International Trusts Under Fire - The Expanding Scope of Litigation

Law Lectures for Practitioners 1997

A classic by the late Peter G. Willoughby

Visiting Professor, City University of Hong Kong*

The author wishes to acknowledge his appreciation to all those who have assisted in

supplying copies of transcripts and reports of trust cases, in particular Philip Baker of Gray's

Inn Chambers and John Rae, Managing Director of ANZ Grindlays Bank Trust Corporation

(Jersey) Ltd, Barry McCutcheon for his many helpful suggestions for improvements, and

Anthony Travers and Timothy Ridley OBE for inspiring some of the ideas contained in this

paper.

Background

Over the last three decades there has been wide-spread and increasing

use of trusts as a way of holding personal wealth confidentially. Trusts

have been created for many reasons, often in offshore jurisdictions, in an

effort to reduce tax liabilities, to alter the devolution of assets on death,

to avoid the inconvenience and publicity of probate, and to shelter assets

from actual or potential creditors.

Unfortunately, trusts have all too frequently been marketed as

'products' by people who have not understood or appreciated the strict

legal requirements for the creation and proper administration of valid

and enforceable trusts. The practical implications of matters such as

forced heirship rights, which might affect the validity of transfers of assets

to a trustee and also involve the trustee in personal liability, have been

underestimated, as have also the dangers of retaining direct or indirect

control in a settlor or beneficiaries through asset'holding companies of

which the settlor is the sole director, private unit trusts, letters of wishes,

and protectors with wide powers. The trust legislation of some offshore

jurisdictions, in an effort to be user-friendly by seeking to overcome

perceived disadvantages in the equitable rules developed over many

centuries, have distorted the trust concept and unwittingly permitted

the creation of what are in substance different legal relationships such as

bailments, agencies, and nomineeships, unconvincingly disguised as

'international trusts.' These so-called trusts are unlikely to be treated as

genuine trusts by other jurisdictions in which, for example, the assets are

situated, and at best they will operate as resulting trusts to the settlor or

the latter's estate,

As those whose wealth was transferred into trusts twenty or so years

ago die, the validity and effectiveness of trust arrangements are coming

under attack from disinherited heirs and other disappointed relatives,

former spouses, revenue authorities, and creditors. Recent litigation in

a number of jurisdictions has shown that trusts may be set aside and the

assets claimed by relatives, creditors, and revenue authorities for a

variety of reasons. This may be because the settlor retained control over

the assets so as to render the trust a sham, because the trust was void for

uncertainty from the outset, because the assets are situated in a

jurisdiction which does not recognise trusts, because the trust does not

conform with essential equitable criteria (despite compliance with the

international trust law of the offshore Island of Utopia), because the

trust deed was in substance a will which is invalid as incorrectly

executed or because creditors are able to establish, in the jurisdiction

of the trust assets, that the trust was intended to defraud creditors or,

more probably, was not a true trust in the equitable sense but in

substance a bailment, agency, or nomineeship disguised as a trust. Even

where a trust has been set up properly, as in the common case of a

discretionary trust supported by a collateral letter of wishes and with a

reputable trust company based in an offshore jurisdiction as the trustee,

it may be possible to attack the way in which the trust has been

administered. Where a protector has been appointed with wide powers

and the protector is a close friend or relative of the settlor, the trust may

be attacked as a sham. Even where the protector has limited powers, the

exercise of those powers may be challenged. It is also possible that some

of the more recent innovative company law concepts will not be

accepted by the courts of the larger jurisdictions with the consequence

that trust structures using asset-holding companies will fail to achieve

the desired result.

The purpose of this lecture is to review some of the recent case law

from a number of jurisdictions and to point out the dangers for trusts that

have not been created in accordance with equitable rules or that have

not been properly administered. There are also dangers for trusts that

have been scrupulously administered and suggestions will be made that

may minimise the risks of litigation. It needs to be understood, however,

that trust litigation is now wide-spread and professional trustees should

appreciate that sooner or later a disappointed relative will probably sue

them.

The main areas of trust litigation are as follows:

• Attacks on trusts alleging their invalidity for failure to meet essential

criteria

• Attacks on trusts on the ground that they are invalid under the law

of the settlor's home jurisdiction

• Attacks on trusts on the ground that they are invalid as inadequately

executed wills

» Attacks from creditors seeking to set trusts aside as frauds on their

claims or for any of the first three reasons above

• Allegations that the trust has not been properly administered and

that the trustees have acted in breach of trust

• Breach of directors' duties in relation to asset-holding companies

• Attempts by beneficiaries and others to obtain copies of the trust

records

• Disputes over compliance with letters of wishes

• Problems with protectors and the exercise of their powers

• The possible liabilities of professional advisers in relation to trusts

Was the trust invalid because it did not meet essential criteria?

The leading case is Rahman v Chase Bank Trust Company (CI) Ltd [1991]

JLR 103, a decision of the Jersey Royal Court in which the plaintiff was

the widow of the deceased settlor. In this case Mrs Rahman was successful

in persuading the Royal Court to set aside the trust under an old principle

of Jersey law that 'donner et retenir ne vaut' (to give and to retain is not

possible) and also more importantly because the trust was a sham. In the

view of the court Mr Rahman had never intended to lose control of the

trust assets and had continued to take all decisions relating to the

management of the assets as if he were the absolute owner of them,

merely notifying the trustee of his decisions from time to time. The

repercussions of the Rahman case continue to be felt as attempts are made

to set trusts aside for a variety of reasons.

In many cases in which trusts have been proposed, the initial

reaction of the settlor to the need to transfer legal ownership and control

to trustees, who are very often unknown to the settlor personally and in

another jurisdiction, has been unfavourable. The reluctance of the

settlor is usually mollified by advice that he can retain indirect control

by means of a letter of wishes or the appointment of a friend as protector.

In cases where it can still be said that the trustees genuinely obtain and

then retain control over the trust assets and exercise their discretion to

do what is best for the beneficiaries, there may be little danger of the trust

being declared a sham. However, where indirect control continues to be

exercised by the settlor through, for example, a protector who has wide

powers of control over the trustee, it is far from certain that the principle

in the Rahman case cannot be applied. Quite where the line will be drawn

by the courts in various jurisdictions between the sort of crude sham

revealed in the Rahman case on the one hand and non-binding advice

given by a letter of wishes, often at variance with the terms of the trust

deed, or veto powers exercised by a protector on the other, is a matter for

conjecture. It seems probable that limited powers of veto given to a

protector with a power to appoint and dismiss trustees need not endanger

the validity of a trust, although in these circumstances it is now clear that

the courts of most equity jurisdictions will regard protector powers of this

sort as fiduciary with the result that protectors may be required to show

that they have exercised them in the best interests of the beneficiaries

rather than for personal reasons or at the behest of the settlor. Clear

evidence of the latter could lead to a Rahman situation. In passing, it

should be mentioned that the provisions of some international trust laws

which allow the settlor to direct the trustees as to the disposition of the

trust assets are likely to result in some jurisdictions regarding such socalled

trusts as invalid, at any rate in relation to matters within their own

jurisdictions.

Courts in the United States appear to be approaching the issue of

effective control by settlors by applying the 'alter ego' theory to trusts and

also asset-holding companies (see Deryll Wayne Pack v United States (US

District Court for Eastern District of California; 77 AFTR 2d Par 96-476,

No CV-F-92-5327 REC); United States v Reinhard P Mueller (US Court of

Appeals for Eleventh Circuit; 77 AFTR 2d Par 96-457, No 94-3617); and

the discussion in relation to actions by creditors to have trusts set aside).

It should be emphasised that the consequences for a trustee of a trust

that is held to be a sham are potentially extremely serious. The trustee

will never have been more than a nominee for the settlor who remains

the sole beneficial owner. Any action of the trustee that has been

inconsistent with the continued ownership of the settlor will have been

unlawful. Fees will have to be repaid with interest and the trustee will

have to make good losses caused by distributions to beneficiaries other

than the settlor or, if he has died, his estate.

