A donor writes a generous check and adds a note: "For the youth scholarship fund." Two years later, the scholarship program has quietly wound down, but the money is still sitting in your accounts. Now what?
Restricted gifts are among the most common sources of confusion, and occasionally legal trouble, for nonprofit boards. A restriction is not a suggestion. When a donor gives money for a stated purpose, your organization has made a legal promise to use it that way. Spending it elsewhere is not just poor form; in many states it can expose the organization and its leaders to real liability.
Here is what your board needs to understand to keep those promises and stay out of trouble.
Three Kinds of Restrictions (and One That Isn't)
Not every note on a check creates a legal obligation. Boards should be able to tell the difference.
- Purpose restrictions limit how the money is spent. "For the after-school program" or "for building repairs."
- Time restrictions limit when the money can be spent. A multi-year pledge or a gift designated for next fiscal year.
- Permanent restrictions (endowments) require you to hold the principal indefinitely and spend only the earnings, according to the gift agreement and state law.
- Board designations are not donor restrictions. When your own board sets aside money for a rainy-day reserve or a future project, the board can un-designate it later. A donor cannot. Do not confuse the two in your accounting or your minutes.
The practical test: a restriction is binding only when the donor imposes it. Your board's own intentions, however sincere, are always reversible.
Where Boards Get Into Trouble
Most restricted-fund problems trace back to a handful of avoidable mistakes.
Spending restricted money on general operations. This is the big one. If cash is tight and a restricted grant is sitting in the bank, the temptation to "borrow" from it is strong. Doing so without the ability to pay it back is a breach of the donor's trust and, potentially, the law. Restricted cash is not your cash.
Accepting restrictions you cannot honor. A donor offers $50,000 for a program you are about to discontinue, or for a purpose so narrow you will never realistically use it. Saying yes creates a promise you cannot keep. It is far easier to negotiate the terms before the gift arrives than to unwind them afterward.
Losing track of the terms. The staff member who accepted the gift leaves. The award letter is filed somewhere. Three years later, no one remembers exactly what the money was for. Restrictions do not expire when institutional memory does.
Treating pledges as spendable cash. A five-year pledge is revenue, but it is not money in the bank. Boards that budget against uncollected pledges can find themselves short.
What the Board Should Actually Do
The board does not process gifts, but it is responsible for the systems that keep restricted funds honest.
Insist on written gift terms. Every significant restricted gift should have documentation: a grant agreement, a signed pledge form, or at minimum the donor's written designation. Verbal restrictions are hard to honor and harder to defend.
Require restricted-fund tracking in your financials. Your finance reports should separate unrestricted, temporarily restricted, and permanently restricted net assets. If your board cannot see how much restricted money you hold and what it is earmarked for, you cannot govern it. This is one place where a clear financial dashboard and clean board records earn their keep.
Watch the release of restrictions. When you spend restricted funds on their intended purpose, that money "releases" from restriction and shows up as revenue in your operating results. A sudden swing in your net assets often traces back to a large release. Ask your treasurer to flag these so the board is not surprised.
Match cash to commitments. At least annually, confirm that you are actually holding enough cash and pledges to cover your outstanding restricted obligations. If restricted balances exceed available cash, you have a problem to fix now, not later.
When a Restriction No Longer Makes Sense
Sometimes a restriction becomes impossible, impractical, or wasteful. The program ended. The building was sold. The scholarship criteria describe a student who no longer exists. You cannot simply decide to redirect the money.
You have three legitimate paths, roughly in order of preference:
- Go back to the donor. If the donor is living and reachable, ask them to release or modify the restriction in writing. This is the cleanest solution by far. Many donors are happy to redirect funds to a related current need.
- Apply your state's small-fund rules. Most states have adopted the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which lets organizations modify or release restrictions on older, smaller funds (often those under $25,000 and more than 20 years old) after notifying the state attorney general, without going to court.
- Petition the court (cy pres). For larger or older restrictions where the donor is gone, a court can approve redirecting the funds to a purpose "as near as possible" to the original intent. This is the formal, and most expensive, route.
What you may not do is quietly repurpose the money and hope no one notices. Document every decision in your minutes, and get legal advice before releasing any significant restriction.
Build a Simple Gift Acceptance Habit
Most of this becomes routine with a little structure. Before your organization accepts a restricted gift, someone should be able to answer three questions:
- Can we actually use this money for the stated purpose, on the donor's timeline?
- Are the terms in writing?
- Do we have a way to track it separately and prove we honored it?
If the answer to any of these is no, pause before you accept. A gift acceptance policy (a topic worth its own board discussion) turns these questions into a habit rather than a scramble.
The Takeaway
A restricted gift is a promise wearing the clothes of a donation. Your board's job is not to process the paperwork, but to make sure the organization keeps every promise it makes to donors: the money goes where it was meant to go, it stays trackable, and when a restriction truly no longer fits, you change it the right way rather than the quiet way. Ask your treasurer for a restricted-funds summary at your next meeting. If one does not exist, that is your first action item.