Responsible investing by charities: is clarity on the horizon?

The current legal position is not, in fact, terribly “current”. The case law dates from Harries v Church Commissioners for England [1992] 1 WLR 1241 – often called the “Bishop of Oxford case”.

In the Bishop of Oxford case, the Court held that normally, where charity trustees held investments, in order to discharge their duty to further the purposes of the charity, they would have to seek the maximum return from their investments that was consistent with commercial prudence.

The reasoning for this, as nicely summarised in the judgment, was: “Most charities need money; and the more of it there is available the more the trustees can seek to accomplish”.

The judgment did recognise that – in addition to situations in which the governing document of the charity required the trustees to take into account non-financial considerations in making investment decisions – in some “comparatively rare” circumstances, the position may not be as straightforward, and listed these as follows:

• If the objects of the charity are such that investments of a particular type would conflict with the aims of the charity – for example, the investment by cancer research charities in tobacco shares – the charity trustees should not invest in that type of investment.
• If the holding of certain investments by trustees “might hamper a charity’s work by making potential recipients of aid unwilling to be helped because of the source of the charity’s money, or by alienating some of those who support the charity financially”, the charity trustees would have to balance the difficulties or financial loss against the risk of financial detriment to the charity if those investments were to be excluded from the charity’s portfolio, and may decide not to invest in those investments if it was in the charity’s best interests.
• It was made clear in the judgment, however, that the greater the risk of financial detriment to the charity, the clearer the charity trustees would need to be of the advantages to the charity of the decision not to invest.
• Charity trustees may, if they wish, “accommodate the views of those who consider that on moral grounds a particular investment would be in conflict with the objects of the charity” provided that they are satisfied that to do so would not involve a risk of “significant financial detriment” to the charity.

The current guidance from the Charity Commission reflects these circumstances in section 3.3 on “ethical investments”, which it defines as financial investment involving investing in a way that “reflects a charity’s values and ethos and does not run counter to its aims”, and highlights that, as a financial investment, ethical investing is subject to the usual trustee duties as regards to investment.

It recognises that ethical investment may take the form of negative screening, positive screening or stakeholder activism, and gives the examples of:

• an environmental charity with aims to protect wildlife and the environment deciding to avoid investing in companies with a poor environmental record (negative screening)
• a charity with the aim of educating the public in the causes and prevention of heart disease deciding to choose to invest in companies that promote healthy living through their products and services (positive screening)

It should be noted that the legal underpinnings for the current guidance also state that “an ethical investment policy may be entirely consistent with this principle of seeking the best returns” and that “trustees are free to adopt any ethical investment policy which they reasonably believe will provide the best balance of risk and reward for their charity”.

Neil Pearson, head of ESG and social value at Mills & Reeve said: 

“Underpinning a lot of the concern about charities investing “responsibly” is an assumption that investing “responsibly” produces a lower return on the investment.

In a post-pandemic world, where there is real momentum to “build back better” (or greener), businesses that contribute to the problems of society, and the environment, rather than help address those problems, may be regarded by charity trustees as greater investment risks.

For instance, Larry Fink (CEO of Blackrock, with $7tn of assets under management), in his most recent letter to CEOs, observed that:

“Over the course of 2020, we have seen how purposeful companies, with better environmental, social, and governance (ESG) profiles, have outperformed their peers. During 2020, 81%25 of a globally-representative selection of sustainable indexes outperformed their parent benchmark”.

So charity trustees looking to improve the ESG profile of their investment portfolio should take advice on whether a more  “responsible” investment policy can be justified purely on the grounds of better longer-term prospects.

And there is a growing number of financial advisers who offer expertise in the field of “responsible” investment."

For an increasing number of charities, the current legal position seems outdated, given the current widespread ESG focus, and the limited exceptions provided by the Bishop of Oxford case, do not seem to allow charities the freedom to invest as they see fit and that the charity trustees feel they need.

It may be easy enough for a cancer research charity not to invest in tobacco companies, as being contrary to its objects.

What if, however, a cancer research charity wants to respond to the climate crisis by not investing in companies that contribute to the crisis through their activities?

That might still be possible, if it could be demonstrated that such an investment decision would be supported by its stakeholders and not risk significant financial detriment to the charity, or that failure to make such an investment decision would adversely affect its financial support from donations to such an extent that the financial detriment to the charity resulting from that would outweigh the risk to the charity of failing to make the investment.