Another issue which goes to the initial validity of a trust is the

question of certainty. There have been a very large number of 'off the

shelf 'Red Cross' trusts used around the world over the past 25 years

which are of doubtful validity. In its crudest form the trust will be created

by a dummy settlor giving a nominal sum to the trustee, and the trust deed

will name the local Red Cross branch or some other charity as a

discretionary beneficiary and provide for a power to name further

beneficiaries usually from within a defined class. What then often

happens is that no additional beneficiaries are formally appointed, even

though there may be a letter of wishes indicating the substantive settlor's

preferences, and the trustee, perhaps a British Virgin Islands international

business company owned by an investment adviser, will make

payments to the settlor as and when the latter needs funds. Very often

there are no records of decisions of any kind made by the trustee other

than bank statements and portfolio valuations which have been sent to

the settlor from time to time. The Red Cross is invariably not informed

of its status as a beneficiary nor is there any intention of benefiting it. In

these circumstances many problems exist but the fundamental one is the

failure to identify beneficiaries. It is apparent that the selection of the

Red Cross as a discretionary beneficiary without intending to benefit it

is bogus and if no other beneficiaries have been identified the trust will,

if challenged, arguably be held void for uncertainty. If the Red Cross or

other charity discovers that it is named as a beneficiary, perhaps because

the trust results in litigation, as happened in the Isle of Man case Steele

v Paz Ltd (10/10/95 - CH 1992/95), already complex litigation will

become even more of problem for the trustee.

These issues were recently explored in litigation in the Isle of Man

in Steele v Paz Ltd (10/10/95 - CH 1992/95). The case involved some 28

defendants and was very complicated. The main issue concerned the

validity of a declaration of trust made between a Panamanian company

as settlor and an Isle of Man trust company as trustee. Under the terms

of the trust the shares in the company were to be held on trust for the Red

Cross Society of Ireland and for such other persons as the trustees should

appoint with the consent of the protector. At first instance the Isle of

Man judge held that the trust was void for uncertainty. There was never

any intention that the Red Cross Society of Ireland should benefit and

no protector had been appointed who could confirm the appointment of

other beneficiaries with the result that there were no beneficiaries. The

judge also held that the uncertainty could not be cured by the court

appointing a protector. On appeal, however, it was held that the powers

that any appointed protector would have to exercise under the terms of

the trust were fiduciary. The appeal court thought that, as there were no

restrictions limiting the choice of a protector to any particular persons,

it had power to appoint a protector. The result was that other beneficiaries

could be ascertained by appointments approved by a protector and

the trust was not after all void for uncertainty. The court did not have to

decide whether the Red Cross Society of Ireland was a genuine beneficiary.

On this issue the first instance decisions remains important.

Although the problem of uncertainty was eventually resolved in

Steele v Paz, it was a close call and other 'Red Cross' trusts which do not

provide for protectors but rely on letters of wishes to indicate beneficiaries

may well be at risk of being held void for uncertainty if no

beneficiaries have been appointed. A possible way out of the problem

would be to establish that the letter of wishes should be regarded as part

of the trust deed, for which there is some authority (see Hartigan

Nominees Pty Ltd v Rydge (1992) 29 NSWLR 405), but this is usually not

what is intended and might have unfortunate tax repercussions. Moreover

it is often the case that the letter of wishes is inconsistent with the

terms of the trust deed. Steele v Paz was subject to a further appeal to the

Privy Council in London but leave to appeal was refused.

Was the trust invalid according to the law of the settlor's home

jurisdiction?

Trusts are frequently set up by persons domiciled in forced heirship and

civil law jurisdictions which do not recognise trusts. In general terms

these jurisdictions are the civil law countries of continental Europe,

Japan, and probably China, and Moslem countries which follow Sharia

law. Many offshore jurisdictions have enacted trust laws which provide

expressly for the recognition of trusts even though they would not be

recognised by the law of the settlor's home territory and even though a

trust has been specifically created to render the forced heirship laws of

another country of no effect.

Recent litigation in the Cayman Islands has shown that provisions

in trust laws of this kind may have a limited effect (see Re the Lemos Trust

Settlement [1992-3] C1LR 26 and Lemos v Coutts & Co (Cayman) Ltd

[1992-3] CILR 5). This will often be the case where the trust assets are

situated in the jurisdiction of the settlor's domicile or some other

jurisdiction which does not recognise trusts, rather than in the jurisdiction

of the trustee. While it may be possible to change the situs of assets

by transferring them to a holding company in the offshore jurisdiction of

the trustee, it should not be assumed that the veil of incorporation will

not be lifted, or the United States' alter ego theory applied, particularly

where an international business company is used as a holding company.

Such companies are viewed with increasing dissatisfaction by some

jurisdictions and the practice in several offshore jurisdictions of having

two company laws, a regulated one for resident users which requires

much disclosure and an unregulated one for non-resident users, is coming

under increasing scrutiny and criticism.

In the Lemos litigation the disappointed heirs of a deceased Greek

shipping owner brought proceedings in Greece to set aside part of a trust

set up in the Cayman Islands by the deceased. One of the deceased's sons

also brought proceedings in Cayman. The Greek actions were commenced

against the trustee and a number of companies and individuals

alleged to have been involved in the establishment and administration

of the trust, some of whom were resident in Greece. Several causes of

action were asserted with the object of giving effect to forced heirship

claims under Greek law on the basis that the trust assets were part of the

deceased's estate. The proceedings in the Cayman court were against the

trustee alone and resulted in various interlocutory matters being resolved.

These related to the inspection of trust documents and the right

of the trustee to have its legal costs of defending the trust paid out of the

trust assets. The main issues never came to trial in either Greece or

Cayman because there was a settlement under which two of the forced

heirship claimants were, it is understood, paid 8 per cent of the trust

assets. They were also removed from the class of beneficiaries under the

trust. The practical result was that s 6 of the Cayman Islands Trusts

(Foreign Element) Law 1987, which seeks to render the forced heirship

laws of another jurisdiction of no effect, did not entirely achieve its

objective. On the other hand it has been said that the Cayman legislation

produced a better result in relation to forced heirship than if no

action at all had been taken.

There are other problems which can arise in circumstances where

the trust law of one jurisdiction is used to frustrate the succession law of

another jurisdiction which have yet to be resolved. For example, in the

event of proceedings in a jurisdiction in which trust assets are situated,

there is the possibility that the trust might not be upheld on the grounds

of public policy. It might also be argued that the forced heirship law is not

merely a matter of succession law after death but may also apply inter

vivos to render a transfer of assets to trustees, that was designed to

frustrate succession rights, invalid under the law of the transferor's

domicile. Under many forced heirship systems, transfers of assets by gift

before death can be set aside and the transferees can then be required to

surrender the assets after the death of the donor. The heirs, therefore,

may have a claim against the trustee of a trust created in the settlor's

lifetime. Where the trustee is owned by a bank the fact that the trustee

is not itself in the jurisdiction of forced heirship will not necessarily

protect the parent bank if it has a branch office or subsidiary company in

the forced heirship jurisdiction of the deceased settlor.

Was the trust in substance a will which is invalid for want of due

execution?

A possibly fruitful way of attacking a trust is to allege that it was in

substance a will which is invalid for want of due execution. Although this

was not the basis for the decision in Rahman, it is noteworthy that the

evidence showed that Mr Rahman retained full control over the trust

assets and referred to the trust as his will. If, therefore, Mr Rahman never

understood the nature of the trust which he had been advised to create,

this could have been another ground for setting aside his trust.

Possibly the most important reason for using a trust, particularly

where a wealthy entrepreneur has personal and business assets in many

different jurisdictions, is the avoidance of the delay, inconvenience,

cost, and publicity involved with obtaining probate. This is often

inconvenient enough where only one jurisdiction is involved but where

there are assets in several jurisdictions there is all the more reason to

bring all the assets together into one or more holding companies the

shares of which are held by a trust. In passing it is relevant to mention

that, while some jurisdictions advertise the fact that they do not have

estate or inheritance taxes as such, some do have ad valorem probate

duties or fees which can be quite expensive where a wealthy estate is

involved. The alternative to a trust for a multi-national entrepreneur

may be separate wills for the assets in each jurisdiction. This will

overcome the inconvenience of having to reseal a grant of probate in the

case of a will dealing with all the assets but remains administratively

burdensome, slow, and expensive because separate grants of probate will

be needed. Generally, therefore, a trust is usually the best solution but it

is important to set it up correctly. The danger of a trust being set aside as

an invalid will was illustrated in the Canadian case of Re Pfrimmer's

Estate [1936] 2 DLR 460 (Manitoba). In that case the trust allowed the

settlor to have effective control over the assets until death when they

were to be sold and the proceeds distributed. There was also evidence

that the settlor had deliberately set up the trust to avoid probate. The

court held that the trust was in substance a will which was ineffective

because the formalities of execution necessary for a valid will had not

been observed. This is yet another example of the danger of creating a

trust under which the settlor retains too much control over the assets.

Although this was not an issue in the case, it should be appreciated that

a trustee of what turns out to be an invalid will can get into very serious

difficulty if, after the death of the 'settlor/testator,' the assets are administered

without the authority of a grant of probate or letters of administration.

