January 9 th, 1998
By Terrance S. Carter, B.A., LL.B.©
PROPOSED NEW "PRUDENT INVESTOR" STANDARD FOR CHARITIES IN ONTARIO
January 5th, 1998
By: Terrance S. Carter, B.A., LL.B,
Overview: On February 3rd, 1997, the Province of Ontario introduced Bill 122, which proposes amendments to the authorized investment provisions in the Trustee Act of Ontario. The legislation died on the Order paper when the Legislature was prorogued at the end of December, 1997 and it is not yet known when the Bill will be re-introduced. If the legislation proceeds as previously drafted it would replace the statutory list of permitted investments by establishing a statutory "prudent investor" standard to determine what investments trustees can invest in. This new statutory standard would generally apply to the investment of charitable funds by directors and other members of controlling boards of charities.
While there are many positive aspects to the proposed legislation, such as providing authorization for investments in mutual funds, there are also troublesome aspects that will increase the liability exposure for directors of charities, particularly as it relates to liability for inadequate investments.
Current Trustee Investment Powers: All charities that operate in Ontario are considered to have trust obligations with respect to their charitable funds. As a result, the members of the controlling boards of those charities, whether they be boards of directors, boards of trustees or boards of management, are considered to have trustee-like duties as fiduciaries in the administration of charitable funds. Historically, trustees were expected to make investment decisions in accordance with what was expected of a "prudent person". In Ontario, this common law rule was supplanted by a statutory list of permitted investments under the Trustee Act, which list dates back to the turn of the century when it was more important to preserve property instead of maximizing investment returns.
Generally, the Trustee Act list of investments applies only if the charity is either; (a) a corporation or a trust created in Ontario, or; (b) a charity incorporated federally or in another province with its head office or principal place of business in Ontario; and in either situation has constating documents that:
1. are silent about investment powers; or
2. describes its investment powers as being "those authorized by law for trustees to invest in" or such similar terminology.
Conversely, the current statutory list of investments generally does not apply if the charity is either:
1. a corporation or a trust created in Ontario, and already has a broad form of prudent investor power in its constating documents; or
2. is incorporated federally or in another province and refers to a specific investment power, such as that contained in the Federal Insurance Companies Act.
By contrast, the new "prudent investor" rule under the proposed amendments to the Trustee Act would generally apply to most charities located or operating in Ontario.
New "Prudent Investor" Rule: The current statutory list of permitted investments has for some time been recognized as not reflecting economic reality or the effect of inflation. In 1996, the Uniform Law Conference of Canada adopted the model "Trustee Investment Act" that, if adopted, would have removed the legal list of permitted investments, established a "prudent investor rule", permitted investments in mutual funds, and permitted delegation of investment decisions to professional investment advisors.
Unfortunately, Bill 122 does not include all of the recommendations of the Uniform Law Conference of Canada. This will result in serious practical problems involving investments for charities in Ontario. At present, it is not clear whether the Government is intending to make any changes to the proposed legislation when it is re-introduced. As a result, it is important for charities to understand the new investments powers proposed under Bill 122. The principal changes are summarized below as follows:
• The statutory list of investments is to be abolished and replaced with the statutory standard that a trustee "must exercise the care, skill, diligence and judgement that a prudent investor would exercise in making investments". This establishes a new mandatory standard of care for investments for a trustee, and is generally considered to be an objective standard, although it may be applied by the courts in a subjective context.
• A trustee will be able to "invest trust property in any form of property in which a prudent investor might invest". In addition, notwithstanding any rule of law that otherwise prohibits the delegation of investment powers, a trustee will be able to invest in mutual funds. This amendment permitting investments in mutual funds is of significant benefit to many charities that are currently investing in mutual funds in Ontario without legal authority. However, since there is no definition of what a "mutual fund" is in Bill 122, it is likely that the courts will be called upon to interpret what is meant by this investment term.
• The proposed amendments establish the following list of seven mandatory criteria that a trustee must consider in making an investment in addition to any other criteria that are relevant under the circumstances:
* general economic conditions;
* the possible effect of inflation or deflation;
* the expected tax consequences of investment decisions or strategies;
* the role that each investment or course of action plays within the overall trust portfolio;
* the expected total return from income and the appreciation of capital;
* needs for liquidity, regularity of income and preservation or appreciation of capital;
* an asset's special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.
The Attorney General of Ontario has stated in a letter that a trustee who does not consider each criterion to the same degree will have to demonstrate that it was prudent to prefer one criteria over another. The fact that a list is set out in legislation will increase the responsibility placed upon directors to carefully consider each criterion and therefore increase their exposure to liability if they fail to do so.
• The amendments also state that a trustee must diversify the investments of trust property to an extent that is appropriate to;
* the requirements of the trust; and
* the general economic and investment market condition.
This means that simply placing monies into one investment, whether it be a G.I.C. or even a "balanced" mutual fund, may not satisfy the requirement that trustees "diversify" the investments.
• Although the amendments will permit trustees to obtain investment advice and to rely upon that advice, the trustees are still not permitted to delegate investment decisions to an investment advisor or manager. While trustees will not be liable for the investment advice that has been relied upon, the relief from liability only exists if a prudent investor would rely upon such advice. As a result, the decision to retain an investment advisor may result in the same liability for directors as if they were making the investment decision themselves.
