Trust Basics - HLD Law

Trust Basics

Trust Basics

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A Brief History of Trusts

  • Trusts developed in feudal England as a legal mechanism for protecting assets and financial planning.
  • The feudal doctrine of seisin (which recognised the concept of legal ownership of land) acknowledged the feoffee (the holder or trustee)  as having legal ownership of the land, but did not recognise the equitable interest of the cestuis que use (the beneficiary for whom the land was held)
  • Following the Norman invasion of England in 1066, the English legal system underwent significant development and crystallisation. This was achieved through the introduction of a ‘circuit system’ whereby the King’s judges travelled throughout the country and moulded the various local customs into a coherent system of law which would apply to the country as a whole. This new system was called the common law. Judges further developed the English common law through precedent over the next 300 years.
  • During the Fourteenth Century it became the prevailing practice of landowners in England to ensure that legal title to their land was held by others (in a trust relationship). The purpose of this was to split the legal and beneficial ownership of land between persons. Trusts were a popular device to avoid feudal dues or financial obligations that were payable by a tenant to his lord and to the King. In the Sixteenth Century, King Henry VIII and Parliament attempted to deal with this form of tax avoidance by passing the Statute of Uses[1] in 1535.
  • The influence of the Court of Chancery was finally recognised in the Earl of Oxford’s Case[2]. where the court held that to the extent which the principles of common law and equity conflicted, equity prevailed giving equity significant standing in law.

Modern Trust Law

  • Trusts have remained a prominent feature of the law. Australian trust law stems from this English history and has developed its own doctrines, rules, and peculiarities that practitioners ought to be familiar with. In this paper I will address some of the prominent features of Australian trust law.

A Trust or not a Trust

  • No trust will be valid unless the ‘three certainties” exist[3]. The three certainties are:
    • Certainty of Intention;
    • Certainty of Subject; and
    • Certainty of Object;

Certainty of Intention

  • You cannot create a trust by mistake, you must intend to create it. A lack of clear intention can result in a trust never coming into existence.
    • A common failure to create a trust occurs in the context of Wills where the testator says words such as ‘I hope that’, ‘I would like that’, ‘I trust that. These phrases express a desire, wish or hope that some part of their estate will benefit a particular beneficiary, however they often do not expressly direct that a trust is to be created. These phrases are called words of precaution or precatory words, their use will enliven doubt about the testator’s certainty of intention:
      • before 1871 the Court of Chancery gave phrases like these the benefit of the doubt and held that they did constitute a valid trust;
      • this approach diverged significantly in the case of Lambe v Eames[4] . In this case the testator gave his estate to his widow “to be at her disposal in any way she thinks best for the benefit of herself and her family[5]. It was held that these words did not create a valid trust in favour of the widow’s family and instead passed the deceased’s estate to his widow absolutely;
      • in Re Adams and the Kensington Vestry[6] a gift was made “in full confidence that she will do what is right as to the disposal thereof between my children either in her lifetime or by will after her decease.”[7] In this case the courts affirmed the view in Lambe[8] and similarly held that the words did not give rise to a trust at law.

Sham Trusts

  • In some cases, a Settlor will create a trust that is intended to fail. These are called sham trusts and their purpose is to revert ownership of property, purportedly transferred to the trustee, back to the settlor for the purposes of defeating some creditor from claiming possession of the trust property. The parties to the sham trust will represent to the world that a valid trust exists but knowing that the settlor wishes to retain full control of the assets including the legal and equitable ownership of the trust fund. Once the sham is detected the property will revert back to the settlor of the trust.

Certainty of Subject

  • The property which constitutes the subject matter of the trust must be certain, that is clearly described and identifiable (or reasonably capable of being ascertained).
  • Usually the property of a trust will consist of some material thing, such as a wedding ring or real property, however trust property may also include other types of property such as an equitable interest or a chose in action.
    • It was held in Don King Inc v Warren[9] that property such as contracts involving personal skills could be the subject of a trust:
    • “in principle I can see no objection to a party to contracts involving skill and confidence or containing non-assignment provisions from becoming trustee of the benefit of being the contracting party as well as the benefit of the rights conferred. I can see no reason why the law should limit the parties…”
    • The subject of a trust can be wide and varied, however normally it will be a sum of money which will establish the trust, such as $10 or $100.
    • The subject of the trust must be specific:
      • it was held in Palmer v Simmonds[10] that the expression “the bulk of my estate” was too uncertain;
      • Sprange v Barnard[11] considered certainty of subject where a testatrix left a sum of £300 for in the first instance her husband, and subsequently upon his death, the remainder of that sum to several beneficiaries. It was held that no trust arose, and the husband would become the sole beneficiary of the entire amount. The court held that the language used in the Testatrix’s Will indicated the making of a gift to the husband and not an intention to bind the husband to hold the sum as trustee for the benefit of any others;
      • in Re Golay’s Will trusts[12] the testator directed that his executors were to provide a “reasonable income” to a beneficiary. The court held this was sufficient certainty to create a trust.