The 'trustee' will be an executor de son tort and liable for heavy

penalties because the assets will be governed by the rules of intestate

succession. In addition, those entitled under the intestacy rules will be

able to sue the 'trustee' if assets have been distributed to the wrong people

or to the right people in the wrong proportions. It follows that whenever

a trust is set up to avoid the need for probate, the trustee should be

particularly careful to ensure that it is set up correctly without giving the

settlor control of the trust assets. Some of the so-called asset protection

trusts which have been created under the international trust laws of

certain offshore jurisdictions, when challenged in an orthodox equitable

jurisdiction, could well fail on the ground that they are invalidly

executed wills irrespective of other remedies available to creditors.

Can the trust be set aside by creditors?

It may be possible for a creditor to have a trust set aside or disregarded

by a court in the jurisdiction of the place where the assets are situated.

This is most likely to occur under statutory remedies specifically designed

to protect creditors such as, in the case of the United Kingdom,

the Statute of Elizabeth 1 (Ch 5) 1571 or the Insolvency Act 1986 (see,

eg, Alsop Wilkinspn (a firm) v Neary [1995] 1 All ER 431). In many

offshore jurisdictions that have enacted legislation designed to attract

so-called asset protection trusts, there is usually a time limit within

which foreign judgments can be enforced against trust assets. For

example, in the Cook Islands under s 13B of the International Trusts

Act 1984 the period is two years. In a recent decision of the Cook Islands

Court of Appeal (515 South Orange Grove Owners Association v Orange

Grove Partners (No I) (1995) No 208/94) the issue was whether

proceedings for a Mareva injunction taken in the Cook Islands to

enforce a judgment obtained in California had been commenced in

time. In the course of a 28 page judgment Sir Duncan McMullin, the

presiding judge of the Cook Islands Court of Appeal, analysed a number

of provisions of the Cook Islands International Trusts Act 1984 and

pointed out many drafting errors and the ambiguity of some of its

provisions. He was scathing with regard to the alleged purpose of the

legislation which was explained by counsel for the respondents as

'unashamed soliciting of funds to improve the economic position of the

Cook Islands by giving protection against creditors exercising their

rights.' Sir Duncan thought that the question of the date from which the

two-year limitation period was to run was ambiguously expressed in

s 13B(8)(b). It could mean the date when the original cause of action

arose or the date of the finding of the jury which resulted in the

Californian judgment in favour of the appellants who were the Californian

plaintiffs. As to this, the judge observed:

In the end we think the Court should strive to give a common sense

approach to a piece of legislation which is at once very sophisticated

but also ineptly drafted in parts. We think that the better view is that

Parliament, in attempting to balance the interest of settlors, trustees

and creditors, has prescribed certain specific limitation periods; that

the right to sue on either a cause of action or a judgment is abridged

but not eliminated, and that a common sense interpretation should

allow for intention to be given to those two concepts. It should not

be lightly assumed that Parliament intended to defeat the claims of

creditors by allowing international trusts to be used to perpetrate a

fraud against a creditor.

He then went on to find that the two-year period ran from the date

of the finding of the jury and not from the date when the cause of action

arose in California, with the result that the proceedings in the Cook

Islands to enforce the judgment were effective. An attempt was then

made to prevent publication of the judgment in reliance upon s 23(2) of

the International Trusts Act 1984 which provides for hearings in camera

and no publication of the proceedings without leave of the court. Sir

Duncan McMullin was, by implication, highly critical of this provision

and commented that 'it would be strange if those most directly affected

by this legislation and its proper interpretation ... were to be denied

knowledge of the ruling of the highest domestic Court of the Cook

Islands.' He was not 'impressed by the argument that 'secrecy is the

cornerstone of the legislation' and had no hesitation in ordering 'that

both the substantive judgment and this present judgment be published

within and outside the Cook Islands.'

Following the reinstatement of the Mareva injunction, the plaintiffs

learned for the first time of a second trust to which assets had been

transferred. This resulted in a further action (515 South Orange Grove

Owners Association v Orange Grove Partners (No 2) (1996) No 31/96) in

which the plaintiffs were again successful.

It is doubtful whether the highest domestic court of any jurisdiction

has ever delivered more scathingly critical judgments of a jurisdiction's

own legislation and it is much to the credit of the Cook Islands judiciary

that such shabby legislation has been so sweepingly discredited. Those

who embark upon the drafting of legislation designed to enable debtors

to evade their creditors should realise that when the merits of a case lie

with creditors most judges will strive somehow to find against the debtor.

That is perhaps the most important message from the Orange Grove cases.

Since they were decided, it has been claimed that the first decision 'has

now been substantially negated and the underlying intent of the Act

confirmed' by amendment to the International Trustees Act (Offshore

Investment, February 1997, p 4). What this overlooks is the distaste

many judges have for explicit asset protection legislation. In the case of

the Cook Islands further controversy is likely because the International

Trusts Act, as recently amended, now contains a provision for migrating

foreign trusts to the Cook Islands which are deemed to be back-dated to

the date of the original creation of the foreign trust if a creditor makes a

claim after migration to the Cook Islands. This has made the International

Trusts Act even more unattractive to some and is likely to

infuriate many judges and increase the judicial attempts to favour

creditors. Other jurisdictions tempted to follow the Cook Islands in

enacting so-called asset protection trust laws would be wise to study the

judgments of Sir Duncan McMullin before doing so.

It should be noted that an asset protection trust governed by a trust

law which allows the settlor to retain control over the trust assets will

create a further problem for the debtor if sued by a creditor in the

debtor's jurisdiction. A judge might, for example, order the debtor to

direct the transferee trustee to transfer the trust assets to the creditor

under the powers given to the settlor in the trust deed subject to the

sanction of imprisonment for contempt of court. The importance of the

location of the debtor was emphasised in Re Larry Portnoy 201 Bankr

685 (1996), a United States case in which the debtor was unsuccessful

in getting his bankruptcy set aside. The debtor had transferred many of

his assets to a trust administered in Jersey and subject to Jersey law. The

trust had been created, with the settlor as the principal beneficiary and

his children as the other beneficiaries, two months before Portnoy's

business got into serious financial trouble. The court held that the fact

that the trust was subject to Jersey law was not the relevant issue. What

was relevant was whether the debtor had set up the trust for the purpose

of concealing his assets from a major creditor. As to this the Bankruptcy

Court for the Southern District of New York had jurisdiction for the

purpose of interpreting the relevant bankruptcy legislation and the

effect on this of the Jersey trust. The validity of the trust was therefore

of no relevance,

The decisions in the Orange Grove cases turned on whether the

proceedings commenced in the Cook Islands had been commenced in

time. The decision in the Supreme Court of the Bahamas in Grupo Torras

SA v Sheikh Fahad (judgment delivered 1 September 1995) shows,

however, that where the evidence indicates that the primary beneficiary

of a trust treats the trust as an alter ego, the court will lift the veil so as

to determine to what extent trust funds allegedly misappropriated are to

be considered as the beneficiary's and therefore subject to a tracing order.

The decision was interlocutory and resulted in a Mareva injunction

remaining in force and an order allowing amendment of the statement

of claim to include claims for declarations that assets owned, controlled,

or managed by various trustees or protectors of several trusts were 'in

equity and/or law the assets of Sheikh Fahad.'

This line of attack seems likely to place many so-called asset

protection trusts which take advantage of legislation giving settlors

control over the trust assets in grave danger where, at any rate, the assets

are claimed by others. The effect is to by-pass any limitation period and

make it unnecessary to argue that the trust was a sham.

It cannot be emphasised too strongly that claims which dispute the

settlor's and therefore the trustees' ownership present very serious

dangers for trustees. If the claim is successful the trustees will have no

right to their fees or, subject to what is said later, to an indemnity for their

legal costs. Distributions of assets will have been unlawful and will have

to be reimbursed by the trustees. If the settlor is dead the trustee will be

an executor de son tort and liable to the estate of the deceased to which

the trust assets belong. Where there are estate or death taxes to pay the

trustees will have unlawfully intermeddled with the deceased 'settlor's'

estate and will normally be liable to very severe financial penalties.

These claims are likely to be particularly common in those jurisdictions

like the Cook Islands, Nevis, and the Bahamas which have short

limitation periods designed to frustrate creditors. There is also likely to

be a further problem in these and similar jurisdictions in that, once the

limitation period has passed, the trustees may become over confident and

careless in the administration of the trust, thus making it all the easier for

a claim to be made that the trust was a sham. Where a trustee is faced with

a claim challenging the ownership of the trust assets an application

should be made to the court for directions, failing this if the claim is

successful the trustee is most unlikely to be entitled to be indemnified for

legal costs from the trust assets (see Alsop Wilkinson (a firm) v Neary

[1995] 1 All ER 431, discussed later).

