TRUSTS, CONTROLLING INTERESTS AND NOMINEE DIRECTORS
Christopher Cant sets out some of the less obvious, but potentially risky, areas of concern for
nominee directors and trustees
(taken from Issue No 18 – January 2002)
In re Lucking1 one of the submissions made was that the Court should look through the company in which the trust held shares and treat the company’s business as belonging directly to the trust. Had this submission been accepted the position regarding controlling interests in a company held as trust assets would be much simpler. Unsurprisingly it was not. There is a clear distinction drawn between assets or a business held by trustees and the same assets or business held by a company in which the trust has a controlling interest (whether by virtue of ownership of all the company’s shares or a majority holding). In consequence a different analysis is needed when considering issues such as breach of trust and defences to such claims.
This article is an attempt to consider some of the additional complications that arise from a trust fund comprising a controlling interest in a company rather than owning directly the business carried on or the assets held by the company. There are significant differences and these are matters which should be drawn to the attention of a settlor particularly if there is a choice as to whether or not the trust is to hold shares or the business direct.
Trustees’ duties –
The statutory duty of care imposed by s.1 Trustee Act 2000 will be relevant as regards the acquisition of the shareholding (if the result of an exercise of the power of investment by the trustees), the retention of the controlling interest (if settled) and on reviews of the trust investments. It is unlikely that it will in practice change the position prior to the enactment of that Act.
The statement of the principles applicable to such by Brightman J. (as he then was) in Bartlett v Barclays Bank Trust Company2 has been generally accepted and applied3. These have become known as `the Barlett principles`. Due to this general acceptance it is worth setting out the passage in full
`The bank, as trustee, was bound to act in relation to the shares and to the controlling position which they conferred, in the same manner as a prudent man of business. The prudent man of business will act in the such manner as is necessary to safeguard his investment. He will do this in two ways. If facts come to his knowledge which tell him that the company’s affairs are not being conducted as they should be, or which put him on inquiry, he will take appropriate action. Appropriate action will no doubt consist in the first instance of inquiry of and consultation with the directors, and in the last but not unlikely resort, the convening of a general meeting to replace one or more directors. What the prudent man of business will not do is to content himself with the receipt of such information on the affairs of the company as a shareholder ordinarily receives at annual general meetings. Since he has the power to do so, he will go further and see that he has sufficient information to enable him to make a responsible decision from time to time either to let matters proceed as they are proceeding or to intervene if he is dissatisfied.`
There is perhaps some assistance to be gained from seeing how the trustees’ duties were pleaded in Walker v Stones (supra). The original pleadings in that case were that the trustees were under a duty
(i) not to procure or participate in the disposition of assets held by companies in which the trust was interested which if the assets had been trust assets would have
involved a breach of duties;
(ii) to act prudently to preserve assets of the company;
(iii) not knowingly to stand by idly whilst the assets of the company were depleted.
Slade L.J. accepted that these duties reflected the Bartlett principles.
The duties of the trustees in general are to ensure that they have sufficient information to be alerted to any risks to the trust investment in the company and then when alerted to take the appropriate action. What steps should they take to achieve this?
Compliance with Barlett principles –
There are a number of options open to trustees when seeking to satisfy the Bartlett principles. In re Lucking supra it was stated by Cross J.4 that a reasonably prudent man would be represented on the board of a company in which he is the majority shareholder. He would achieve this either by being a director (possibly the managing director) or appointing a nominee. Cross J. considered that trustees with a controlling interest in a company should act in the same manner.
However, it is clear that although representation on the board is one means of complying with the Bartlett principles it is not the only means. Failure to have such representation will not automatically mean that the trustees have not complied with those principles.
Oliver J. in re Miller’s Will Trust5 accepted that it was satisfactory that an accountant trustee was also the company auditor without the trustees having a representative on the board.
Brightman J. stated that he did not understand Cross J in re Lucking to be saying that in every case it was the duty of the trustees to have one of them or a nominee on the board6. He considered that there could be equally satisfactory alternatives. Without imposing any restriction on the nature of the methods adopted by the trustees he regarded one possibility to be the receipt of copies of the agenda and minutes of board meetings (if regularly held), the receipt of monthly management accounts in the case of trading concern, or quarterly reports. This must be dependent on the particular circumstances.
