Cy Pres, Modification, and Dissolution of Nonprofits

In previous posts, I discussed the basics of nonprofit organizations and founding a nonprofit. In this post, I discuss making changes to a nonprofit organization, specifically modifying its purpose or terms through the cy pres doctrine and winding it up through dissolution.

Cy Pres

Cy pres is a doctrine whereby a court changes the terms of a charitable trust to accommodate a change in circumstances that frustrate the fulfillment of the settlor’s intent. The term comes from the Anglo-French legal phrase cy pres comme possible, meaning “as near as possible.”

As an example, if a settlor were to establish a trust to provide scholarships for students attending a specific college that later dissolves, the court may modify the trust to direct its funds in a substantially similar manner, even though fulfilling the settlor’s original terms is now impossible.

The Uniform Trust Code § 413, now adopted in some form in more than 35 states, provides that cy pres applies when a charitable trust’s purpose becomes unlawful, impracticable, impossible to achieve, or wasteful. When any of these conditions is met, the trust does not fail; instead, a court may modify the trust in a manner consistent with the settlor’s charitable purposes.

Importantly, the UTC creates a rebuttable presumption of general charitable intent. Under the traditional common-law rule, the party seeking cy pres bore the burden of proving that the settlor had a general charitable intent broad enough to permit modification. The UTC reverses this burden—general charitable intent is now presumed unless the trust instrument expressly provides otherwise. The Restatement (Third) of Trusts § 67 goes even further, essentially eliminating the general-charitable-intent requirement and applying cy pres unless the trust terms provide otherwise.

In practice, this means that a court considering cy pres will look at whether: (1) the trust was a valid charitable trust, (2) the trust’s charitable purpose has become unlawful, impracticable, impossible to achieve, or wasteful, and (3) the trust instrument does not contain language expressly limiting the trust to a specific purpose that would rebut the presumption of general charitable intent.

So, in the example above, if the settlor’s intent was to provide scholarships to needy students, cy pres would likely be appropriate. If the intent was specifically to benefit a particular alma mater with no broader charitable purpose, a court might find the presumption rebutted—though under modern law, this is increasingly rare.

It should be noted that cy pres changes the purpose of the trust, something that courts generally disfavor. It will therefore allow for only the smallest possible changes. Cy pres will not justify changing a trust simply because there is a better way to accomplish the settlor’s intent. It will only be utilized in the most extreme circumstances, such as where fulfilling the trust terms is impossible.

The Doctrine of Deviation

Closely related to cy pres is the doctrine of deviation. Traditionally, deviation allowed a court to alter only the administrative provisions of a trust—not its general goal or purpose. Under the modern rule, as reflected in UTC § 412 and the Restatement (Third) of Trusts § 66, courts may also modify distributive provisions, though the standard for doing so is higher than for purely administrative changes.

Deviation applies when compliance with the trust’s terms is impossible or illegal, or when circumstances not anticipated by the settlor would substantially impair the trust’s purposes. The party seeking deviation bears the burden of demonstrating that these requirements are met, as courts disfavor changing the terms of a trust. The key distinction remains that deviation does not change the trust’s underlying charitable purpose—that is the exclusive province of cy pres.

Cy Pres in Class Action Settlements

The cy pres doctrine has also been adopted in the class action context. When a class action lawsuit settles and the resulting settlement fund cannot be fully distributed to class members—whether because some members cannot be located, fail to file claims, or the individual amounts are too small to justify the cost of distribution—courts may direct the remaining funds to charitable organizations under cy pres.

While Federal Rule of Civil Procedure 23(e) requires courts to find class action settlements “fair, reasonable, and adequate,” the rule itself does not mention cy pres. The practice has instead developed through case law and the ALI’s Principles of Aggregate Litigation § 3.07, which recommends that cy pres recipients have a sufficient nexus to the interests of the class members. So, for example, residual funds from a consumer privacy class action might be directed to a nonprofit that advocates for digital privacy rights.

Class counsel typically nominates prospective recipient organizations, and the court reviews these nominations to ensure the proposed recipients will advance interests related to the underlying claims.