Creditors are not, of course, restricted to remedies designed to

protect their claims and may be able to attack a trust as a sham, an invalid

will, a trust that is void for uncertainty or as a legal relationship that in

substance is a bailment of chattels, an agency, or a nomineeship rather

than a trust, because the settlor has retained overall control of the assets,

The critical issues in practice are likely to be the place where the

assets are in reality situated and the place where the debtor is located and

not what the laws of the trustee's jurisdiction state. The importance of

the place where the assets are situated was bluntly demonstrated in Duttle

v Bander Kass (1992) 82 Cir 5084 (KMW), a decision of the District

Court of the Southern District of New York. The case concerned a

creditor who was trying to execute judgment for US$3,866,714.62 by

seizing property in the United States which was, in the words of Wood

DJ, nominally owned by others and a Liechtenstein trust set up by the

debtor. The Liechtenstein trustee refused to submit to the court's

jurisdiction and claimed not to recognise foreign judgments. As to this

Wood DJ stated:

It would be inequitable to allow a fraudulent settlor of a trust to

keep the trustee beyond the equitable reach of a court by selecting

a trustee who stated that he would not appear in [an] American

court, and refused to submit to deposition on the question of

jurisdiction...

The judge had no hesitation in assuming jurisdiction over the trust

assets, most of which were in the state of New York. There seems little

doubt that a similar approach will be adopted with many of the so-called

asset protection trusts set up under the trust legislation of certain offshore

jurisdictions.

In passing it could be said that trusts have always concerned asset

protection and the hijacking of the term to apply only to trusts set up to

protect debtors from claims by creditors is confusing and inaccurate.

Whether debtor protection trusts, of the types that have been fostered by

some offshore jurisdictions, will have any long-lasting use has yet to be

established. It seems that at best they may sometimes achieve a better

result for some settlors, particularly in relation to frivolous claims funded

on a contingency basis, than would have been the case had no action

been taken. However, being established to protect settlors rather than to

benefit beneficiaries, they run a particularly high risk of being challenged

as shams.

The approach adopted by Wood DJ has been developed in further

decisions of courts in the United States. In the first, Deryll Wayne Pack

v United States (US District Court for Eastern District of California; 77

AFTR Par 96-476, No CV-F-92-5327 REC) Coyle DJ applied the 'alter

ego theory' to allow the enforcement of a tax lien against the property of

an offshore trust on the ground that both the trust and the trustee were

alter egos of the taxpayer. The learned judge explained that the issue of

personal jurisdiction was irrelevant because the government was 'relying

on this court's in rem jurisdiction in seeking the default judgments.' In

this context State (California) law set out two requirements: first, unity

of interest and ownership to the extent that there was no 'legal separateness

of the individual and the alter ego' and, second, a finding that

'observance of the fiction of separate existence would ... promote fraud

or injustice.' In the second case, United States v Reinhard P Mueller (US

Court of Appeals for Eleventh Circuit; 77 AFTR 2d Par 96-457, No 94-

3617), a conviction for income tax evasion was affirmed and in course of

doing so the court held that a company in which the taxpayer held stock

was his alter ego.

The use of the 'alter ego' approach in the case of trusts is in substance

equivalent to the argument that a trust is invalid because the settlor has

remained in effective control. When applied to companies it is an

example of lifting the veil of incorporation. It seems likely that many

trusts together with associated asset-holding companies will be successfully

attacked by creditors in situations where the settlor has remained in

effective control of the assets or has continued to enjoy benefits from

them. It further appears that an international trust law which has been

designed to enable the settlor to retain control over assets will be

ineffective in preventing a creditor from seizing trust assets in the

jurisdiction of the creditor, at any rate where that jurisdiction is the

United States of America. It appears likely that other major jurisdictions

will follow approaches similar to those of the United States courts.

The place where the debtor is physically present may be more

important than the location of either the trust, the trust assets, or the law

governing the operation and interpretation of the trust if the courts of the

location of the debtor are prepared to enforce judgment debts or other

orders by imprisoning debtors for contempt of court. Although Re Larry

Portnoy 201 Bankr 685 (1996) concerned an unsuccessful attempt to

have a bankruptcy adjudication set aside, the case emphasises that

jurisdiction over a debtor within the jurisdiction in which legal proceedings

are brought is often more important than the place where an offshore

asset protection trust is created or the law which governs the administration

and interpretation of the terms of the trust deed.

A recent English case involving an application by a creditor provides

an example of a trust being disregarded as a sham and therefore of no

effect. In Midland Bank v Wyatt [1994] EGCS 113 (see also Shan

Warnock-Smith, 'Midland Bank PLC v Wyatt: Sham Trusts come to the

United Kingdom' [1994] Private Client Business 410) a man made a

declaration of trust of his assets in favour of his wife and children and put

the instrument away in his safe. He incurred various liabilities to the

bank which obtained a charging order over the assets. The bank had no

knowledge of the alleged trust which was not disclosed until after the

charging order was made. The court held that the debtor had no real

intention of benefiting his wife and children and that therefore the

declaration of trust was a mere pretence or sham which did not have

priority over the charging order. While it is generally true that it is easier

to have a unilateral declaration of trust set aside as a sham than a trust

involving the transfer of assets to a third person such as a trustee,

nevertheless a trust under which the settlor retains a power of revocation

and other wide powers relating to the control and distribution of assets

which override those of the trustees is probably in equally serious danger

of being set aside as a sham or classified as creating a legal relationship

such as a bailment, agency, or nomineeship rather than a trust. This will

be particularly so where the trustees have done very little to administer

the trust other than to record and act upon the instructions of the settlor

or a protector appointed by the settlor who takes instructions from the

settlor. Where the settlor has a general power of attorney or a governing

directorship of a trading company, the shares of which are ultimately

held by a trustee, it will also be important to be able to demonstrate that

all parts of the trust and corporate structure are genuine and scrupulously

administered and that the trustee exercises proper control over the assets

in the best interests of the beneficiaries. Statements in correspondence

and file notes that a trustee exercises its powers for the benefit of the

'client' or the 'customer' will often be an indication that the trustee is

acting as a mere nominee for the settlor who is still regarded as the real

owner of the trust assets. The trust will then be in danger of being

successfully attacked by creditors of the settlor and others as a sham or

mere nomineeship.

Scrupulous, but sometimes misguided, administration of a trust,

which could result in it being set aside as a sham or nomineeship, should

be distinguished from failure to administer scrupulously which, under

separate heads of vulnerability, could result in either the trust being

attacked as a sham or the trustees being sued for breach of trust.

Has the trust been scrupulously administered having regard to the

onerous duties imposed by the law on trustees or have the trustees

committed breaches of trust?

The duties of trustees are many and they are onerous. They are especially

onerous in relation to trust companies owned and operated by large

institutions, such as banks and accountancy and lawyers' firms, which

advertise and profess special skill. There have been some institutional

trustees which have not observed the fundamental duty of putting the

interests of the beneficiaries before everything else. Trust records which

show that the trustee has regularly taken instructions from the settlor

who is referred to as the 'client' or 'the customer' are prima facie evidence

of breach of the overriding duty of the trustee to act in the best interests

of the beneficiaries. It is also sometimes the case that promotional

literature makes it clear that 'the client' will be able to retain control of

the trust assets, that the trust is a 'living will,' and that the letter of wishes

creates a unified contract between the settlor and the trustees. Claims of

this sort may be used by a plaintiff in litigation to prove that neither the

trustees nor the settlor fully understood the nature of the trust relationship.

If the trust records also show that all the trust investments have

been managed by a sister company owned by the bank, which is charging

commissions or other fees, that will be strong evidence of a further failure

to understand and observe the fiduciary duty of a trustee not to make

secret profits. A trustee which can be shown to have put the commercial

interests of its parent bank above those of the beneficiaries will be guilty

of breach of trust. As was stated in Cowan v Scargill [1985] Ch 270, 292

a trustee owes 'undivided loyalty to the beneficiaries.' An institutional

trustee that overlooks this will receive little mercy in any legal proceedings

for damages and recovery of secret profits brought by a beneficiary.

