Balancing a settlor's aspirations with trustee responsibilities
Trustees presented with the not uncommon scenario of a settlor wishing to retain certain controls over the trust can face a number of challenges, the key one being how to balance the settlor's desire to retain control against the risks of compromising the essential validity of the trust.
Briefing - 01/02/2014
This article will seek to summarise some of the potential ways in which a settlor's desire to retain control - specifically in relation to investment strategy but also more generally - might be accommodated.
It is increasingly likely that prospective settlors with an entrepreneurial flair will only consider establishing a trust if they feel that there are sufficient safeguards to ensure that the trustees will accommodate that flair. The challenges can be particularly acute for the trustees of traditionally drawn trusts with either an entrepreneurial settlor or beneficiaries who are no longer convinced that the trustees should invest in a conventional trust portfolio, especially where the trustees may, at the request of the settlor, have invested in what might be considered more speculative or higher risk trustee investments. Recognising that basic trust law does not permit trustees to balance out their wins and losses it may, in these circumstances, be appropriate for trustees wishing to continue to accommodate the entrepreneurial spirit within their investment strategy to consider whether their powers or indeed the trust structure could be varied - if not to mitigate a potential breach of trust action in relation to past investments, at least to mitigate the likelihood of future actions.
Reserving powers to settlorsIn some cases the settlor will personally wish to retain the right to be involved with the exercise of the trustees' principal discretions and subject to certain legal and sometimes tax constraints this can often be accommodated. It is not at all uncommon for a settlor to want to retain the power to hire and fire trustees, to change the proper law and also, in certain cases, to be consulted on the exercise of significant discretions such as the addition and exclusion of beneficiaries from the beneficial class. The settlor may also wish to be involved with formulating the trustees' investment strategy and sometimes approving specific investments themselves. In considering whether or not it is appropriate to retain such powers the settlor should be advised on whether there may be any adverse tax implications and be aware of the possibility that an aggrieved party could in the future allege that the trust was in fact a sham - i.e. that neither the settlor nor the trustee actually intended to enter into a trustee relationship at all.
Where a settlor wishes to retain significant powers the trustees will be well advised to consider carefully at the outset whether they feel comfortable with the concept that they have, however properly, abrogated powers they would traditionally expect to exercise.
Appointment of a protectorWhere a settlor wishes to retain certain controls but does not actually wish to exercise the controls himself he may consider the appointment of a protector. The protector may retain some of the powers referred to above, or the trust may make the exercise of certain powers subject to protector consent. Most commonly this will include the trustees' discretion to make capital distributions.
As before, trustees have to be happy that the proposed relationship will work - and in this context they will be well advised to ensure that they have met with the protector and that he fully understands the nature and extent of his role. Whilst the protector is often a friend or trusted advisor of the settlor it is helpful to ensure that they are pragmatic and, if necessary, willing to challenge the settlor should any requested exercise of the protector's powers appear to be inappropriate. Where protectorship works well there is no doubt that it can considerably enhance the relationship between trustees and beneficiaries - but the trustees must equally be alive to the possibility that the relationship could break down. Examples of this may be because the protector does not wish to get involved in trust matters, or where the protector finds themselves siding too often with certain beneficiaries. This can put the trustees in a very challenging position, at worst leading to an application to court.
Wherever protectorship provisions are to be incorporated within trust documentation trustees should check those provisions very carefully to ensure that they will not find themselves compromised if the relationship should break down.
Investment director provisionsExperience suggests that more and more entrepreneurial settlors are wishing to be closely involved with the trustees' investment strategy. To accommodate this, investment director provisions could be incorporated within the terms of the new trust. These can provide the settlor (or anyone of his choice) with wide powers in relation to the trustees' investment responsibility, which can include the choice of investments and the timing of making and realising those investments. As stated above, the trustees will have to be certain that they can live with the abrogation of something which would customarily be one of their principal responsibilities - and in coming to this conclusion they will no doubt take into account the investment experience of the settlor or proposed appointee. Looking ahead, there must always be a question as to how the trustees would react if a well-informed investment director were to request them to make an investment which they found completely inconsistent with previous practice. The trustees should consider such an eventuality before taking on the trusteeship. There is of course always the risk that the trustees could find themselves in an impossible situation where they totally disagree with an investment recommendation but have no alternative but to accede to it according to the terms of the trust. Natural fiduciary caution would be justified here but the trustee would have to hope that the widely drawn exoneration clause (which would almost inevitably have formed part of the investment director provisions) would be construed so as to protect the trustee from any breach of trust claim. A trustee will also clearly have to hope that the courts prove sympathetic; for most traditional trustees it has to be admitted that such a situation will continue to provide some uncertainty until the courts have been given an opportunity to opine on the effectiveness of such provisions in practice.
