The ESG & Impact Problem for Family Trustees
ESG (environmental, social, and governance) and impact investing have exploded in popularity: a recent PwC report suggests that ESG may make up more than 20% of all assets under management, or $34 trillion. This growth has been driven in part by interest from younger, “next gen” millenials and Gen Zers, who overwhelmingly favor investments that align with their social and environmental values. Although it is unclear whether most ESG investing has real impact, it is absolutely clear that there is demand for these investment products.
This has created a problem for trustees of family trusts: can they choose ESG or impact investments without running afoul of their fiduciary duties?
The short answer is that we don’t know. A trustee owes a duty of loyalty to a trust’s beneficiaries. Under the “sole interest rule,” this has historically been interpreted to require that the trustee only consider the interests of those beneficiaries, and not any other concern–such as personal interest, the interests of others, or broader social or environmental interests. The interests of beneficiaries have also been interpreted narrowly, and effectively reduced to their financial interests. A trustee has a duty to invest prudently, which generally requires a diversified portfolio with market-level (or better) risk and return. Taken together, some legal scholars have concluded that a trustee cannot select ESG investments–such as negative screens that eliminate oil companies–or impact investments–such as an investment in a solar or wind farm with positive environmental impacts–unless (1) they have demonstrated market-level returns and (2) the trustee is selecting them because of those market returns, and not for social or environmental (ie, “collateral”) reasons.
If this analysis is correct, it imposes serious limits on the ability of trustees to engage in ESG or impact investing. Some argue, however, that this fiduciary conflict is illusory, and that trustees should not only feel free to take on these investments but may have a fiduciary obligation to do so. This argument has several versions. Some believe that ESG is likely to produce better financial returns over time than traditional investment approaches, and therefore that trustees would be short-sighted (on pure financial grounds) to ignore it. Others argue that even without superior financial performance, trustees can and should consider the long-term social and environmental interests of beneficiaries and future remainder beneficiaries, who will suffer if society and the planet suffer.
There is no obvious or simple answer to this debate, and that is itself the problem. Trustees work in the shadow of litigation by disgruntled beneficiaries. Uncertainty is the enemy: without clear authority, trustees are unlikely to feel comfortable with ESG or impact investing, at least absent market-level financial returns. Their reticence may lead to “dabbling” in some such investing to satisfy eager beneficiaries, or to outright rejection of these investments. Either may cause conflict with beneficiaries, or between co-trustees with different interpretations of their fiduciary obligations.
What’s Needed: A Simple Opt-In Mechanism
Regardless of one’s view of ESG investing, conflict or paralysis in trustee-beneficiary relations is unfortunate. Waiting for the courts to clarify these issues does not seem like a reasonable solution: judicial common law evolves very slowly, and many beneficiaries feel real urgency around shifting trust assets into ESG and impact investments. Meanwhile, the ever-changing cacophony of commentators davening over these fiduciary questions only adds to trustees’ confusion.
To provide clarity, we need two things:
- a clear set of modifying language that grantors (or settlors) can include in their trusts to change the default fiduciary duties to allow ESG and impact investing;
- clarity that state trust law will stand behind and enforce those modifications, rather than override them and re-impose fiduciary confusion.
In essence, grantors should be able to indicate that they want a more expansive understanding of a trustee’s fiduciary duties, and those wishes should be honored.
The B Corp Movement and the B Trust Analogy
Happily, for direction we can borrow from a very successful analogous development in corporate law that has unfolded over the last 15 years: the “B Corp” or “benefit corporation” movement. To understand how B Trusts could work for ESG investing, let us take a short detour to explore B Corps and how they alter traditional corporate law.
Like trustees, members of a corporate board of directors also have fiduciary duties–in this case, to the corporation and its shareholders. Those duties include a duty to act in the “best interests of the corporation” they serve. In a traditional for-profit corporation, the historical doctrine of “shareholder primacy” holds that this requires maximizing financial profit for shareholders. Consideration of others’ interests cannot conflict with shareholders’ interests. Historically, this has been understood to limit the ability of corporate directors to consider the interests of society more generally, unless doing so is profit-maximizing for the firm on financial grounds. This has long been the default understanding in corporate law and corporate governance.
This does not mean that traditional corporations cannot engage in any action with social or environmental benefits. Instead, it means that such actions must be demonstrably in the shareholders’ interests–and, according to most understandings, in their financial interests. Like with trustees considering ESG or impact investments, this limits the ability of a traditional corporation to consider actions that might harm profitability but have real social impact. It narrows the focus by bringing all discussion back to financial metrics as opposed to broader social or environmental goals.
Becoming a benefit corporation changes this default. In a benefit corporation, the “best interests of the corporation” are defined to include consideration of such broader concerns. This relieves fiduciary pressure on the corporation’s directors by explicitly obligating them–or at least permitting them–to weight social and environmental factors, even if unprofitable, in their decision-making. Opting in to this alternative fiduciary regime promises to protect corporate directors from shareholder litigation if the corporation pursues social or environmental objectives.
In the last decade, the B Corp movement has gone from theory to reality. It has used the same two-pronged approach outlined above. First, various groups have articulated clear alternative fiduciary standards for benefit corporations to adopt. For example, B Lab (a private global certification effort) has now certified over six thousand companies as B Corps that commit to heightened social, environmental, governance, and transparency standards. Second, activists have lobbied state legislatures to adopt statutes explicitly permitting benefit corporations. Thirty-six states and the District of Columbia recognize “benefit corporations” by statute as corporate entities with social, community, and environmental goals beyond profit-seeking. Thus, if a corporation opts in, its directors have a state-sanctioned safe harbor protecting their actions.
