Has your trust got the right powers?
Trusts come in all shapes and sizes but the longer a trust lasts and the larger the potential value of the assets the more likely it is that the beneficiaries will look closely at how the trustees are managing it and this in part depends on their skills in observing the powers they have but also looking ahead to ensure they have sufficient powers. Some recent cases illustrate the need for vigilance.
Trusts have traditionally been used to hold a successful business person’s business be it shares transferred into trust during his or her lifetime or under their Will; often as part of a tax planning exercise or as a means of ensuring the whole business was kept together for the benefit of a range of beneficiaries hopefully protected from divorce and bankruptcy.
The challenge in drafting such trusts is to include enough powers for the trustees to enable future needs to be met whilst at the same time including protections for trustees, particularly professional trustees, which may provide a defence against possible claims for breach of trust by disgruntled beneficiaries.
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Actions for breach of trust are more likely to arise where there has been inaction or a failure to future proof the trust so trust administrators should be active in their review of trusts under their management.
Do trustees have the ability to retain in trust only the original shares transferred by the business person or must they diversify in the light of s.4 Trustee Act 2000?
The case of Gregson v HAE Trustees Ltd  EWHC 1006  WTLR 999 confirms that the obligation is to consider diversification rather than actually diversify:
Henry Cohen created a discretionary trust for the issue of his grandparents on 17 June 1960 and appointed HAE Trustees Ltd (HAE) as trustee. HAE was incorporated on 30 May 1960 to act as executor or administrator of estates or as a trustee.
The Settlor and his two brothers, Alfred and Edwin, acquired and built up the furniture store Courts plc and by the early 1960s it was a valuable company. The original directors of HAE were the three brothers and later others were added who were mostly members of the Cohen family.
Substantially the whole of the property of the trust consisted of shares in Courts and HAE retained these shares since they were put into trust.
The claimant is a member of the Cohen family and a beneficiary of the settlement. Her share is 25.733% of the trust fund. Unfortunately, Courts went into administration on 30 November 2004 and was insolvent so the shares became worthless. The claimant alleged that HAE was in breach of duty in failing to review and diversify the assets of the settlement.
Since HAE had no assets as a result of the insolvency the real targets of the claimant were the directors of HAE. She sought to claim against them not directly but by alleging that they were liable to HAE for a breach of their duty of care to HAE and that such claims are trust property of the settlement – known as a ‘dog-leg’ claim.
The wording of the settlement deed contained the following clauses:
“1(b) “the Trust Fund” means the said sum of £100 and any further money or property that may at any time or times hereafter be paid or transferred to or otherwise vested in the Trustees by or at the instance of the settlor without any other direction or declaration of trust and the property for the time being representing the same respectively.
2. The Trustees shall hold the Trust Fund as to so much thereof as shall consist of money upon trust to retain the same [or] any part thereof uninvested for so long as the Trustees may think fit or at any time or times in the discretion of the Trustees to invest the same or any part thereof in any manner hereinafter authorised and as to property other than money upon trust to allow the same or any part thereof to remain in its actual condition or state of investment for so long as the Trustees may think fit or at any time or times in the discretion of the Trustees to sell call in and convert into money the same or any part thereof.
8. Money subject to the trusts hereof may be invested in the purchase or other acquisition of any property of whatsoever nature and wheresoever situate and whether or not subject to encumbrances or involving liability of any kind (including the lending or deposit of money with or without any personal or other security and upon any terms and conditions whatsoever) to the intent that the Trustees shall have the same full free and unrestricted powers of investment and of changing investments as if they were absolutely entitled to the Trust Fund beneficially.”
By clauses 4 & 5 of the Memorandum and Articles of HAE the affairs of the company were to be conducted with a view to avoiding the acquisition of any profit or gain and no part of the income, property or assets of the company were to be transferred whether by way of dividend, bonus or otherwise to any member of the company. It was trustee not just of this settlement but also of a number of Cohen family trusts.
