The current pandemic and its impact on markets reminds us of the economic crisis of 2009-2010. Leaving aside for the experts the question of whether the pandemic has triggered or will trigger an economic crisis leading to a recession, the current volatility of financial markets is raising questions for charitable organizations and foundations about how to manage their investments and whether they can (and/or should) be contributing to the federal and provincial governments’ current strategy to spend, spend, spend.
Like in 2009-2010, there are plenty of organizations in the sector that will face significant challenges. Some governments will surely deal with their own resulting deficits by cutting funding to nonprofit organizations. On the donation side, donors will either be confident enough in the recovery before the end of this year to resume giving at near normal levels or, still feeling the uncertainty of the past year, will continue to hold off until the situation is clearer. If the latter happens, it will be too late for many organizations to make appropriate adjustments. Further, with likely negative returns on investments, foundations will likely be facing a reduced ability to meet their disbursement quota requirements under the Income Tax Act.
Contrast this with the high order fiduciary obligations similar to those of trustees that directors of charitable organizations and foundations have with regard to charitable property, most particularly their investment holdings. In Ontario, this is particularly so in relation to the obligation to comply with the prudent investment standard in the Trustee Act. It is hoped that many organizations are weathering the crisis by relying on sound investment policies to guide their decision-making. The following is a brief reminder of important principles relevant to investment policies:
- in Ontario, the Trustee Act requires that there be an investment policy if investment decision making is delegated to an investment manager
- an investment policy can provide the board of the organization with protection from personal liability in the event that a loss occurs, if such a loss resulted from the board relying on the policy for the investment of trust property, and the policy was such that a prudent investor would adopt under similar circumstances
- an investment policy can assist in ensuring that the board has addressed the statutory requirements to comply with the investment criteria and other guidance regarding diversification of investments.
With respect to endowments and other types of restricted gifts, charities have similar fiduciary obligations to respect the terms of the restricted gifts, particularly as those terms relate to the protection of capital. Any failure to respect the terms of such gifts could be considered breach of trust, unless access to such funds is being sought in the current context pursuant to the PGT’s Statement discussed above.
In the recent bull market, charities that have endowments have had little difficulty in meeting their 3.5% disbursement quota. However, if recent trends continue (which is likely), they will have difficulty doing so, either because insufficient income will be earned or because insufficient capital gains have been realized and capitalised in order to avoid encroachment. For organizations that will have difficulty meeting the 3.5% disbursement quota, the following strategies could be considered:
- Carefully read the agreements in question. If a gift is not required to be held in perpetuity, it may be that the period of time that the original capital was to be held has expired and available for disbursement or the agreement permits encroachment on capital in “unusual or extraordinary circumstances” (a more common provision following the last economic crisis);
- If the gift was created by a will, any restrictions contained in the will concerning how long the gift is to be held for must be complied with, but if there is no clear statement in the will concerning how long the endowment is to be held and the only terminology used in the will is “endowment” or something similar, then legal advice could be sought to determine whether the testator had intended to establish a perpetual endowment
- Determine how much an increase in the value of a particular fund is the result of realised capital gains that have been capitalised and might be used to meet the 3.5% disbursement quota.
- A request could be made to CRA to grant a reduction in the disbursement quota for a particular fiscal year if an application is made in writing.
These difficult financial times have created unique challenges concerning the management of investments and endowment funds for charities in Canada. Continued reliance on a sound investment policy and avoiding triggering losses while the markets are in turmoil should assist charitable organizations and foundations in staying the course. Further, while the statutory requirements under the Income Tax Act remain the same in bad and good financial times, charities do have options available to them in order to meet their disbursement quota requirements when facing financial difficulties. Finally, if the organization is in danger of closing, recourse could be had to accessing restricted funds provided the PGT’s guidelines are adhered to.