There have been a number of recent cases in which the failure of

institutional trust companies to administer trusts properly have resulted

in awards of damages against them. One of the leading cases is Bartlett v

Barclays Bank Trust Co Ltd [1980] 1 All ER 139. The facts of that case

were that a trust had been set up in 1920 which included as its major asset

a controlling shareholding in a family trading company. By the 1970s

another generation had taken over the management of the company and

the board of directors decided to invest in two property development

schemes. One of these schemes was a financial disaster, the effect of

which was to reduce the value of the trust assets by a significant amount.

A beneficiary sued the trust company and restitution of the loss to the

trust assets was awarded. The records showed that the bank had, as a

major shareholder, received annual reports and accounts but had remained

a passive observer throughout and had never intervened or

queried the directors' proposals. The decision of the English Court of

Appeal is summarised in the head note as follows:

It was a trustee's duty to conduct trust business with the care that a

reasonably prudent businessman would extend to his own affairs,

and, in the case of a private company in which he was a majority

shareholder, a prudent businessman would not be content to receive

only such information on that company's activities as was dispensed

at annual general meetings. Moreover, a professional corporate

trustee, such as the bank, owed a higher duty of care and was liable

for loss caused to a trust by neglect to exercise the special care and

skill which it professed to have. It followed that, notwithstanding

the calibre of the board, the bank, as the controlling shareholder

under the settlement, was under a duty as trustee of the settlement

Internationa! trusts under fireto ensure that it received an adequate flow

of information from theboard on [the company's]

activities in time to enable it to make use

of the information to protect the beneficiaries' interests by preventing

the ... project from being commenced and later from becoming

the financial disaster it did. The bank was therefore in breach of

trust in neglecting to ensure that it received such information and

in confining itself to the receipt of the information dispensed at the

annual general meetings. Even without such information, however,

the bank had known enough to put it on enquiry about the projects.

Since the loss to the trust funds would not have occurred if the bank

had intervened to prevent [the company's] participation in the ...

project, as it ought to have done, it followed that the bank's breach

of trust had caused the loss and that it was liable for that loss.

It was evident that the board of directors were reasonable people who

would have followed any reasonable policy desired by the bank had the

bank's wishes been indicated to the board. As the judgment went on to

state: The loss to the trust fund could have been avoided (as I find)

without difficulty or disruption had the bank been prepared to lead, in a

broad sense, rather than to follow.'

Bartlett v Barclays Bank Trustee emphasises the importance of trustees

safeguarding the trust assets and in this connection makes it clear

that a trustee has a positive duty to keep itself informed and a positive

duty to act if the trust assets are in danger. This is not to say that

speculative investments are not permitted where the trust deed authorises

them.

It is usual to try to reduce the potential liability of trustees under the

Bartlett principle by providing in the trust deed that trustees need not

become involved with the management of trading and other companies

whose shares are held by the trust unless they have actual knowledge of

an act of dishonesty or malpractice. If there are several trustees it should

be provided that any trustee with such knowledge must inform the

others.

A word of warning is nevertheless appropriate because, while there

is authority for saying that the trustees' liability for breach of trust can

be exempted, there comes a point when an exculpation clause becomes

inconsistent with the core concept of a trust. It is therefore doubtful

whether trustees can be exempted from all responsibility where the

principal trust asset consists of a majority shareholding in a family

company. Some of the very long exculpatory clauses in trust deeds may

well be held to be of limited effect or, worse still, may be evidence that

the trustees have no genuine duty to the beneficiaries because real

control over the trust assets remains with the family with the result that

the trust is in substance a sham. If the trustees are to avoid this result they

will have to take some active interest in the way the company is run and

perhaps even consider using their majority voting power to remove the

settlor and beneficiaries from the board. In the USA it has been held

that clauses which seek to exclude liability for gross negligence, recklessness,

or acts of bad faith are invalid as repugnant to the essence of the

trust relationship. In Browning v Fidelity Trust Company 250 F 321 (3rd

Cir 1918) it was held that the law 'determines a point beyond which the

parties cannot agree to relieve a trustee for breach of a trust duty. For

instance, a trustee cannot contract for immunity from liability for acts

of gross negligence or for acts done in bad faith. Such contracts are

invalid because [they are] repugnant to law.' It appears, however, that

under English law it is possible to exclude liability for gross negligence

so long as the trustee has not acted dishonestly (see Armitage v Nurse,

CA 1997, not yet reported).

Another way in which the dangers for trustees posed by the Bartlett

case can perhaps be reduced is to establish a private unit trust to hold the

shares in any private trading company and to arrange for the units to be

held by the trustees of a discretionary trust. This practice has been used

quite widely where shares in Hong Kong trading companies are to be

held in trust. The result may be that the trustees cannot be liable under

the Bartlett principle because they have no control over the companies

whose shares are held in the unit trust. On the other hand this type of

arrangement at best probably does no more than shift the responsibility

to the unit trustees and, if the latter are made up of the settlor and

principal beneficiaries of the discretionary trust, this may be evidence

that the decretionary trustees are not exercising their discretion independently.

Hong Kong structures using private unit trusts are sometimes

highly incestuous arrangements in great danger of attack as shams. This

is particularly so where the unit trust is operated like a trading company,

does not keep the records normally expected of a unit trust, and is not

accountable under the terms of the discretionary trust to the trustees of

that trust.

The Barclays Bank Trustee case was followed in West v Lazard

Brothers Co (Jersey) Ltd 1993 Jersey unreported judgments 136

(18 October 1993), a first instance decision of the Jersey Royal Court.

This was a complicated case and the judgment runs to 186 pages. The

facts are too complicated to summarise here but in essence Lazards were

responsible for losing nearly all the trust assets. The trustee tried to

escape liability by relying on exoneration clauses in the trust deed which

was a standard form or 'shelf trust the terms of which had never been

seen by the plaintiff, Mr West, or explained to him. There were two

exoneration clauses in the trust deed as follows:

9(f) The Trustees shall not be liable in respect of any purported

exercise of any duties or powers under this trust save only that

if they acted fraudulently they shall not be entitled to the

protection conferred hereby;

and

20 In the execution of the trusts and powers hereof no trustee

shall be liable for any loss to the Trust Fund arising in

consequence of the failure depreciation or loss or any investment

made in good faith or by reason of any act or omission

made in good faith or of any other matter or thing except wilful

and individual fraud and wrongdoing on the part of the

Trustee whom it is sought to be made liable.

The court held that:

The terms [of the first clause] are so comprehensive that we are not

prepared to uphold it. We strike it out to the extent that if offends

against Article 26(9) [of the Trust (Jersey) Law]. We find it void as

being repugnant to the fundamental concept of a trust.

In passing, however, it should be noted that in a later decision,

Midland Bank Trustee (Jersey) Ltd v Federated Pension Services (1995)

(unreported), the Jersey Court of Appeal doubted the need for the last

sentence and stated that it should not be regarded as authority for the

proposition that an exemption clause in a trust deed is to be regarded as

void on grounds of public policy or repugnancy (see also Armitage v

Nurse, discussed below).

Article 26(9) of the Trust (Jersey) Law as amended in 1989 provides

that: 'Nothing in the terms of a trust shall relieve, release or exonerate

a trustee from liability for breach of trust arising from his own fraud, wilful

misconduct or gross negligence.'

With regard to cl 20 of the trust deed, the Royal Court concluded in

West v Lazard Brothers that it did not operate because the trustee was

guilty of equitable fraud, defined in Kitchen v RAF Association [1958] 2

All ER 241 as 'conduct which having regard to some special relationship

between the two parties concerned, is an unconscionable thing for the

one to do to the other.' The court found that the trustees had acted

fraudulently in the equitable sense and could not rely on the exoneration

clauses. Substantial damages were awarded to Mr West with costs,

which, together with the cost of lost administrative and executive time,

must have been considerable because the trial lasted for eight months

and the dispute for almost thirteen years. Indeed, in a situation such as

this a trustee will normally be wise to settle and avoid the risk of high

costs and bad publicity.

The Jersey Royal Court again considered the effectiveness of exoneration

clauses in Midland Bank Trustee (Jersey) Ltd v Federated Pension

Services Ltd (1994) unreported judgments (4 August 1994) reversed on

appeal (21 December 1995), a case which concerned procrastination

over the transfer of investments to a new investment manager and failure

to seek prompt legal advice as to a technicality arising under the UK

Financial Services Act 1986. The court was highly critical of the failure

of the trustee to seek legal advice promptly which was held to be a breach

of trust. The trustee was, nevertheless, held to be protected by an

exoneration clause in the trust deed because it had not committed 'wilful

default' or 'gross negligence' so that Art 26(9) did not exclude the

operation of the clause. On appeal to the Jersey Court of Appeal, the first

instance decision was overturned in an important judgment which

examined the construction of exemption and exoneration clauses in

detail in the light of many authorities. In relation to Jersey law the

principles were summarised as follows:

(1) There is no general principle in Jersey law (apart from statute)

preventing a trustee from protecting himself against liability

for breach of trust by clear words, save in the case of fraud.

(2) Under Jersey law clauses relied on by trustees as exculpating

them from liability for breach of trust are to be construed at

least as narrowly and strictly as such clauses would be construed

under English law. There is in Jersey no statutory equivalent of

the Unfair Contract Terms Act 1977 which arguably applies to

exculpatory clauses in trust deeds.

(3) The principles of construction we have set out apply under

Jersey law to the construction of such clauses. [In essence these

are that all exculpatory clauses are restrictiveiy construed, that

they will be resolved against the party relying on the clause if

ambiguous and that ambiguity will be construed more strongly

against the person who made the document where that person

seeks to rely on the clause.]

(4) Such clauses are, however, subject to the statutory restrictions

in the [Jersey Trust] 1984 Law (in its original form and as

subsequently amended).

Having set out the principles, the appeal court decided that, under

Art 26(9) of the Trust (Jersey) Law as amended in 1989 (which was held

to be applicable), exoneration clauses cannot excuse a trustee who is

'guilty of fraud, wilful misconduct or gross negligence.' On the facts

although fraud and wilful misconduct were not relevant the trustee was

guilty of gross negligence. The appeal court held, overruling the decision

at first instance, that 'gross negligence' does not require 'mens rea' or

'intentional disregard or danger' as the Royal Court had found at first

instance. It means no more than a serious or flagrant degree of negligence.

The facts showed an inexcusable delay of more than six months

in resolving a legal technicality which could easily have been resolved by

obtaining legal advice. The defendant had therefore failed to take the

elementary step of finding out what its duty was in these circumstances.

In the case of a paid professional trustee this was a serious matter and

therefore the trustee was held liable to make good the loss to the pension

fund caused by the delay in reinvesting the funds. It should be stressed

that the basis of compensation for breach of trust is stricter than the

normal rule that damages are measured by reference to foreseeability and

is the restoration of the actual value of what has been lost by the

beneficiaries, which with the benefit of hindsight can be seen to have

been caused by the breach (see the discussion in Target Holdings Ltd v

Redferns [1995] 3 WLR 352 where the rules applicable to traditional

trusts were explained although held by the House of Lords to be

inapplicable to bare trusts arising in commercial situations).

In Armitage v Nurse (1997, as yet unreported) the English Court of

Appeal considered the construction of trustee exemption clauses and

their scope. The main issue concerned an exemption clause which was

as follows:

No Trustee shall be liable for any loss or damage which may happen

to Paula's fund or any part thereof or the income thereof at any time

or from any cause whatsoever unless such loss or damage shall be

caused by his own actual fraud.

The appellant contended that the clause was void for repugnancy or

on the grounds of public policy. The court was, however, unanimous in

concluding that the clause was not void on either of these grounds and,

after reviewing the English authorities in depth, that its effect was to

exempt a 'trustee from liability for loss or damage to the trust property no

matter how indolent, imprudent, lacking in diligence, negligent or wilful

he may have been, so long as he has not acted dishonestly.' Reference was

made to Midland Bank Trustee v Federation Pension Services and to the fact

that Jersey law provides for a statutory restriction on the scope of

exemption clauses which prevents exclusion from liability for gross

negligence. In addition the court held that the words 'actual fraud' meant

dishonesty and not the common law tort of deceit. There is, however, a

widespread view that a professional trustee which claims and advertises

specialist skills in return for a fee ought not to be able to avoid liability

for gross negligence and it may be that English and Scottish law will be

amended.

The extent to which a settlor can restrict a trustee's investment

discretion is difficult issue for a trustee faced with a settlor who insists that

the sole or main trust asset is to be a controlling shareholding in a family

business which he wishes to continue to run during his lifetime. Such a

proposal runs a very serious risk of removing one of the core incidents of

the trust concept, namely trustee control over the trust assets, and may

leave the trust open to attack as a sham. It is, however, clear that if the

trust deed is sufficiently specific the trustee's investment discretion can

be excluded (Re Hurst (1890) 63 LT 665; Re Hart's Hill Trust [1943] 2 All

ER 557). There are now many trust structures which attempt to achieve

the holding by a trustee of the shares of a family company as the main

trust asset while allowing continued control by the family to the effective

exclusion of the trustees. It remains to be seen, however, as these

structures are attacked in heirship claims or by tax authorities following

the death of the settlor or a beneficiary, whether the core concept of the

trust can survive such a structure. Several interesting structures involving

the use of special purpose companies or Cayman Islands exempt

limited partnerships are explored by Timothy Ridley in his helpful article

'Special Trust Structures a Helping Hand to the Professional Trustee?'

(1996) 5 Journal of International Trust and Corporate Planning 44.

An area of particular concern for trustees in the administration of

trusts is that of their obligations in relation to reviewing investments and

protecting the trust assets. In Learoyd v Whiteley (1897) 12 App Cas 727

(HL) the test laid down was that of the 'ordinary prudent man of

business.' Lindley LJ put it this way:

The principle applicable to cases of this description was stated ... to

be that a trustee ought to conduct the business of the trust in the

same manner that an ordinary prudent man of business would

conduct his own, and that beyond that there is no liability or

obligation on the trustee. I accept this principle; but in applying it

care must be taken not to lose sight of the fact that the business of

the trustee, and the business which the ordinary prudent man is

supposed to be conducting for himself, is the business of investing

money for the benefit of persons who are to enjoy it at some future

time, and not for the sole benefit of the person entitled to the present

income. The duty of a trustee is not to take such care only as a

prudent man would take if he had only himself to consider; the duty

rather is to take such care as an ordinary prudent man would take if

he were minded to make an investment for the benefit of other

people for whom he felt morally bound to provide.

Halsbury LC emphasised that the fundamental principle was the

preservation of capital and rejected the view expressed in the Court of

Appeal that there is a different degree of care according to whether there

are persons to take in the future or whether the trust fund was created for

one beneficiary absolutely. He stressed that:

The question must be the due care of the capital sum. Whether the

capital sura is one in which there is a life estate only, or absolutely

for the use of the beneficiary, seems to me to bear no relation to the

question of the due caution which a trustee is bound to exercise in

respect of the investment of the trust fund.

Learoyd v Whiteley remains the leading English authority but the

emphasis on preserving capital and minimising risk has been overtaken

by other considerations such as the effect of inflation and the far greater

sophistication in investment techniques. If a trust fund is to keep up with

inflation it may no longer be enough to rely on Learoyd v Whiteley and

adopt an over-cautious investment policy of merely preserving capital.

The duty now probably requires the careful management of investment

risk rather than the avoidance of all risk. The evolving modern approach

that trustees should follow was admirably summarised by Hoffman J in

the first instance decision in Nestle v National Westminster Bank Pic of 20

June 1988 (unreported) when he observed: 'Modern trustees acting

within their investment powers are entitled to be judged by the standards

of current portfolio theory, which emphasizes the risk level of the entire

portfolio rather than the risk attaching to each investment taken in

isolation.'

In the Nestle case the plaintiff's claim against the bank as trustee

concerned the investment policies followed by the bank in relation to

funds subject to a will trust established in 1922. The plaintiff had become

absolutely entitled to the capital of the funds on the death of her father

in 1986. The funds were then worth £269,203 but the plaintiff contended

that if the funds had been properly managed and proper investment

policies had been followed by the bank they would have been worth

well over £1 million. The bank was held to have misunderstood the

investment clause in the testator's will which established the trust, failed

in its duty to review the investments regularly, and wrongly to have failed

to take legal advice as to the scope of its investment powers under the

will. The burden was, however, on the plaintiff to prove that she had

suffered loss as a result of the bank's breaches of duty. This, in the view

of the judge at first instance and in the view of the Court of Appeal, she

had failed to do. In reaching their decision the Court of Appeal judges

did little to clarify the modern investment duties of trustees. Plainly if

trustees allow the nominal value of the trust investments to diminish

they will be at risk under the prudent businessman test as explained in

Learoyd v Whiteley. On the other hand, if inflation is allowed to diminish

the real value of the trust fund because the trustees have focused solely

on maintaining the nominal value, criticism can also be expected,

particularly if it can be shown that professional trustees did not seek

expert advice to ensure that 'the standards of current portfolio theory'

were observed.

