When can trustees invest ethically?

Recent decisions make it easier for trustees to invest ethically without breaching their duties, but a lot of barriers remain. Regardless, settlors can design trusts which enable or require trustees to invest ethically.

Trustees have fiduciary duties to administer a trust in its beneficiaries’ interests. Managing the trust fund by making wise investment decisions to preserve the trust fund and maximise its return benefits the beneficiaries by making more funds available to them. In addition to broad fiduciary duties, trustees typically have a default duty to invest prudently imposed by s. 30 of the Trusts Act 2019. This places an even higher expectation on trustees to make risk appropriate investment decisions maximising trust fund return. By its nature, ethical investment reduces options trustees can invest in by excluding non-ethical investment opportunities, so trustees must take care to not breach their duties by investing ethically. 

Ethical investment comes in many flavours. Three common flavours are:

1. Negative screening: prevents investing in unethical investments;
2. Positive screening: requires investments to satisfy ethical criteria before investing; and
3. Stakeholder activism: investing in unethical investments then using resulting powers to encourage the unethical entity to act ethically.

Negative screening

Butler-Sloss v. The Charity Commission for England and Wales [2022] EWHC 974 (Ch) discussed investment principles broadly and more specifically, what trustees of a charity should do if an investment contradicted their charitable purpose. Justice Green held that investments should generally maximise financial return but non-financial aspects can play a role. If trustees reasonably believe that an investment or a class of investments might contradict the charitable purpose, the trustees must weigh all relevant factors.  In particular financial risk, trust reputational harm, and the degree to which the investments contradict the charitable purpose were relevant factors. Caution was sounded about making moral judgements to screen investment because different people may have different opinions as to an investment’s morality. This decision empowers trustees to negatively screen investments that contradict their trust’s charitable purposes, but it does not broadly allow ethical investments. 

There may be situations where trustees of a charity are required to not invest in a particular investment opportunity because it contradicts the purpose of the charity. For example, if the trustees of the Red Cross invested into companies with the main business activity of producing military tanks, this might be successfully challenged. This style of scenario was contemplated in cases like Harries v. Church Commissioners for England [1992] 1 WLR 1241, but there is sparse commentary on it.

The scope for ethical investment is still limited following Butler-Sloss. However, this case significantly evolves the law beyond Cowan v. Scargill [1985] Ch 270 where trustees were required to put aside their social and political views and potentially even act dishonourably (though not illegally) to maximise financial return for the trust. Megarry VC did not allow negative screening by excluding investments in oil.

Positive screening

Positive screening is more restrictive than negative screening and poses more problems for trustees. In Harries, the plaintiff sought declarations that would expand the negative screening policy used by the Commissioners (equivalent to trustees) to a positive screening policy. This would require all investments to promote Christianity, even if this was financially harmful. Nicholls VC refused to give the declarations sought by the plaintiff because it was too ambiguous what trustees must do when making any particular investment decision. Different people would have different opinions on whether an investment was inconsistent with promoting Christianity. There is a general flavour of reluctance in judicial decisions relating to impose positive screening investment policies upon charities.

Unlike charities where the charitable purpose overlays investment decisions, trustees of non-charitable trusts are barred from a positive screening investment policy. The seminal case is Cowan — the trustees must put the beneficiaries’ interests, namely financial interests, above the trustees’ moral preferences.

Stakeholder activism

Stakeholder activism involves investing in morally dubious companies to try to make them change their ways.  Assuming that the initial investment is financially beneficial, this creates few initial problems for the trust. 

Problems arise when the trustees exercise their powers as shareholders to promote outcomes which, while ethically positive, are financially harmful. For example, Harries considered an analogous scenario where a decision was being made whether to sell houses at or below market value in a village where local people struggled to afford houses. Nicholls VC thought that because the commissioners were unable to do this without express powers allowing this because they were not a housing charity aimed at improving housing affordability.

How to set up your trust for ethical investment

Trustees have their powers and duties defined by trust deeds, so trustees can invest ethically where a trust deed is set up to give them this option. To achieve this, a settlor should first exclude the duty to invest prudently to allow further considerations other than maximising financial return to guide trustees. 

Next, the trust deed should identify clear procedures to help guide trustees when making investments. The more specific you can make the trust deed, the more protection this provides the trustees to invest ethically.  For example, a trust deed could forbid particular types of investments, require trustees to consider factors like benefit to the environment from an investment, or provide a more general requirement like requiring trustees to invest ethically. Depending on your circumstances, we would recommend different approaches.

The easiest policy to enact is forbidding specific objectionable investments because it is the clearest and simplest to follow. However, it is unlikely that a settlor can think of all possibly objectionable investments, so it is best to also add a requirement for trustees to consider and appropriately weight the ethical implications of any investment. Trustees must be careful to properly record in their minutes of meetings that they have followed these procedures because otherwise any decisions made would be invalid and trustees would likely have breached their duties.

While a trust deed can require a trustee to ethically invest, the issue is defining what this requires the trustee to do. Many obligations are too unclear and open ended, such as requiring trustees to only make investments that further the Christian faith. This is because it is unclear and open to interpretation whether most investments will or will not further the Christian faith. Such clauses in trust deeds make it difficult for trustees to effectively manage the trust and opens them up to claims by disaffected people that they are breaching their trustee duties.

Another option for trustees if they have a small number of identifiable beneficiaries and a trust deed that does not allow them to invest ethically would be seeking prior consent from the beneficiaries. There are several ways to approach this, but the underpinning idea is that the trust fund is held for the beneficiaries, so if they consent to ethically investing, it is acceptable.

Fiduciaries more generally

While this article has focused on trustees as fiduciaries, the same analysis applies to other trustees. For example, an executor is a trustee and must manage the estate of the deceased person according to their fiduciary duties. They need to bear the restrictions on ethical investments in mind when making investment decisions.

K3 private wealth team

K3’s private wealth team works with clients to create robust legal structures to safeguard current and future wealth. Setting up robust legal structures now helps ensure they produce the effects that intended, simplifies management and safeguards from potential liability in future. We are experts in the interlocking areas of law required to make these structures effective such as trusts, wills, relationship property, powers of attorney, immigration, and overseas investment. This is our private wealth team’s sole focus.

We can assist in creating, resolving disputes with, or managing structures like trusts, wills, and contracting out agreements. We are well versed create family trusts and charities that are fit for purpose, helping manage them effectively, and deal with any potential disputes. We work extensively with accountants, tax experts, financial advisers, insurers and other experts to protect current and future wealth.

Helen Edwards, Director and head of K3 legal’s Private Wealth team

Helen leads the Private Wealth team at K3 Legal, where she specialises in creating and managing robust trusts and wills to safeguard client wealth. With 23 years of post-qualification experience in both New Zealand and London, Helen brings a wealth of knowledge and keen commercial acumen to her role. Her extensive background allows her to craft effective and practical solutions for addressing client problems.

In addition to her work in private wealth, Helen is involved in private equity investing, capital raising, and business/share acquisitions and dispositions.