Have your cake and eat it?

01 May 2013 Dinesh Menon

Have your cake and eat it?

Dinsh Menon on reserved powers trusts.

Conventional trust doctrine states that once a settlor settles certain assets in a trust, legal title over those assets moves from the settlor to the trustee. While fundamental trust principles remain entrenched, the trust, as an instrument of wealth management, has evolved dramatically, particularly in certain jurisdictions. One such development is the reserved powers trust.

It may be argued that the reserved powers trust concept is incongruent with well-established trust principles. However, this radical child of the conventional discretionary trust has received statutory support in jurisdictions such as the Cayman Islands,1 Jersey,2 the Bahamas,3 Bermuda4 and the Cook Islands.5 Since, in practice, such a trust tends to see only certain powers reserved6 to the settlor or another trusted person, the concept has survived scrutiny, thus far.

Establishing a trust is a leap of faith for most settlors – thus the need to retain some influence over the trust’s assets, which is usually derived from a lack of familiarity with trusts. Alternatively, a settlor with relevant expertise may wish to retain some control over the management of the trust’s assets.

Present landscape

The increasing acceptance of reserved powers trusts as viable wealth-management tools may be partly down to article 2 of the Hague Trusts Convention,7 which clarifies that ‘the reservation by the settlor of certain rights and powers… (is) not necessarily inconsistent with the existence of a trust’.

Trusts are no longer confined to their traditional purposes of holding, protecting and transferring wealth between generations. Modern-day trusts are often incorporated into a person’s wider wealth-management strategy as a device to manage assets over the medium to long term. Against this backdrop, extensive discretionary powers vested in the trustee may be viewed as being incompatible with personal objectives. The issue is whether reserved powers trusts can withstand reasonable scrutiny into their legitimacy and, if they can, what rules need to be observed to preserve their integrity.

It has been suggested that recent bold developments to the rules that govern common-law trusts in certain jurisdictions are premised on catering to ‘sophisticated’ settlors who require a more active role in managing the trust’s assets.8 The harbinger of this development appears to be the Cayman Islands Trust (Amendment) (Immediate Effect and Reserved Powers) Law 1998 (presently incorporated into Part III of the Cayman Islands Trusts Law). This law was tailored to assist with the structuring of trusts for settlors whose involvement in managing complex assets was viewed as important.9 If nothing else, it served to identify the specific powers that can be reserved by the settlor under law. This legislative development in the Cayman Islands was mirrored in the Bahamas in 1998 by the introduction of s3(2) of the Bahamian Trustee Act 1998 and in Jersey by the introduction of the Trusts (Amendment No. 4) Jersey Law in 2006.

The boundary

When reserved powers are sanctioned by statute, much-needed certainty is provided for that jurisdiction, particularly in such a controversial area. However, a delicate balance still needs to be struck to ensure the trust is not unnecessarily exposed to a challenge against the influence of the settlor.

In Lord Vestey’s Executors v IRC10 the House of Lords had to consider the effect of a provision granting the settlor powers to direct the investments of a trust. Lord Simonds opined: ‘… if I ask how any court of equity would regard this power, it seems to me that the only answer is that it is a fiduciary power to be exercised with a single eye to the benefit of the beneficiaries.’11 Hence, the reservation of wide powers of investment by the settlor or an appointee may find such a person being attached with fiduciary duties in relation to the trust property.

In such a case, the trustee needs to be clear about the circumstances that require its supervision of and, if necessary, intervention in the exercise of such reserved powers, to preserve the interest of the beneficiaries. To do this a trustee needs to be aware of its minimum obligations. This was well expressed in Armitage v Nurse, where Millet LJ describes it as being ‘an irreducible core of obligations owed by the trustees to the beneficiaries and enforceable by them which is fundamental to the concept of a trust… the duty of the trustees to perform the trusts honestly and in good faith for the benefit of the beneficiaries is the minimum necessary to give substance to the trusts’.12

Navigating within the boundary

Powers reserved by settlors in respect of investments tend to present the greatest risk to trustees because trustees have overriding duties to invest trust assets in a prudent manner, ensure adequate flow of information, and intervene, if necessary, to preserve the interest of the beneficiaries. However, settlors who have reserved such powers will rarely welcome trustee interference.