• Trustees will be relieved from liability only if the loss resulted from an investment plan that comprised reasonable assessments of risk and that a prudent investor would adopt in comparable circumstances. As a result, there will be very little practical protection for trustees under the amendments. More importantly, the relief that is currently available for technical breaches of trust under Section 35 of the Trustee Act will no longer be available for breaches of trust relating to investments. This unfortunate restriction means that directors who are found in breach of trust will not be able to look to the court for relief, even if the directors acted in good faith.
• Although the amendments state that if a trustee is liable, the court can look at the overall performance of investments in assessing damages against the trustee, each separate investment decision will still result in a separate finding of breach of trust and resulting damages on a personal basis, with the remedial provisions applying only to the assessment of damages, not to a finding of breach of trust.
Application of New Standard: When Bill 122 does become law, then the new "prudent investor" standard will generally apply to all Ontario charitable trusts or charities incorporated by letters patent or by special Acts, (except for special Act corporations with an existing investment power), and all federal or other provincial incorporated charities that have their head offices or principal places of business in Ontario and do not have specific statutory investment powers, (such as the investment authority under the Federal Insurance Companies Act). As a result, the new trustee investment power proposed will have much broader application than the current investment provisions under the existing Trustee Act.
Considering of the practical difficulties that will be faced by directors of charities concerning investment decisions (see accompanying article at page ), it is hoped that the Provincial Government will reconsider the provisions of Bill 122 when it is reintroduced and adopt the "Trustee Investment Act" proposed by the Uniform Law Conference of Canada, including the restoration of the ability to obtain relief from technical breaches of trust arising from investment decisions.
However, unless present efforts to this end that are being made by various charitable groups and the Canadian Bar Association of Ontario are successful, directors of charities in Ontario will need to be become better informed about the investment obligations placed upon them and ensure that they are dealing with investment decisions in a careful and prudent manner as a "prudent investor" would. Being a director of a charity has never been for the faint of heart, and these proposed amendments make that statement even more true than ever.
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PRACTICAL CONSEQUENCES OF THE PROPOSED "PRUDENT INVESTOR" RULE FOR CHARITIES
When the Ontario Government introduced Bill 122 to amend the Trustee Act, (see accompanying article at page for details, it was generally perceived as providing remedial relief from the overly restrictive investment provisions of the Trustee Act. Although the proposed investment power set out in Bill 122, when it is re-introduced, will provide more flexibility for professional trustees and those who act under testamentary and inter vivos trusts, its application to directors of charities will have serious consequences which may not have been fully understood by the Government when Bill 122 was given first reading.
Most of the problems with the new legislation could be remedied if the government adopted the provisions of the model "Trustee Investment Act" proposed by the Uniform Law Conference of Canada. However, as amendments to Bill 122 may not occur when it is reintroduced, some of the more important consequences that charities operating in Ontario affected by the new legislation will need to deal with are summarized below as follows:
• Since the remedial provisions of section 35 of the Trustee Act will no longer apply to investments, charities should review both their current and past investments to determine if investment decisions have violated the Trustee Act and, if so, whether they should consider applying for relief from technical breach of trust now under the current Section 35 of the Trustee Act before its application to investment is repealed.
• As a result of the mandatory criteria that will need to be considered by boards of charities, directors of charities will now be called upon to account not only for potential losses that occur from investment decisions but also for income that might have been earned through more creative and aggressive investment choices. This not a responsibility that most directors are either aware of or are prepared to assume.
• The board of directors will need to become familiar with the new investment provisions and consider each of the mandatory investment criteria before making any investment decisions. The board may need to record each investment decision with reference to the mandatory investment criteria having being considered and why some criteria may have been given greater consideration than others.
• The board of a charity, even a small charity, will need to consider retaining an investment advisor with a proven reputation to provide carefully documented investment recommendations to the board. The investment advisor should provide a written report, which in turn should be attached to the board minutes. The board of a charity will need to carefully monitor the performance of its investment adviser and be prepared to change advisors if a "prudent investor" would do so in similar circumstances.
• Investment decisions should be made by the full board of directors, instead of only an executive committee or finance committee, since the decisions that are made will have a direct impact upon every board member, whether they were part of the investment decision or not.
• The board of directors for a charity will need to meet as frequently as investment decisions are required to be made, which in turns means that board members will need to attend every board meeting, unless absolutely necessary, since absence from board meetings will not necessarily relieve them from liability for investment decisions that are made in their absence.
• If a board member disagrees with an investment decision, it is essential that the board minutes reflect the objection by a board members. If a board member did not attend a board meeting and subsequently learns of an investment that they do not agree with, that board member should voice his or her opposition at the next board meeting (and preferably in writing to all other board members before the board meeting takes place).
• Board members of a charity need to be thoroughly informed about the responsibilities that they face in making investment decisions as a "prudent investor" would. This would also require board members to become generally well informed on investment matters.
• In recognition of the increased responsibility and liability placed upon directors of charities concerning investment decisions, unless a board member is prepared to fulfil the fiduciary obligations placed upon them under the proposed amendments to the Trustee Act, they should carefully consider whether they should continue on the Board of Directors.
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