While most states’ trust laws do not address sustainable investing, in August 2021 New Hampshire became the second state to enact a law that permits trustees to invest trust assets in a way that reflects the trust beneficiaries’ values and beliefs.
Sustainable Investing Approaches
While the term “ESG” and the ESG framework are relatively new, investing with an eye toward non-financial metrics has been around for many years. Socially responsible investing (SRI) was one philosophical antecedent to today’s ESG. During the 1960s, 70s and 80s, SRI was exemplified by calls to divest from defense contractors during the Vietnam War and from South African companies in response to the system of apartheid. Today, investors may adopt exclusionary screens to remove exposure to fossil fuels, tobacco or firearms from their portfolios, whether out of a concern for investment returns or out of a sense of moral objection. Investors may also engage in thematic investing, whereby portfolios are designed to further their broader goals (for example, renewable energy or inclusive finance), or impact investing, where capital is deployed in pursuit of both financial and ESG objectives. The demand for these types of sustainable investments is significant and growing, as investors increasingly seek to use their capital both to earn investment return and to advance their values and beliefs.
Constraints On Sustainable Investing In Trusts
Trustees of irrevocable trusts must navigate this investing landscape while remaining mindful of their fiduciary duty to invest the trust assets. Fiduciary duty is the layer of law that has developed over centuries to create structure and limits to the role of a trustee, defining the trustee’s obligations to all of the parties interested in the trust. Broadly speaking, a trustee has a duty to implement the intent of the trust’s settlor in establishing the trust by investing, administering, and distributing the trust property for the benefit of the trust’s beneficiaries, both current and future. When looking specifically at fiduciary duty surrounding a trustee’s investment decisions, two features of fiduciary duty come into play – the trustee’s duty of prudence and the trustee’s duty of loyalty:
The duty of prudence requires a trustee to invest the trust assets as a prudent investor would, considering the purposes and terms of the trust. This duty is often referred to as “the prudent investor rule.” Generally, the prudent investor rule requires a trustee to look to all sources of information that could inform an investment decision, including general economic conditions, the expected return from income and appreciation of capital, the role that each investment plays within the overall portfolio, and the expected tax consequences of different investment decisions or strategies. No technique is per se prudent or imprudent under this rule.
Investors using the ESG framework understand that many types of ESG information can inform the expected performance of a particular investment. For example, a company that manufactures a product through a process that creates pollution may face future litigation as a response to that pollution, such that its polluting activities today will translate into legal liabilities tomorrow. Similarly, a company with a board of directors that does not have a conflict-of-interest policy might not have effective leadership to guide the firm through upcoming challenges.
Although difficulties remain in the industry’s ability to effectively gather and evaluate ESG information, it is generally agreed that ESG factors can potentially have a material impact on the return expectations of a proposed investment. Accordingly, depending on the purposes and terms of a particular trust, it could be prudent for the trustee to integrate ESG information into its investment decisions, but a trustee is generally not required to incorporate this information into the decision process in order to comply with the duty of prudence.
The duty of loyalty requires a trustee to administer a trust exclusively in the interest of the beneficiaries, both current and future. Under the duty of loyalty, a trustee may not use its role to achieve any other objective, even if the goal is laudable and the beneficiaries are not harmed. Generally, the duty of loyalty evolved in order to protect beneficiaries by categorically prohibiting conflicts of interest in the trustee, rather than permitting and regulating them. (Note that the duty of loyalty may have different parameters and results in the context of a fiduciary’s management of ERISA plans assets, or a fiduciary’s management of purely charitable trusts and corporations.)
Viewed through the lens of the duty of loyalty, some types of ESG investing are a clear violation of a trustee’s fiduciary duty. The duty of loyalty requires that when investing a trust’s portfolio, a trustee should not be motivated by any goal other than advancing the interests of the beneficiaries as provided in the trust instrument. Thus, designing a portfolio to support or achieve a goal that is outside of the purpose of the trust as expressed in the trust document – for example, cleaner oceans or a reduction in fossil fuels – is a breach of the trustee’s duty of loyalty.
However, what if the settlor has expressly authorized the investment of trust assets in line with the settlor’s personal goals or values by a provision within the trust instrument itself? Very few states expressly allow a settlor to include a provision in a trust document which permits sustainable investing strategies, regardless of investment performance. However, many practitioners in New Hampshire agree that the respect for settlor intent that is built into the New Hampshire Trust Code would enforce such a provision included by a settlor in a New Hampshire trust document. These types of provisions, however, are quite new; settlors and their lawyers generally have not considered this issue at the drafting stage until relatively recently. Absent a provision in a trust instrument sanctioning investing to achieve a goal or value that is collateral to the interests of the beneficiaries, can the trust beneficiaries themselves come together and agree that a trust portfolio may be invested in a way that seeks to achieve such a goal?
New Hampshire’s Trust Laws Enable Sustainable Investing
Recognizing the appropriateness and growing interest in ESG investing in trusts, in 2021 New Hampshire became one of the first states to allow trustees to pursue a sustainable investing strategy, regardless of investment performance, at the express direction of all persons interested in the trust. This is accomplished through a non-judicial settlement agreement (NJSA) – a process already available under the New Hampshire Trust Code for other purposes.
By an NJSA, all interested persons in a trust enter into a binding agreement about a matter connected to the trust. As the name implies, a non-judicial settlement agreement need not be approved by a court. However, the subject matter of the NJSA must concern an issue that a court could rule upon. An NJSA therefore provides an expedient way for parties connected to a trust to resolve a trust matter without court involvement. A final requirement to the NJSA process is that an NJSA may not violate a material purpose of the trust.
New Hampshire’s new law allows this established NJSA process to be used by interested persons who desire that the trust assets be invested according to their social, environmental, or governance objectives, or their other values or beliefs, regardless of investment performance. The new law provides that when an NJSA of this type is in place, a trustee must consider the wishes expressed in the NJSA as the trustee applies the prudent investor rule with respect to the trust’s investments. As with any NJSA, an NJSA around sustainable investing may not violate a material purposes of the trust, and the new law also requires that an NJSA allowing sustainable investment not be contrary to settlor intent.
Generally, the interested persons that must be party to an NJSA include the trust beneficiaries, the trustee, and the trust protector (if any). The settlor is expressly excluded from the list of interested persons. Other provisions of the New Hampshire Trust Code allowing for virtual representation allow current trust beneficiaries to use the NJSA process to create agreements that are binding on future trust beneficiaries. In this way, an NJSA as to sustainable investing addresses the trustee’s duty of loyalty by allowing current trust beneficiaries to create an agreement that is binding on future beneficiaries and by expressly permitting the trustee to seek to achieve the collateral goal of supporting the beneficiaries’ sustainable investing goals.
Thanda Fields Brassard, JD, is VP & Trust Counsel at Fiduciary Trust Company, a privately owned wealth management firm based in Boston, Mass., and General Counsel at Fiduciary Trust of New England, a Fiduciary Trust affiliate and New Hampshire-chartered trust company. Patricia Schatzlein Smock, JD, is Vice President & Trust Counsel at Fiduciary Trust Company. For more information, please visit: www.fiduciary-trust.com.