Looking at trust risks
By Antony Duckworth, Charles Adams, Ritchie & Duckworth, George Town, Cayman Islands
Offshore trust business has changed greatly over the years. Measured by how much we help people to set up and operate satisfactory property arrangements, these changes have been both good and bad.
Many of the changes have external causes, but this is not another diatribe on the policies and conduct of large countries, the organisations they control, or the world economy. Nor is this another commentary on offshore trust legislation, though that too has brought about change. This article focuses on changing perceptions of risk.
Readers are warned that here they will find many gross generalisations.
I encountered offshore trusts when I moved to Cayman in the mid seventies. I was a commercial lawyer from a big London firm, unencumbered by knowledge of trust law. The commercial work in Cayman was varied and often demanding. By contrast, the trust work seemed at first rather uninteresting – but someone had to do it.
The bank trustees had it all sewn up. The provision of trust services was part of a strategy for developing and keeping business in their banking and investment departments. They brought in clients from all around the world to set up trusts, clients who were prepared to give the trustee broad discretion on distribution and investment, full protection against liability for mistake or incompetence, and the right to appoint affiliates as bankers and investment managers. The letter of wishes gave guidance on the exercise of discretions but was not legally binding so, while trustees recognised the moral and commercial imperative to give it due attention, they were not worried about liability.
Everyone was happy and relaxed. The bank strategy worked. The banks felt safe. Of course they recognised the risks of investment management, but trust administration on these terms was not perceived as risky.
Most settlors did in fact trust their trustees to exercise their discretions responsibly; and my impression is that their trust was not misplaced. I remember a few complaints about trustees’ fees (especially the “withdrawal fee”) and a few criticisms of investment performance, but no accusations that trustees were abusing discretion. I do not recall any trust litigation in those early years.
The offshore trust was becoming increasingly popular around the world, except in places where tax rules made it disadvantageous.
What then happened could be compared to Eve nibbling the Apple. More prosaically, it might be said that in the eighties and nineties there was, inevitably, an increasing appreciation of risk. Cynics might add that lawyers found it in their interests to frighten trustees. Whichever way you wish to characterise it, there was a slow but steady awakening to the risks of trusteeship, and we left the Garden of Eden.
This seemed to be an entirely good thing. Surely it was good that trustees and their advisers had a better appreciation of the risks? Surely it was good that conference speakers queued up to tell their frowning audiences of the dangers? Surely it was good that trustees spent a little of the trust money on legal advice? Yes, indeed.
But now, after all these years, I fear the pendulum has swung too far. Some trustees see risk lurking in every corner. Hardly any decision is made unless it is blessed by an equally risk-averse lawyer, and the decisions are often defensive. The interests of beneficiaries take a back seat to the avoidance of perceived risk. That is not good. Even from the trustee’s viewpoint it is likely to be counter-productive. And if it is recognised by settlor or beneficiaries, it does swift and often irreparable harm to the relationship.
Some in the offshore trust community have become so worried by the perceived risks that they eagerly reach for non-trust structures. This has been a large part of the impetus behind recent foundation legislation.
The trust, once so popular and benign, has for some of us been turned into something scary. How did this happen? Are the risks really that great?
As best I recall, my earliest worries were for client trustees taking on settlors who had not received independent advice. Many settlors did act on advice, usually from onshore tax or legal advisers, but some did not. We told trustees that it was dangerous for them to recommend a trust and a particular trust instrument, especially when they did not fully understand the tax ramifications.
For some trustees, the answer was to get the settlor’s signature on a suitable waiver – but we lawyers said that a waiver might not always give effective protection.
Then we caused uneasiness by explaining to client trustees that having a broad discretion on distribution or investment did not exclude risk of liability. Discretionary powers had to be exercised carefully, after due consideration, and for the right reasons. Slavish following of letters of wishes or settlor recommendations could land a trustee in hot water.
In a similar vein, we disturbed some trustees by explaining that, even when the trust instrument authorised the trustee or an affiliate to act as banker, this merely displaced the strict rule against conflicting interests, and did not absolve the trustee from its duty to make decisions in the interests of beneficiaries.
Next we drew attention to the uncertainty of the conflict-of-law rules inherited from England, and we warned trustees of the risk of liability if it transpired that they had been treating as valid a trust which was invalidated by applicable foreign laws. Here at least the kindly legislator was able to step in and address the uncertainty. Most offshore centres eventually legislated, but there was debate about the efficacy of the legislation.
When bank trustees introduced simple trust forms for settlors who wanted a will substitute, we warned of the danger that these might be attacked as testamentary instruments. Legislation was introduced in some offshore centres to deal with this, but again debate ensued on its efficacy.
We also warned trustees that clauses giving the settlor or someone else power to give investment directions did not usually absolve the trustee of all responsibility.
Jersey’s Rahman case got us talking about sham, and the dangers for the trustee. Other cases got us talking about protectors – and the dangers for the trustee.
