LEGAL ISSUES IN INVESTMENTS OF
CHARITABLE FUNDS
1. Fiduciary Obligations Of Charities With Regard To Charitable Funds
Charitable trusts and unincorporated associations hold their charitable property as trustees
It is not clear, though, whether charitable corporations are trustees of their unrestricted charitable property
A charitable corporation that holds donor restricted charitable gifts, i.e., endowment funds or restricted funds, does so as a trustee
Directors of a charity are considered to have trustee-like fiduciary duties in the investment of charitable funds
As such, trustee investment powers generally have application to all legal forms of
charities, including charitable corporations
2. Historical Overview Of Trustee Investment Powers
At common law, trustees are expected to act as fiduciaries in making investment decisions
This has generally involved comparing the investment actions of trustees with that of a prudent person
In Ontario, the common law rule was supplemented by a legal list of permitted investments as was set out in the previous Section 26 and 27 of the Trustee Act
A legal list of permitted investments dates back to the turn of the century and was intended to preserve property as opposed to maximizing investment returns
The legal list of investments was seen in recent years as too restrictive and not reflective of current financial reality
This led to the establishment of the "prudent investor" standard in Bill 25 that
amended the Trustee Act, effective as of July 1st, 1999
3. Fundamental Tests Applicable To Trustee Investments
Investments must be authorized either by the terms of the trust, i.e., declaration of trust or letters patent, or by legislation, i.e., Trustee Act
The trustees must deal with investments in accordance with the applicable
investment standard of care and prudence
4. From Authorized Investments Under The Trustee Act Of Ontario
Permitted legal list of investments formally authorized under Section 26 and 27 of the Trustee Act included only conservative investments, such as:
government and municipal securities
first mortgages on real estate in Canada
secured bonds
loan corporations debentures
guaranteed investment certificates
preferred and common shares in "blue chip" companies
The permitted list of investments only applied if the investment was in other respects "reasonable and proper", i.e., exercised in accordance with a required standard of care and prudence of a prudent investor
Investments in mutual funds were not permitted in Ontario
Trustees generally cannot co-mingle trust funds within the charity itself (subject to pending regulations under the Charities Accounting Act) or with other charities
Trustees must distinguish between normal investment powers and special investment powers in endowment agreements and estate gifts
Section 35 provided for court sanctioned relief from technical breaches of trust if trustees otherwise acted honestly and reasonably
Section 35 has been used to provide relief from rules prohibiting remuneration of directors
i.e., Faith Haven Bible Centre case, the court used Section 35 to provide
relief from technical breaches of trust
5. Former Legal List Of Permitted Investments Under Section 26 And 27 Of The Trustee
Act Would Generally Apply If:
A charity was incorporated by letters patent or by a special act in Ontario or was established by an Ontario will as a declaration of trust and was either
silent about investment powers; or
describes its investment powers as being "those authorized by law for trustees to invest in" or such similar phrase
A charity was incorporated federally or in another province that had its head office in Ontario and its letters patent were either
silent about investment power; or
described its investment powers as being "those authorized by law for
trustees to invest in" or such similar phrase
6. Form Legal List Of Permitted Investments Under Section 26 And 27 Of The Trustee
Act Generally Would Not Apply If:
A charity was incorporated by letters patent or a special act in Ontario and included a form of "prudent investor" type of investment power clause
A charity was incorporated federally or in another province that referred to a specific investment power in another statute, i.e.,
Canadian and British Insurance Companies Act
Federal Insurance Companies Act
A charitable trust established in an Ontario will or a declaration of trust that included a form of "prudent investor" investment power clause
The legal list of investment powers under Section 26 and 27 of the Trustee Act
therefore did not have broad general application
B. OVERVIEW OF NEW TRUSTEE INVESTMENT POWERS
UNDER BILL 25 AMENDING THE TRUSTEE ACT
1. History Of Bill 25 Changes To Trustee Investment Powers In The Trustee Act
The former legal list of permitted investments under the Trustee Act did not reflect economic reality or the effect of inflation
The 1997 Uniform Law Conference of Canada adopted the Model "Trustee Investment Act" that
removed the legal list of permitted investments
established the "prudent investor rule" for investment power
permitted investments in mutual funds
permitted delegation of investment decisions to professional investment advisors
In February of 1997, the Ontario Government Introduced Bill 122 called "Red Tape Reduction Act" that included new investment powers under the Trustee Act
The changes to the Trustee Act were welcomed but require some changes
Bill 122 died on the Order Paper when the Legislature was prorogued in December, 1997
The same legislation was re-introduced on November 30th, 1998 as Bill 25
Bill 25 was proclaimed in force on July 1st, 1999
2. Review Of New Investment Powers In The Trustee Act Amendments Under Bill 25
New investment powers will not apply to investment provisions that are contained in other provincial Acts, such as charities established by private legislation
Repeal of statutory list of permitted investments
Replaced with new "prudent investor" standard
Trustee must exercise the care that a "prudent investor" would exercise in making investments
this establishes the "prudent investor" standard as the mandatory standard of care for investment
the standard of care is generally an objective standard with a subjective application
A trustee may invest in
mutual funds (but "mutual funds" is not defined)
common trust funds of trust companies in certain limited circumstances
A trustee must consider at least the following criteria in planning investments in addition to any other criteria that is relevant to 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.
