Ten Things a Trustee Shouldn’t Say or Do
Jenny McKeown and Arabella Saker
Allen & Overy
(From Issue 9, October 1999)
It is extremely difficult in a commercial and competitive business such as the professional trustee industry to identify potentially dangerous situations before they occur. In this article, we take a lighthearted look at some of the more common dilemmas which a trustee may encounter. However, the purpose of this article is not to suggest that any of the trustees concerned were inept (as the saying goes, “there but for the grace of God go I”). In almost all of the cases set out below, the trustees concerned were reputable, professional trustees. It is intended to highlight how trustees may be able, even when under pressure or facing a difficult enquiry, to respond in a way which reduces the possibility of a mere risk becoming a reality.
1 Trustees’ discretions
Snow White was trustee of a discretionary trust for the seven dwarves. She exercised her discretion to distribute 75% of the trust assets to Happy, whose financial circumstances seemed less secure than the others. Grumpy wrote to complain. Snow White responded in surprise that she thought the dwarves had agreed to this among themselves, but in case she had misunderstood, she enclosed a trustee indemnity for them to sign.
More appropriate response
It was not appropriate to send an indemnity and Snow White’s apparent defensiveness fuelled Grumpy’s concerns. Snow White would have been better advised to keep regular contact with all of the dwarves so as to be familiar with all their needs and wishes. She should then have exercised her discretion independently, without giving reasons. In the absence of obvious malice or capriciousness, her decision could not then be faulted.
2 Shares in family companies
Albert, a scientist, settled shares in his biochemical company on trust for his children, shortly before floating it on the Stock Exchange. The Trust Deed gave the trustees wide powers of investment and sale. After a few years of startling performance, the company’s value went into steady decline and the company is now in liquidation. Albert’s son, Louis, was upset to discover that the trustees had never sold any of the shares and his inheritance was worthless. He wrote to the trustees to ask why none had been sold. The trustees replied that Albert had never asked them to sell any, and they had charged a lower trustee fee to reflect their limited involvement in investment decisions. Louis was understandably surprised to hear that there could be such a thing as a second-class trusteeship, and his complaint escalated.
The safer approach
The trustees had mistakenly overlooked the full extent of their responsibilities. They should have referred primarily to the Trust Deed as the source of their duties, powers and discretions. They might have been in the habit of liaising closely with Albert, but it is from the beneficiaries and not Albert that any claim against the trustees would come. They therefore laboured under the mistaken impression that they had no independent discretion to sell the shares.
3 Settlor’s influence over investments
Trustco Limited was trustee of a trust with a valuable property portfolio. At the request of the settlor, Trustco gave the settlor a power of attorney to enable him to advise them on further property purchases. The settlor used the power of attorney to sell one of the properties without Trustco’s knowledge, causing a loss to the trust fund.
A better course of action
Trustco was mistaken in thinking that it needed to give the settlor a power of attorney in order to enable him to advise them on investment policy, since a trustee can seek guidance on investment matters without delegation. However, since the well-known Jersey case of Rahman v Chase Bank (CI) Trust Company Ltd  JLR 103, it is generally imprudent to rely too heavily on a settlor’s investment advice, and leaving the assets of the trust under his sole control increases the risk that the trust may be attacked as being a sham. Trustco would have been more prudent to keep control of the assets and conduct regular periodic reviews of investment policy with the settlor, whilst not permitting him to dictate individual transactions.
4 In-house funds and self dealing
Offshore Fiduciaries Limited was appointed trustee of a trust with very broad powers of investment. It then appointed itself as Investment Adviser, charging a further fee. In its capacity as Investment Adviser, it recommended that the trustee should invest a large part of the trust fund in the OFL Growth Fund, an in-house fund, for which it received a further commission.
A more prudent approach
As trustee, OFL already had very broad powers of investment, and it achieved nothing (except an extra fee) by appointing itself as Investment Adviser. Furthermore, the appointment may have been legally invalid because, under most systems of law (including English law), it is generally not possible to make a contract with yourself. Whilst it may be perfectly proper to invest in an in-house fund, a prudent trustee might seek independent investment advice before doing so, and check the trust deed contains powers of self-dealing which enable him properly to keep the commissions. It goes without saying that a trustee must always consider the interests of the beneficiaries and not what profit he might make, since if a trustee has an improper motive this can render even an authorised investment unauthorised.
5 Payments to non-beneficiaries
Mr Rusty set up a discretionary trust in favour of his friends, Dougal, Florence, Dylan and Brian. Some years later, he revised his letter of wishes and in it requested the trustees to make a substantial payment for the benefit of Zebedee. The trustees did so.
A safer course of action
The trustees were mistaken in believing that the terms of the letter of wishes were binding on them, or that they could override the provisions of the trust deed. The trustees could not properly have made any distribution to Zebedee unless, on proper consideration of the matter, they determined that it was in the best interests of one or more of the named beneficiaries to do so.
6 The effective date of a deed
Some years ago, Uncle Bulgaria settled some money into an offshore trust for his children, the oldest of whom, Orinoco, was approaching his 18th birthday in late April, 1999. Following the changes made by Finance Act, 1998 to the capital gains tax treatment of the trust under Taxation of Chargeable Gains Act, 1992, if Orinoco remained a beneficiary after his 18th birthday, the trust would be “tainted” and Uncle Bulgaria would become liable to pay tax on all the capital gains arising in the trust (as he is UK domiciled). The trustees therefore decided to exclude Orinoco from the trust but, owing to an administrative oversight, failed to do so before his 18th birthday. Realising their error, they backdated the Deed of Exclusion to the day before his birthday.
Is the trust tainted?
