The Ontario Government recently released draft legislation aimed at various matters under the label of reducing red tape. Contained in that legislation is a substantive change that is very significant for charities in Ontario. This change has the potential of opening the door a little wider for charities and foundations who are interested in making social investments. The draft legislation proposes amendments to the Charities Accounting Act designed to facilitate social investments by charities in the province.
Many charities will be familiar with concepts such as "impact investing", "mission investing" and "program-related investments". There are differences between these concepts, but they share certain common features. They refer to investments – typically loans or equity investments – that are made to generate both financial returns for the investor charity and "social" returns that further the public benefit and a charitable purpose. In many cases, investor charities are prepared to sacrifice financial returns on these investments in favour of the "social" returns that will result from the use of the invested funds by the investee. A low-interest loan to support the growth of a business devoted specifically to hiring disabled or hard-to-employ individuals is one example of this type of investment.
Charities in Ontario have been making these types of investments for many years. Some charities, however, have been uncertain as to how these investments fit within the "prudent investor standard" under the Trustee Act (Ontario). The Trustee Act provides that charities in Ontario, when investing charitable funds, must "exercise the care, skill, diligence and judgment that a prudent investor would exercise in making investments." The Trustee Act lists specific factors that charities must consider in making investments, most of which relate to the prospective financial return and related risk associated with the investment. Charities have wondered, therefore, whether and to what extent they can use endowment funds or other assets to make impact investments that accept lower financial returns and/or involve higher risk with a view to advancing a social purpose. Do these investments meet the prudent investor standard?
In our view, the "prudent investor standard" in the Trustee Act has always provided scope for charities to make impact investments within the context of an overall investment portfolio. The Trustee Act expressly allows a charity to consider "an asset's special relationship or special value to the purposes of the trust..." when making investment decisions, which gives scope to consider – in addition to financial factors – how an investment may further the charity's purpose. Uncertainty, however, has persisted in the sector, and some charities and foundations have been reluctant to move forward with impact investments for this reason.
The proposed amendments to the Charities Accounting Act are intended to provide greater clarity for charities in Ontario that are looking to engage in impact investing. They are designed specifically to address the perceived tension between the prudent investor standard under the Trustee Act and the imperatives of impact investing.
The proposed amendments introduce the defined term "social investment". A "social investment" is defined as the use of charitable property in order to (a) directly further the purposes of the charity, and (b) achieve a financial return. The concept of "financial return" is defined broadly in the proposed amendments. It refers to any outcome in respect of the invested property that is better in financial terms than expending all the property. In other words, an investment that generates any financial return to the charity, no matter how small, will be considered to achieve a financial return for the purposes of this definition.
For investments by charities that meet the definition of "social investment", the draft legislation includes three core provisions:
- charities are permitted to make social investments, subject to the limitation in (b);
- where the social investment is proposed to be made with charitable property that is subject to restrictions on spending out of capital, the social investment can only be made if the charity expects that the investment will not contravene the restrictions on spending out of capital; and
- the social investment will not be subject to the prudent investor standard in the Trustee Act.
There are several requirements to be met when making social investments. A charity must consider whether it needs advice when making social investments and to obtain and follow such advice if necessary. It must also review their social investments from time to time (and consider anew whether they need advice). Finally, the board must be satisfied that the investment is in the best interests of the charity.
The draft amendments confirm that charities will not be in breach of trust to the extent that they are acting on advice. It is not possible to limit or exclude these requirements in the charity's corporate documents (if a corporation) or trust deed (if structured as a trust).
The proposed amendments are helpful in providing clear legislative authority for charities to make social investments, confirming that charities do not need to worry whether such investments fit within the traditional prudent investor standard. These amendments should provide greater comfort to those charities and foundations that are looking to expand their impact investment activities.
Although they represent a possible advancement for the sector, there are a number of questions regarding these proposed changes. It is unclear how the requirement to consider the need for and, if necessary, obtain advice will be applied in practice. How will a board deal with this requirement? The proposed amendments are also not explicit in setting out the type(s) of advice (i.e., legal, financial, etc.) that must be considered. Furthermore, what specifically is required of boards in order to be satisfied that the investment is in the best interests of the charity? It is expected that the Office of the Public Guardian and Trustee (PGT) will release guidance that will assist charities in understanding how the PGT will interpret these changes, and any specific forms of due diligence that the regulator will expect.
Charities will also need to consider their requirements under the Income Tax Act when making social investments. The federal tax rules are separate from provincial trust law requirements and the prudent investor standard. In particular, the Canada Revenue Agency (CRA) generally takes the position that any investment in a non-qualified donee that is made on below market terms may be considered a gift to a non-qualified donee if it is not structured as a program-related investment meeting CRA's requirements for direction and control.
The proposed legislation, when passed, will likely be welcome in the sector and may spur increased impact investment activity despite these uncertainties. As of this date, Bill 154 has passed second reading and has been referred to the Standing Committee on Justice Policy. We will update readers as the Bill progresses. For those who believe that finding new ways of unlocking capital for the public good is positive, these proposals are an encouraging step.
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