A Practitioner’s Guide to the Law Commission Proposals on the Law of Trusts
Many practitioners will have followed, to a greater or lesser extent, the progress of the Review of the law of trusts which the Law Commission has undertaken over the past two years. After five Interest Papers and a Preferred Approach Paper it therefore seems timely to consider the recommendations the Law Commissioners are likely to make and to consider the possible impact these will have, from a general practitioner’s perspective, on this body of law.
The Law Commission has carried out a commendable degree of consultation and a significant number of submissions have been made by various organisations, including numerous oral and written submissions by ADLS on the various Issues Papers and the Preferred Approach Paper. It is not the intention of this article to restate each of the issues raised in these submissions but rather to bring to practitioners’ attention those areas which will have the greatest impact upon the legal profession, and its clients, if the Law Commission proposals proceed as they currently stand.
New Trusts Act
Briefly, the Law Commission proposes to recommend the repeal of the Trustee Act 1956 and the introduction of a new Trusts Act that is intended to be both consistent with existing core trust law and to go beyond the old Trustee Act by codifying many of the principles set out in decisions reached by the courts. It is also its stated aim that the legislation will be modern, relevant, efficient, clear, accessible and educative. To achieve these ends it recommends: the inclusion and codification of core trust principles; the use of both mandatory and default provisions to be applied to trusts (both existing and new); enhanced trustee accountability and powers; and an intention to reduce the need for applications for directions from the court. This sets a high benchmark in terms of expectation for the proposed legislation while attempting to maintain an arm’s length policy of minimal regulation.
From the outset the Law Commission adopted the approach of defining the concept of an express trust by focussing on the circumstances in which a trust is created and by effectively codifying the three certainties so familiar to practitioners from law school and case law. Proposals 1-4 cover this area comprehensively and recommend that there be a specific statutory provision that renders void any trust not covered by one of the three certainties. Significantly, and to the relief of many practitioners for the development of trust law, it rightly does not recommend the introduction of any sections that would attempt to list or define the legitimate purposes for which a trust may be settled. It also clarifies that no additional provisions are necessary to cover the issue of sham trusts.
It then moves on to the issue of trustees’ duties and it is at this point that all practitioners should pay careful attention to the Law Commission’s initial proposals. In its attempt to clearly codify the law in a manner that lay persons can understand, the Law Commission has recommended that legislation would provide simplified summaries of what the duties of the trustees are. This is, in many respects, an admirable approach that stems from an awareness that, regardless of the effective work and advice of the drafter of the trust deed, many trustees do not appear to appreciate the duties, both of conduct and content, that they owe to the beneficiaries of the trust and the extent to which they may be able to exclude liability. The Law Commission therefore adopted a three-pronged approach to this issue: firstly, by attempting to define the conduct of all trustees; by introducing mandatory duties that will be implied into every trust without exclusion or modification; and by creating a list of default duties that apply unless modified (not all of these can be excluded).
The law in relation to the conduct of trustees was effectively summarised in the case of Armitage v Nurse (1997) which held that a trust deed may expressly reduce the obligations of the trustee to a great extent until the point where the conduct of the trustees is held to be a wilful breach of the trust deed, a matter of dishonesty or recklessness. The Law Commission proposals extend beyond this to introduce mandatory and positive duties such as the requirement for the trustees to exercise such care and skill as is reasonable in the circumstances (including a higher duty for those held to have special knowledge or experience) in relation to all the mandatory content duties discussed below. This represents a significant move beyond the existing law and is intended to effectively rewrite many existing trust deeds and to impact trustees’ current practice. Practitioners would be well advised to take an active interest in the Commission’s final report and draft legislation, given the significance of many of the reforms proposed, and the potential impact these will have on their professional liability.
The following proposals are closely tied to this positive requirement in that Proposal 6(1) implies into every trust a number of duties, such as the necessity to understand and adhere to the terms of the trust. This would, in the view of the authors, be better expressed as a requirement for trustees to use ‘best endeavours’ to understand the terms of the trust in light of the existence of a great many trust deeds that suffer from poor drafting and obtuse or archaic language – not to mention the inherent complexity of trust law. The importance of this issue is heightened by the clear exclusion of any clause attempting to limit the application of these duties.
If the principles of Armitage v Nurse continued to apply to these proposed mandatory content duties, so that liability could be limited to wilful breach of trust, gross negligence or recklessness, the duties would be less burdensome. As it stands under the proposals, an ‘innocent’ failure to understand the terms of a trust could cause the loss of the trustee’s right of indemnity out of trust assets, with catastrophic consequences. This could encourage trustees to err on the side of caution and apply to the court for directions in circumstances where interpretation of a deed is complex or challenging. While this is the entirely correct course of action in a limited range of scenarios, it would be an expensive and impractical outcome if it became a common response to obscure drafting.