Nonprofits seeking to receive cy pres awards often cultivate relationships with class action attorneys and provide supporting materials—such as organizational literature and declarations—demonstrating their relevance to the types of cases being settled. This has become an important funding source for many public interest organizations.

It is worth noting that cy pres–only settlements—where no funds are distributed directly to class members—have drawn increasing judicial scrutiny. The Supreme Court considered this issue in Frank v. Gaos (2019), though it ultimately resolved the case on standing grounds without reaching the cy pres question directly.

Dissolution and Distribution of Assets

If a public benefit organization wants to wind up, it must distribute its assets to another public benefit organization, or to a federal, state, or local government for a public purpose. It cannot merely distribute its assets to the organization’s insiders, as a business would.

This stands in contrast to a mutual benefit organization, which may distribute its assets to its members after the organization’s debts have been paid and proper winding up procedures are complete. (Note that not all states allow this loophole for mutual benefit organizations.)

Involuntary Dissolution

While we would like to think that nonprofits are always wound up voluntarily—whether the mission was accomplished or the insiders simply no longer wish to keep the organization going—this is not always the case. Sometimes a nonprofit organization can be forced to wind up, even if its leaders do not wish to do so.

Among the most common events that may trigger the involuntary dissolution of a nonprofit are the following:

1. Abandonment of activity. This occurs where the organization abandons the nonprofit activity for which it was founded. It may not continue to exist as a nonprofit if it fails to fulfill the purpose that allowed it to qualify for nonprofit status in the first place.

2. Insufficient assets. If the organization does not have sufficient resources to carry on its purpose, then it must dissolve.

3. Deadlock. If the insiders of a nonprofit are unable to agree on how to run the organization, it may have to dissolve. Proper planning, however, particularly in the drafting of the bylaws, should prevent such a result. It is therefore important to form a nonprofit with the assistance of competent legal counsel to plan for this possibility.

These are not the only grounds. State statutes also provide for administrative dissolution—for example, where an organization fails to file required annual reports, fails to maintain a registered agent, or fails to pay required fees. Judicial dissolution may also be triggered by fraud in obtaining the articles of incorporation, exceeding or abusing corporate authority, or illegal or oppressive conduct by the organization’s directors.

It is important to note, however, that under 11 U.S.C. § 303(a), creditors generally cannot force charitable nonprofit organizations into involuntary bankruptcy. The Bankruptcy Code exempts from involuntary proceedings any corporation that is “not a moneyed, business, or commercial corporation,” which includes churches, schools, and charitable foundations. A nonprofit may, however, voluntarily file for bankruptcy under Chapter 7 or Chapter 11. And a nonprofit that engages in substantial commercial activity could potentially lose this protection if a court characterizes it as a “commercial corporation” based on its actual operations.

The 501(c)(3) Dissolution Clause

The IRS requires 501(c)(3) organizations to include a dissolution clause in their organizing documents—whether articles of incorporation, a trust instrument, or articles of association—as a condition of tax-exempt status. This clause must provide that, upon dissolution, the organization’s remaining assets will be distributed exclusively for exempt purposes within the meaning of Section 501(c)(3) or to a federal, state, or local government for a public purpose. The IRS provides suggested dissolution language in Publication 557.

A missing or defective dissolution clause is one of the most common reasons that Form 1023 applications encounter delays, as the IRS will issue a development letter requesting corrective amendments before granting tax-exempt status. While some states have laws that satisfy this requirement by operation of law, it is generally advisable to include the language explicitly in the organizing documents rather than rely on state law alone.

Filing Requirements Upon Dissolution

An organization that dissolves must file a final Form 990 (or Form 990-EZ) with the IRS, checking the “terminated” box and completing Schedule N (Liquidation, Termination, Dissolution, or Significant Disposition of Net Assets). Schedule N requires detailed reporting on all asset distributions, including the fair market value of assets distributed, the identity of recipients, and whether the organization notified the state attorney general of its intent to dissolve. This final return is due by the fifteenth day of the fifth month after the date of termination.

