Chapter 3

Part II Part II

Chapter 3 Chapter 3

Property Risks

T

o pursue its mission every nonprofit uses various kinds of property.

Some of this property the nonprofit owns; other property it has the right to use.

Here are a few examples of the varied kinds of property:

■ Some nonprofits own the buildings they occupy; most rent office or other space and thus they have only the right to use the buildings.

■ Most nonprofits own the records of their contributors’ past donations;

some also rent lists of potential contributors from firms that compile data on donors likely to empathize with their mission.

■ Some nonprofits own the vehicles they need for daily operation, and some lease such vehicles. Others rent vehicles for a few days or ask to borrow their employees’ or volunteers’ vehicles.

■ Many nonprofits own or lease other long-term equipment to use in their offices, for recreational programs, or for recurring seasonal events.

■ Like organizations in the private sector, many nonprofits hold licenses from state or local governments that are necessary for engaging in the activities that are essential to their community-serving missions, such as providing virtually free food, housing, or medical care to clients.

■ Many nonprofits issue publications to which they own the copyrights.

Some nonprofits reprint in their publications substantial portions of others’ copyrighted materials with the permission of the holder of the copyright on the reprinted material.

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■ Some nonprofits hold property borrowed from others for extended pe- riods. Examples are museums or community theaters that borrow works of art or staging materials for particular presentations and thrift shops that hold others’ property on consignment until sold. These groups often lend property they own to others for similar purposes.

■ All nonprofits have some form of financial assets, including cash on hand, bank accounts, stocks, bonds, promissory notes, records of ac- counts, and pledges of promised payments.

■ Virtually all nonprofits have current inventories, such as office supplies or foodstuffs or merchandise for sale, to sustain daily operations for a few months at a time.

Beyond the present rights to own or use different kinds of property, many nonprofits have, or expect to have, future rights to own, use, receive income from, or otherwise benefit from property under the terms of supporters’ wills, grants from foundations or other benefactors, or other arrangements that underlie various planned giving programs. Even though future property rights can be crucial to a nonprofit’s success, this chapter focuses only on losses to the property a nonprofit currently owns or uses.

There are two reasons for excluding future interests in property from this discussion. First, a future interest may not materialize: A supporter may change his or her will to eliminate a previous or a promised bequest; a pres- ent or anticipated grantor may change its priorities or disavow a commit- ment under circumstances that make it difficult for a nonprofit to pursue what it thought were firm commitments. Second, property laws regarding future interest and the wills, deeds, and other documents conveying such interest can be very complex and vary by jurisdiction. A nonprofit looking to safeguard future interests in any kind of property should consult com- petent legal counsel about the details of specific cases rather than relying on general statements offered here.

To provide a comprehensive framework through which the managers of virtually any nonprofit organization can understand and manage the property losses that threaten it, the major sections of this chapter explore:

■ Types of property subject to loss

■ Perils causing property losses

■ Interests harmed by property losses

types of property subject to loss 45

■ Financial impact of property losses

■ Mission-critical consequences of property losses

■ Methods of identifying potential property losses

This chapter aims to establish a general framework that the leaders of any nonprofit can apply to appraise the specific property losses that may strike their organization. This framework is consistent with the five aspects of all accidental losses: (1) resource threatened, (2) peril causing loss, (3) usual frequency of loss, (4) typical severity of loss, and (5) variability of loss frequency and severity. This chapter also explains, in a property-loss con- text, the fundamental reasoning process for appraising any type of loss po- tential. Such reasoning process will help assess income, liability, people, and reputation losses in the chapters that follow.

Types of Property Subject to Loss

Very broadly, property is anything that can be owned. Driven partly by history and partly by logic, the law has for centuries divided all property into two broad categories: tangible property (physical, or capable of being touched, such as a building, a car, or window draperies) and intangible property (having no physical substance, such as a copyright or a $10,000 bank account). Evidence of intangible property, such as a document from the copyright office or a bank statement showing the $10,000 balance, is not the intangible property itself. Tangible property falls into two broad categories: real property and personal property. Real property is roughly equivalent to the more common term real estate, meaning land and things of value permanently attached to it, such as buildings, other structures, road pavements, and things growing on land, such as crops or other vegetation.