Duty to Account
Proposal 6(1)(b) provides for a “duty to account to the beneficiaries for the trust property” and is expanded by Proposal 9 which appears to incorporate a wider duty to inform. The “duty to account” in Proposal 6(1)(b) does not mean a duty to prepare and furnish formal financial statements; rather it means the lesser obligation to ‘account’ in a non-financial reporting sense. This is the ‘non-negotiable’ obligation, whereas the broader obligation to inform in Proposal 9 may be modified by the trust deed.
Proposals 6 and 9 are to a large extent an attempt to codify the rules set out in Rosewood v Schmidt (2003), however the lack of precision in the drafting of Proposal 9 (which was probably inevitable), and its interaction with the mandatory duty to account in Proposal 6(1)(b), will inevitably result in the Courts having to arbitrate in respect of the extent of the trustee’s duty to provide information: in other words, the proposals may not create greater certainty for trustees or beneficiaries than presently exists.
One of the reasons that the law concerning the provision of information to beneficiaries is so honoured in the breach is that many trust settlors are reluctant for their children to be informed as to the level of wealth in the family trust, because of the concern that this might result in the children not seeking to advance their own personal, professional and financial development as much as the parents might like, due to an expectation of receiving wealth from the family trust. Whilst beneficiaries’ rights are important, one also needs to take into account the fact that a trust is put in place to achieve a settlor’s specific objectives and therefore the ‘rights’ of the settlor should be recognised.
The concept of a “qualifying beneficiary” being defined as one who is entitled to receive information is sensible as clearly there have to be some beneficiaries, or at least one, entitled to information so that the trustees can be held to account. However in the authors’ opinion it would be better if there was legislative provision permitting the trust deed to specify who the qualifying beneficiaries are. For example, the deed might provide that during the lifetime of the settlor or the survivor of the settlor those individuals shall be the only qualifying beneficiaries, but that after their deaths the children (taking a typical example) should all be qualifying beneficiaries. In this way there will always be a class of persons entitled to information who can “keep the trustees honest”.
In Proposal 7 the Law Commission has provided a list of default duties, some of which may be fully excluded such as the duty to act without reward. At the same time, others may only be modified where this does not conflict with any of the mandatory duties referred to above, including such concepts as the duty to maintain “impartiality or evenhandedness between beneficiaries”. The duty to act with “evenhandedness” is of concern as it could well leave the trustees open to criticism and even liability, as it implies an obligation to treat beneficiaries within the same class (e.g. siblings) in exactly the same way, which may not be appropriate or in line with the settlor’s wishes. Where an existing trust deed did not provide express wording as to whom or the manner in which any distributions should be made, sufficient to be interpreted to exclude or modify this duty, then trustees may find themselves in an exceptionally difficult position. This is particularly the case where the settlor is no longer in a position to provide a Memorandum of Wishes.
Personal Liability of Directors of Corporate Trustees Proposals 34 and 36 will give great concern to practitioners, other professionals and lay people who act as trustees. Proposal 34 provides in certain circumstances for personal liability of directors to creditors of a corporate trustee, and Proposal 36 provides for directors of a corporate trustee to have direct fiduciary liability to trust beneficiaries. Proposal 34 ‘borrows’ certain provisions from Australian law that were targeted towards trading trusts which deliberately excluded or lost the trustees’ right of indemnity out of trust assets, to the detriment of creditors. Arguably these provisions are not necessary in New Zealand given the provisions in our Companies Act 1993 (ss 135 and 136 in particular) which can make directors personally liable for trading recklessly or whilst insolvent. Moreover, the Commission’s sensible proposal that corporate trustees should be obliged to disclose trustee status in all communications and contracts means there is an opportunity for parties such as trust creditors to obtain personal guarantees from the underlying client if concerned about their rights of recovery. Otherwise, the loss of the right of indemnity as a result of a very minor or inconsequential breach of trust, which was neither contrived nor resulted in any disadvantage to the beneficiaries, would trigger personal liability.
With regard to Proposal 36, there is no reason why the directors of a corporate trustee should be deemed to have a personal fiduciary obligation to beneficiaries when those individuals have chosen, with the agreement of the settlor, to provide trustee services via a corporate vehicle. As long as there is adequate disclosure to the settlor of the consequences of the use of a corporate trustee, this should be a matter that parties may agree upon. The Commission seems to assume that having individuals as trustees is the norm. That may have been the case in New Zealand 20 years ago, but New Zealand has now fallen into the standard approach internationally of using corporate trustees.
