A trustee’s duties in volatile markets

Introduction

Market volatility arising from the COVID-19 pandemic is unlike anything experienced in recent history. Two of the largest single day drops in the history of the Dow Jones Industrial Average occurred in March 2020. Later that same month, the S&P 500 Index experienced an 18% surge over a period of three days; and since March, stock indexes in both Canada and the U.S. have recovered significantly from the lows brought on by the pandemic. With this level of volatility in the markets, investors are forced to base their decisions on uncertain and rapidly evolving market conditions.

Trustees that have trust property invested in the markets have additional considerations that can make their roles particularly challenging in these times. In addition to following the terms of the trust deed or indenture, a trustee must continue to act in the best interests of beneficiaries and to comply with the trust legislation in their province. The purpose of this article is to consider the general duties imposed on trustees with an emphasis on duties relating to investing trust property and the possible consequences of failing to comply with such duties. To illustrate, we will refer to trustee legislation and case law from both B.C. and Ontario.

A Reminder of A Trustee’s General Duties

The law imposes a number of general duties upon trustees, including the following:

1. To act in the best interests of the beneficiaries;
2. To act honestly and with the level of skill and prudence which would be expected of a reasonable person administering their own affairs;
3. Not to delegate their office to others (with some exceptions); and
4. Not to profit personally from their dealings with trust property.

In addition to the duties that the law imposes on trustees, the terms of the trust instrument must be followed by the trustees.

With respect to investments, trustees are generally expected to exercise the care, skill, diligence and judgment that a prudent investor would exercise when making investments. This does not mean, however, that a trustee is authorized to invest in a manner inconsistent with the trust instrument. To illustrate how this standard is applied, it is helpful to examine specific legislation and case law.

Prudent Investor Standard – British Columbia

Trustee Act, RSBC 1996, c. 464 (the “B.C. Act”)

The following is a brief overview of some of the most important provisions in the B.C. Act relating to investments made by trustees.

Pursuant to section 15.1 of the B.C. Act, a trustee may invest property in any form or security that a prudent investor might invest, so long as this is not done in a manner inconsistent with the trust.

Section 15.2 of the B.C. Act sets out the standard of care for trustees when investing trust property:

Standard of care

15.2  In investing trust property, a trustee must exercise the care, skill, diligence and judgment that a prudent investor would exercise in making investments.

Section 15.3 of the B.C. Act effectively protects the trustee from liability for a loss to the trust arising out of an investment of trust property if the plan or strategy for the investment that led to the loss was one that a prudent investor would adopt in comparable circumstances. Section 15.5 provides that a trustee may delegate to an agent the degree of authority with respect to the investment of trust property that a prudent investor might delegate in accordance with ordinary business practice.

To better understand the prudent investor standard and how a court would apply the above legislative provisions, it is helpful to examine a case.

Miles v. Vince, 2014 BCCA 289 (“Miles”)

In this case, the court considered whether the trustee of an insurance trust had complied with the prudent investor standard as set out in section 15.2 of the B.C. Act. The trustee had invested all of the insurance trust’s assets in a real estate development called “Main Street Properties.”

The Court of Appeal considered the prudent investor standard in the B.C. Act, especially in light of the fact that the B.C. Act, unlike other provincial statutes, does not expressly impose a duty on trustees to diversify investments. In so doing, the Court of Appeal quoted from Professor Donavan Waters who, in his text Waters Law of Trusts in Canada, writes:

It is true that in some jurisdictions, particularly those retaining the prudent man standard, there is room for argument as to whether the trustee has the duty to diversify. The new prudent investor standard, based on modern portfolio theory, leaves less room for argument; diversity is inherent in modern portfolio theory. Even so, the circumstances of a trust might be inconsistent with diversification. For example, if a trustee is expected to hold property only for a few weeks, it might not be prudent to expose the assets to the volatility which inheres in equity investments [emphasis added].

The Court found that a trustee must always assess the level of risk in a portfolio and the prudent investor standard requires the trustee consider the need for diversification. In this case, the Court of Appeal held that the trustee did not meet the standard of a prudent investor and removed her as the trustee of the insurance trust. In considering a trust’s investments, a trustee must regularly consider the portfolio’s risk exposure and whether further diversification is necessary. In volatile markets, this may mean considering whether a portfolio needs to be rebalanced to ensure that one investment or asset class does not expose the trust to disproportionate risk.

Prudent Investor Standard – Ontario

Trustee Act, RSO 1990, c T.23 (the “Ontario Act”)

Section 27 of the Ontario Act is similar to section 15 of the B.C. Act. There is a prudent investor standard and a requirement that the trustee not act in a manner that is inconsistent with the terms of the trust.

However, subsection 27(5) of the Ontario Act sets out the following criteria that a trustee must consider when planning the investment of trust property:

1. General economic conditions;
2. The possible effect of inflation or deflation;
3. The expected tax consequences of investment decisions or strategies;
4. The role that each investment or course of action plays within the overall trust portfolio;
5. The expected total return from income and the appreciation of capital;
6. Needs for liquidity, regularity of income and preservation or appreciation of capital; and
7. An asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.