The directors of HAE said that they did consider the question of diversification from time to time and had good grounds for concluding that the shares should be retained. It was always the wish of the Cohen family that Courts should remain substantially a family owned and managed company. The directors also rely on letters of wishes by which the settlor indicated that the shares should not be sold unless there was a takeover. The family’s combined shareholding in Courts was a majority shareholding until late 2004 and diversification would have risked eliminating the family’s controlling holding. Other matters affecting diversification were the cost of the tax bill from any sale of shares and the terms of the shareholder agreements affecting the shares.
It was also strongly stated that the claimant had, with full knowledge, consented to and concurred in the retention of the Courts shares by HAE.
There were two main issues in the case:
- Whether the directors owed an indirect duty to the beneficiaries of the settlement under a dog-leg claim and
- Whether there was an obligation on them to diversify the trust assets
The dog-leg claim failed. On the second issue the directors argued that they were not under a duty to diversify away from the Courts shares since they were not part of the investments of the trusts under s.4(2) Trustee Act 2000 but were simply retained under clause 2 of the settlement. Since HAE had not decided to convert the shares into money none of the investment duties under the Trustee Act 2000 applied to the shares.
Section 4 imposes two separate duties:
- it requires the trustees in exercising a power of investment to have regard to the standard investment criteria; and
- from time to time to review the investments of the trust and consider whether, having regard to the standard investment criteria, they should be varied.
For the purposes of the Act “the investments of the trust” comprise any asset of the trust which happens to be invested whether originally settled or coming into that state of investment later. The purpose of the statutory duties under the Trustee Act 2000 was to protect beneficiaries and therefore they apply not just to after acquired investments but also to all the property of the trust.
The Judge also rejected the notion that clause 2 of the settlement overrode the application of s.4(2) of the Act as the shares were not available for investment because HAE had not exercised its discretion to convert them. HAE had complete discretion whether to keep the shares or convert or sell them and invest the proceeds.
However, the Judge did point out the important qualification to the duty to diversify which appears in s.4(3)(b) – “in so far as is appropriate to the circumstances of the trust”. In this case the matters which were capable of qualifying the appropriateness of diversification of the trust were:
- the nature and purpose of the settlement
- the existence of clause 2
- the letters of wishes
- the shareholdings of other family members or trusts in Courts
He confirmed that the duty in s.4(3) is a duty to review and consider diversification of the investments of the trust not a duty to diversify.
Do the trustees have to get involved in the management of the business?
In the case of Jones v. Firkin-Flood  EWHC 2417 the deceased had three children: Daniel (D), Ian (I) and Louise (L). Whilst Douglas, the deceased, was ill with cancer he made various Wills, the last was made 4 days before he died. Under this Will he appointed as executors and trustees his solicitor (J), I and two long-standing friends N and B.
The Will divided his estate into two parts – a trust fund and residue. The first part was constituted as the Bredbury Hall Trust Fund and consisted of all his shares in two companies. This fund was to be held on broad discretionary trusts in favour of D, I and L and I’s children. The residue of his estate was to be divided into different proportions for his children: 50% to I; 30% to D and 10% to L.
The deceased died in February 2001. In March a meeting attended by D, I and L agreed that in default of any discretionary appointment shares in the income of the trust fund were to be divided as to 60% for I, 30% for D and 10% for L.
On 31 January 2008 the trustees of the Bredbury Hall Trust along with other shareholders in one of the two companies contracted to sell the company to Bredbury Hall Ltd for an aggregate consideration in cash and assets of £17,458,763. At that time the shares sold were held as to 456 by the trustees, 71 by I and 274 by the other company whose shares were owned by the trust. As part of the sale the Trustees undertook not to distribute that part of the trust fund which constituted cash for seven years.
At the trustees’ meeting on 6 February 2008 they unanimously resolved that the capital of the trust should be distributed as soon as possible – £2.5 million to D; £1.5 million to L; and the balance to I.
The claim was brought by D and L about the inadequacy of distribution to them (they alleged it should have been equal shares) and as to the failure of the trustees to provide proper accounts and information in connection with the administration of the estate and the trust fund.
The trustees issued a Part 8 claim under CPR 64.2 seeking the Court’s determination as to whether their powers under the Will were restricted, limited or compromised by the alleged equal shares agreement; and second, whether the trustees might properly exercise their powers of appointment and distribution under the Will trust so as to give effect to the proposed distribution of capital.