Personal property is all tangible property other than real property.

Tangible Property

A nonprofit may own or have the right to occupy real property, such as its offices, and personal property, such as the office equipment or vehicles it owns, leases, or borrows. To get a good general grasp of the range of a nonprofit’s tangible real and personal property, think of all the places it op- erates. Any facilities it occupies regularly it almost certainly owns or leases.

In each of those facilities, it uses many items of equipment, furniture, and supplies, most of which is either owned or rented. Even when a nonprofit does business in places it does not regularly occupy—as when it delivers meals to people’s homes or runs a public information booth at some asso- ciation’s annual meeting in a convention center—that nonprofit uses its own or rented vehicles, equipment, and supplies to conduct these facets of its operations. A nonprofit’s tangible property, real or personal, is every- where that nonprofit has a presence, including the overhead projectors, display racks, and posters in the homes, cars, luggage, and hotel rooms of its staff when they are preparing for or in the midst of a trip, sometimes even a pleasure trip after a major business meeting.

Intangible Property

Virtually every nonprofit owns intangible property, much of it symbolized or documented by something tangible that itself has little value. Consider a nonprofit’s financial assets, which may include cash on hand, bank and investment accounts, and corporate or governmental stock certificates or bonds. The cash is tangible personal property, its value printed on its face, and is best kept locked away because anybody can use it for anything. The same is true for stock and bond certificates, although they usually are more difficult than cash to exchange because their value is determined in the fi- nancial markets. These certificates typically cannot be sold in legitimate markets without documentary proof of rightful ownership.

Bank and investment account records have no inherent value—they are just pieces of paper. But these pieces of paper may represent great in- tangible value—conceivably, a nonprofit’s greatest single value—depend- ing on how much a bank or investment broker will let a nonprofit withdraw on the basis of these account records. This may be many millions of dollars for a philanthropic foundation whose nonprofit mission is to help others; it may be nothing for a nonprofit that is in bankruptcy and who current bank accounts have been frozen by the courts.

Closely related to bank and investment account records are banking and investment account documents: checks, deposit slips, investment order slips, and the like. These are inherently very valuable because they are like keys to the vault, giving their holder access to all the intangible assets in those

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banking and investment accounts, especially if other procedural safeguards fail. Therefore, these documents should be carefully guarded under lock and key or kept in the hands of a nonprofit’s most trusted people, who fol- low money- and document-handling procedures that shield them from both temptation and suspicion.

The most valuable asset of virtually every nonprofit is an intangible one: its mission, the community-serving goal that defines its distinctive purpose, its reason for being. The law specially recognizes this purpose as worthy of particular privileges because it serves the public good. The non- profit’s efforts in pursuing this goal, its mission, often relieve the govern- ment of activities it otherwise would have to undertake. An intangible asset, the nonprofit’s mission, is the basis for a very practical benefit for each nonprofit: not only some special postal rates but, perhaps more impor- tantly, freedom from paying most taxes and power to grant tax deductions to those who support it financially.

This intangible asset—a distinctive, government-sanctioned mission coupled with a favored tax status—is symbolized by each nonprofit’s char- ter and tax-exemption documents issued by a state or the federal govern- ment. But as an intangible asset, the mission exists separately from the charter and the tax documents. Their destruction does not directly endan- ger the nonprofit’s privileged status, although a nonprofit’s management al- most always specially guards these documents and moves immediately to replace them if they are damaged or destroyed. Nonetheless, the mission and the special tax status are vulnerable to some special dangers that are just as intangible as the mission asset itself. The dangers include tax penalties and loss of reputation because of (1) abandonment, by pursuing activities and income unrelated to the mission; (2) neglect, by failing to devote the greater part of income and other resources to serving clients; or (3) disloy- alty, by officers, employees, volunteers, or others associated with the non- profit becoming more interested in their own financial or other personal well-being than in pursuing the mission.

