Canada: Private Foundations And Big Life Changes: What Happens At Divorce, Disability, And Death?

For my high net worth clients, setting up a private foundation is an exciting process.

During that process, few immediately think of unpleasant matters like divorce, disability or death—seismic life changes that could derail a family's philanthropic goals.

But what if the two co-heads of a family foundation later separate? What if the controlling member becomes mentally incapable or dies?

PRIVATE FOUNDATIONS: A REFRESHER

Many wealthy families like to set up their own charitable foundations through which they can give to other charities. The typical family foundation is structured as a "private foundation," which is one of the three designations given to registered charities in Canada (the other two being public foundations and charitable organizations).

A charity will be designated as a private foundation when more than half of the directors or trustees of the underlying corporation or trust do not deal arm's length with one another because of family ties or close business ties. A charity will also be designated as a private foundation if a majority of the foundation's funding comes from a person or group of related people who control the charity in any way.

Many clients prefer to set up a private foundation so that the two heads of the family (i.e. spouses or parents) are not only directors or trustees but also the sole members or protectors who have the power to add or remove those directors or trustees.

This arrangement maximizes the spouses or parents' control over the foundation, its governing officials, and how the foundation spends its capital. However, without proper succession planning, this set-up also leaves the foundation vulnerable to disruptive life events like divorce, disability and death.

SEPARATION AND DIVORCE

It might surprise some clients, but a private foundation's assets are not considered to be personal property or family property that a couple can divide or recoup after separation.

Once property has been gifted, the legal owner of that property is not the donor; it is the foundation.

On top of this, current Canadian tax rules prevent registered charities from gifting or returning property outright to individuals, unless those transfers meet certain strict criteria.

This state of affairs leaves foundation co-heads with two choices after separation or divorce.

First, a separating couple could continue to manage the foundation together.

A good example of this model is the largest foundation in the US, the Bill and Melinda Gates Foundation. Despite divorcing in 2021, Bill Gates and Melinda French Gates remain the co-chairs of their foundation, stewarding its $50 billion in assets together—at least for a two-year trial period.

Alternatively, if former spouses cannot get along but both wish to exercise control over the foundation's assets, the separating couple could consider continuing their charitable work through two separate entities.

For instance, one spouse would retain control over the existing foundation. The other spouse would resign as a director/trustee and/or member/protector of the foundation, but then set up their own private foundation. The existing foundation would then gift part of its assets to the newer foundation (which Canadian tax law allows) and each spouse would essentially run their own foundation.

It would be wise for family members, at the outset, to have a robust conversation about what should happen in the event that two directors or members later separate. Better yet, the directors should codify their decision in the form of a written board policy that could be updated from time to time.

For example, such a policy could say that person X or any spouse who is a director but who is not related by blood to the main family would resign from their position. Such a policy would help give much-needed clarity later on and avoid the need for directors/members to choose sides in the middle of an emotionally-charged marital breakdown.

DEATH AND DISABILITY

Separation or divorce aside, death and disability could also disrupt a private foundation and its good work if its original planners and key personnel are not careful.

In these instances, having wills or powers of attorney in place might not be enough.

Here, many clients mistakenly believe two things. The first mistaken belief is that their attorney (appointed under a power of attorney) or their executor (appointed under a will) can seamlessly take over their role as director or member when they become disabled or die.

This first belief is wrong. Director or member positions are held personally. An attorney or executor cannot step into those positions automatically. Also, a foundation's governing documents generally provide that a director or member ceases to hold office when they become incapable or die.

The second mistaken belief is that they can "gift" their membership interest in a foundation after their deaths through their wills.

The second belief is also incorrect. Unless a foundation's bylaws specifically provide that membership interests are transferable (specifically, transferable at death through a written document), an existing member cannot gift their membership in a private foundation to another person by way of will.

As a result, without the correct kind of planning, a private foundation could be left with no members or directors when they all become incapable or die. A court order may be needed to appoint new members or directors (for example, see subsection 132(3) of the Canada Not-for-profit Corporations Act).

The time and expense of obtaining a court order could be avoided if the foundation's governing documents contained clear rules for what is to happen if all of its key members/directors or protectors/trustees were to resign, become incapable or die. For example, a foundation's bylaws or trust documents could say that, in such a circumstance, persons X, Y, and Z of the next generation will automatically become members/directors or protectors/trustees and take control.

As in the divorce context, it helps if private foundations take a proactive approach, instead of a reactive approach, to matters of death, disability and succession.

Ideally, while they are alive and capable, the founders should appoint members of the next generation to serve alongside them as directors of the foundation. This approach gives the future leaders a runway to learn and to grow. It also gives them a less-than-abrupt transition when the old guard becomes disabled or suddenly dies.

CLOSING THOUGHTS

A favourite saying of mine is "failing to plan is planning to fail." Of course, no client intends to have their charitable endeavours fail. But if they do not think ahead to—and, more importantly, get ahead of—the unpleasant or the inevitable like the divorce, disability, or death of their key personnel, they are inadvertently setting up their philanthropic goals for failure. Planning now, codifying decisions, and having the uncomfortable conversations sooner rather than later are all key.

Setting up a private foundation is a cause for celebration. And a private foundation, properly set up to weather life's storms, can help Canadian families continue to do good in their communities for a long, long time.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.