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Tuesday, March 17, 2015

Fiduciary Duty, Higher Education, and the Zone of Insolvency

Questions continue to emerge about the situation at Sweet Briar and the decision-making process that led to its closure, and the situation seems destined for litigation. One of the issues that seems to run through the discourse, though, is one I’ve been thinking about for a few years: to whom do the college decision-makers owe a fiduciary duty?

A letter from Virginia State Senator J. Chapman "Chap" Petersen to Attorney General Mark Herring raises the question explicitly.  The letter questions the legality of the announced closure, asks for an opinion on the legal status of restricted donations, and asks “Does the Board have a fiduciary duty to protect the interests of donors and students, as well as the mission of the College?

The issue of fiduciary duty presents an interesting question, and I would add a follow-up: does that fiduciary duty change (or should it) when a nonprofit institution is operating in the so-called “zone of insolvency”?

In recent decades, colleges and universities have attempted to act more like businesses (the so-called “corporatization” of higher education) and, in doing so, may have acted in ways that are inconsistent with nonprofit principles. In particular, I suspect that the increasing spiral of rising tuition and concomitant discounts is one of the leading causes of financial distress in higher education—and it may well be that prior Board decisions underlie Sweet Briar's current financial crisis.

But regardless of how Sweet Briar got to this point, whose interests should now be paramount?  I think there is no doubt that the Board owes a duty to the “mission of the College.” But how is that best served? The stated mission of the College is to educate women—but there are far more options for women’s education now than there were at the college’s founding, making it appear less important that that mission be served by Sweet Briar College.  I also think there is a strong argument that colleges and universities have a fiduciary duty to act in the best interest of their students. I suspect that there is a contractual duty (though I am doubtful there is a fiduciary one) to donors; restricted funds probably should and will go back to donors or be distributed under cy pres principles.

There may be some conflict between the interests of educational goals, students, and donors. Nonetheless, I think that the main source of tension and potential conflict arises from an idea not actually stated in Senator Peterson’s letter—the idea that the Board could also have a duty to the institution itself. When a nonprofit institution is financially solvent, it may be reasonable to think in terms of a trustee’s duty to protect the institution and its future; ideally, the interests of the institution would be aligned with the interests of the institution's mission. When the institution is not financially solvent, however—and when strategies to gain solvency would seem to conflict with the institution’s mission—then there is a significant potential for a conflict of interest. The restriction of nonprofit status (exchanged for some nice tax breaks) suggest that the interests of the institution (and its management, including faculty) have to take a back seat in the face of such a conflict. I don't know if the Sweet Briar board made the right call, and I am troubled by a reported lack of transparency in its decision-making. For Sweet Briar, questions of power, duty, and potential conflicts will likely get hashed out in court. 

Posted by Cassandra Burke Robertson on March 17, 2015 at 12:12 AM in Culture, Current Affairs, Life of Law Schools | Permalink


Any thought or comments (or creative legal suggestions) would be Greatly appreciated!!!!

I would love to hear thoughts on whether or not there is any precedent for holding that for-profit law schools or colleges owe a fiduciary duty to student when the school is deriving over 80% of its income from federal backed loans?

Or, what are any possible options for holding a 3 member board of directors (who have 100% ownership)accountable for actions that directly oppose the interest of its student. In particular when the owners/board have uniformly held themselves to the public as... being technically "for profit" (due to political necessity of gaining approval for the school) but operating like a non-profit... (all distributions taken by the board were done in secret, with even the faculty having no idea the board had ever taken such distributions).

Posted by: kent | May 18, 2015 12:24:22 AM

What about where an institution is solvent, but none the less the interests of the institution and the mission diverge?

I'm thinking particularly of something like the March of Dimes. When the organizations mission disappears, it appears that the trustees *may* switch to a different mission and keep the organization going. But do fiduciary principles say that they *must*? Is it an option to dissolve a non-profit simply because it has achieved its goals, despite being perfectly solvent?

Posted by: brad | Mar 17, 2015 12:00:49 PM

Who the beneficiaries are is a very difficult question, I think. In the context of a non-profit, the "mission" of the institution seems as good an answer as any. If we analogize to the for-profit world (where almost all our fiduciary law comes from), the "mission" of the institution is to make money. The standard beneficiaries are the shareholders. A director then has a duty to act in the best interests of the shareholders. Looking at the university, the students are not really analogous to shareholders. They actually look more like customers since they are paying money to receive an education. I want to agree with the notion that the university owes a duty to its students, but I'm not sure where the fiduciary duty would come from. I think one could argue that fulfilling the duty to the "mission" means acting in the best interests of the students, but I'm not sure that implies or requires any direct fiduciary duties to the students. Or is this a distinction without a difference?

Posted by: Philip | Mar 17, 2015 11:13:57 AM

Prof and Philip, these are great points, but I'd like to drill down a bit more. Prof is of course right that the zone of insolvency is less influential in the for-profit world after N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 99 (Del. 2007). Before that case, many had argued that there was a fiduciary duty to creditors that arose in the "zone"--as a matter of Delaware corporate law, the Delaware Supreme Court shut that down. But I still like the concept is a useful one in the nonprofit (and specifically higher ed) world, where there may be other fiduciary duties at play. But, while certainly less doctrinally relevant in the for-profit world, I do think it's a helpful analytical construct.

Re: Philip, I think we largely agree on the overall priorities, but defining the terms gets tricky. For a college, what does "actual insolvency" look like? Again in the for-profit world you'd either look for liabilities exceeding assets or an inability to pay to pay bills as they become due. If you wait to get to that point as an institution of higher ed, you would be creating a big mess for everyone--which is why I think that the idea of the "zone of insolvency" can be a useful construct.

On the last point--I am intrigued that you say that the duty "runs to the institution" and I wonder what that would look like (especially since you agree that it doesn't mean a duty to, e.g., faculty/admins). Perhaps that adds urgency to the question of clarifying who the beneficiaries are, or who they should we.

Posted by: CBR | Mar 17, 2015 10:31:48 AM

Chiming in to agree with Prof. If duties shift at all (a debatable proposition), only actual insolvency could trigger that. If you are a trustee, then your fiduciary duties run to the institution. Insolvency doesn't change this; the duties are still owed to the institution. What could change are the beneficiaries of the "trust." In the context of a for-profit institution, who these beneficiaries are seems pretty clear (shareholders when solvent, creditors when insolvent). Figuring out who the beneficiaries of a college like Sweet Briar seems a bit more difficult. I do think that the interests of management/faculty would take a back seat to other interests in this context.

Posted by: Philip | Mar 17, 2015 9:44:30 AM

Just to be clear, the Zone of Insolvency is a disappearing concept following Delaware's Ghewalla (sp?) case around 2007.

Posted by: Prof | Mar 17, 2015 9:19:38 AM

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