Creating a trust – the dangers of not seeking legal advice

 In Trusts

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Creating a trust – North v Wilkinson [2018] EWCA 161

Case Summary from LawSkills | Private Client specialist trainersJohn North, father of the appellants, had carried on a venture as a sole trader. He had designed various devices and over the years had accepted investments from others who entered into agreements with him as to how their investment in the business would treated. None of these agreements were written by a lawyer, and the question arose of whether Mr North had intended to create trusts in favour of these contributors to his business.

The facts

Mr North had designed a device that had been used by Electrolux without his permission. Mr North commenced proceedings, which eventually settled with him receiving nearly $18m in damages. The claimants alleged that they invested significant sums with Mr North for the purpose of enabling him to develop and exploit his inventions. They had all invested on the basis of agreements that they would receive back their original investment, a sum equivalent to five times that investment, and a percentage as agreed between each of them and Mr North. The claimants had argued that the damages from Electrolux were fruits of the venture, and they were entitled to a percentage share of them. The claimants had received a default judgment on this matter in their favour, but Mr North had not paid the sums he owed.

Judge Pelling held in the High Court that Mr North had validly created trusts in favour of the investors—the respondents in this hearing—albeit with ’some hesitation’. Permission to appeal was granted.

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The decision

The Court of Appeal noted that in order to determine whether Mr North intended to create trusts in favour of the investors, the question was whether the three certainties were met —the beneficiaries, the property to be subject to the trust, and the intention to create the trust.

There was no question in this case of the identity of the beneficiaries. The points in issue were whether Mr North intended to create a trust and, if so, the property to be subject to it.

Certainty of subject-matter

For there to be a trust, there must be identifiable trust property.

It is worth recording that, so far as the researches of counsel and the court go, there is no decision of any court addressing a trust created by a sole trader of his business. Nor has any discussion of such a trust been found in any textbook or precedents book.

It was submitted by the appellants’ counsel that there were insurmountable difficulties in identifying the relevant assets. They did not include Mr North’s personal non-business assets, but it was impossible to draw the line with a sufficient degree of certainty.

The Court of Appeal did not accept this argument. “It is true that they may be difficult questions as to whether a particular asset falls for the purposes of a trust to be an asset of the business, but the courts have for many years had to resolve such issues.” One example given by the court was of a bequest in a Will of a business to a particular beneficiary, requiring the assets of that business to be identified.

Counsel also argued that the assets of the business were a constantly changing collection of assets about which there would be uncertainty.

The Court of Appeal held that, “constantly changing assets can form the subject of a valid trust”.

The arguments in the submissions above would apply equally to a trust of the whole business as to a trust of a share of the business. The next submission, however, was directed specifically at the case of a trust of an undivided share of a business. Counsel submitted that such a trust could not take effect on account of an insufficient identification of the assets subject to the trust.

In my judgment,…it is necessary to look at each class of asset of the business. In terms of certainty of subject, I do not see a difficulty in a trust of a share of an indivisible asset, such as real property, intellectual property rights or book debts.”

In a case such as the one being considered, where the beneficial interest would attach to a percentage of a fluctuating credit balance, such a trust would not lack certainty of subject matter, but raised serious issues as to how it would be intended to operate. Those issues would be relevant to whether Mr North had the necessary intention to create a trust.

The creation of a trust of a share in a sole trader’s business undoubtedly causes difficulties, which have not been explored in any authority, but as I see it, they go more to the question of intention than to the issue of certainly of subject-matter.”

Sufficient intention to create a trust

The Court noted that the relevant documents in this case had been prepared without legal advice. The documentation showed the parties had ‘limited understanding of legal matters’, and ‘to a lawyer, it borders in many places on the incoherent’! The Court continued, however, by noting that there is no formality or particular required language for the creation of a trust. It had to examine the terms of the document to determine whether Mr North intended to create a trust and, if so, whether there is certainty as regards the trust property.

Looking at Mr North’s agreement with one of his investors, Mr Wilkinson, first, it was noted that the Court did not believe it had contractual effect: critical terms (such as his annual salary) were subject to further agreement. Mr Wilkinson’s case for a trust of 5% (or 8%) of the business carried on by Mr North as a sole trader rested essentially on the last sentence of the first paragraph of the document:

“The equity position will cover the activities of any company or corporate vehicle, trust, partnership or similar of John North, his heirs or successors.”

The judge at first instance had correctly directed himself that for this document to create a valid trust, the words used by Mr North must show an intention to create a trust, and had concluded, hesitantly, that the requirement was satisfied. The Court of Appeal said, however, that the judge appeared not to have considered that his analysis of the sentence above could lead to a conclusion other than a trust, such as a personal obligation. Nor had he considered the difficulties in a finding of a trust which in turn suggested that Mr North could not have intended to create a trust.

The judge had been right to find that the purpose of Mr Wilkinson’s agreement was to provide him with an equity shareholding in the company that would carry on the business, and that informed the meaning of the sentence highlighted above. But a shareholding would give him a contractual right to share in dividends declared, capital distributions and the like. A shareholding of the size envisaged would not entitle him to participation in or influence over the management of the business. The Court of Appeal considered that this was not a “template for a direct proprietary interest in the assets and goodwill of the business if carried on my Mr North as a sole trader”. The main purpose of the agreement suggested that, if anything, contractual rights were the intended effect of the critical sentence.

This conclusion supported the second ground for concluding a trust had not been created: the agreement had not begun to address some of the issues that would need to be addressed if a trust were intended. No thought had been given to how liabilities of the business would be dealt with; nor how the business would be managed if a trust were created. No provision was made for the fact that the highly speculative nature of the business did not fit well with the conventional duties of trustees.

The final reason to conclude no trust was created was that the language used in the agreement was “inapposite to create a trust, all the more so in the light of the considerations rehearsed above”. Although the intention to create a trust did not require the use of the word trust or similar language, there must be “a clear declaration of trust and that means there must be clear evidence from what is said or done of an intention to create a trust” (Scarman, LJ in Paul v Constance [1977] 1 WLR 527). The Court of Appeal held that there was no such clear evidence in this agreement.

The Court of Appeal considered the other letters of agreement that had been entered into by Mr North and the investors. It did not follow from Mr North’s failure to give effect to what he promised in the letters that he created an immediate trust of undivided shares in his business in favour of the investors. There were no words suggesting the creation of a trust: “the obvious consequence of the failure is not a trust but, as was submitted by the appellants, a claim for damages against Mr North”.

Practice points

  1. The Court noted that in considering whether a trust had been created one looked to the three certainties, but statements as to the settlor’s intention made subsequently are irrelevant. Practitioners should encourage clients to understand that they cannot ‘rewrite history’ merely by advocating what they have previously intended.
  2. Small businesses may be tempted to avoid legal costs and draft documents themselves. Practitioners can use cases such as this one as an example of why paying for legal advice can be a good investment in the long run.
  3. It is unusual to be in brand new territory, where neither authority nor discussion in textbooks can be found. There is perhaps a reason why there has never been recorded discussion of a trust of an undivided share in a sole trader business — it is not very practical!
  4. The Court noted that legal and technical wording was not needed to create a trust. When drafting agreements, the plainer the language used, the easier it will be for a client to understand its meaning and consequences.
  5. Calling something an agreement does not make it one! If enough matters are left uncertain, it may not have contractual effect.

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Case Summary from LawSkills | Private Client specialist trainers