidelity Wins Donor Advised Fund Breach of Promise Case, But Questions Remain

April 6, 2021, 8:00 AM

Nearly four years following a highly publicized and contentious lawsuit brought by donors to a donor advised fund (DAF) against Fidelity Investments Charitable Gift Fund (Fidelity Charitable) alleging broken promises and negligence in connection with the mishandling of the liquidation of publicly traded securities donated in 2017 valued at approximately $100 million, in Fairbairn v. Fidelity Charitable, the U.S. District Court for the Northern District of California has ruled in favor of Fidelity Charitable. Fairbairn v. Fidelity Investment Charitable Gift Fund, No. 3:13-cv-04881 (N.D. Cal. Feb. 26, 2021).

In their complaint filed on Aug. 10, 2018, the Fairbairns accused Fidelity Charitable of “making false promises to secure a $100 million donation … and then outrageously mishandling the donation,” leaving the Fairbairns with tens of millions of dollars less in their DAF available to fund charitable activities and causing a significant reduction of their charitable income tax deduction.

The Fairbairns asserted that Fidelity Charitable made personalized legally enforceable promises regarding the manner in which their donated securities would be liquidated, including using sophisticated, state-of-the-art methods for liquidating large blocks of stock, allowing the Fairbairns to advise on a price limit, and not liquidating any shares until 2018. However, after receiving the contribution of the securities, and without consulting with the Fairbairns, Fidelity Charitable liquidated the entire block of donated shares over a two and a half hour trading window on Dec. 29, 2017, the last business day of the year, causing a more than 30% run-down of the stock value.

The court stated that to succeed on the breach of the promise claims, the donors had to prove that the promises had actually been made by Fidelity Charitable and then broken. In the end, however, the court held that the donors were unable to prove by a preponderance of the evidence that Fidelity actually made the alleged promises and, even if it did, the Fairbairns could not have reasonably relied on those promises in deciding to donate the stock to their Fidelity Charitable DAF.

On the negligence claim asserted by the Fairbairns in connection with Fidelity’s “botched liquidation” of the donated securities, the court stated that in order to award any monetary damages, Fidelity Charitable and the donors must be considered to have a “special relationship,” which then triggers a duty of care owed by Fidelity to the donors, the breach of which can result in monetary damages. While the court stated that there were at least two factors weighted in favor of finding the requisite special relationship here, it did not finally resolve the issue because, in the end, the Fairbairns did not persuade the court that even if such a duty was owed to the Fairbairns, it was breached. Indeed, the court stated “the Fairbairns have not come close to proving what Fidelity did violated the standard of care for the DAF.”

The very premise of a fund being classified as a DAF for tax purposes under tax code Section 4966(d)(2)(A), and the attendant tax advantages of a DAF over those of a private foundation, is that the fund be “owned and controlled by a sponsoring organization” and that the donor merely have “advisory privileges,” not legally binding control over donated assets. Clearly, a DAF is not intended to allow sponsors of DAFs to make legally binding personalized promises for which donors retain a right of enforcement, given that such a right would go beyond mere advisory privileges. And, once a donor contributes assets to the fund, the imposition on the sponsoring organization of a duty of care owed to the donor to a DAF would also appear antithetical to the fundamental principles of a DAF, and once the assets are contributed, any duty of care presumably should be owed only to the sponsoring organization and the furtherance of its charitable purposes.

Yet, based on the decision in Fairbairn v. Fidelity Charitable, donors may be able to retain rights to enforce legally binding promises on the sponsoring organization of the DAF on such matters as the liquidation of donated securities, although the court in this case found that there was a lack of sufficient evidence for the donors to prevail on this issue. Where, however, a sponsor of a DAF makes what are legally binding promises backed by sufficient evidence with respect to which the donor retains the right to enforce, the fund established by the donor may be disqualified from DAF treatment under Section 4966(d)(2)(A), with the donor facing the potential for substantially negative tax consequences. So, caution should clearly be exercised in this context.

Although the court did not opine on whether a “special relationship” existed between the Fairbairns and Fidelity Charitable, it clearly indicated that such a special relationship could potentially exist between a sponsoring organization and a donor and, in such a situation, a sponsoring organization of a DAF could be held liable to a donor for a breach of a duty of care in connection with its negligent handling of the liquidation of donated securities or other matters relating to the administration of the DAF. Thus, Fairbairn v. Fidelity Charitable may open the door to litigation involving a DAF in the case of a disgruntled donor who believes that a sponsoring organization has mismanaged the DAF or acted improperly with respect to its administration or otherwise, thereby potentially supporting a claim by the donor that the sponsoring organization has breached a duty of care owed to the donor.

The Fairbairn v. Fidelity Charitable case is clearly a reminder for sponsors of DAFs to clearly spell out the policies and procedures utilized in administering DAFs and not to make any individualized promises to particular donors establishing a DAF, no matter how large the potential donation might be. As a cautionary measure, such polices and procedures should clearly indicate that they prevail over any contrary assurances, whether made verbally or in writing, that might otherwise be given by a representative of the sponsoring organization. The case is also a reminder for donors intending to establish a DAF to fully review the policies and procedures of the sponsoring organization of a DAF, as these vary among sponsoring organizations. Donors to a DAF should also be made keenly aware that they only have advisory privileges and if they do want to retain control over assets aimed for charitable purposes, a private foundation may be a better choice subject, however, to lesser tax benefits than those offered by a DAF.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Richard L. Fox is a shareholder and attorney in the Philadelphia office of Buchanan Ingersoll & Rooney, PC, where he writes and speaks frequently on issues pertaining to philanthropic planning. Richard can be reached at (215) 665-3811 and richard.fox@bipc.com.

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.