May a foundation engage in a related-party transaction? David Feldman Charitable Foundation, Re, a decision of the Ontario Surrogate Court in 1987, involved a related-party transaction of a private foundation.
David Feldman was a successful businessman, made a substantial income in 1984 and, to reduce his income tax, incorporated a private foundation under Part III of the Ontario Corporations Act. He gave the foundation $180,000.
There were three directors of the foundation, consisting of Mr. Feldman, his lawyer and his accountant.
Immediately after receiving the gift of capital, the directors approved an unsecured loan of $175,000 (i.e., the entire amount of the gift less $5,000) to Mr. Feldman's private company in exchange for a promissory note and later a loan agreement (but still no security). The loan was repayable on the later of the death of Mr. Feldman or 10 years.
The foundation received no independent legal advice in relation to making the loan.
The loan did not go into default and remained in good standing. Therefore, the private foundation suffered no loss. The issue arose when the corporation was required to pass its accounts under the Charities Accounting Act (Ontario) and the loan came to the attention of the Public Guardian and Trustee.
Even though there was no evidence of loss to the foundation, the surrogate court stated that the directors of the foundation had breached their fiduciary duties to the foundation in approving the loan. It was a related-party transaction. Mr. Feldman, a director of the foundation, also controlled the corporate borrower. The accountant was employed by the corporate borrower. No independent legal advice was given to the foundation when it entered into the loan agreement.
Nevertheless, since this case only involved passing of accounts and no loss had been proven, the court held that it did not have jurisdiction to order the directors to repay the loan. The court refused to pass and approve the accounts and declined to order costs in favour of the directors.
3. Key Observations
The principle to be derived from David Feldman Charitable Foundation is that a private foundation should not engage in related-party transactions - certainly without independent legal advice and on commercial terms that protect the interests of the foundation. The principle has broader application to charitable corporations generally - although since operating charities and public foundations are not under the control of a single donor or group of related donors, the issue of conflict is much less likely to arise in the case of operating charities and public foundations than in private foundations, such as in this case.