The danger for trustees was apparent in the Nestle case even though

the trustees were successful in resisting a claim for restitution because the

plaintiff was unable to prove loss. The trustees were, however, unsuccessful

in the recent New Zealand case of Re Mulligan, Hampton v PGG Trust

ltd (1996) unreported, NZHCt, CP 772/92. This case involved a

challenge to the performance of trustees over a long period. Breach of

trust was alleged, the main allegation being that the trustees took no

steps to protect the capital of the trust against the effect of inflation. The

plaintiff's case was, therefore, that the real value of the capital had been

grossly eroded.

The trust in question was a will trust which came into effect on the

death of the testator, Mr Mulligan, in 1949. The testator's widow, Bessie

Mulligan, received a substantial legacy and a life interest which did not

fall in until 1990 when she died aged 91. The capital then became

divisible between ten nieces and nephews of the testator. In 1965 when

the major asset of the Mulligan estate (a farm) was sold the trust fund was

worth NZ$108,000. According to expert evidence on behalf of the

plaintiffs (the nephews and nieces) the equivalent inflation-adjusted

figure by 1990 would have been NZ$1,368,000.

The first defendant PGG Trust Limited and Mrs Mulligan had been

co-trustees of the trust fund. Throughout the 25 years from 1965 to 1990

the trust fund was invested in fixed interest investments and as a result

Bessie Mulligan enjoyed a good income. On her death she had an estate

30

of NZ$686,000 which she left to relatives on her side of the family. In

contrast, the trust fund was worth only NZ$102,000, a sum which was

insufficient to purchase one average residential property: in 1965 the

trust fund could have purchased fourteen such properties.

The thrust of the case against the trustees was one of lack of evenhandedness

in that the interests of the life tenant were preferred to those

of the beneficiaries entitled in remainder. The evidence showed that

although PGG Trust Limited, a professional trustee, was well aware of

the need to diversify the trust investment portfolio they had not done so

because Bessie Mulligan had opposed any change in investment policy.

The learned judge held that PGG Trust Limited had failed in its duty as

a trustee because it should have insisted on advising its co-trustee of the

need to diversify. In taking the easy way out and avoiding a conflict with

Bessie Mulligan, it had failed in the performance of its duties as a

professional trustee and thereby denied Mrs Mulligan the advice and

assistance which she deserved. It was also held that Mrs Mulligan had

been guilty of breach of trust in failing to fulfil her duty of trusteeship to

the beneficiaries entitled in remainder. The judge concluded that by the

1970s prudent trustees would have invested 40 per cent of the trust fund

in equities and that the failure to do so had resulted in a loss of $ 170,640.

Both trustees were at fault and therefore jointly liable. In the case of Mrs

Mulligan the liability to make restitution fell on her estate.

The Mulligan case was not simply a case of a professional trustee

being guilty of breach of trust for failure to diversify investments. There

were two trustees, one lay and the other professional, and it was to a large

extent because the lay trustee was unco-operative that prudent investment

decisions were not taken. However, the case does show that where,

for whatever reason, trustees allow a fund to be reduced in value through

failure to manage portfolio risk properly they can be sued for breach of

trust and will be ordered to make good any loss than can be proved. The

case is also a salutary reminder of the duty of co-trustees to act unanimously

and of the problems than can arise where there are two or more

trustees and one of them is not a professional trustee. It appears from the

Mulligan case that not only must a professional trustee take proper steps

to ensure that the appropriate investment decisions are taken but is also

under a duty to advise the lay trustee, however unco-operative he or she

may be, to co-operate in the making of appropriate investment decisions.

Plainly, given the sophistication of modern investment techniques, it is

prudent for a professional trustee, and essential for a lay trustee, to obtain

independent expert investment advice,

Breach of directors' duties in relation to asset-holding companies

The common trust structure will usually involve asset-holding companies

with the shares of the companies or of an ultimate group holding

company held by the trustee. It is not unusual for trustee companies to

arrange the formation of holding companies and to provide directors for

these companies. Very often these directors are referred to as 'nominee

directors.' It should be emphasised that this term is highly misleading and

that there is really no such thing as a nominee directorship under most

systems of company law. All directors owe fiduciary duties to their

companies and for this reason it is important that any asset-holding

companies within a trust structure are properly run by the directors with

real meetings held from time to time. It is also very important that those

who provide companies ensure that they and the individuals or companies

which are directors make proper checks on transactions passing

through the companies.

The case of Agip (Africa) Ltd v Jackson [1992] 4 All ER 451 is a

warning of the calamitous consequences of not taking the duties of a

'nominee' director sufficiently seriously. The case concerned a reputable

firm of accountants in the Isle of Man which took over an existing

arrangement from a well-known international firm under which payee

companies were provided to receive and transfer money on behalf of the

plaintiff. Unfortunately the plaintiff's chief accountant was systematically

defrauding his employer by altering the names of payees and the

substituted payees were all companies set up and controlled by the Isle

of Man accountants. Although not parties to the fraud, the directors,

who were the partners and an employee of the Isle of Man firm, were held

liable to repay the moneys defrauded as constructive trustees. The

evidence showed that the directors of the companies knew that the

arrangement involved some impropriety but thought it concerned avoiding

Tunisian exchange control. They, however, made no inquiries and

therefore knowingly assisted in a dishonest scheme which turned out to

be rather more dishonest than they had suspected. The court also

thought that they knew they were laundering money even if they did not

know the precise reason. They ought therefore to have made full

inquiries and were liable as constructive trustees for their failure to act

prudently.

Agip was followed by Royal Brunei Airlines SDN BHD v Tan [1995]

3 WLR 64 where it was held that a third party, be it knowingly or

innocently, who has dishonestly assisted a trustee to commit a breach of

trust will be liable to the beneficiary for the loss caused by the breach,

even though the third party has not received trust property and the

trustee has not been dishonest or fraudulent. For these purposes the

dishonesty of the third party will be assessed objectively. Dishonesty

means not acting as an honest person would act in the circumstances and

could be equated with conscious impropriety in contrast with negligent

conduct or carelessness. In this context the court will take into account

the personal attributes of the third party such as experience and intelligence.

The decision, which extends the rules for deciding when a third

party can be liable as a constructive trustee, is of particular importance

to financial intermediaries, such as banks and their trustee companies.

The New Zealand case of Springfield Acres Ltd (In Liquidation) v

Abacus (Hong Kong) Ltd [1994] 3 NZLR 503 provides another example

of the dangers of professional advisers who are directors of companies

owned by their firms. The case concerned a transfer of the assets of a

company to defeat the claim of a judgment creditor. The assets were

transferred first to a British Virgin Islands international business company

and then to a Hong Kong company owned by a leading firm of Hong

Kong accountants. The two companies were acting as trustees of trusts

of which the beneficiaries were relatives of a director who was also the

major shareholder of the debtor transferor company. One of the partners

in the accountancy firm was a director of the Hong Kong company. He

also assisted in setting up the trusts, forming the British Virgin Islands

company, and making the Hong Kong company available to act as a

corporate trustee to carry out the transactions. He had, therefore, in the

view of the court, wilfully shut his eyes to the obvious and had not made

the inquiries expected of an honest and reasonable man. Accordingly,

there was a good arguable case against him and the Hong Kong company

for breach of constructive trust. The New Zealand High Court could,

therefore, assume jurisdiction in respect of the defendant company and

its directors even though both were outside the jurisdiction.

A number of recent cases (Dorchester Finance Co Ltd v Stebbings

[1989] BCLC 498, Kuwait Asia Bank EC v National Mutual Life Nominee

Ltd [1990] 3 All ER 404, Lipkin Gorman v Karpnale Ltd [1992] 4 All ER

512, Finers v Miro [1991] 1 All ER 182, Re D'Jan of London Ltd [1993]

BCC 646, Bishopsgate Investment Management Ltd v Maxwell [1994] 1 All

ER 261, and Grant Adams vR [1995] 1WLR52 (PC)) show how the days

of so-called nominee or passive directors, even if non-executives, are

over and illustrate how company directors, lawyers, accountants, and

bankers can find themselves liable in negligence, as constructive trustees,

or worse still guilty of conspiracy through failure to act upon

suspicions, signing documents in blank, preparing minutes which show

absent directors as present, or other failure to exercise due diligence.

Money laundering legislation throughout the world has now made the

potential for criminal liability even greater.