Unfortunately for Uncle Bulgaria, it is. The effective date of a document is the date on which it is actually signed, and not (if earlier) the date it bears on its face. The trustees will be doing Uncle Bulgaria no favours (and are likely to commit a criminal offence themselves) if they conceal their mistake. They should co-operate with him and his advisers by providing the information necessary for him to make a tax return, and may also consider whether it may now be in the interests of the beneficiaries to retire in favour of UK-based trustees, as Uncle Bulgaria’s liability to tax may ultimately be visited on the trust fund in any event.
7 Settlor’s tax claims
Mrs Rabbit (a UK domiciled individual) set up an offshore trust for her children Mopsy, Flopsy, Cottontail and Peter. Recently, the effects of section 86 Taxation of Chargeable Gains Act 1992 (as amended by Finance Act 1998) have meant that she has become liable to pay tax on the capital gains realised by the trust. Schedule 5, paragraph 6 TCGA entitles a settlor in these circumstances to claim reimbursement from the trustee. Mrs Rabbit claimed her tax from the trustees, who sent her a cheque by return of post.
What should the trustee have done?
As Mrs Rabbit is neither a beneficiary, nor a creditor, of the trust, the trustees cannot automatically meet her claim. They need to weigh up the best interests of the beneficiaries. It may be in their best financial interests to oblige their mother to bear the burden of taxation; however, it is not necessarily in their best overall interests if this causes a family rift. If the trustees decide to resist her claim, Mrs Rabbit may seek to issue proceedings against them, and the trustee should seek legal advice as to whether her claim, under an English tax statute, is enforceable against them.
8 Claims by heirs and spouses
Some years ago, unbeknownst to her husband Richard, Cindy, a Ruritanian millionairess, set up a discretionary trust for the benefit of herself and their children. Cindy and Richard are now getting divorced. Under Ruritanian law, he is automatically the owner of 50% of the matrimonial assets. During the course of the proceedings, Richard becomes aware of the existence of the trust and issues proceedings against the trustees for a share of the fund. The trustees decide to resist his claim.
Were the trustees right to do this?
The trustees may have mistakenly assumed that it is only the interests of the named beneficiaries which they should protect, and they may have therefore automatically decided to defend the claim. However, what they may have failed to appreciate is that Richard may be entitled to claim a share of the trust assets and his position may therefore effecttively be that of an additional beneficiary. It would be best to take advice as to whether Ruritanian law operates to vest title to the money in Richard, or whether it merely creates a debt. If the trust money did not belong entirely to Cindy, the trustees should remain neutral, so as not to prefer the interests of the named class of beneficiaries over those of Richard, and should make an application to the court for directions as to how to proceed.
9 Exculpation Clauses
Bill wrote to Flowerpot Trust Company, the trustee of a trust for his children, asking them to make a substantial donation to the horticultural charity set up by his brother Ben. Flowerpot was doubtful as to whether it had power to make payments to a charity, but believing this to be in a good cause, and that in any event the broadly-worded trustee exculpation clause in the trust deed would protect them if they were wrong, they made the payment.
Will the clause cover them
Flowerpot didn’t think about the beneficiaries at all; it was trying to please the settlor. Under English law, the case Armitage v Nurse CA  1 All ER 705 suggested that, if a trustee “acts in a way which he does not honestly believe is in [the beneficiaries’] interests then he is acting dishonestly”. No trustee exemption clause can protect a trustee from liability for dishonest conduct. Even if Flowerpot honestly (but wrongly) believed that the payment was in the interests of the beneficiaries, Flowerpot’s actions had an element of deliberate risk-taking (as it had one eye on the exculpation clause) and deliberate conduct would almost certainly not be protected by the clause. Alternatively, its action may have been negligent. Under some systems of law, changes in the law have been made (or are proposed, for example in England) which mean that a remunerated trustee cannot purport to exclude its liability for negligence.
10 Mud-slinging competitions
Finally, something from an entirely different category: Rupert, a beneficiary of a discretionary trust, wrote to the trustees to enquire why it was that the value of the fund had deteriorated substantially over a number of years and why the trustees had invested in wine, holiday villas and other luxuries. The trustees responded that it was none of Rupert’s business, and that they would not now exercise their discretion in his favour. Furthermore, they added for good measure, the settlor had never liked him anyway (a copy note from the settlor to this effect was enclosed). This sparked long-running and expensive litigation.
What the trustees should have done
We accept that none of our readers would consider responding in this way and would point out that this response did not come from a professional trustee. The trustees would be well advised to provide Rupert with information about the trust’s investments, to which he is after all entitled (Re Londonderry’s Settlement Ch 594, Butt v Kelson  Ch 197). If Rupert continues to raise concerns, the trustees should seek legal advice, and appropriate solutions might include making an application to the court, or retiring in favour of another trustee. Of course, the trustees were unwise to allow themselves to become embroiled in personal and emotive issues. If Rupert is motivated by family tensions then this might be a case which could be resolved by mediation or another form of ADR which might also preserve the client relationship.
The examples above are merely illustrations of how easy it can be for a trustee under pressure to make the wrong choice. The modern trusteeship is increasingly fraught with difficulties, with litigation becoming more commonplace. We hope that this article illustrates that there is no substitute for good staff training and supervision, together with timely and appropriate use of professional advice.
Jenny McKeown and Arabella Saker
Jenny McKeown is an associate in the Litigation Department at Allen & Overy andArabella Saker is an associate in the Private Client Department at that firm.
This article first appeared in the July edition of Trust Litigation Quarterly published by Allen & Overy and is reprinted with their kind permission. Readers wishing to receive future issues of that publication shouldcontact Jennifer Yap on 020 7330 3000.