Mission-related values, perils, and safeguards are very important in all as- pects of risk management for nonprofit organizations. Later chapters on in- come, liability, people, and reputation losses will return to these values and threats to a nonprofit’s mission and other intangible resources. The balance of this chapter concentrates on losses to a nonprofit’s tangible property.

Perils Causing Property Losses

Experts in preventing or coping with accidents, crimes, lawsuits, disasters, and other unforeseen events often divide the perils that cause these losses into three broad categories: natural perils, human perils, and economic perils. Although this three-way grouping can lead to confusion or honest debate, it often helps in thinking about the root causes of losses and, there- fore, how to prevent or where to place responsibility for those losses. Ex- hibit 3.1 is a chart of some typical natural, human, and economic perils that can unexpectedly damage real and personal property.

Exhibit 3.1 is by no means a complete listing of the perils a nonprofit organization faces. In fact, the number of items in each column is arbitrar- ily limited to 10, although each category could contain scores of perils. To stimulate thought about perils that could threaten a nonprofit, some of the listed perils are described very broadly, (e.g., windstorm, crime), while others are more specific (e.g., mold, currency fluctuation). Finally, the per- ils selected for the chart illustrate that their relative importance may shift over time: riots are not the news-making threat today that they were 30 years ago, and neither terrorism nor mold were major property loss con- cerns in the United States until 5 or 10 years ago.

EXHIBIT 3.1 Typical Natural, Human, and Economic Perils

Natural Human Economic

Collapse (gravity) Drought

Earth movement (quakes, etc.) Fire, natural origin Flood

Mold Rot

Temperature extremes Vermin Windstorm

(hurricane, etc.)

Carelessness Crime

Explosion, human origin Fire, human origin Lawsuit

Pollution (air, noise, etc.) Riot

Sabotage Strike, boycott Terrorism

Currency fluctuation Interest rate or price change Legal and regulatory change Political change

Population shift Preference shift Recession

Resource depletion Technological change War

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Natural Perils

Natural perils are forces of nature that act without any human intervention.

Gravity, for example, can cause the collapse of an aging building, especially one that has not been adequately maintained. Poorly maintained properties are also particularly susceptible to flood, rot, and windstorm, whether from a hurricane in the eastern United States, a tornado in the Midwest, or an Asian typhoon. Vermin—pesky, destructive wild animals—also vary by territory. Raccoons and deer are vermin in temperate climates, snakes in more tropical areas, and bear in colder regions, and rats and insects are every- where. Fire occurring naturally, usually ignited by lightning, is another universal natural peril. All natural perils can damage both real property and any personal property located in or on that real property

Natural perils cannot be avoided, they “come with the territory,” and a nonprofit that is not free to move to another region (or at least to higher ground above a local flood plain) is vulnerable to the natural perils that characterize a particular location. For example, some areas experience losses from various forms of earth movement, such as earthquakes, volcanic eruptions, sinkholes, or landslides, much more frequently than do other areas. A nonprofit that is committed to a given geographic area or specific area cannot fully prevent losses from natural perils. It can only reduce them through appropriate, usually architectural or other physical loss controls:

good construction, walls and dikes to shield property from wind and water, and tight roofs, foundations, windows, and doors to prevent wind, water, and vermin from entering the premises. A nonprofit that owns its facilities can take these steps directly; a nonprofit that is a renter may have to nego- tiate these safeguards with its landlord or move to a more secure location.

