Chapter 2- Discretionary and Protective Trusts PDF

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TOPIC 2 : DISCRETIONARY AND PROTECTIVE TRUSTS Aspects Information Discretionary Trusts 1. Definition:  A trust where the property is conveyed to trustees to be held by them on trust, to apply the income or capital or both for the benefits of the members of a class of beneficiaries, in such proporti...

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TOPIC 2 : DISCRETIONARY AND PROTECTIVE TRUSTS Aspects

Information

Discretionary Trusts

1. Definition:  A trust where the property is conveyed to trustees to be held by them on trust, to apply the income or capital or both for the benefits of the members of a class of beneficiaries, in such proportions as the trustees shall, in their absolute discretion, think fit  The trustees are given a discretion as to who shall receive income and/or capital from the trust, and in some cases what amount, if any, they shall receive  The trustees in a discretionary trust must make sure that certain requirements are fulfilled ie:  Conceptual certainty  Administrative workability  The class of beneficiaries must not be capricious(inconsistent) 2. Reasons for creation: a) It enables the settlor to divest himself of ownership over the property but still be able to control its distribution b) It enables the trustee to provide for unforeseen circumstances and to provide financial aid based on need c) To protect the dissipation of the trust property from wasteful beneficiaries d) To prevent the effects of bankruptcy e) To protect beneficiary against creditors f) To continue to exercise control over young or improvident beneficiaries.  The discretionary beneficiary owns nothing which he can sell or which his creditors can seize (save in certain situations), since property would be vested in him upon the exercise of the trustees discretion in his favour Case: Elia bte Husein Awang Salim v Hong Kong Bank Trustee (Singapore) Ltd  A settlement of property was made by an indenture (deed) dated 1933. The principal beneficiary was also a trustee under the settlement.  Upon making certain unauthorized investment, the principal beneficiarytrustee and other trustees were removed by the court order in 1986. At the time, the settlement worth A$800,000. In consequence of this order, he was deprived of his right to receive his share of the net income of the settlement. The indenture provided that upon failure of the trust, the trustees would hold the income on a discretionary trust for the maintenance of the principal beneficiary’s spouse and issue.  The wife and issue of the principal beneficiary applied for maintenance and to the new trustees. The new trustees declined to pay on the ground that the principal beneficiary owed money to the trust. The wife and issue brought an action against the new trustees.  The court granted the claim of the wife and issue, and held that the principal beneficiary’s beneficial entitlement was indeed forfeited under the court order and he was not entitled to any income and owed money to the trust. However, this does not preclude his wife and children from benefiting under the discretionary trust. 3. Significance of DT  Beneficiaries as a whole are the trust owner of the property.  If all are adults and under no disability, they may combine together to terminate the trust and demand distribution of the property.

o Case : Saunders v Vaultier o Facts : A father left in his will stock in a company for his young son, to

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be held by a trustee for his son as the sole beneficiary until he turns twenty-five years of age. The stock was to accrue and accumulate interest and dividends over the years. The terms of the trust instructed the trustee to transfer the stock to his son when he reaches twenty-five years of age. However, when the son turned twenty-one years old, he requested that the trustee transfers the stock and funds to him, thus terminating the trust. Issue : The question arose as to whether the beneficiary of trust may require the termination and/or transfer of the trust and thereto prior to the date stipulated in the terms of the trust. Held :The Court stipulated the rule that, where the beneficiary has an absolute, indefeasible interest in a trust, and is of an adult age and of sound mind, then the sole beneficiary may require the trust to be terminated and trustee to transfer the legal estate before the date stipulated in the terms of the trust. The Court propounded the principle that a sole beneficiary, or the absolute consent of all beneficiaries to a trust, enables the beneficiary to terminate or transfer their beneficial interest under a trust. Thus, although it may be contrary to the intentions of the father for the value of the stock to accrue interest for a longer period, the son, as the sole beneficiary, was not bound to wait until the age of twenty-five and was able to require payment and divest the stock at the earlier age of twenty-one against the terms of the trust. The rule: If a trust is set up to endure for a period of time, yet the beneficiaries, all being of the age of majority, and unanimous, may have the trust collapsed and the proceeds disbursed.

The trustee throughout are under an obligation to perform the trust, in context of DT, to exercise their discretion and to make selection after proper consideration. If trustee do not exercise a merely permissive power within a reasonable time  it ceases to be exercisable and the trusts in default operate. In Re Locker’s Settlement Trust o In case of trust, where trustees are under a duty to distribute, but neglect to do so within a reasonable time, the court has allowed trustees, willing and competent to do so, to repair their own inaction. In McPhail v Doulton o If trustees fail to exercise their discretion, the court can compel them to exercise the trust. In Re Gulbenkian’s Settlement Trusts (No 2) o An object of DT may renounce his right to be considered as potential beneficiary and at any rate, if he does so far valuable consideration, he thereupon ceases to be an object of the trust.