The Court concluded that:
- Due to the similarity between his last Will and earlier Wills the testator had formed a settled intention to provide for his children in unequal shares, with I receiving the largest share. There was no equal shares agreement. The trustees were entitled under their powers of investment to give the warranties provided on a sale of the trust’s shareholding in order to achieve the best price yet were able to distribute the trust fund.
- The share sale agreement was valid and binding on D and L in that if they received a capital distribution from the trust they would have had to provide the covenant required of them by the share sale agreement. The trustees had not surrendered their discretion by virtue of this sale agreement and there was no loss to D and L for which the trustees could be liable to them.
- The trustees had abdicated their duties. J in particular demonstrated his unfitness to be the sole professional trustee. I had committed substantial and serious breaches of trust by both commission and omission but this was mitigated by the fact that he was ignorant of his duties as both a director and trustee because J had not advised him of these duties. N and B were also guilty of breach of duty but entirely by omission. In other words I was allowed to run the businesses which were assets of the trust without any interference from the other trustees. There was no clause in the Will absolving the trustees of the need to receive an adequate flow of information to make use of their controlling interest should this be necessary for the protection of the trust assets – Barlett v Barclays Bank Trust Co  1 All ER 139.
- The governing criterion, consistent with the need to have regard first and foremost to the interests of the beneficiaries was to constitute a body of trustees who would be able to restore the administration of the trust as a basis of commanding confidence and respect of all the beneficiaries and enabling impartial consideration of the beneficiaries’ claims over distribution.
As a result J, I and B were removed as trustees. N was retained to preserve some family connection.
This case provides a timely reminder of the dangers of adopting a laissez-faire approach to the supervision of a trust’s trading businesses and of the particular risks which can arise when beneficiaries are also involved in the running of the business. The trustees did not participate in setting I’s salary and took no interest in the fact that the businesses did not pay out any dividends.
It is not sufficient to claim ignorance of one’s duties as a trustee and the penalty of failure is removal and potential personal liability. It was not a defence for the trustees here to say ‘we were just doing what the settlor wanted’. Trustees must consider and exercise their powers and duties fairly and impartially.
If the trust does not contain modern or sufficient powers what should you do?
In cases where there is sufficient value in the trust and it is worthwhile to incur costs to improve the position for the future then trustees must look to the courts for a solution.
The recent case of Sutton & others v England & Others  EWHC 3270 illustrates some of the practical difficulties involved. This was a complex case requesting directions for the trustees, authorisations for things done in the past and to be done in the future and extra powers under the trusts.
The Settlement was created in 1940 by four brothers and benefitted their respective families. It provided for the fund to be divided unequally on the death of the last surviving issue of the four brothers living at the date of the settlement; meanwhile the income was to be paid equally to the brothers until their deaths and thereafter in equal shares to their children per stirpes with successive generations taking if the prior one failed. There was also cross accruer provisions.
Subsequently, the Settlement deed was rectified to amend the payment of income in unequal shares along the same lines of division of the ultimate capital i.e. 50%, 20%, 15% and 15%.
Ever since the 1 December 1949 when the Deed of Rectification came into effect the income has been divided in accordance with this unequal percentage division.
The basic problem with the administration of the trusts is that the way the Settlement was worded meant that the beneficiaries of each stirps do not have a share of the income of a specified part of the fund but rather a specified share in the income of the whole fund – i.e. there are not sub-funds or partitions; so that when one life tenant dies it is difficult to determine the incidence of any capital tax – the deaths generate a liability and the tax has been paid but how should it affect the income portion of the stirps?
Over the years the trustees made a decision that the income of the stirps had to be adjusted – they did this by treating the tax paid as if it were an advance to the ultimate beneficiaries of that stirp and treating the beneficiaries of that stirps as if they had received income equivalent of interest on that tax and bringing it into hotchpot. This was done on the advice of counsel and has been done on more than one occasion in the past.