One possible solution to this conundrum is to incorporate an ‘anti-Bartlett13 clause into the trust instrument. Such a clause expressly removes the trustees’ obligation to enquire and supervise, but it will not exonerate a trustee that, having become aware of a situation that may require it to use its powers of intervention, fails to intervene. It might also be helpful for the trust instrument to explicitly state that the settlor is managing the assets on behalf of the trust and not as their own assets. In any case, trustees should bear in mind that the power reserved may be regarded as being fiduciary in nature and that it may therefore fall on the trustee to make it known if it is unhappy with certain results. Thus, the trustee still ought to keep an eye on how a reserved power is being exercised by the reserving party.

In addition to including an anti-Bartlett clause, as a precautionary measure, appropriate releases and indemnities in relation to any reserved powers ought to be provided to relieve the trustee of possible liabilities. While these measures serve to minimise the trustee’s risk exposure they do not grant total immunity, and a trustee must still pay attention to its irreducible core of fiduciary duties14 and exercise its independent judgment.

If investment powers are reserved through an underlying company of the trust, where the settlor is the director of this company, it would be crucial to at least provide the trustee with the means to remove the investment manager if the investments do not perform adequately. This implies that the trustee will be provided with regular information to permit it to discharge its duties. Trustees cannot remain blind to the way a reserved power is being exercised. It might even be prudent to have the trustee and the investment manager enter an agreement setting out the terms that govern the exercise of the reserved powers.

If permitting the settlor to reserve the exercise of investment powers proves to be problematic, other options are available, namely: (i) replacing direction-making powers with consent-based powers, (ii) providing the settlor with direction-making powers but keeping the trustee in control until they are exercised, or (iii) providing the trustee with powers to supervise the exercise of the reserved powers by the reserving party. These options provide a middle ground between a settlor’s intentions to reserve certain powers and ensuring that the trustee is still able to discharge its fiduciary duties.

Another issue to consider is that if a reserved powers trust is challenged and it is found that there is no real trust, the trustee is likely to be regarded as being a nominee of the settlor. Consequently, it will need to account to the settlor for all assets it has held, including assets it has disposed of or distributed. Also, any trustee’s fees may be found to have been inappropriately charged and may have to be returned. This possible outcome ought to be considered during the discussion phase, since prevention is less expensive than cure.

Striking the right balance with reserved powers trusts is critical. If the trustee’s position as the legal owner of the assets is undermined, this can lend support to an inquiry into whether there was a genuine intention to create a trust. If the settlor is found to be in effective control of the trust assets, they may have to contend with significant adverse tax implications.

Conclusion

While service providers may view the reserved powers trust as a good opportunity to market a product that allows the client greater control than they might have had with a traditional discretionary trust, a trustee should ensure that the terms of the reserved powers trust permit it to intervene to preserve the interest of the beneficiaries.

  • 1Cayman Islands Trust Law (2001 Revision), s14
  • 2Trusts (Jersey) Law, article 9A
  • 3Bahamas Trustee Act 1998, s3(1) and s3(2)
  • 4Bermuda Trusts (Special Provisions) Act 1989, s2(3)
  • 5International Trusts Act 1984, s13C
  • 6Examples of ‘reserved powers’: to remove trustees; appoint new trustees; revoke the trust, wholly or partially; add or exclude beneficiaries; and act as investment manager/advisor
  • 7The Hague Convention on the Law Applicable to Trusts and on Their Recognition
  • 8Simon D Trevethick, ‘Recent Changes to the Trustees Act and the Civil Law Act’, Singapore Law Gazette (August 2005, vol 1)
  • 9Justin Appleyard, ‘Cayman Islands’, in Trusts in Prime Jurisdictions (ed Alon Kaplan) (London, Globe Business Publishing, 2006) at 120
  • 10[1949] 1 All ER 1108
  • 11Ibid, 1115 D
  • 12Armitage v Nurse [1998] Ch 241, per Millett LJ
  • 13Bartlett v Barclays Bank Trust Co Ltd [1980] Ch 515, 533–534, Brightman J
  • 14Armitage v Nurse [1998] Ch 241, per Millett LJ

Authors

Dinesh Menon

CPD Reflective Learning