Such a charity would have to take care to be able to justify its decision on the basis of good evidence, most likely provided by taking professional advice.

So, while it may be possible, it may not be easy or inexpensive to do so.

Public opinion generally, and feeling in the sector particularly, seems to be leaning in the direction of all investors using their influence to do more both in relation to climate change, and in relation to other areas such as social justice issues.

As the law, however, at present only allows charities to invest other than for maximum returns in accordance with the exceptions set out in the Bishop of Oxford case, this prompted a coalition of charities to seek permission in 2019 from the Charity Commission to refer a number of difficult charity law questions about responsible investment to the Tribunal.

Permission was not given. But, in January 2020, the Charity Commission sought views on the barriers trustees they felt were preventing them from investing “responsibly”, and in line with their charity’s aims. The responses from this programme of work resulted in new draft guidance on responsible investing.

The draft new guidance, on which a consultation finished earlier this year, is definitely to be welcomed. Apart from rebranding “ethical investment” as “responsible investment”, it is generally more permissive of responsible investment in its tone.

It contains some more useful examples of responsible investment – not only covering negative screening, positive screening and stakeholder activism, but also including the example of “a heritage charity avoiding investments in fossil fuels because the trustees have evidence that this would damage its reputation, reduce donations and not be in the charity’s best interests”.

In its aim of being more permissive of responsible investment, the draft new guidance was curious in one respect, however, in that it sought to re-interpret the Bishop of Oxford case, limiting its legal principles to charities with a duty to invest imposed in the charity’s governing document – that is, those with investment permanent endowment.

For all other charities, without such investment permanent endowment, the draft new guidance stated the following “broader” principles of draft section:

4.5A:“4.5.1 All charity trustees must act only to further their charity’s charitable purposes, and act in the best interests of the charity.            

4.5.2 Charity trustees should follow principles of good decision making (as set out in the Commission’s guidance CC27) which include, for example, the duty to avoid conflicts of interest.

4.5.3 Charitable trusts and unincorporated associations must follow the investment principles of the Trustee Act 2000, for example relating to advice and diversification (see Section 3 of this Legal Underpinning -Trustees duties, and Section 12 -delegation). These principles technically only apply to “trusts” in the narrow sense of the word, but the Commission recommends these as best practice for other types of charity.

4.5.4  Under section 172 Companies Act 2006, a director of a charitable company must act in the way he considers, in good faith, would be most likely to achieve its purposes, and in doing so have regard (amongst other matters) to the impact of the company's operations on the community and the environment and the desirability of the company maintaining a reputation for high standards of business conduct.  The duty to “have regard to” matters plainly cannot override any other specific duties and is also subservient to the need to act to achieve the company’s purposes.”

The aim of the Commission in producing the new draft guidance was set out in its initial request for views in 2020 – it wanted to:

“ensure charities are aware of what they can do in this area, to understand their options when it comes to investing responsibly, and if necessary, equip them with tools to help make thoughtfully considered decisions.”

The Commission was not in a position to change the legal situation, only to provide guidance that would give charity trustees more confidence to make decisions about responsible investment.

This makes its new interpretation of the old Bishop of Oxford case interesting, and may explain why only days after it began its consultation on the draft new guidance, an application was made to the High Court under s.115(5) Charities Act 2011 for permission for charity trustees to bring proceedings to obtain declaratory relief and directions where they wished to adopt "responsible" investment policies which allowed them to exclude investments that were not aligned with their charities' purposes of environmental protection and improvement.

In the decision on the application, which is seemingly not available free to view, but can be accessed through PLC here, the Judge made a number of points in allowing the application to proceed, as follows:

• the issues raised by the proceedings were “highly topical” and seemingly unresolved by legal authority
• a decision in the area would not only provide necessary protection for the claimants, but would also provide clarity for charity trustees generally
• the Commission acknowledged that the proposed proceedings raised complex issues of charity law and Commission policy, and had wider implications for charities in England and Wales
• the Commission’s apparently new interpretation of the Bishop of Oxford case only added to the need for the matter to be looked at afresh by the court
• the proposed proceedings would also help inform the Charity Commission guidance on responsible investment

The Commission, following the application, noted the existence of the proceedings in its information about the consultation, but confirmed that it would continue with the consultation in any case, and take into account the outcome of the proceedings in due course.