What should a foundation do with unused funds?

Q: What recourse does a foundation have if a grantee doesn’t use the grant for the purposes intended? Can the foundation require that the funds be returned?

A: This is largely a matter of contract law, says Thora Johnson, a Washington lawyer who works with nonprofit clients. In general, if there was no written contract between the foundation and the grantee that specifically outlined how the money was to be used, she says, it would be difficult to recoup funds.

But Ms. Johnson says that she hasn’t had any clients who have dealt with this issue. “I suspect that it does not come up very often,” she says.

Indeed, smart foundations generally protect themselves from such scenarios by having its grantees sign grant agreements, says Tim Walter, chief executive of the Association of Small Foundations, in Washington.

This document should include the following elements, he says:

• Goals to be achieved with the grant.
• The amount and payment schedule.
• Certification of the grantee’s current tax-exempt and public-charity status.
• Expectations for grant reporting, such as whether interim reports are required and what format those reports should take, and whether the reports should include backup materials, timelines, and so on.
• Expectations for evaluating the grant.
• If and how the foundation would like the grantee to publicize the grant and who pays for doing that.
• The project budget, if applicable, and a provision that no changes can be made without the foundation’s approval
• Provisions for ending the grant and recovering the money if it has been used improperly.

Mr. Walter advises foundations to require the grantee to return the signed document before any money is transferred.

“Negotiating grant agreements that document mutual expectations goes a long way toward avoiding misunderstandings and legal action,” he says. “More broadly, having open discussions of needs and goals with your grantees builds relationships, trust, and a sense of shared accountability.”

If a foundation does not have a grant agreement in place, recovering misused funds will be more difficult, but not necessarily impossible, says Jane Nober, special counsel for the Council on Foundations, in Washington. A grant proposal, for instance, might be sufficient in setting the terms of the funding.

However, she adds, with no documentation of a grant’s original purpose, the foundation must simply appeal to the grantee’s conscience to secure reimbursement or redirection of the funds. If the foundation is a longtime or major supporter, a foundation may indeed be able to pressure a grantee into returning the funds.”

Sample grant-agreement documents can be found in the Council on Foundations’ book Grantmaking Basics: A Field Guide for Funders ($35 for members, $55 for nonmembers), which can be ordered on the Council on Foundations’ Web site or by calling (888) 239-5221.

Additional information can be found in the Association of Small Foundations’ primer Communicating With Grantees: Building Effective Relationships Throughout the Grantmaking Process ($10 for association members, $15 for nonmembers), available on the association’s Web site, or by calling (888) 212-9922.

Mr. Walter also suggests consulting a lawyer who is knowledgeable about foundation regulations. To help find legal and other services, visit the Association of Small Foundations’ online Professional Directory of member-nominated advisers.