How B Trusts Could Work
Like in the B Corp context, a two-pronged approach to B Trusts would need to include (1) private articulation of standardized B Trust provisions that grantors could include in their trusts (just as B Labs provides B Corp certification standards) and (2) modification of state trust law to make such provisions enforceable. Together, this could provide trustees with the safe harbor and reassurance they need.
A non-profit (like B Labs) would be a perfect vehicle for creating standardized B Trust terms. Such provisions might include:
- Redefining “best interests”: B Trusts could include provisions indicating that the grantor desired the “best interests of the beneficiaries” to be conceived broadly to include community, social, and/or environmental considerations. This would define the best interests to be broader than financial gain, so that a trustee could convincingly argue that an investment that created environmental impact (but little measurable financial profit) was also in the beneficiary’s interest.
- Amending the “sole interest” rule: B Trusts could likewise modify the sole interest rule explicitly to permit consideration of broader concerns.
- Redefining “prudent investment”: B Trusts might also redefine prudent investing so that trustees could safely consider social and environmental factors as part of long-term “prudence.” In other words, for a B Trust, preserving, regenerating, or at least not harming the environment might factor into the decision as to whether an investment should be considered prudent.
- Impact reporting: B Trusts might include requirements to report on broader social impact of investments to beneficiaries, in addition to normal financial reporting requirements, just as the bylaws of many B Corps impose such reporting requirements.
I do not claim to have thought through exactly how these provisions should be drafted, or whether they could be adopted by a grantor a la carte versus as a set. (For a scholarly article with examples of some such language, see here.) But some articulation of standardized terms would make it far easier and less anxiety-provoking for grantors and their attorneys, who inevitably prefer trust language that has been broadly adopted by others.
The modification of state law would be the second prong of a B Trust movement. Although various trust laws already permit grantors to include such pro-ESG provisions, and suggest that courts would protect a trustee that followed them, there remains confusion about how safe a trustee really is in such circumstances. Even with a clear directive from a grantor that an ESG or impact investment is permitted even if it is not financially beneficial (or could be a negative for a portfolio’s risk-adjusted returns), some legal scholars have doubted that state courts would protect a trustee that took such impact-oriented action.
Again, uncertainty breeds conflict and paralysis. Only if state law clearly authorizes B Trust provisions are many trustees likely to take ESG and/or impact investing seriously, given the fiduciary risks involved. As a model, in 2018 Delaware took statutory action along these lines by explicitly amending their trust code to make a trust term enforceable that prescribes “sustainable or socially responsible investment strategies … with or without regard to investment performance.” This modifies the common law fiduciary duties of a trustee to allow following a grantor’s express wishes in this regards. This is exactly the sort of state law reform that B Trust advocates should champion. Since then, several other states–Oregon, Illinois, New Hampshire, and Georgia–have adopted similar (although not identical) provisions.
Unfortunately, some of these amendments are less than clear and may introduce new fiduciary confusions. An organized B Trusts movement could provide coherence to this nascent reform of state trust laws. There are many questions to be addressed. Should a grantor’s wishes control, or can a trustee consider a beneficiary’s ESG-related desires? What if there are multiple beneficiaries in a trust with different views? Must a trustee be able to measure or demonstrate social or environmental impact, if they are foregoing traditional financial gain? Even with such demonstrable impact, how much can a trustee impair the financial health of a trust for such social or environmental goals? Is there some ceiling beyond which a trustee will again run afoul of fiduciary obligations to the living or future beneficiaries? For existing or historical trusts, should beneficiaries be able to petition a court–through a non-judicial settlement agreement, for example–to modernize a trust to become a B Trust? Or must the original grantor be the one to opt in to the B Trust regime?
These questions deserve a uniform answer. My point here is simply that uncertainty is not helpful in the trust context, or in trustee-beneficiary relationships. B Trusts could reduce all of this uncertainty by creating a uniform and coherent approach that grantors, attorneys, and states could enact.
The B Corp certification process and the benefit corporation movement in state law illustrate the power of uniformity, messaging, and branding. B Trusts should follow this example. Creating a simple opt-in regime that modifies traditional fiduciary duties will make it far easier to incorporate social and environmental concerns into the family trust arena. Put simply, even if grantors and attorneys could do these things today, the B Corp experience suggests that they are more likely to do so with clear guidance and standardized forms that become widely shared, used by others, and recognized by interpreting courts. Making B Trusts easy is likely to make them far more common.
This essay is designed to provoke thought and discussion–and, perhaps, to launch a B Trust movement. There is a great deal to think through to make such a movement successful. But if we are to take seriously the desires of many beneficiaries–particularly younger or “next gen” beneficiaries–we may need to create clear trust provisions, backed up by clear state law, that allow trustees to take broader social and environmental benefits into account when administering family trusts.
Although I can find no articles calling for “B Trusts” or explicitly drawing the analogy between B Corps and the ESG issue in trust investing, there are several excellent articles on the general topic.
For the leading legal scholarship on this topic, see Max M. Schanzenbach & Robert H. Sitkoff, Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee, 72 Stanford Law Review 381 (2020). You can download this article here.
For an article describing the pro-ESG and anti-ESG regulations being pushed at the state level for the investment of pension funds–which are very akin to private trusts in some ways–see ESG Battlegrounds: How the States are Shaping the Regulatory Landscape in the U.S. This article is available here.
See also Gerard F. Joyce & Bryan D. Kirk, Taking the Next Step With ESG Investing in Trusts. This is available here.
The same fiduciary conflict over ESG investing arises in the context of pension fund investing. There are various articles addressing this conflict, which has parallels to the trustee’s problem in family trusts. See one example here.