What the trustees need to do is ensure that the measures that they have taken in respect of the company lead them to reasonably believe that they will receive an adequate flow of information in time to allow them to use their control to protect the trust fund. It may be that the particular circumstances of the company are such that the trustees can only reasonably have such a belief if there is a representative of the trust on the board. Much may depend on the composition of the board, the amount invested by the trust in the company and the nature of the business carried on by the company. One factor that the trustees will have to assess is the risk of harm to the value of the trust’s holding in the period between the receipt of information requiring action and the trustees being able to execute that action. Having a representative on the board may increase the chances of as speedier response from the trustees.
It is important that the trustees should consider carefully what methods to adopt in order to satisfy the Bartlett principles. This needs to be at the time when the investment is acquired (whether on the setting up of the trust or subsequently) and then reviewed on a regular basis thereafter. These deliberations by the trustees should be recorded setting out the various alternatives considered and the factors which have influenced the trustees in selecting a particular method or methods. One of the options which the trustees should nearly always consider is the appointment of a representative to the board even if they decide against it.
Breach of trust –
The claim against the trusts if the company suffers losses is different from claims against trustees who own the assets or business directly rather than through a company. The nature of the trust asset affects the manner in which the breach arises and is pleaded. The claim relates not to the losses suffered by those assets or that business but rather to the loss in value of the share holding. The breaches comprise not the acts which caused the losses to the company but rather either or both the failure to receive information which would have alerted the trustees to the danger or to take steps to prevent the company from acting in such a way as to suffer loss.
The breaches constitute omissions rather than positive acts. The trustees will not necessarily be liable for breach of trust because, say, the directors have acted wrongfully. They will be liable if they have failed to be alerted to the danger of the directors’ wrongful conduct when they should have been or if they have failed to act to stop such wrongful conduct when they had information which should have alerted them to the danger. It is possible that the trustees could be liable even though the directors have not acted wrongfully. For example, it is not clear that the directors of the company in Barlett v Barclays Bank Trust Company acted wrongfully as regards the company even though the bank was found to be liable for breach of trust. The ventures entered into by the company were speculative and from a trust investment point of view dangerous but that did not mean that the directors were in breach of a duty owed to the company.
The differences between trustees holding investments or a business directly in the trust fund and trustees having a controlling interest in a company will affect the defences available to the trustees.
A comparison between the judgment in re Lucking and the Court of Appeal judgments in Walker v Stones illustrate the increased complexity that has arisen in relation to breach of trust claims and in particular the possible defences sought to be relied on by the defendant trustees.
Clauses protecting the trustees – Walker v Stones was concerned in part with an application to strike out the breach of trust claims against the trustees. One ground for that application was that the trust deed contained what has now become a standard clause exonerating the trustees from liability in respect of the management of companies. It is the type of clause that has been incorporated in response to the decision in Barlett. The Court of Appeal applied the decision in Armitage v Nurse7 in giving effect to such a clause with the consequence that the claim was struck out against one of the trustees. The claim continued against the other trustee on the basis that there was an argument that he had acted in a manner which a trustee would not reasonably believe was in the interest of the beneficiaries and that this would constitute `dishonesty` for the purposes of the clause. The scope of the clause did not protect a trustee from breaches in which he had acted dishonestly. In Walker it was alleged that the trustee had acted for the benefit of persons who were not beneficiaries and that on an objective standard this did not constitute an honest exercise of the trustees powers. It was held that this aspect of the matter had to go to trial.
In each case it is necessary to consider the specific clauses of the trust deed in order to ascertain whether or not the trustees can rely on any of the exoneration clauses to stop any claim for breach of trust. When the claim concerns loss arising from the affairs of a company complete protection is conferred by the appropriate exoneration clause provided that the breach does not constitute a dishonest one. When the breach alleged concerns assets owned directly by the trustees then there may be greater scope on the part of the claimants for arguing that the breach is outside the scope of the clause.8
Double recovery principle – since the House of Lords decision in Johnson v Gore Wood & Co.9 applying the Prudential Assurance principle10 there have been numerous cases in which claims for damages made by persons interested in a company’s shares have failed on the ground that the loss was also suffered by that company and it also had a claim to recover the loss. To allow the claim by the person interested in the company’s shares to succeed would be to allow the possibility of recovery both by that person and also the company in respect of the same loss.