Human Perils

Human perils include all the destructive conduct (actions or failure to act) of individual people acting alone or the destructive conduct of people act- ing in concert. Two of the most prevalent human perils are the most dif- ficult to define and to control: carelessness and crime. Carelessness can encompass unsupervised or inattentive operation of an automobile or other machinery that causes damage, stumbling into and smashing valuable an- tiques, or failing to maintain buildings or equipment until they crumble or

fail to function. Crimes against property, causing its theft or destruction—

robbery, burglary, shoplifting, embezzlement, fraud, arson, vandalism, in- vasion of copyright—are as varied as the forms of real, personal, and intangible property and as changeable as human imagination can devise.

Witness the recent explosions in fraud against the elderly and identity theft.

Fire, a human peril when ignited by human action or inaction, can over- lap with crime when it is arson and with carelessness when fires started by good people for good purposes somehow get out of control.

Lawsuit is a human peril because people cause other people property losses when they sue one another. It is the act of bringing suit that triggers property losses for the defendant, whether the suit is later settled out of court or by a final legal ruling. Usually the defendant’s loss is money paid to the plaintiff as damages or to the government as fines. Depending on the nature of the civil or criminal suit, however, the defendant also may lose ownership of other tangible or intangible property that has become the center of a legal dispute. As later chapters will explain, lawsuits also can cause an organization to lose income or reputation when, for example, it agrees to—or is ordered to—stop doing something that generated a good income or a fine public image.

Most of the other human perils listed involve targeted hostility be- tween one specific group of humans and another group, typically resulting in some intentional damage to property, such as in a riot, planned acts of sabotage, a strike, or terrorism. Note that war is not included as a human peril, because war usually is an act of one government or country against another, not an event that begins as a person-against-person or small group conflict.

Human perils arise from human failings: lack of knowledge or skill, of attention, of focused motivation, or of respect and concern for the well- being of others. The key to countering losses caused by human perils is to avoid or correct these human failings in oneself and in others or to mini- mize the contact that the organization has with such people. No one is per- fect, but everyone can try to improve; therefore, trying improves safety.

Economic Perils

Economic perils include actions of many individuals acting independently but responding similarly to a particular set of conditions. Their similar re-

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sponses to these conditions, although often sensible as individual actions, often have harmful economic consequences for many people.

Economic perils are economy-wide (or macroeconomic) events, which can be quite normal in competitive markets—events that no one person or organization causes or can control. For example, an organization that buys raw materials from or sells its output in other countries can lose money as exchange rates fluctuate. Other domestic price changes can also cut into an organization’s income or surplus. These include increases in the costs of raw materials or in wage and salary costs or a decrease in what peo- ple are willing to pay for the goods or services an organization sells. Many organizations, especially nonprofits serving local populations, lose clients and funding from donors if the general population declines in these areas or if recession occurs. A major local employer may falter because its prod- ucts have become obsolete or are no longer the ones consumers prefer, or because that employer is dependent on a natural resource, such as a mine, a water source, or soil that is especially well suited to a particular crop. Any such adverse economic change is likely to drain a nonprofit’s cash reserves, especially if its clients’ needs increase just as its funding sources dwindle.

Other community-wide or nationwide changes that affect a nonprofit’s general legal environment may have damaging effects on its financial re- sources. A nonprofit’s costs may be increased by federal, state, or local statutes governing what a nonprofit may do, how it is funded, or how it must report to the government or to its constituencies—or by the regula- tions implementing these statutes. These statutes and regulations can also reduce its revenues or deprive it of the use of some of the facilities on which it depends. A change in the political party in power, nationally or locally, also may cloud a nonprofit’s financial future. Such adverse changes, although they may be basically legal or political, are important to a non- profit because they threaten its economic prospects, and thus its ability to fulfill its mission.

Economic perils are beyond the direct control of a nonprofit or any other single organization; no organization created these perils, and none can stop such a peril from running its course. The best strategy for protection from economic perils is to insulate the nonprofit from their effects. The key is to diversify, to reduce any overdependence on any single group of clients, funding source, product, or service—and, if possible, from any single com- munity or geographic area. Another key is to develop a contingency plan: