Trustee Duties; The Duty of Care PDF

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Duncan Sheehan...

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Trustee Duties; The Duty of Care So far, we have examined the requirements for the creation of a valid trust. We will now consider the trust once it is up and running. Specifically, we will examine various types of trustee duties. Introduction The office of the trustee is a demanding one. Trustees are required to hold property on trust for another person, thus acting for the benefit of the beneficiary. Trustees are subject to a number of duties (unless exempted by the trust instrument), including:  The duty of care – a duty to act carefully; and  The fiduciary duty – a duty to act loyally or with proper motives A trustee holds an office that involves onerous duties and responsibilities. For an express trust, it is not possible to impose trusteeship on a person without their consent (Westdeutsche Landesbank Girozentrale v Islington LBC). Note that this is not the case for a constructive trust i.e. a trust created by the law. In order to understand trustee duties, it is essential to understand one of the central policy considerations in relation to trustee duties, which is the attempt to balance two perhapsconflicting aims: 1. Regulating trustees so that they actually act for the benefit of the beneficiaries; and 2. Permitting trustees a certain degree of discretion to operate so people (particularly professional trustees) are willing to take on the role of a trustee. This debate plays out repeatedly in relation to: o Trust investment, o The scope of fiduciary duties; and o The operation of exemption clauses.

The Duty of Care The duty of care refers to the duty to act carefully. Trustees are subject to a duty to comply with the standard of care expected of all trustees. There has been some debate over the precise way to define the required standard of conduct. The standard of

conduct expected of trustees was originally laid down by Lord Blackburn in Speight v Gaunt. He noted that: “As a general rule, a trustee sufficiently discharges his duty if he takes in managing trust affairs all those precautions which an ordinary prudent man of business would take in managing similar affairs of his own”. The standard laid down in Speight was an objective test that judged a trustee’s conduct against that of a reasonable trustee, regardless of their skills, experience or knowledge. There has been some suggestion that professionals would be held to a higher standard of care on account of the fact that they hold themselves out as having expertise over that of ordinary persons (Brightman J in Bartlett v Barclays Bank Trust Co Ltd) The duty of care of trustees now has statutory basis: Section 1(1) Trustee Act 2000 ‘Whenever the duty under this subsection applies to a trustee, he must exercise such care and skill as is reasonable in the circumstances, having regard in particular – a) To any special knowledge or experience that he has or holds himself out as having, and b) If he acts as trustee in the course of a business or profession, to any special knowledge or experience that it is reasonable to expect of a person acting in the course of that kind of business or profession.’ The Act also states when the statutory duty of care applied to the functions of trustees, listed in Schedule 1, such as:  Investment;  The acquisition of land;  The appointment of agents, nominees and custodians; and  The insurance of trust property. Schedule 1, para 7, also states that the statutory duty of care does not apply ‘if or insofar it appears from the trust instrument that the duty is not meant to apply’. Note that the common law duty of care continues to apply to the exercise of powers and functions not listed in Schedule 1 of the Trustee Act 2000. Defining the duty of care The Trustee Act 2000 lays down an objective ‘reasonableness’ standard with respect to the duty of care. All trustees are

required to comply with the standard of a reasonable trustee, although reasonableness is determined based on the circumstances. It is debateable as to whether circumstances (for instance, the lack of experience of a trustee) would permit a trustee to be held to a lower standard of care than that of a reasonable trustee. However, the statute is explicit in requiring a higher standard of care from two categories of trustee: 1. The first category relates to a trustee who possesses or who holds themselves as possessing special knowledge of experience. For instance, a trustee who claims to have special experience in trust administration will be held to a higher standard of care than a trustee who does not claim to have such experience. 2. The second category relates to a trustee who acts professionally. Section 28(5) 2000 Act states that ‘a trustee acts in professional capacity if they act in the course of a profession or business that involves the provision of services in connection with the management or administration of trusts’. The growing use of the trust as a vehicle for property management has led to the rise of professional trustees (such as banks or solicitors’ firms) who provide services in connection with the administration of trusts. In such a case, a trustee would be held to a standard of care reasonably expected from a person within that specific business or profession.