The principle has been applied so as to defeat a claim by a controlling shareholder against a solicitor for negligence when the solicitor was acting for both the shareholder and the company and the loss claimed by the shareholder was the reduction in value in his shares in the company.11
The defence holds good even if the company’s claim has in the meantime been determined by settlement or the application of the Limitation Acts.12 The existence of a defence to the company’s claim at the time that the claim would otherwise arise will not prevent the application of this principle to preclude the making of a claim by the shareholder.13 A decision by the company (or its liquidator) that it will not proceed with it’s claim will also not prevent the principle being applied to defeat a claim by the shareholder for the same loss.14
The principle does not operate to prevent claims by the shareholder only in those circumstances in which the company has recovered the loss. It is sufficient that the company had a claim (even if it has gone or will not be pursued) or the company would have had one but for there being a defence (whether one which was available from the start or arose later).
Were this to apply in the context of claims against trustees in relation to the reduction in the value of the controlling interests in companies it would mean that regardless of exoneration clauses there would be a complete defence to the claim when the company also had a claim. This would have a significant impact on breach of trust claims in such circumstances.
In Walker v Stones the Court of Appeal held that the principle did not apply. Sir Christopher Slade held that the double recovery principle would not apply if two conditions were satisfied,15namely:
(i) the claimant can establish that the defendant’s conduct was a breach of a duty which was owed to the claimant personally; and
(ii) the Court considers that the claimant has been caused personal loss which is `separate and distinct` from any loss occasioned to the company.
The point was important in that case because the exoneration clause had not stopped the claim against one of the two trustees. It was held that the Prudential Assurance principle did not apply in that case which concerned loss arising from alleged misappropriation of assets of subsidiaries and the charging of company assets alleged for the benefit of others.
It was said that in some cases `the Court may be faced with a difficult question in deciding whether or not, on the particular facts, the second condition is satisfied.` It was not clear whether this reference to difficult cases was a general one in the context of the Prudential Assurance principle and so included cases in which the claim was not based on breach of trust but, for instance, was for solicitor’s negligence. Alternatively was the reference restricted to breach of trust cases and so holds open the possibility that in different circumstances the principle could be relied on as a defence by trustees.
The matters which formed the basis of the complaint in Walker v Stones were such that it is difficult to imagine another set of circumstances which could cause the principle to apply when those in Walker did not. In consequence it is unlikely that the principle will provide a useful protection for trustees facing a claim for breach of trust. However, the principle may in the appropriate circumstances still provide a protection for solicitors facing a claim for professional negligence from trustees. Similarly, it may also be available to defend claims against any nominees of the trustees appointed to the board of the relevant company in which the trust has an interest.
It is relevant to this point that one of the applications considered in Walker v Stones was to join as a defendant an individual on the ground that he had participated in the wrongful diversion of company assets by the directors. This application failed due to the application of the Prudential Assurance principle.
The principle clearly does have an important role to play in the context of claims on behalf of the trust against persons other than the trustees.
In many cases the trustees will consider that the appropriate course of action to pursue in order to ensure sufficient protection for the trust in relation to a controlling interest in a company will be to appoint a nominee to the board of the company. The precise obligations and responsibilities attached to such a position have never been considered comprehensively. There are dicta relating to specific points which tend to highlight some of the conflicts which may face a nominee but nothing which sets out the full responsibilities of a nominee director.
One of the results of the decision in Walker v Stones may be to subject nominee directors to greater scrutiny. If claims against trustees are blocked due to the exoneration clauses in the particular trust deed then the nominee’s conduct may be investigated with a view to ascertaining whether a claim on behalf of the trust would lie against the nominee instead.
Greater consideration by trustees when appointing nominee directors may be required in any event due to the enactment of the Trustee Act 2000. How do nominee directors fit into the regime provided in respect of the delegation of functions to agents by trustees and do nominee directors exercise `asset management functions`?