All these warnings and debates, repeated at conferences and in professional journals, have naturally disturbed trustees, as they were meant to do. But many trustees still felt quite comfortable, believing that they would be protected from liability by their exculpation clauses – until we told them about the sting in the tail of Armitage v Nurse, a kind of Catch 22 rule that an exculpation clause protects the trustee only if the trustee is not relying on it.
This is only a summary of the discomforting things we lawyers have diligently explained to our trustee clients over the years. Is it any wonder that their love affair with the trust has cooled? Is it any wonder that some trustees involve their lawyers on a routine basis in trust administration, obtaining thereby a kind of insurance at the expense of the trust?
Perhaps not. But the truth is that in most cases the risks of trusteeship can be managed effectively without routine legal advice, and without sacrificing the interests of beneficiaries, as long as the trust instrument is suitable to meet the requirements of the case.
On the other hand it is plain, at least with the benefit of hindsight, that many trust instruments are not suitable. Why is that?
Part of the answer is that professional trustees recognise the reluctance of some settlors to pay front end legal costs, even though they are modest compared to the legal costs that are likely to be incurred sooner or later if the trust instrument is not suitable.
Another part of the answer is that not all settlors’ lawyers recognise the need to plan and draft in a way that keeps out unwanted responsibilities and risks, and facilitates the resolution of difficulties.
Trustees were not the only ones to become more sensitive to risk. An increasing proportion of new settlors came from non-trust countries, and they and their domestic advisers were less inclined to put their faith in the trustee, the offshore courts, or the law of trusts. They wanted reserved powers, protectors and supervisory arrangements.
Indeed the same might be said, to some extent, of settlors who took their advice in the USA, where the simple discretionary trust has always been viewed with some skepticism.
The protector idea became increasingly popular. It focused attention generally on how best to reassure settlors that their trusts would operate as intended, and avoid the pitfalls along the way.
As well as considering the administrative risks, settlors have become increasingly sensitive to the possibility that handing large sums of money to beneficiaries may not be the best way of benefiting them. Wealth involves risk.
Consideration of these risks by or on behalf of settlors has led to a variety of interesting arrangements, including the private trust company, the family office, and the multi-family office. There has also been a greater philanthropic tendency.
This is very constructive – making use of the versatility of the trust, made even more versatile by innovative offshore legislation. But, as ever, there is a need to keep an eye on the big picture. The removal or reduction of one risk is quite likely to add a new risk. So this is an exercise in dialectics, balancing measures and risks to match the settlor’s priorities.
Some protectors have also been learning that what they supposed was a risk-free office is seldom that. The risks for protectors, and for trustees and beneficiaries, are often higher than they need to be – because, by and large, we still have not sorted out how to draft protector provisions.
Another change since the days of Eden is that trust litigation has become common. Everyone who has experienced trust litigation appreciates the terrible cost, and the harm it can do to family and other relationships. This is a risk which needs to be considered when the trust is being created. It can be reduced by suitable drafting, and by suitable handling of the questions and problems that inevitably arise from time to time.
Of course litigation risk cannot be removed altogether, and the availability of the court to enforce trusts and to deal with problems is a key attraction of the trust. My concern is the frequency of applications to the court on issues which could have been avoided or resolved by other methods, and also the numbers of lawyers usually involved.
The underlying cause of the problem is not that wealthy people are quarrelsome but that so often the trustee and other people involved in a potential dispute, and their lawyers, are confident of getting their costs/fees paid out of the trust fund, win or lose. So there is no disincentive to litigate, no disincentive to try a doubtful argument – no incentive to resolve difficulties or questions by quicker more amicable means – no incentive, come to that, for lawyers drafting or reviewing trust instruments to minimise litigation risk.
The system depends on the professionalism of trustees and lawyers, not their self-interest. And professionalism is not always as strong as it needs to be. Perhaps judges should be tougher on costs.
If the new common law foundations prove as popular and risk-free as their promoters hope, and operate satisfactorily as trust-substitutes without paying a lot of money to lawyers for drafting, advice or litigation, it might be suggested that we lawyers had been hoist with our own petard.
But I shall be surprised if that is what happens. Foundations may well become popular, but I doubt if they will prove to be significantly more risk-free than trusts, and I suspect that we lawyers will still get our share.
The Jersey legislation is the clearest of those I have read. It would be interesting to see a comparison of the risks for those who administer Jersey foundations and those who administer Jersey trusts – assuming in both cases sensible planning and drafting.
It would also be interesting to see a comparison of the litigation risk. The Jersey legislation gives a very wide range of persons standing to apply to the court to exercise its jurisdiction over foundations. That raises several questions, and seems to indicate that foundation litigation may be even more frequent, complex and expensive than trust litigation.
Those who hanker for a trust-substitute and think wistfully how easy and safe it is to form and manage a private investment company should recognise that this ease and safety are not a consequence of incorporation but of there being all-powerful members who can do what they want with their company. If there are no members, no owners, and the structure is to be launched like a rocket into the future, it needs to be carefully constructed, and the crew must take responsibility.
BOOKMARK
THIS PAGE