Distribution to Public Benefit Organizations

If a charitable organization receives property that is given for a specific purpose, it must be applied for that purpose. So, for example, if a university receives a $100,000 donation to endow a scholarship for first-generation college students, the university must use this money for this purpose. It is not free to use it as it sees fit. Any deviation from the gift’s purpose must occur through the cy pres doctrine.

This concept is particularly important when a nonprofit dissolves while still holding donated assets. As it is the duty of such a dissolved organization to distribute its assets to other public benefit organizations, it must ensure that donations so earmarked are delivered to another nonprofit that will carry out the donor’s desires.

Still, in such situations, the standard is generally more flexible than that imposed on the organization that originally received the donation. Some states, such as New York and Michigan, look to “activities substantially similar” to those of the dissolving organization when approving asset distributions. Others, such as California and Texas, focus on whether the receiving organization has a “similar charitable purpose.” The exact standard varies by jurisdiction, but the common thread is that courts and attorneys general recognize the practical difficulty of finding a perfect match when the original recipient no longer exists. An analogous purpose or similar program of activities is generally acceptable.

Disputes over assets frequently arise in the context of a local chapter of a national organization. In these cases, the nature of the assets and any attachments that they have will be considered.

So, for example, where a donor has given a large donation to a local chapter of the YMCA, should that chapter dissolve, the nature and purpose of the gift must be considered when deciding whether that gift should be transferred to another public benefits organization or whether it should be assumed by the parent organization.

Conclusion

The modification and dissolution of a nonprofit organization can be a complex matter—often more complicated than dealing with a for-profit corporation. The doctrine of cy pres, the distinction between public and mutual benefit organizations, and the special requirements for distributing donated assets all add layers of complexity. The organization has a duty to both the public and its donors, neither of which may be insiders at the time the organization is changed or dissolved.

Because of these unique obligations, modifying or dissolving a nonprofit must be done with great care and, ideally, with the assistance of competent legal counsel experienced in nonprofit law.

Frequently Asked Questions

What does cy pres mean?

Cy pres comes from the Anglo-French legal phrase cy pres comme possible, meaning “as near as possible.” In trust law, the doctrine allows a court to modify a charitable trust’s purpose to one as near as possible to the settlor’s original intent when that intent can no longer be fulfilled.

When can a court apply cy pres to a charitable trust?

Under the Uniform Trust Code § 413, a court may apply cy pres when a charitable trust’s purpose has become unlawful, impracticable, impossible to achieve, or wasteful. The UTC presumes the settlor had a general charitable intent, so cy pres applies unless the trust instrument expressly provides otherwise. This is a significant departure from the traditional common-law rule, which required the party seeking cy pres to affirmatively prove general charitable intent.

What is the difference between cy pres and the doctrine of deviation?

Cy pres modifies the charitable purpose of a trust, while deviation modifies only the administrative or distributive terms without changing the trust’s underlying goal. Both require circumstances that make compliance with the original terms impossible, impracticable, or illegal.

What happens to a nonprofit’s assets when it dissolves?

A public benefit nonprofit must distribute its remaining assets to another public benefit organization or to a government entity for a public purpose. It cannot distribute assets to insiders the way a for-profit business would. Earmarked donations must go to an organization that will carry out a substantially similar charitable purpose.

How does cy pres work in class action settlements?

When a class action lawsuit settles and the settlement fund cannot be fully distributed to class members—because some are unreachable, fail to file claims, or the per-person amounts are too small to justify distribution—courts may direct the remaining funds to charitable organizations under cy pres. The recipient organizations must generally have a nexus to the interests of the class members.

Can creditors force a nonprofit into bankruptcy?

Generally, no. Under 11 U.S.C. § 303(a), creditors cannot file involuntary bankruptcy petitions against charitable nonprofits such as churches, schools, and foundations. A nonprofit may, however, voluntarily file for Chapter 7 or Chapter 11 bankruptcy. And a nonprofit that engages in substantial commercial activity could potentially lose this protection if a court classifies it as a “commercial corporation” based on its actual operations.