Nominee directors/company – It is important to try to understand the responsibilities owed by the nominee director to the company. These will impose restrictions on the nominee which will affect the manner in which the nominee is able to discharge its role as regards the trust. From the authorities it appears that:-
(i) as a matter of law there is no objection to the appointment of a nominee. However, it has been stated that if the terms of the appointment seek to impose an obligation that the nominee acts as director in accordance with the instructions of the appointor then that would be unlawful;16
(ii) a nominee director does not enjoy a special position within the company. The nominee is subject to the overriding and predominant duty to serve the interests of the board in preference if a conflict arises to the interests of the appointor.17 Street J. stated that the nominee must exercise constant vigilance to ensure that he did not compromise or surrender integrity and independence which the nominee must use for the benefit of the board. In the case of an ordinary commercial company this is readily understandable. The unthinking compliance by a nominee with instructions given by the nominee’s appointor may constitute oppression of the minority.18 If the company is merely a convenient or advantageous means of holding assets for the purposes of the trust then the possibility of such conflict would seem to be small. If the company is carrying on a business then the scope for conflict is greater. The need for caution on the part of the trustees will not necessarily be reflected in the commercial approach to be adopted by the board. This is a difference as mentioned above which is illustrated by the Bartlettcase. A recent example of a case in which the interest of a shareholder may differ from that of the company is with the offer recently made by the Hermes Pension fund for the shares of EFM. It does not concern a trust with a controlling interest but it illustrates the type of problem that could occur particularly as one of the directors of EFM had been appointed by Hermes.
(iii) a director may not be entitled to see everything concerning a company’s affairs. Any confidential information can not be disclosed by a director against the interests of the company. In the case of a nominee director information may be withheld from the nominee if there is a risk that it will be disclosed by the nominee to the appointor.19 This would suggest that before appointing a nominee it should be established that the nominee has a right to disclose information without regard to possible conflicts. Such a right needs to be established as against the company and not just between the nominee and the trustees.
Nominee/trustees – many nominee directors will have been appointed without formality. There will be no formal agreement between the trustees and the nominee. It may even be that one of the trustees is the nominee as was the case in re Lucking. In such circumstances what obligations does the nominee undertake as regards the trustees?
The nominee is not a trustee merely by reason of having taken on the position of nominee director albeit that the same person may be a trustee as well. Normally, a director owes no duty to the shareholders of the company.20
Clearly, the nominee is taking on the role of providing a service to the trustees by accepting the position and it is one which is likely to be remunerated. In those circumstances a fiduciary relationship will arise whether or not the nominee is formally an agent.21 This can not give rise to the normal unqualified consequences of a fiduciary relationship because the relationship between the trust and the nominee is not exclusive. This is not a case in which the fiduciary has taken on conflicting obligations to two different principals without the informed consent of those principals but which will nevertheless bind the fiduciary. The obligations owed to the trust must be qualified by the nature of the position taken on by the nominee as director. The obligations owed to the trustees will have to take account of the restrictions imposed on the nominee as director of the company.
The statutory duty of care provided in s.1 Trustee Act 2000 will not apply to the nominee.
However, the existence of the fiduciary relationship does mean that the nominee will owe substantial obligations to the trustees and if the trust suffers a reduction in the value of it’s share holding then the nominee may run the risk of a claim for equitable compensation in the event that the nominee has failed to provide the trustees with sufficient information or has been involved in wrongful acts regarding the company’s acts. The nominee should not be liable for loss resulting from the company carrying out transactions which put at risk the assets and would be breaches of trust if the assets were held directly by the trustees but which are not wrongful acts as regards the company. The nominee is not a trustee and should not, therefore, have a responsibility which is coextensive with the trustees.
On the basis that there is a duty owed by the nominee director to the trust what practical value will it have? Does it provide a viable alternative to be investigated when a claim direct against the trustees will fail or is the likelihood that this route will also be blocked?
Defences to claims on behalf of the trust against nominees directors
It is unlikely that the nominee will have the protection of any exoneration clauses similar to those included for the benefit of the trustees. The protection contained in the articles of association is for the directors and will not extend to claims on behalf of the trust. The principal defence, therefore, that may be available to the nominee will be the Prudential Assuranceprinciple discussed above. This defence will not be available if the company has no claim against the nominee. It is perfectly possible that the trustees may have a complaint against the nominee but the company none. For example, if the nominee has failed to provide the trustees with information which would have caused them to act. This will not affect the company and no claim will lie on behalf of the company.