Certainty of Object

  • Depending on the nature of the trust the certainty of objects requirement will vary:
    • For fixed trusts, where the trustee would usually have Bare Powers the beneficiaries must satisfy the List Certainty Rule.
    • For a discretionary trust where the trustee is likely to have Trust Powers the objects of a trust must satisfy the Criterion Certainty Rule, Loose Class or Administrative Workability requirements.
    • Charitable trusts are subject to a different standard of certainty I will not delve into here.
  • The certainty requirement for Bare Powers is more severe than for Trust Powers:
    • in Re Gestetner[13] Harman J indicated that for Bare Powers it is sufficient for the trustee to be able to compile a list of all of the beneficiaries of a class of objects. This has been referred to as List Certainty and Criterion Certainty;
    • in the landmark case of Inland Revenue Commissioner v Broadway Cottages Trust[14] the courts held that: “the trustee should know, or be able to ascertain, all the objects from which he was enjoined to select by the terms of the trust”;
    • in the case of McPhail v Doulton[15], Lord Wilberforce diverged from the List Certainty Rule and widened the test for Trust Powers to an “is or is not” test. Lord Wilberforce  considered whether it “can it be said with certainty that any given individual is or is not a member of the class”[16]:
      • the “is or is not” test may result in the list of potential beneficiaries being extremely wide. Accordingly, Lord Wilberforce placed a limit on the extent of the class of beneficiaries by saying that a class could not be so large such that it would become “administratively unworkable”. It is not clear when a class of potential beneficiaries would become so large as to become administratively unworkable. Lord Wilberforce posited this sentiment in McPhail[17] said:
        • “There may be a… case where the meaning of the words used is clear but the definition of beneficiaries is so hopelessly wide as not to form anything like a class so that the trust is administratively unworkable or in Lord Eldon LC’s words one that cannot be executed… I hesitate to give examples for they may prejudice future cases, but perhaps “all the residents of Greater London” will serve. I do not think that a discretionary trust for “relatives” even of a living person falls within this category”[18].
      • in Re Manistry’s Settlement Templeman J suggested that a power to benefit ‘residents of Greater London’ is void as being capricious “because the terms of the power negative any sensible intention on the part of the settlor[19].  There is no clear understanding of how the test in McPhail is to apply. Perhaps, it is when the class is so large that a trustee is unable to contemplate the class of potential beneficiaries in a single instance or begin to come to a method of distributing among such a class that the “administratively unworkable” test would apply. ’.

Everything Must end – the Rule Against Perpetuities

  • Perpetuities laws apply in Australia and limit the period by the which interests in property of a trust must vest in a beneficiary of the trust. At common law, the modern Rule against Perpetuities provides that an interest in real or personal property is void if it vests later than 21 years after the death of a life in being. The referable life in being must have been alive at the date of the creation of the trust. All jurisdictions except South Australia have a Rule Against Perpetuities, with the limitation being shortened from a life in being plus 21 years to 80 years
    • The common law principle of the rule against perpetuities was set out in Re Thompson
    • “A grant or other limitation of any estate or interest to take effect in possession or enjoyment at a future time, and which is not, from the time of its creation, a vested estate or interest, will be void ab initio if, at the time when the limitation takes effect, there is a possibility that the estate or interest limited will not vest within the period of a life or lives then in being, or within a further period of twenty-one years thereafter” [20].
    • Selecting one person who was not going to die in a short time is not a simple task. Needless to say, selecting a person who dies shortly after the creation of the trust is less than ideal. To alleviate the difficulty a drafting device was adopted where the person selected would be the last survivor of all the lineal descendants of the Monarch, living at the date when the instrument creating the future estate or interest commenced. Twenty-five years after the death of Queen Victoria she had about 120 lineal descendants.
    • South Australia has abolished the Rule Against Perpetuities, practitioners should take care when dealing with older trusts that have real property in multiple jurisdictions. The Rule Against Perpetuities is not one that is often at the forefront of a practitioner’s mind, but there will be occasions when proper attention will prevent an unfortunate circumstance.
    • In South Australia, the Attorney General is empowered to vest a trust which has been in existence for an excessive period.