The Commission’s proposal on this issue will cause a wholesale departure of individuals from the provision of fiduciary services which will be distinctly harmful to settlors, beneficiaries, and hence the wider community.
Less Contentious Proposals
The proposals do provide many non-controversial and welcome additions to trust legislation, including statutory recognition that the trustee has “all the powers of a natural person” which will please many practitioners who long struggled with banks etc. to prove that the trustees have the power to take out loans. Also included is an excellent proposal to amend s 25 of the Companies Act to require trustees to disclose their status where they are acting as a trustee of a trust. In its submissions ADLS recommended that it would be logical that this disclosure be extended to the new Land Transfer Bill to require that there be an automatic noting on the land register where an interest was held by a trustee acting for a trust. This decision appeared to meet with the support of one of the Law Commissioners to whom it was initially proposed, however it is unclear as to its ability to be effected.
An example of the proposal’s attempt to craft legislation that can be easily understood by lay persons is seen in Proposal 10 where the duty to retain copies of documents is spelt out. These are instructions that will seem de rigeur for lawyers but should improve trustees’ records keeping. However, it is of concern that an over-emphasis on such a consumer protection approach to drafting has led to the use of unclear terminology as is seen in the “duty to account” provisions. The Law Commission’s proposals are rightly focused on improving and clarifying the standards of trust management in New Zealand, however practitioners should be aware that this has led to some proposals appearing to provide much wider powers of examination to beneficiaries while greatly increasing the burden and liability of trustees. An example of this consumer protection style approach may be seen in the provisions relating to the appointment and removal of trustees, which proposes that those exercising such a power owe a duty to act in good faith and honesty.
Public Trust’s Role
The Law Commission proposals also recommend that the powers and responsibilities of the Public Trust be extended to include wide ranging roles such as supervision of trustees, provision of advice to trustees, and acting as an ‘independent’ decisionmaker/ arbitrator (although the latter term is not used). There is a concern as to whether the Public Trust presently has the resources/skills to carry out these functions, and perhaps more importantly whether it is appropriate to vest these roles in a body which competes with the legal profession and other service providers.
District & Family Court Jurisdiction
Proposals 50 and 51 moot the possible jurisdiction of the District Court and the Family Court in relation to trust matters. We believe that there are concerns among the profession about the capacity of the District Court to adequately handle complex trust litigation. If the District Court is to be given jurisdiction in trust matters, then in our opinion any party to litigation should have the ability as of right to require the proceedings to be heard before the High Court. There is a proposed monetary threshold of $500,000, but given that the cost of litigation in either the District Court or High Court can be significant, a party who is concerned that handling at District Court level may be inadequate should have the ability to require a High Court hearing rather than potentially having to subsequently appeal a District Court judgment to the High Court.
The authors are of the view that the Family Court should not have any jurisdiction in respect of trust matters. Some of the aberrant decisions that came out of the Family Court in relation to (for example) the ‘alter ego’ line of cases, and many other decisions, lead to the conclusion that the Family Court has the capacity to ride rough shod over trust law principles in an effort to achieve what might be considered an equitable outcome from a relationship property perspective.
The Commission should be applauded for its willingness to listen constructively to submissions made by practitioners, with the intention of ‘getting it right’. This is not always the case in law reform processes driven by government departments (Inland Revenue Department being a case in point) where a cynic might suggest that the outcomes have been largely predetermined.
It is good news that the Commission has not taken an overly prescriptive approach to the drafting and design of trust structures. Flexibility has always been the hallmark of the trust concept, and enabled it to evolve over the centuries to cater for changing social and economic circumstances.
However practitioners should take a close interest in this law reform process: it is important we put our case forward strongly to attempt to ameliorate some of the harsher and less practical elements of the proposals.
John Hart has specialised in tax and trust law for 29 years, providing advice to a wide range of New Zealand and offshore corporate and private clients, and not-for-profit organisations. The majority of his work is cross-border/ international in nature. John is a frequent presenter at conferences in New Zealand and internationally, and has authored numerous publications on tax and trust law issues. He is Chairman of the New Zealand branch of the Society of Trust and Estate Practitioners (STEP) and has served as a STEP Worldwide Council member.
Timothy Orr is the ADLS Documents and Precedents manager, and facilitated the organisation of the recent consultation meeting on the Law Commission’s Review of the Law of Trusts: Summary of Preferred Approach paper.