THE RIGHTS OF BENEFICIARIES TO THE IMPARTIAL JUDGEMENT OF THEIR TRUSTEES
John Ross Martyn examines the positon of trustees and conflicts of interest and
finds that all may not be as is often assumed
(taken from Issue No 17 October 2001)
The principles of trust law are well established, and do their work well. Were this not the case, countries other than those of the common law would not have adopted them (no doubt with some modifications) to create their own laws of trusts. Recently news has come of what may well be their greatest triumph, the promulgation of a law of trusts for the People’s Republic of China.
One of the reasons for the success of trust law may be its comparative flexibility. However, it is perhaps a mark of this flexibility that the relationship between its different principles, and indeed their content, has not been conclusively defined.
This article will suggest that there is one principle which has hitherto been somewhat neglected, and may need to receive more attention than it has. This is the principle that beneficiaries are entitled to have the advantage of the impartial judgement of all their trustees.
Four fiduciary rules
Before saying anything more about this suggested principle, four more prominent and perhaps better known principles must be stated. This can be conveniently be done by reference to their formulations in Chapter 20 the new edition of Lewin on Trusts. They are as follows:-
1. A trustee is not in general allowed to retain a benefit acquired or profit made by him from the use of the trust property or in the course of and by virtue of his trusteeship (the profit rule).
2. A trustee is not allowed to place himself in a position where his personal interest, or interest in another fiduciary capacity, conflicts or possibly may conflict with his duty (the conflict rule).
3. A trustee is disabled from purchasing the trust property, whether the sale is by private contract or public auction, and whether it is by himself as a single trustee or with the sanction of his co-trustees (the self dealing rule). This is derived, at least in part, from the conflict rule
4. A purchase by a trustee of a beneficial interest in trust property can be set aside by the selling beneficiary unless the trustee can show that he has taken no advantage of his position and has made full disclosure to the beneficiary, and that the transaction is fair and honest (the fair dealing rule).
The absence of any conclusive definition of the relationship between the rules is illustrated by the different views that have been expressed about the first two of them, the profit rule and the conflict rule. Textbooks of high authority such asSnell’s Equity and Underhill and Hayton on Trusts and Trustees, and the decisions of the House of Lords in Phipps v. Boardman1 and Swain v. Law Society2, have treated the rule that a trustee cannot make a profit from his trust as part of the wider rule that a trustee must not put himself in a position where his duty and interest may conflict. However the editors of Lewin argue persuasively at 20-27 that it is better to speak of two distinct, though allied rules. This is because, as happened in Phipps v. Boardman itself, the profit rule applies even if there is no conflict of interest.
There are a number of exceptions to the self dealing rule. Apart from certain classes of transaction authorised by statute, and those sanctioned by the court in particular cases, the exceptions as mentioned in Lewin are such transactions as are made:-
1. In accordance with a power expressly conferred by the relevant trust instrument.
2. In circumstances where the trustee has not placed himself in a position of conflict of interest and duty but has been placed in that position by the settlor or the terms of the trust.
3. With the concurrence of the beneficiaries, all being of full age and capacity, after a full and proper disclosure as been made to them.
Is there a fifth rule?
Lewin states at 20-64 that the self dealing rule applies to loans made by trustees out of trust assets to one of themselves. It cites Anon. v. Walker3 as the primary authority, and then a number of others. The statement must be correct. However later in the book, amidst a number of miscellaneous points about the exercise by trustees of their investment powers, it is put on a somewhat different basis when applied to loans on mortgage. The passage is at 35-170, and reads as follows:-
`Trustees are precluded from lending on mortgage to one of themselves, as all must exercise an impartial judgement as to the sufficiency of the security.`
On its wording, this is not merely an application of the self dealing rule. It appears to be derived from, and be an example of, another principle. This is the principle that beneficiaries are entitled to have the advantage of the impartial judgement of all their trustees. It might be called `the impartial judgement rule`.
Two of the three cases cited in support of the statement at 35-170 of Lewin can be read as supporting the existence of a separate principle, and the third does not cast doubt on it. In Anon. v. Walker at 7, Leach MR said:-
`When a testator empowers three executors to lend money on personal security, he must be taken to rely upon the united vigilance of the three with respect to the solvency of the borrower. If two of the three lend it to the third, this object is defeated, and it is a breach of trust.`
To the same effect is the remark of Pepys MR (afterwards Lord Cottenham LC) inStickney v.Sewell4:-
`The testator intended that the estate should have the benefit of the executors’ discretion; but they lend to themselves.`
These cases are old ones, but it remains the law that `The beneficiary is entitled to the decision of all his trustees but, at the same time, he is entitled to require that the decision is made independently of any private interest or competing duty of any of the trustees`: Hart J in The Public Trustee v. Cooper5.
It is probably unnecessary to go into the question whether there is a separate `impartial judgement rule`, or whether it is merely an aspect of the self dealing and conflicts rules. Cases in which an impartial judgement rule would apply, but the conflict and self dealing rules would not, are likely to be very rare indeed.
Even if the right of the beneficiaries to the impartial judgement of all the trustees is no more than an aspect of the conflict and self dealing rules, it broadens their emphasis. It makes their purpose not only one of preventing conflicts between duty and interest, but also of ensuring that the beneficiaries have the advantage of the judgement of all the trustees. This may be an especially significant consideration if the testator or settlor has chosen his trustees for the different kinds of expertise they each possess.