ROLES OF A TRUST

Settlor

  • The settlor is the person responsible for charging the trustee with the fiduciary duty to hold the trust fund on the trusts defined in the trust deed for the benefit of the beneficiaries.
    • Normally the settlor will be an unrelated accountant or solicitor of the Trustee, they are rarely a relative. The Income Tax Assessment Act[21]  provides that if the person who establishes a Trust (the Settlor) has the power to terminate a Trust (that is, is the same person as the Trustee and in some cases a Beneficiary) then the Trust will be deemed not to exist and the trustee of the trust will be assessed as having to pay income tax on the income of the trust by the ATO, rather than income tax being assessed in the hands of the beneficiaries of the trust to whom distributions are made. Typically a trust deed will expressly exclude a settlor as a beneficiary of the trust and prohibit a distribution of the trust fund to them. This principle is largely based on the notion that you cannot have a fiduciary relationship with yourself, there must be some other party to whom you owe the duty;
    • When a trust fails for want of certainty or the trust by virtue of the rule against perpetuities vests back with the settlor (being the original settlor or the person who contribute the trust property). This can be difficult if the settlor is dead or now unknown to the trustee. There may be a clause that prevents such a revision in the trust deed such as a takers in default provision.

Trustee

  • Trustees, having accepted the fiduciary duty requested of them by the Settlor have many powers and responsibilities. Normally a trust deed will contain all the of necessary powers to enable the trustee to properly administer the trust. Particularly where trust deeds have not been prepared by a solicitor but perhaps made in an impromptu manner there may be limited powers available for the trustee to act in the interests of the beneficiaries. The Trustee Act[22] contains numerous powers and provisions which will enable the trustee to overcome many deficiencies in the trust deed.
    • Given the trustee holds legal title to the trust’s assets, he or she owes fiduciary duties to the beneficiaries who hold the equitable title in those assets. Fiduciary duties include:
      • the duty to act honestly and in good faith;
      • the duty to act with due care, skill and diligence in relation to the best interests of beneficiaries;
      • the duty to avoid conflicts of interests; and
      • the duty not to profit from the trust.
      • A trustee who breaches one of their duties risks being liable for any loss arising from that breach.
    • Where a trustee suffers a loss as a result of their administration of a trust, the trustee will be entitled to be indemnified out of the trust fund. Usually this provision is contained within the trust deed and also enshrined in legislation. In equitable principle, the right of indemnity is implied in “the trust”. In Worrall v Harford Lord Eldon held:
      • “It is in the nature of the office of a trustee, whether expressed in the instrument, or not, that the trust property shall reimburse him all the charges and expenses incurred in the execution of the trust. That is implied in every such deed” [23].
    • The right of indemnity can be particularly useful in the case of a fixed trust where the beneficiary has turned hostile against the trustee. Where for instance a developer wishes to buy are large parcel of land with the intention of subdivision and development. The owners have a house on the land and wish to retain their house after the subdivision. The trustee will acquire the whole land to conduct the subdivision and then hold the parcel of land which retains the house on trust for the beneficiary. In this instance a bare trust is often most appropriate which often does not contain lengthy powers, the bare trust deed would usually require the trustee to simply transfer the property after the subdivision has occurred. If the beneficiary turns hostile to the developer and refuses to pay charges and liabilities associated with the property this would be an instance where the trustee’s right of indemnity or power of sale contained within the Trustee Act[24] will offer relief to the trustee.
    • In some cases the Trustee may need to breach their fiduciary duty, perhaps they have a conflict of interest and wish to benefit themselves in the course of their administration of the trust. Particularly in the case of a fixed trust the trustee may seek permission from the Beneficiaries to breach their fiduciary obligations or breach a trust, normally one cannot consent to such an act however the Trustee Act[25] provides that where the beneficiary has given their permission the Supreme Court may cause the beneficiary who gave such permission to indemnify the trustee for any loss. This is a discretionary power, the supreme court may not give such permission.