There are two approaches in the text books for dealing with this problem:
- The arithmetic approach – adopted in this case; and
- The proportionate approach – proposed by HMRC on one death but not taken up by the trustees
There are no right or wrong approaches it would seem but taking the arithmetic approach has made a difference over time because of inflation and the increase therefore in asset values. The trustees wish to change tack and make an advance which they would like to treat in future on the proportionate basis without unravelling the part treatment. The court was asked to effectively ‘let sleeping dogs lie’ as far as the past was concerned whilst at the same time give the trustees absolute discretion to as to how IHT should be borne and reflected between those beneficially interested in the fund in the future.
The judge was quite prepared and did approve of the past action but was not prepared to provide the trustees an absolute discretion in the future. He offered to add a power to act on the Opinion of senior chancery counsel having given notice to the adult beneficiaries and the parents of any minors in case they wanted to challenge that advice.
One of the reasons the trustees wanted the discretionary power was because one branch of the family had relocated to America and the combination of UK IHT and US taxes where there was no double tax relief for the clash would be sufficient to wipe out the whole of the capital value of the potential stirps in the fund on the death of the current life tenant. There was a good chance that these tax consequences could be ameliorated by an appropriation of assets to a sub-trust but there was no power to appropriate under the existing trusts.
The trustees wanted the court to provide such a power and exercise its jurisdiction under s.57 Trustee Act 1925 to do this. The Judge set out the words of the section and noted that the ability of the court to vest a power in the trustees under this section was ‘where in the management or administration of any property invested in the trustees….is in the opinion of the court expedient……the court may by order confer upon the trustees ….the necessary power for the purpose’.
However, the list of transactions in s.57 for which the power may be needed were:
- Other disposition
- Any purchase
- Or other transaction
Appropriation was not in this list and although it would be expedient to permit the trustees this power the Judge was not inclined to grant it. He reviewed the old and modern authority and noted that a power of appropriation can be conferred or exercised where the prime purpose is administrative and managerial and any affect on the beneficial interests is incidental but he felt it would not be incidental in this case. He said that the family could always make an application under the Variation of Trusts Act 1958 to achieve what they wanted.
The trustees also wanted confirmation that they could use s.32 Trustee Act 1925 to advance non-contingent interests to two adult children of the current US life tenant by removing the cross accruer rights of others in their share so as to create a divorce of the US beneficiaries strip from the rest of the fund. He was not willing to give his blessing on using s.32 in this way. He said the proposed acts were not being done to ‘property subject to the trust’ but to ‘interests under the trust’ and only property could be advanced under s.32.
He was however willing to permit the trust to be altered to include some additional administrative powers in line with modern trusts using his s.57 powers. The only exception to the list was one which dealt with the payment of tax liabilities and sought to permit trustees to pay these liabilities from the trust even though they were not enforceable against the trustees. He felt that was going too far, particularly as the only reason for it appeared to be to protect any particular trustee who may be faced with difficulties in travelling abroad personally to a country whose taxes had not been met because they could not be enforced against the trust. He said if this was a real problem then in a particular case an application for directions would have to be made when the matter arose.
Altogether, the trustees did not get much from the exercise but it highlights that there is perhaps a little used section in the Trustee Act 1925 which might be able to help a trustee lacking express powers in other more simple cases.
- The moral of these stories is to keep all the trusts you manage or of which you are a trustee under review – don’t fall asleep on the job!
- When drafting trusts consider the nature and purpose of the trust and therefore whether it is likely the Settlor will want the trustees to diversify or not. If not, it is worth including a clause advising the trustees that they are under no obligation to diversify and accompanying the trust with a full letter of wishes setting out why this trust might usefully not diversify and what was the Settlor’s purpose in creating the trust with the particular assets he or she did.
- Where the trust is to hold business assets do consider whether an anti-Barlett clause is needed. If the business is likely to be run by a beneficiary who is also a trustee make sure s/he is fully briefed and updated as to his or her duties as trustee. If there is likely to be self-dealing does the trust need to be able to permit this without an immediate breach of trust?
- New financial products come along; new taxes arrive and beneficiaries seek new horizons in other jurisdictions – so always be vigilant as to the impact this might have on trusts you manage and consider including the useful clause permitting trustees to be able to alter their administrative provisions at will to keep the trust fresh and able to cope with change.
© Gill Steel, LawSkills Ltd. 2010
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