If a trustee cannot satisfy the criteria, then the Attorney General has stated that the trustee will need to demonstrate that it was prudent to prefer one criteria over others
The list of criteria is generally a codification of the common law
The mandatory nature of the criteria, though, increases liability exposure for directors
All of the criteria must be reviewed in developing an investment plan of a charity
A trustee must diversify the investment of trust property where appropriate to
the requirements of the trust; and
general economic and investment market conditions
It is not known how far must trustees go in diversifying investments
Are issues of morality in investments justification not to make an investment notwithstanding diversification requirements?
i.e., opportunities to invest in casino related businesses
i.e., opportunities to invest in tobacco companies
New statutory investment requirements do not override specific terms of trust
possible that charitable objects may override obligation to diversify and obtain the best investment possible
advisable to refer to a statement of faith or other statement of principals, if applicable, in the charitable objects of a charity as part of a charitable trust that would override investment obligations
A trustee may obtain investment advice but there is no statutory power to delegate investment decisions
an investment advisor can give advice to the trustees, but does not have the statutory authority to make investment decisions
whether trustees can delegate at common law is unclear
as a result, directors of charities in fulfilling their trustee investment duty of care will need to meet on a frequent basis to make investment decisions or develop an effective investment policy for use with a discretionary investment fund manager
A trustee is not liable for relying on investment advice, provided that, prudent investors would rely on such advice
New statutory protection from liability for investment decisions will only apply if the loss resulted from an investment plan that comprised a reasonable assessment of risk that a prudent investor would adopt in similar circumstances
but very little practical protection for trustees
no relief will be available from technical breach of trust as is currently available under the existing Section 35 of the Trustee Act
director and officer liability insurance generally does not cover breach of trust
If a trustee is liable, then the courts can look at the overall performance of investments in assessing damages against the trust (i.e., a modern investment portfolio theory)
each separate investment decision can result in a breach of trust
remedial provisions apply only to assessment of damages not to relieving from the breach of trust itself
New investment powers apply to trusts created before and after proclamation of amendments in Bill 25 on July 1st, 1999
the new investment powers, however, do not have retroactive application and therefore do not cure past breach of trust, such as a past investment in a mutual fund
technical breaches of trust in investments can no longer be remedied under
current Section 35 of the Trustee Act
1. New Trustee Investment Powers In Bill 25 Will Apply To
All Ontario charitable trusts, unincorporated associations or charities incorporated by letters patent or by Special Acts, except Special Act corporations with an existing investment power provision; and
All federal or other provincial charities that have their head offices in Ontario and
do not have specific statutory investment powers
2. New Trustee Investment Powers Under Bill 25 Will Therefore Have Much Broader
Application Than The Former Trustee Act Investment Provisions
1. It is essential that each charity review its Letters Patent or Special Legislation to determine
if the new trustee investment power, will apply
2. Consideration may need to be given to applying for Supplementary Letters Patent to avoid
the mandatory investment criteria in the Trustee Act
3. For charities that are affected by the new investment power provisions under Bill 25, the
following considerations should be addressed:
A charity's Board of Directors should become familiar with new Trustee Act investment power provisions with a copy being given to each board member
The Board will need to consider the mandatory list of investment criteria in establishing an investment plan
The Board should develop an investment policy and make a record of each investment decision with reference back to the investment policy
The Board should consider retaining an investment advisor with a proven record to provide investment recommendations to the Board
The investment advisor should provide regular written reports to be attached to Board minutes
The Board will need to carefully monitor the performance of an investment advisor and be prepared to change advisors if a "prudent investor" would do so
The Board does not have the statutory authority to delegate investment decision to a discretionary investment fund manager, but if the Board does, it should develop and implement an investment policy to set out terms of reference in which the investment manager would operate
The Board should meet frequently in order to make prompt investment decisions that may need to be made
Investment decisions should be made at full board meetings, unless there is an authorized delegation to either an executive or finance committees in accordance with the terms of an investment policy
Proper notice of board meetings must be given to board members, preferably with notice when investment issues will be discussed
Board members should become as informed on investment issues as a "prudent person" would
If Board members cannot fulfil their fiduciary obligations concerning investment
matters, they should seek legal advice to consider the advisability of resigning
DISCLAIMER: This summary of Legal Issues in Investments of Charitable Funds is distributed with the understanding that it does not constitute legal advice or establishing the solicitor/client relationship by way of any information contained herein. The contents are intended for general information purposes only and under no circumstances can be relied upon for legal decision making without first consulting with a lawyer and obtaining a written opinion concerning the specifics of your particular situation.
Wardlaw, Mullin, Carter, Thwaites & Ward
235 Broadway, P.O. Box 67, Orangeville, Ontario, L9W 2Z5
Telephone:(519) 941-1760 Fax:(519) 941-3688
E-Mail: tcarter@wardlaw.on.ca Web Site: www.wardlaw.on.ca