A. INTRODUCTION
On January 13, 2014, the British Columbia
Supreme Court in the Fenton Estate decision (2014 BCSC 39) considered an
application to authorize a “total return investment strategy” (i.e.
to allow capital gains to be distributed as a supplement to income) in order to
meet the 3.5% disbursement quota of a charity under the Income Tax Act.
This Charity Law Bulletin provides a brief overview of the decision and in
particular the Court’s reasoning concerning why the implementation of a total return
investment strategy was justified in order to allow the trustee to encroach on
a portion of the capital gains of the charitable trust even though to do so was
not permitted under the terms of the will creating the trust.
B. THE FENTON ESTATE CASE
In his will, the deceased Anthony Michael
Jewell Fenton directed his executor to establish a private charitable trust,
the Tony and Mignon Fenton Trust (the “Trust”), which was to hold the gifted capital in trust in perpetuity. Any
net annual income derived from the Trust was to be distributed to organizations
or individuals that supported infirm elderly in need of home care in Oak Bay,
British Columbia. Further, the will directed the trustee to reinvest a portion
of the Trust’s income to protect the capital from inflation. However, the will
restricted the trustee to distributing only net annual income (i.e. “interest, dividends, rents, royalties and the like”), and as such, the Trust was precluded from encroaching on and
distributing any capital.
The problem surrounding the Trust arose
because the disbursement quota for registered charities under the Income Tax
Act requires that a charity disburse 3.5% of the average fair market value
of its investment property in the preceding 24-month period. Failure to
disburse this minimum amount could result in loss of charitable status. This
became an issue for the Trust, as historically low rates of returns on
investments did not allow the Trust to generate sufficient annual income to
meet the 3.5% disbursement quota, let alone be able to reinvest a portion of
income to protect the capital from inflation as directed by the terms of the
will. The will prevented the trustee from encroaching on capital because the
capital of the Trust was required to be held in trust “in
perpetuity”. Concerning what constituted the capital of the Trust, the Court
was clear that capital gains were considered to be part of the original
capital, not income:
“I view a gain
on, or appreciation of, capital to become part of capital by definition, as
opposed to an addition to capital from interest or income earned on it. For the
purposes of this petition, I consider a power to distribute some part of
capital gains as an encroachment on capital...”
The trustee consequently applied to the
British Columbia Supreme Court for relief by requesting that the Court
authorize a total return investment strategy.
C. THE TOTAL RETURN INVESTMENT STRATEGY
In general, a total return investment
strategy provides an approach for the administration of a charitable trust that
permits the trustee to seek the best returns of income and capital gains
without making any distinction between them. In this case, the use of a total
return investment strategy would provide a degree of flexibility that would
allow the trustee to encroach on capital gains in any year that it
is necessary, notwithstanding that to do so was prohibited under the will, by
adding capital gains to income in order to meet the 3.5% disbursement quota and
thereby avoid jeopardizing the Trust's charitable status.
In considering whether to authorize a
total return investment strategy in this case, the Court considered its use in
previous cases. Specifically, it examined the application of a total return
investment strategy in two similar cases, Re Killam Estate ((1999), 185
NSR (2d) 201) and Re Stillman Estate ((2003), 5 ETR (3d) 260).
Re Killam Estate concerned a will that set up charitable trusts aimed at the
betterment of higher education. The will restricted income to being spent only
to further those objects. To protect the trust from the effects of inflation,
the trustees sought judicial approval of a total return investment strategy to
allow them to distribute portions of realized capital gains to meet the annual
distribution goal of 5% of the market value of the funds. The Court stated that
it had the inherent scheme-making jurisdiction over administration of the trust
to implement a total return investment strategy and thereby permit the trustees
to distribute capital gains despite this being “contrary
to the expressed, unequivocal direction” expressed
in the will.
The facts in Re Stillman Estate were similar to those in Fenton Estate. In Re Stillman Estate,
the trustees were directed under the will to distribute income to charitable
beneficiaries in perpetuity, but had no power to encroach on capital. The trust
was unable to meet the disbursement quota (at that time 4.5%) from income
alone. The trustees consequently sought judicial authorization to utilize a
total return investment strategy. The Court permitted the trustees to
distribute capital gains through a total return investment strategy despite the
will containing directions to the contrary. However, in Re Stillman Estate,
the Court did not do so pursuant to the Court’s
inherent scheme-making jurisdiction of the court over administrative matters,
but instead relied upon the Court’s narrower and more
conservative cy près scheme-making jurisdiction. Cy près jurisdiction allows the court to vary
the terms of a charitable trust and create a scheme for a charitable purpose
trust where its purpose has become impossible or impracticable to attain.
D. CONCLUSION
In the Fenton Estate decision, the
Court followed the more conservative decision in Re Stillman Estate,
granting an order permitting the use of the total return investment strategy
based upon the Court’s cy près scheme-making jurisdiction in order to
allow the trustee to add a portion of realized capital gains to income as
necessary to meet the 3.5% disbursement quota. Whether the authority to
establish a total return investment strategy is based upon the inherent
scheme-making jurisdiction of the court over administration or upon the court’s more limited cy près jurisdiction is less important than
the willingness of the court to grant an order permitting a total return
investment strategy that permits encroachment on capital gains where necessary
in order to meet the disbursement quota of a charity. As such, this case will
no doubt serve as a useful precedent for other charities facing similar
situations.