When does the statutory duty of care apply? Appointment of agents The statutory duty of care applies when a trustee appoints agents to act on their behalf. Traditionally, the trustee was expected to perform all duties and responsibilities in relation to the trust personally. However, with the growing complexity of trust administration, many trustees may lack the expertise to discharge particular responsibilities and may seek to appoint agents to act on their behalf. Section 11(1) 2000 Act states that trustees may ‘authorise any person to exercise any or all of their delegable functions as their agent’. Note that not all trustee functions can be delegated. Section 11(2) of the Act states that non-delegable functions include:  Asset distribution;

 Power to determine whether payments are to be made from income or capital;  Power to appoint trustees; and  Power to delegate functions or appoint nominees or custodians. A person who has been appointed as an agent to exercise a function is ‘subject to any specific duties or restrictions attached to the function’ (Section 13(1) 2000 Act). For instance, a person authorised to act as an agent to exercise the general power of investment is subject to the duties in relation to that function, such as the consideration of the standard investment criteria. It is important to remember, particularly for problem questions, that those who have been appointed as an agent are subject to the same duties as the trustee. Therefore, agents are also subject to the duty of care that trustees are subject to in the exercise of the functions that are listed in Schedule 1. Once an agent is appointed, the trustee can’t simply just forget about their duties in relation to the trust. Trustees must keep under review the arrangements under which the agent acts and consider whether ‘there is a need to exercise any power of intervention that they have’ (Section 22(1) 2000 Act).The power of intervention includes a power to give instructions to the agent of a power to revoke the authorisation or appointment (Section 22(4) 2000 Act). There are special restrictions on the delegation of asset management functions of trustees. These functions include investment of trust assets, acquisition of trust property, and management and disposal of trust property (Section 15(5)). The delegation of these functions has to be by an agreement that is in or is evidenced by writing (Section 15(1)). The agreement must include a term that the agent shall comply with the policy statement prepared by the trustee to ‘give guidance as to how the functions should be exercised’ (Section 15(2)). The policy statement should be formulated ‘with a view to ensuring that the functions will be exercised in the best interests of the trust’ (Section 15(3)). Trustees still have a duty to consider ‘whether there is any need to revise or replace the policy statement’ and revise or replace it if they do think so, as well as a duty to

assess whether the policy statement is being complied with (Section 22(2)). Section 23(1) states that trustees are only liable for any act of the agent if they have failed to comply with the duty of care:  When entering into arrangements with the agent (for example, appointing an agent to exercise asset management functions without providing a policy statement to guide the agent), or  When exercising duties under s.22 in relation to reviewing such arrangements or considering the policy statement on asset management

EXAM TIP: If an agent has been appointed for exercising asset management functions, then you need to consider each of the requirements in turn: - Is the delegation evidenced by writing? - Is there a policy statement? - Has the trustee been considering whether the agent is complying with the terms of the policy statement? - Or has the trustee simply appointed the agent and forgotten the trust? Trustee Investment The term ‘investment’ has not actually been defined in the Trustee Act 2000. It is understood to involve the application of ‘money in the purchase of some property from which interest or profit is expected and which property is purchased in order to be held for the sake of the income which it will yield’ (P.O Lawrence J in Re Wragg). In other words, when we refer to trustee investment, we mean investing trust assets with the intention of generating capital growth or income for beneficiaries. The trust instrument (deed) is the starting point to consider the trustees’ powers of investment. Historically, trustees without a wide express power of investment were restricted to investing in a narrow range of investment categories set out in the Trustee Act 1925. However, there has been a significant amount of reform relating to trustee investment as the list set out in the 1925 Act was considered ‘unduly restrictive’.