4. Types of DT 1. Exhaustive DT  Trustees are bound to distribute the whole income but have a discretion as to how the distribution is to be made between objects. 2. Non-exhaustive DT  Trustees have discretion not only as to how the distribution is to be made, but also as to whether and to what extent it is to be made at all.  It conceals the two alternative from McPhail v Doulton o A power of distribution coupled with trust to dispose of the undistributed surplus, by accumulation or otherwise, and o A trust of distribution coupled with a power to withhold a

Problems pertaining the administration of Discretionary Trusts -certainty of object

Protective Trusts

portion and accumulate or otherwise dispose it.  Queries regarding the reasonableness of a discretionary trustees decision  The trustee has to exercise his discretion taking into account the terms of the trust investment.  He needs to consider, e.g., whether there is a power to advance or maintain and whether there is an uncontrollable power.  A trustee cannot exercise his power mala fide  Locus standi of objects to complain about an unfair exercise of a trustee’s discretion  It is important to properly define the class of beneficiaries to avoid problems relating to locus standi of the complainant. 1. Definition:  In England, the application of PT is notable in occupational pension scheme,  PT  A trust assets are ordinarily held to pay an income to the beneficiary, the beneficiary may have access to the capital of the trust with trustee’s permission.  It is a specimen of discretionary trust PT is useful for a settlor who wishes to protect his estate:  Against a wasteful or financially irresponsible beneficiary  against bankruptcy of such a beneficiary  A PT involves the creation of a determinable interest in favour of a third party, coupled with a provision for a gift over to trustees to hold on discretionary trusts in favour of a class of beneficiaries.  E.g- Trustees are directed to pay income to the life tenant (benefisiari seumur hidup) until he becomes insolvent, then his interest ceases and the income would be held on discretionary trust for the beneficiary and his family 2.

Determinable Interest:  A settlor who wishes to create a protective trust has to use the words such as ‘until’ and ‘so long as’ to denote the existence of determinable interest  E.g:  A can use my car until he buys one himself whereupon the car goes to his wife C.  A can use my car until he changes his nationality whereupon the car goes to his wife C  In the above examples, there is a creation of a valid life interest for one beneficiary, plus a determining event which delimits the interest granted to that beneficiary, with the beneficial interest in the same property going to another beneficiary upon the occurrence of the determining event.  With the occurrence of an event that ends the first interest, the second interest in the form of a discretionary trust would be created.

3. PT under Trustee Act 1949:s.38  Where any income, including an annuity or other periodical income payment, is directed to be held on protective trusts for the benefit of any person (in this section called "the principal beneficiary") for the period of his life or for any less period, then, during the period (in this section called the "trust period") the said income shall, without prejudice to any prior interest, be held on the following trusts:  a)Upon trust for the principal beneficiary during the trust period or until he, whether before or after the termination of any prior interest, does or attempts to do or suffers any act or thing, or until any event happens, other than an advance under any statutory or express power, whereby, if the said

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income were payable during the trust period to the principal beneficiary absolutely during that period, he would be deprived of the right to receive the same or any part thereof, in any of which cases, as well as on the termination of the trust period, whichever first happens, this trust of the said income shall fail or determine b)If the trust aforesaid fails or determines during the subsistence of the trust period, then, during the residue of that period, the said income shall be held upon trust for the application thereof for the maintenance or support, or otherwise for the benefit, of all or any one or more exclusively of the other or others of the following persons: the principal beneficiary and his wife or her husband, if any, and his or her children or more remote issue, if any;or if there is no wife or husband or issue of the principal beneficiary in existence, the principal beneficiary and the persons who would, if he were actually dead, be entitled to the trust property or the income thereof or to the annuity fund, if any, or arrears of the annuity, as the case may be, as the trustees in their absolute discretion, without being liable to account for the exercise of such discretion, think fit.

 Therefore, to create a PT under s.38, the settlor would just need to direct that a life interest in the form of an income, an annuity or other periodical income is to be held on ‘protective trust’ by a beneficiary.  On the happening of a certain prescribed determinable event this trust ends and a discretionary trust starts.  The principal beneficiary no longer receives the benefits as it will go to the beneficiaries under the discretionary trust.  Trustees have absolute discretion in this matter and they are not liable to account for the exercise of such discretion.  The beneficiaries under the discretionary trust can be various person but usually it is the spouse and issue of the principal beneficiary.  E/though the principal beneficiary cannot get the income, by securing the payment to the spouse and issue, they are protected. The principal beneficiary is also indirectly covered 4. Significance of PT  A debtor's property is in principle available for the satisfaction of his creditors and, if he becomes bankrupt, it will pass to his trustee in bankruptcy; but it is possible, by making use of a protective trust, to obtain a measure of protection against such an event.  The technique of PT involves the giving of a determinable life interest with a gift over upon the happening of certain events.  The right to receive income from a trust would ordinarily be an asset in the hands of the beneficiary and could be sold, thwarting the intention of the donor to spread the gift over the recipient's lifetime.  To give protection to beneficiaries, a PT automatically converts into a DT, under which the beneficiary has no right to the income, if he or she does anything which breaches a condition specified in the document creating the trust.  PT clauses are commonly used today in occupational pension schemes, to prevent alienation of pension rights.  A similar result was achieved in Re Scientific Pension Plan Trusts (1999) where a forfeiture clause operating on the bankruptcy of a member prevented the benefits passing to the trustee in bankruptcy. Instead they passed to the pension scheme trustees, who had power to apply them for the benefit of the member's dependants.

 A protective trust is a trust which prevents an absolutely-entitled, sui juris beneficiary from taking absolute title to the trust property so that the beneficiary can be treated as having no vested title in that property.  A settlor may wish to use such a protective trust for one of three general purposes. o To prevent a beneficiary who is incompetent in some way from taking absolutely title in property because they are not considered reliable enough to vest absolute title in property in them  for example, a drug addict who is feared incapable of resisting the urge to spend the whole of a trust fund on feeding her addiction. o To prevent the settlor from appearing to have title in property which otherwise the settlor would be required to give up to her creditors in insolvency proceedings: here the trust might be used in an attempt to make it seem that the trust property were owned beneficially by some other person. o To prevent the settlor from appearing to be absolutely entitled to trust property for tax or other regulatory purposes....