Appointor

  • The Appointor has power under the Deed of Settlement to remove and replace the Trustee as they see fit. Accordingly, the person holding the office of Appointor assumes indirect control over the whole operation of the Trust but lacks any power of administration.
    • Where a conflict between a trustee and an appointor occurs it is often the case that whoever strikes first will prevail. Take for example a family trust where person A is the appointor and former trustee, person B their brother, was placed in control of the trust whilst A was working overseas. B could distribute the trust property to themselves before A can remove them as the Trustee. To prevent such occurrences the deed could be amended to require the approval of the appointor before distribution or positions such as the “distributor” who is responsible for directing the trustee with regards to all distributions of the trust.
    • Many trust deeds also require the Appointor to approve of any amendment to the trust deed. This further acts as a guard against the Trustee being able to delete the appointor’s power from the trust deed and then taking full control of the trust.

Beneficiaries

  • The rights of beneficiaries vary considerably depending on the nature of the trust involved. In a discretionary trust (as opposed to say a fixed unit trust), no Beneficiary has a vested interest in the Trust Fund and no Beneficiary can require the Trustee to exercise his discretion to appoint income or capital in his favour. The only right that a Beneficiary has is to the proper administration of the trust fund.

WORKED EXAMPLE

Certainty of Intention

Intention – Option 1

  • The Settlor has expressed the desire to transfer one thousand gold pieces to the Trustee to be held and applied on the trusts and subject to the powers contained in the Trust Deed. The Trustee has agreed to hold and apply:
    • the promise of the Settlor to pay one thousand gold pieces; and
    • (upon payment) the one thousand gold pieces
    • on the trusts and powers hereafter described.

Intention – Option 2

  • In the event that I acquire the property known as “Nonsuch Palace” more specifically described as being the whole of the land contained in Certificate of Title Volume xxxx Folio xxx, I shall hold it on trust for the Beneficiaries in accordance with the trusts and powers contained in this Deed.

Intention – Option 3

  • I give all of my crown jewels to my wife Anne Boleyn (the Trustee) to be at her disposal in any way she may think best, in full confidence that she will act justly as to the disposal thereof between my Beneficiaries.

Certainty of Subject Matter

Trust Fund – Option 1

  • Trust Fund means:
    • the property known as “Hampton Court” more specifically described as being the whole of the land contained in Certificate of Title Volume xxxx Folio xxx; and
    • all income arising therefrom.

Trust  Fund – Option 2

  • Trust Fund means:
    • my finest sword; and
    • 50 bottles of wine.

Trust Fund – Option 3

  • Trust Fund means the sum required to cover the fair living expenses of the Beneficiaries.

Certainty of Objects

Objects of the Trust – Option 1

  • Beneficiary means:
    • King Henry VIII;
    • any suitable wife of King Henry VIII; and
    • the heirs of King Henry VIII.

Objects of the Trust – Option 2

  • Beneficiary means:
    • Edward Tudor;
    • Mary Tudor;
    • Elizabeth Tudor; and
    • any person (excluding the Settlor) who is a resident of the Kingdom of England and France as at the date first hereinbefore written.

Objects of the Trust – Option 3

  • Beneficiary means:
    • any past or present Lord of the Tudor Court; and
    • any relatives or dependants of any past or present Lord of the Tudor Court.

Objects of the Trust – Option 4

  1. Beneficiary means (for their life):
    1. Catherine of Aragon;
    1. Anne Boleyn;
    1. Jane Seymour;
    1. Anne of Cleves;
    1. Catherine Howard;
    1. Catherine Parr; and
    1. the children, grandchildren, parents, grandparents, brothers, sisters, cousins, nephews or nieces of each of the persons named herein.

[1] 27 Hen 8 c 10 (“Statue of Uses’).

[2] (1615) 21 ER 485.

[3] Knight v Knight (1840) 3 Beav 148, (Lord Langdale).

[4] (1871) LR 6 Ch 597 (‘Lambe’).

[5] Ibid. 

[6] (1884) 27 Ch D 394.

[7] Ibid.

[8] Lambe (n 2).

[9] [2000] Ch 291, 320.

[10] (1854) 2 Drew 221.

[11] (1789) 2 Bro CC 585.

[12] [1965] 2 All ER 660.

[13] [1953] 1 All ER 1150,(Harman J).

[14] [1955] Ch 20.

[15] McPhail v Doulton [1970] UKHL 1 (‘Re Baden’s Deed Trusts’).

[16] Ibid.

[17] Re Baden’s Deed Trusts.

[18] Re Baden’s Deed Trusts.

[19] [1973] 2 All ER 1203, 1211 (Templeman J).

[20] [1906] 2 Ch 199, 202.

[21] 1936 (Cth), s 102.

[22] 1936 (SA) (‘Trustee Act’).

[23] (1802) 32 ER 250, 252 (Lord Eldon).

[24] Trustee Act.

[25] Ibid s 57.

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