Letter of wishesA letter of wishes (sometimes called a memorandum of wishes) is a letter provided by the settlor to his trustees to provide guidance on how he would wish the trust to be administered. The letter may be as short or as comprehensive as desired by the settlor. Subject to some constraints on its terms (which might otherwise impugn the validity of the trust itself) the letter can seek to provide very detailed guidance to the trustees in relation to many matters including the investment strategy. In some cases the settlor will ask the trustees to communicate with him during his life and not to agree to any investment strategy or make any particular investment decision without reference to him in the first instance. A letter of wishes is not binding on the trustees - and for most entrepreneurial settlors setting up a new trust it is unlikely that they would be sufficiently comforted by the letter alone. In many cases they will want the retention of their powers to be included within the binding trust documentation.
Investment management committeeIn certain instances where there is an entrepreneurial settlor (and the value of the trust fund justifies it) the trustees might consider establishing an investment management committee advisory board to sit underneath the trust. At Hawksford we are currently working on an application that is shortly to be made to the court in relation to a pre-existing trust to approve the establishment of an investment management committee, which will comprise a number of successful business people with considerable appropriate experience in the areas in which the settlor operates. These people will come together as a committee to consider every recommendation made by the settlor before deciding which of those recommendations should be forwarded to the trustee with an indication that they should be approved. It would be quite possible to build such provisions into a new trust if appropriate.
CommunicationIt is entirely understandable that a prospective settlor will wish the trustees to accommodate his desire to retain control when creating a bespoke trust deed. However, it should always be the trustees' objective to establish, through regular communication, a relationship with the settlor which enables them to fully understand his objectives and motives, so that they would feel comfortable challenging him if it should become necessary. Trustees should be able to have an open discussion with the settlor if they consider that any particular investment recommendation does not fall within the parameters anticipated at the outset of the relationship. For example, if the settlor is seeking to run a number of different entrepreneurial projects, the trustee may feel that it would be more appropriate to reduce the focus to one or two because he cannot devote sufficient time to each of them. In another example it might be appropriate for the trustee to recommend that the settlor delegates responsibilities to people who are operationally knowledgeable once he has had his good idea. It may also prove appropriate to recommend to the settlor that the trustee reduces its risk by encouraging external investment, or promotes potential success by diluting its shareholding in order to encourage investment in a start-up situation to take it to the next level. There are indeed many ways in which trustees can assist entrepreneurial settlors by establishing an open and robust relationship.
FoundationsIn seeking to establish an appropriate relationship a service provider may in fact conclude that a trust is not the most appropriate vehicle through which to structure and meet an entrepreneurial client's objectives. A foundation, with its contractual base and appointed council, may be considered to be a much more appropriate means by which a client can retain control - though an open mind should always be maintained.
Star TrustsIf conventional trust arrangements do not seem appropriate, consideration could also be given to the establishment of a Cayman Star Trust, which incorporates provisions very specifically designed to ensure that the trustees will not to any extent interfere in the activities of companies comprising the trust funds. This is perhaps the ultimate instance of the settlor retaining control. Whether other issues might arise, including potential attacks on the validity of the structure and/or possible tax concerns, would have to be considered in the context of each individual's circumstances at the outset.
SummaryAs will be appreciated from the above examples, which are by no means exhaustive, there are many ways in which a settlor who wishes to retain control can do so. In all cases it is essential for trustees to fully understand what their prospective client wants; really knowing the client before deciding what is appropriate. In many cases it may transpire that the settlor would in fact be happy with arrangements which are also entirely consistent with the trustees' objectives, once they have been assured that a solid and trusting relationship can be established. The ultimate objective must be a structure which fully recognises the client's objectives but also leaves the trustees comfortable that they are able to work within the trust documentation and meet all of their fiduciary duties and responsibilities.
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