Schedule 1 Trustee Investments Act 1961 expanded the rage of authorised investments by dividing permitted investments into:  ‘Narrower-range’ investments (safe) such as fixed-interest government securities; and  ‘Wider-range’ investments (risky) such as equities. However, investment in wider-range investments was only permitted if the trustees divided the trust fund into two, investing only half (later three-quarters) of the fund in equities (S.2(1) 1961 Act). The remaining half still had to be within the narrower-range investments. The requirement of dividing the trust fund was criticised as administratively burdensome and the provisions were seen as ‘unduly restrictive’ (Law Commission, Report on Trustees’ Powers and Duties, No 260, 1999, para 2.17). In response to the demand for reform, the Trustee Act 2000 broadens the investment powers of trustees. It permits a trustee to ‘make any kind of investment that he could make if he were absolutely entitled to the assets of the trust’ (S.3(1) 2000 Act). This is known as the ‘general power of investment’. The ‘general power of investment’ can be limited or excluded by the specific provisions of the trust instrument (s.6(1)(b) 2000 Act). It does not apply to trustees of pension funds (s.36(3) 2000 Act) or authorised unit trusts (s.37(1)).

Duties of trustees in relation to investment Although trustees have wide powers of investment, they are also subject to duties in relation to the investments since they hold the trust property on behalf of the beneficiaries. The statutory duty of care applies to trustees exercising the general power of investment (Schedule 1 Trustee Act 2000). More specifically, there are three types of duties that trustees are subject to in relation to investments: a. Duty to invest prudently; b. Duty to act impartially; and c. Duty to do best for the beneficiaries.

Prudence Being prudent does not mean taking no risk at all, because all investments are subject to risk. The role of the trustee is to manage such risk. The courts in Bartlett v Barclays Bank drew a distinction between ‘a prudent degree of risk on the one hand, and a hazard on the other’. Brightman J noted. ‘however one looks at it, the project [in the case] was a hazardous speculation upon which no trustee could have properly ventured without explicit authority in the trust instrument’. Brightman J therefore tried to draw a distinction between acceptable and unacceptable risk. When trying to determine whether a trustee has taken an unacceptable risk, it is important to remember that trustees’ investment decisions are not judged individually. As stated by the Law Commission 1999, in accordance with modern portfolio theory, ‘investments are best managed by balancing risk and return across the portfolio as a whole, rather than by looking at each investment in isolation’. This is based on the idea that trustees don’t simply hold one investment, but they create a portfolio of a number of different investments. Therefore, whether the portfolio as a whole is too risky is what needs to be considered. For example, if only two of five investments are ‘too risky’, it may be balanced out by the other three ‘safe’ investments. Therefore, the key insight of modern portfolio theory is to spread the risk by investing in different types of things, taking into account the risk appetite of the beneficiaries. In line with the principles of modern portfolio theory, s.4(1) 2000 Act states that trustees are required to have regard to the ‘standard investment criteria’ in exercising their powers of investment. Trustees are also required to review the trust investments ‘from time to time’ and ‘consider whether, having regard to the standard investment criteria, they should be varied’, as stated in s.4(2). It isn’t sufficient, therefore, for the trustee to simply make the investment at the beginning and then simply forget about it. They must continuously review the investment to see whether anything has changed etc. Standard investment criteria