Further, unlike the B.C. Act, the Ontario Act contains the following provision on diversification:

Diversification

27(6) A trustee must diversify the investment of trust property to an extent that is appropriate to,

(a) the requirements of the trust; and

(b) general economic and investment market conditions.

In addition, as in the B.C. Act, the prudent investor standard in the Ontario Act extends beyond the trustee’s investment decisions to include related functions. Specifically, the Ontario Act applies a prudence standard to reliance on investment advice, a decision to delegate investment functions to an agent and the selection and monitoring of an agent. Importantly, any delegation of investment functions to an agent must be made pursuant to a written plan or strategy that meets certain criteria and must be regularly reviewed.

Like the B.C. Act, section 28 of the Ontario Act protects a trustee from liability for losses arising from investments if the conduct that led to the losses conformed to an investment plan that a prudent investor would adopt in comparable circumstances, incorporating reasonable assessments of risk and return. In other words, investment losses do not inexorably lead to liability for a trustee; the prudent investor standard is a test of conduct and not a test of investment performance. Investment losses will only lead to liability where the trustee’s conduct does not meet the standard of a prudent investor.

To better understand how a court would apply the above legislative provisions, it is helpful to examine a case.

Groome Estate v. Groome, 2016 ONSC 7850 (“Groome”)

In this case, the court considered whether the investments made by the trustee of Charles Groome’s estate, Mr. Mowry, met the standard of a prudent investor under the Ontario Act.

Mr. Mowry’s “account objectives” relating to the investment of trust property were stated to be 10% growth and 90% speculative. His “risk tolerance” was stated to be 10% medium and 90% high. In addition to the high risk tolerance, there was an overconcentration of the investment portfolio in the energy sector.

In December 2014, the market for energy stocks crashed, and the portfolio lost a significant amount of value. The total loss resulting from the crash was $164,983. The court was left to consider whether the high risk investments, coupled with the lack of diversification, warranted a finding that Mr. Mowry failed to meet the standard of a prudent investor.

The court specifically noted that subsection 27(6) of the Ontario Act imposed an obligation on trustees to diversify the investment of trust property. Despite the fact that the will of Charles Groome granted the trustee broad and discretionary investment powers, the court held that the will did not override the trustee’s duty to exercise the care, skill, diligence and judgement that a prudent investor would exercise in the circumstances or the duty to diversify the investments.

Ultimately, the court found that Mr. Mowry did not meet the standard of a prudent investor and removed him as the estate trustee.

Consequences for a Trustee

There can be significant consequences for trustees who fail to meet the standard of a prudent investor. As illustrated above, courts have the authority to remove trustees from acting in such a capacity.

Further, a trustee may be held personally liable for any losses that result from the breach of their duties or their failure to meet a particular standard. In Groome, for example, in addition to being removed as trustee, Mr. Mowry was ordered to repay, among other things, 50% of the investment losses arising from the crash in the energy sector. It is important to note that it is not the losses, in and of themselves, that led to personal liability for the trustee. Rather, liability arose from his failure to meet the standard of a prudent investor. The court determined that, since it was not unreasonable for a prudent investor to have invested a portion of the portfolio in the energy sector, the trustee should not be personally liable for all of the losses. Rather, the trustee should only be liable for the portion of the losses that flowed from the failure to appropriately diversify the investments.

The personal liability of trustees is not meant to be punitive but rather to put the beneficiaries in the same position they would have been in had the trustees met the prudent investor standard. The court will look at the actual losses suffered as a result of the imprudent investment(s) and will apply the most appropriate remedy in the circumstances.[1]

Practical Guidance for a Trustee

It is clear that trustees have significant duties to consider when investing trust property. A failure to fulfil these duties or to meet the standard of a prudent investor can lead to potential financial consequences. In consideration of all of the above, trustees should keep in mind the following:

1. Review the terms of the trust instrument to ensure you understand the purpose of the trust and its terms, in particular as they relate to investment of trust property, and you are acting consistent with the terms of the trust.
2. Ensure you obtain professional investment advice. To the extent investment functions are delegated, ensure you do so in accordance with statutory requirements, communicate with investment advisors and oversee all investments and strategies.
3. Consider whether other professional advice, such as tax or legal advice, should be obtained. A lawyer can assist you in understanding the trust instrument and applicable law.
4. Keep records of the professional advice you have obtained, which should be in writing.
5. Ensure that your investments are sufficiently diversified. Investments should be diversified in accordance with the trust’s purposes and terms, whether or not you are in a jurisdiction with legislation that specifically imposes a duty to diversify.
6. Document your decisions in writing, making specific reference to any statutory standards or criteria that you are required to consider and the reasons for exercising or not exercising any discretion given to you in the trust instrument (such as balancing the interests of income and capital beneficiaries).
7. Communicate with beneficiaries proactively and consider providing them with an update on the trust’s performance during this volatile period and the steps you are taking in response, including professional advice.

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[1] See: Canson Enterprises Ltd v Boughton & Co, [1991] 3 SCR 534 and Hodgkinson v Simms, [1994] 3 SCR 377

The authors would like to acknowledge the contributions of Thomas Ghag.