The principle can only operate if both the trustees and the company have claims against the nominee. The issue will then be whether the nominee director will be treated as akin to the trustees in Walker v Stones and thus not entitled to rely on the principle or akin to the proposed additional defendant in that case, the alleged participator in the alleged misappropriation of company assets, and thus entitled to rely on the principle.
This is not an easy issue to decide. The first of the two conditions set out by Sir Christopher Slade in Walker v Stones will have been satisfied. The trustees will have a separate claim against the nominee independent of any claim by the company. The problem is determining whether the loss claimed by the trustees is reflective of the loss to be claimed by the company. This I find much more difficult to answer and certainly more difficult than the Court of Appeal found the task in Walker v Stones.
Logically, I consider that the answer should be that the nominee is treated in the same way as a trustee. The alleged participator in Walker v Stones is more akin to a director who is not subject to independent duties owed to the shareholders. Such a director will be entitled to rely on the Prudential Assurance principle. However, the extra obligations imposed on a nominee director give rise not just to an independent claim that can be pursued by the trustees separately from the company’s claim but also to the possibility that the damages being sought are separate and distinct from the company’s damages.
If this is correct then the position of the nominee is far more vulnerable than that of the trustees. The opportunity to exclude or restrict liability by appropriately drafted provisions has not been the practice. It means that the taking out of insurance by the nominee director is important and that the cover provided by the indemnity policy should be considered carefully so as to cover the full extent of the nominee’s responsibility. An ordinary insurance policy will not be sufficient. It needs to cover claims direct by the trust. In addition to adequate insurance an appropriate exoneration clause should be sought by the proposed nominee director. If the provisions of the Trustee Act 2000 concerning agents applies to the nominee director then such clauses may be invalid (see paragraph 47 below).
Trustee Act 2000
The Act imposes restrictions on the employment of agents22 particularly in the case of agents exercising asset management functions.23 Whether or not the nominee is an agent for the purposes of the other statutory provisions relating to the appointment of agents the nominee does not exercise asset management functions. The functions of the nominee do not include functions relating to the investment of assets subject to the trusts or to the acquiring or managing assets subject to the trusts.24 The nominee is a director of the company and so his functions relate to the assets of the company and not to the assets of the trust. This distinction between the assets of the company and those of the trust is of crucial importance.
What is more difficult is whether the appointment of the nominee is subject to the provisions in ss. 11-14. The nominee is an agent of the trustees. If not then the principal basis for contending that a responsibility is owed to the trust disappears. However, if these provisions do operate then there can only be one nominee appointed unless in the case of more than one they act jointly.25 It is questionable whether two or more nominee directors can act jointly. Each has their own responsibilities as a director of the company.
From the view point of the nominee director the real drawback with the application of these statutory provisions is the restriction preventing terms which limit the liability of the agent unless it is reasonably necessary for them to do so.26 It is strange that at present the trustees are able to benefit from exoneration clauses whilst nominees may be preventing from doing so by statute.
9 Stone Buildings
1  1 WLR 866
2 [ 1980] Ch 515 at page 532
3 see Millett LJ in Bogg v Raper (1998/9) 1 ITELR 267 at page and Sir Christopher Slade in Walker v Stones  WTLR 975 at page 987H to 988D
4 at page 874G/H
5  Law Society Gazette 454
6 at page 533E/H
7  Ch. 241
8 as in Bogg v Raper
9  2 WLR 72
10 [ 1982] Ch. 204
11 Day v Cook  Ll. Rep. P.N. 551
12 In Johnson v Gore Wood the company had settled and the shareholder was prepared to give credit for the amount paid under the settlement.
13 Barings plc (in liquidation) v Coopers & Lybrand Evans-Lombe J. 27th November 2001
14 Giles v Rhind 24th July 2001
15 para.131 and 132
16 Boulting v ACTA  2 Q.B. 606 per Lord Denning at page 626
17 Bennetts v Board of Fire Commissioners (1967) 87 NSWWN 307.
18 As occurred in Scottish Co-op Wholesale Society Limited v Meyer  A.C. 324
19 In Bennetts v Board of Fire Commrs. supra a legal opinion was withheld from the director appointed by a union which was interested in litigation involving the company on the ground that the nominee intended to disclose the opinion ton the union.
20 Percival v Wright  2 Ch. 421
21 Allan v Hyett (1914) 30 TLR 444
22 ss. 11-14
26 s.14(2) and (3).