Asset Management in German Foundations
Responsibility of the management board: proper administration of foundation assets
A foundation’s key characteristic is its assets. The board of directors of a foundation has a type of fiduciary duty towards the foundation’s assets. As a fiduciary trustee, it is expected to manage the foundation’s assets properly.
It must preserve it, enhance it if feasible, and invest it in a way that generates suitable and continuous income so that the foundation can utilize it to achieve its (charitable) objectives. If the management board negligently breaches its duties, it must provide compensation for the foundation.
Only secure investments are not efficient
The previous belief that foundations may only invest in gilt-edged securities and that the board of directors is always “on the safe side” with such investments is outdated. In times of low or even negative interest rates (“penalty interest rates”), a foundation that only invests in supposedly safe investments will not be able to maintain its assets in terms of their portfolio or value.
It is clear that a board of directors that leaves a significant portion of the foundation’s assets in a current account or savings book without paying interest is not acting in good faith. In cases of doubt, this may even constitute a misuse of funds that is harmful to the charitable organization in Germany.
Diversification as a fundamental rule of professional asset management
The board of directors is correct to adopt a diversified investment strategy, i.e., to distribute the foundation’s assets across various asset classes, such as
- near-cash investments,
- fixed-interest bonds,
- shares, and
- real estate
and, if possible, spread it regionally (USA, Europe, Asia, etc.), unless the founder has specified otherwise in the foundation agreement.
Speculative investments and their tax implications
Even investments that seem speculative at first glance, such as private equity investments, warrants, and futures, are not inherently forbidden for foundations, provided they are not used for speculative purposes, i.e., “gambling”.
They can certainly serve as an addition to a well-balanced portfolio or as a means of hedging a portfolio in individual cases. Of course, it is crucial that the management board knows and understands what it is doing. They must realize that private equity investments, for instance, are not liquid and that warrants and futures are high-risk tools.
Besides the risk inherent in the investment, the board of directors must be aware that certain investments, e.g., investments in commercial funds, result in the foundation establishing a taxable business operation with them. The income from the investments is then taxable. Whether there is a risk of such taxation should always be clarified before making an investment decision.
Financial crises deplete foundation assets
In times of high interest rates, rising stock market prices, and a robust property market, foundations generally do not experience any asset loss and therefore do not incur any losses or liability. However, in times of crisis, the foundation and its governing bodies are at risk:
- Black Thursday 1929, which marked the start of the Great Depression in the 1930s,
- The price collapse on October 19, 1987, which was largely driven by computer-assisted selling,
- The bursting of the internet bubble and the decline of the “new market” in 2000,
- The financial crisis that started with the collapse of the U.S. investment bank Lehman Brothers in 2008, and
- The significant price drops following the coronavirus crisis in March 2020,
demonstrate the vulnerability of the global economy.
Asset management becomes crucial in the face of losses
Foundations may sometimes face dramatic losses during such stock market crashes. The question of whether the asset management was adequate or if the board of directors can be held accountable for the loss and must compensate for it, quickly arises.
The obligation to pay damages is not merely theoretical but has practical implications, as evidenced by a judgement of the Federal Court of Justice from 2014. According to this judgement, the board of directors of the foundation had to reimburse 1.4 million euros for improperly investing the assets. The fact that the foundation’s board of trustees concealed the actions of the board of directors did not absolve the latter.
How we assist foundations and foundation boards
In close collaboration with the asset managers and banks engaged by your foundation, we provide advice on all legal and tax matters related to asset management. Typical advisory assignments include:
- Identifying the legal liability risks of the acting bodies in relation to the foundation’s asset management, considering the “perpetual investment horizon” of foundations (realize book losses or “sit it out”?)
- Determining the liability risks of honorary and remunerated foundation bodies, considering potential allegations of fault on one hand and legal requirements and those from the foundation statutes on the other
- Drafting of articles of association and advising on the procurement of D&O insurance policies to mitigate liability risks
- Offering guidance on the preparation and legally compliant documentation of investment decisions for which the management board has discretionary powers
- Drafting contracts with banks and asset managers
- Providing advice on and establishment of special funds
- Expert advice on issues related to the preservation of the basic assets
- Determining which funds are subject to the timely utilization of funds and which funds may be transferred to the reserves (e.g., reallocation reserve)
- Clarifying the tax treatment of asset investments (tax-free asset management vs. taxable commercial business operations)
- Verifying the permissibility of reallocations within the foundation’s assets
- Enforcing claims for damages by the foundation against foundation bodies and defense against such claims
- Implementing compliance regulations to prevent conflicts of interest on the part of the Management Board in relation to asset management
- Developing investment guidelines
Your attorneys for foundation investments
Do you have legal or tax-related queries about your foundation assets? Our specialist tax attorneys are always available to assist you. Please feel free to contact us!
The easiest way to reach us is through e-mail (info@winheller.com) or via phone (+49 69 76 75 77 85 24). Don’t hesitate to get in touch with us at any time with your inquiries!