S.4(1) of the Act states that trustees are required to have regard to the ‘standard investment criteria’ (SIC) when exercising their powers of investment: 1.Suitability The first of the SIC is suitability, i.e. ‘the suitability to the trust of investments of the same kind as any particular investment proposed to be made or retained and of that particular investment as an investment of that kind’ (s.4(3)(a). The type of investment should be suitable to the needs of the trust. Explanatory Note 23 to the Trustee Act 2000 states that factors that are relevant in determining whether an investment is suitable include ‘considerations as to the size and risk of the investment and the need to produce an appropriate balance between income and capital growth to meet the needs of the trust’. For example, a trustee should not make a risky investment where the trust fund is the sole source of income for a beneficiary, so that they may lose their sole source of income due to a risky investment. 2.Diversification The second of the SIC is diversification, i.e. ‘the need for diversification of investments of the trust, in so far as it is appropriate to the circumstances of the trust’ (s.4(3)(b). Diversification spreads investment risk and the extent of diversification depends on the trust. A trust over a house for residential purposes impliedly restricts investments to that house. A trust with a small capital fund will be less diversified than a larger fund. For larger funds, a balanced portfolio of investments will likely include a mixture of different types of investments in a variety of sectors. Section 5(1) 2000 Act states that before exercising any power of investment, a trustee must obtain and consider proper advice about the way in which the power should be exercised, having regard to the SIC. This duty is not limited to the first time an investment is made but applies on a continuing basis. Similarly, s.5(2) states that when reviewing the investments of the trust, a trustee must obtain and consider proper advice about whether the investments should be varied. ‘Proper’ advice is defined in s.5(4) as ‘the advice of a person who is reasonably believed by the trustee to be qualified to give it by his ability in and practical experience of financial and other

matters relating to the proposed investment’. S.5(3) states that the requirement to obtain proper advice does not apply if a trustee ‘reasonably concludes that in all the circumstances it is necessary or inappropriate to do so’. The statute doesn’t specify what these circumstances are, but one likely situation could be when the trust fund is really small with limited funds and so the sensible option would be just to keep the funds in a bank account. Several of the issues relating to trustee investment were highlighted in: Nestle v National Westminster Bank (No 2) - A testator died and named his widow, two sons and wives and one grandchild as the beneficiaries. The trust fund was worth £270,000. The grandchild claimed that if the trustee bank (NatWest) had acted with proper car and skill in relation to investments, the trust fund would have been worth more than £1 million. - The trustee failed to obtain proper legal advice as to its scope of investment powers. The bank assumed that it was restricted to investing in the shares of certain companies and it did not take any steps to obtain legal advice as to the interpretation of the trust instrument. The trustee bank also failed to conduct periodic reviews of the investment. - However, Hoffmann J held that there was no breach of the duty of care. Although the investments made by the trustee ‘fell woefully short of maintaining the real value of the fund’, the failure to maintain the real value in itself was not a breach of the trust since that might be impossible or might ‘require extraordinary skill or luck’. - The beneficiary also failed to prove the argument that the trust fund would have been more valuable if the investments had been made in a wider and more diverse range of equities. This constituted the loss of a chance and the claimant had failed to provide any evidence that a more diversified portfolio would have performed better. - The performance of the trustee could not ‘be judged in hindsight’ but rather ‘in light of the investment conditions then prevailing’. Therefore, trustees and their investment decisions can only be judged against common market practice.

The decision in Nestle has been subject to a lot of critique. Watt and Stauch argue that the court has conflated two separate issues: breach of duty of care and of loss. This is because the decision seems to imply that even if a trustee is acting imprudently, the burden of proof on the beneficiary to prove the loss caused is set very high and it is almost impossible to prove that a fund would have been of greater value if certain decisions had been taken. The investment market is unpredictable and since it is so hard to prove loss, it is really difficult to hold trustees liable for loss of opportunity. It is therefore difficult to argue that this case has reached the balance stated in the introduction. Impartiality Trustees have to act in the interests of the beneficiaries, but different classes of beneficiaries may have different and conflicting interests. For example, life tenants are entitled to income from trust property and would be interested in maximising investment income while beneficiaries entitled to the remainder would be interested in maximizing the capital value of the trust fund. In the case of Nestle, the remainder beneficiary alleged that the trustee had made investments favouring the life tenants. In such a case, ‘the obligation of a trustee is to administer the trust fund impartially, or fairly…having regard to the different interests of beneficiaries’, although the court recognised that it was not always ‘easy to decide what is an equitable balance’. It is important to note that the duty of impartiality does not necessarily mean equality. It is permissible for the trustees to prefer one class over another provided that the discretion was exercised taking into account proper considerations and not on account of irrelevant or impr...