Three practical consequences
I want to suggest three ways – readers may well be able to think of others – in which all this may be significant in the regular administration of trusts, and in trust disputes.
1. If the purpose of the conflict rule is, in part at least, to ensure that the beneficiaries of a trust have the advantage of the judgement of all the trustees, this purpose has to be borne in mind whenever any question arises as to whether the rule applies to a particular set of facts. It has also to be borne in mind whenever the rule does apply, and a transaction is being carried through in a way that is intended to avoid its consequences. Suppose, for example, a trustee is purchasing trust property, and the purchase is being made effective by the concurrence of all the beneficiaries, they all being of full legal capacity. The beneficiaries may well obtain independent valuation advice, either because of their own commercial good sense or because the trustees are advised that it is required in order to satisfy the fair dealing rule. However, if the purchasing trustee has an expertise which is relevant to the transaction – say, he is a surveyor and the property is a building – the beneficiaries ought not only to have it for these reasons. They ought also to have it because the testator or settlor may well have appointed the purchasing trustee in order that the trust should have the benefit of his particular expertise. They are not getting that, and ought to have a substitute. Arguably, they ought to have it even though neither commercial prudence, nor the fair dealing rule, require it.
2. The second practical consequence concerns the exercise by the trustees of their powers when they, or persons connected with them, are beneficiaries. On this topic Lewin at 20-116 onwards distinguishes between the administrative and the dispositive powers of trustees. It observes that the profit and the conflict rules create no more than a relatively slight problem for the exercise of administrative powers in this situation. The problem is relatively slight because the general duty of the trustees in exercising administrative powers (for example, a power of investment) is to act in the best interests of the trust for the benefit of the beneficiaries as a whole, acting impartially, or fairly, as between beneficiaries with different interests, including themselves if they are beneficiaries. If the conflict rule applied the result would be that a trustee could not be a beneficiary, which is not English law. It then explains that the problem is more acute for dispositive powers, but that the conflict rule is in practice often excluded because one or both of two of the exceptions to the rule apply. These are those numbered 1 and 2 above, namely where the trustee has been placed in a position of conflict by the settlor or the terms of the trust, and where a power expressly conferred by the trust instrument allows the transaction that would otherwise infringe the rule. The operation of these exceptions in relation to the dispositive powers of trustees has been shown by such recent cases on pension schemes as Re Drexel Burnham Lambert U.K. Pension Plan6 and Edge v. Pensions Ombudsman7.
Any dissent from Lewin ought to be a hesitant and diffident one. Nevertheless I will venture two. The first is that there are arguably three classes of powers. As well as administrative and dispositive ones, there is an intermediate class, made up of at least two members: powers of maintenance such as that in s.31 Trustee Act 1925, and powers of advancement such as that in s.32: see Thomas on Powers, at footnote 36 to paragraph 1-14. Secondly, the reason why administrative powers (including for this purpose powers of maintenance and advancement) create no more than a slight problem for the exercise of administrative powers may not reflect the nature of those powers. It may be no more than an application of exception 1, that the conflict rule does not apply where the trustee has been placed in a position of conflict by the settlor or the terms of the trust.
If this is right, then the application or the conflict rule to administrative powers, and to intermediate powers such as those of maintenance and advancement, requires more examination. The exception must apply when an original trustee, appointed by the settlor, exercises such a power. An example would be a father who is an original trustee exercising a power of advancement in favour of his child, or a business man who is an original trustee making an investment which benefits a relative of his. In the former case the action of the trustee cannot be challenged, provided only that he acts in good faith. In the latter, it cannot be challenged if he has acted in good faith and with the appropriate standard of care. It is the settlor who has placed the trustee in a position of conflict, not the trustee himself.
However, it will not be the settlor who has put a successor trustee in a position of conflict. Therefore such a trustee has to rely upon the suggestion in Lewin that the conflict rule is in effect overridden by the principle that the general duty of the trustees is to act in the best interests of the trust for the benefit of the beneficiaries as a whole, acting impartially, or fairly, as between beneficiaries with different interests, including themselves if they are beneficiaries. This may be right. However, if the beneficiaries have a right to the impartial judgement of all the trustees, the view that the conflict rule is simply overridden by the general duty is less persuasive (as indeed Lewin hints in its references to the Drexel Burnham Lambert case at 20-123). A successor trustee exercising an administrative power in a way that benefits himself or a person connected with him must tread carefully. If the court is concerned at his inevitable lack of impartiality, it will look for evidence that he has considered whether, and satisfied himself that, a trustee with no personal interest would have been as likely as he to exercise the power in the same way.
3. There would seem to be no reason why the right of beneficiaries to have the impartial judgement of all their trustees should not be subject to the terms of the trust. Clauses in trust documents which allow trustees to put themselves in a position where their duty and their interest are in conflict, or which allow self dealing, are generally accepted as proper and effective, at least if safeguards are built in (although the position is not entirely clear: see Lewin at 20-88). Many if not most of the forms of such clauses already in use do on their true construction allow powers to be exercised even though all the trustees cannot use their impartial judgement. The prudent drafter will ensure that settlors at least consider including such clauses, and that his drafts of them are directed not only to the conflict and self dealing rules, but to the impartial judgement rule (or subrule).
John Ross Martyn
5 New Square
1  2 AC46
2  1 AC598
3  5 Russ.7
4  1 Myl. & Cr. 8 at 14
5  WTLR 901, 933F
6  1 WLR 32
7  Ch. 512