Attempts by beneficiaries and others to obtain copies of trust

documents and records

Whenever a beneficiary is concerned as to the due administration of a

trust or wishes to challenge the validity of a trust there will normally be

an attempt to obtain copies of all trust documents and records held by the

trustees. This was one of the main preliminary issues in the Lemos

litigation, Re the Lemos Trust Settlement [1992-93] CILR 26 and Lemos

v Coutts and Co (Cayman) Ltd [1992-3] CILR 5, as well as in another

recent Cayman Islands decision, Re Ojjeh Trust [1992-3] CILR 348, and

the important decision of the New South Wales Court of Appeal in

Hartigan Nominees Pty Ltd v Rydge (1992) 29 NSWLR 405.

As far as English law is concerned, the general principle was stated

in O'Rourke v Darbishire [1920] AC 581 in the following way:

The beneficiary is entitled to see all trust documents because they are

trust documents and because he is a beneficiary. They are in this

sense his own. Action or no action, he is entitled to access to them.

This has nothing to do with discovery. The right to discovery is a

right to see someone else's documents. The proprietary right is a right

to access to documents which are your own.

34 Law Lectures for Practitioners 1991

It has become clear that there are limits to this proprietary right and

the leading English case is now Re Londonderry's Settlement [1965] Ch

918, a case which involved an application by a discretionary beneficiary

for copies of various trust documents including records of trustees'

meetings' and correspondence with the beneficiaries. The trustees supplied

copies of documents relating to the appointment of beneficiaries

and annual accounts but applied to the court for guidance as to whether

they should provide any further documents. The English Court of

Appeal held that the trustees were not required to disclose agendas of

meetings of trustees, correspondence relating to appointments with

those who had power to appoint beneficiaries, correspondence between

trustees, appointors, and beneficiaries, or minutes of meetings at which

decisions were made by the appointors or the trustees relating to the

exercise of their discretions.

The Londonderry case was cited with approval in the Lemos cases and

in the Ojjeh and Hartigan cases. In the Lemos litigation the Cayman

Islands Court of Appeal confirmed the proprietary right of a beneficiary

to see trust documents but emphasised that this was not an absolute right.

The court said that trust documents were confidential and if a trustee was

bound to disclose to any beneficiary any information received relating to

beneficiaries his duties under the trust and its protection would become

impossible. The plaintiffs wanted to obtain evidence of the trust and its

administration from the trustee for the purpose of proceedings that had

been started in Greece and it was argued strongly on their behalf that the

right to all the trust documents was a proprietary one. This argument was

however rejected. The impasse was eventually resolved by a unilateral

offer made by the trustee to disclose audited accounts in return for an

undertaking by the beneficiary not to use the material in the Greek

proceedings.

The Ojjeh case also involved a dispute about access to trust documentation.

The case involved an application to the court by a Cayman

Island-based trustee for directions relating to foreign proceedings in

which Mrs Ojjeh had obtained appointment of a guardian for her son,

who was a minor, with a right of access to copies of trust documents

relating to the son's interest under the trust. The trust owned a number

of private companies incorporated in various countries and the trustee

did not think it was in the interests of the trust to make available full

information about these companies because of the need for confidentiality

in relation to commercially sensitive matters. On this issue the court

agreed with the trustees and thought that Mrs Ojjeh's demands were

'unreasonable, untenable and oppressive' and that the trustee was right

to restrict the documents to be released. However, any doubts as to the

commercial sensitivity of documents were to be referred to the Cayman

court, because the trust was governed by Cayman law, and not left to a

unilateral decision by the trustee.

The New South Wales decision of Hartigan Nominees Pty Ltd v

Rydge (1992) 29 NSWLR 405 concerned a dispute over disclosure by

trustees of a memorandum of wishes provided by the substantive settlor

who was described by the court as the 'instigator' of the trust in a case

involving a trust initially set up by a dummy settlor. The proceedings

were brought by a person within a class of eligible beneficiaries under

the terms of the trust. The court held by a majority that a memorandum

or letter of wishes provided by a settlor for the use of the trustees in

exercising their discretionary powers is not a document which the

trustees are bound to disclose to a beneficiary on request if it was

provided on a confidential basis. The majority also confirmed that a

trustee may take a memorandum of wishes into account in exercising a

discretion but was not bound to do so. The English case of Re Londondeny's

Settlement was followed.

It is of interest that the judge who delivered the minority judgment

thought that a memorandum of wishes was a trust document which was

distinguishable from those documents, such as minutes of meetings and

correspondence between trustees and beneficiaries, of which a beneficiary

was not entitled to copies. He thought that, because the trustees

interpreted their duties under the trust deed with the help of the

memorandum of wishes, the trust deed was supplemented by it and that,

therefore, the memorandum of wishes was a document which should be

disclosed. This is a possibly worrying aspect of the use of memoranda or

letters of wishes which might open up an argument that a tax authority

could be entitled to see any letter of wishes as part of the trust documentation.

The judge did, however, agree that disclosure of a memorandum

of wishes might not be possible if the settlor expressly made it a

confidential document. While this may provide a way round any question

of having to disclose such a document, a safer approach would be for

the trustees to record the settlor's wishes in a file note and to have no

memorandum or letter of wishes signed by the settlor.

Professor David Hayton QC believes that it is better to regard a

beneficiary's right to information as stemming from the status as beneficiary

and the trustee's status as an accountable fiduciary. In his article

The Irreducible Core Content of Trusteeship' (1996) 5:1 Journal of

International Trust and Corporate Planning 3, Professor Hayton explains

the right of a beneficiary to information as a 'necessary incident

of the trustee-beneficiary relationship at the core of the trust' which

requires the trustee 'to find and pay a beneficiary entitled to an income

or capital payment, thereby making such beneficiary aware that he is a

beneficiary.' A trustee is also under a duty to make a discretionary

beneficiary aware that he is such 'because knowledge of the trust is

necessary to make the trustee accountable, this being an essential core

incident of the relationship of trustee and beneficiary' (see Chaine-

Nickson v Bank of Ireland [1976] IR 393). It follows that blanket attempts

by settlors to exclude all trust information from beneficiaries will not be

enforceable because they are repugnant to the trust relationship. A

settlor may, however, exclude the objects of a power from knowledge of

their status (Re Manisty [1974] Ch 17, 25).

Apart from beneficiaries there can be others who seek information

such as foreign tax authorities. This can pose serious problems for trustees

who on the one hand owe an obligation to defend the trust but on the

other hand might find that an employee is detained at the airport for

unpaid taxes or that a branch office or associated company is harassed by

the tax authority in the foreign country where tax is demanded.

In these circumstances it is prudent for the trustees to apply to the

court for guidance. A recent Jersey Royal Court decision, Re the settlements

between X and Blampied and Abacus (CI) Ltd unreported judgments (28

January 1994) was a case in which the court was asked to decide whether

the trustees should supply information concerning three trust settlements

to the personal representatives of the deceased settlor to enable an estate

tax return to be made to the US Internal Revenue Service. The Royal

Court was faced with a dilemma because it was bound by the principle of

private international law that no country is required to enforce tax payable

in another country. The court decided, however, that it could nevertheless

order information to be provided to persons in other jurisdictions who

have a duty under the laws in those jurisdictions to make tax returns. The

trustees were therefore ordered to disclose the three settlements to the

personal representatives and to supply such information about the trusts

as the US legal advisers thought necessary for the completion of the estate

tax return. This decision is supported by that of the House of Lords in Re

State of Norway's Applications (Nos 1 and 2) [1989] 1 All ER 745 where it

was held that a letter of request issued by a Norwegian court did not

amount to the attempted enforcement, either directly or indirectly, of

Norwegian revenue laws in England but was merely concerned with

seeking the assistance of the English court to obtain evidence to enable

Norwegian revenue laws to be enforced in Norway.

There have been instances where tax authorities have requested

letters of wishes and on sight of them have attempted to assess the named

beneficiaries to tax. Very often tax legislation will empower a tax

authority to inspect relevant documents and it is therefore important

that letters of wishes are not drafted so that there is any room for an

argument that they are any more than non-binding indications of the

settlor's wishes which do not fetter the powers of the trustees. A letter or

memorandum of wishes should also be signed some time after the

execution of the trust deed in order to counter any argument that it forms

part of the terms of the trust deed. The trust deed should not refer to any

letter of wishes because this might imply that it was to be incorporated

by reference. Even so it is probably better for the trustees to keep their

own record of the settlor's wishes and not to have a letter or memorandum

of wishes signed by the settlor.

Disputes over compliance with letters of wishes

Reference has already been made to the Hartigan Nominees decision in

which it was held by a majority of two to one that a memorandum of

wishes was not a trust document which had to be disclosed to a

beneficiary. The court also held that a trustee may, in exercising his

discretion in relation to a trust, take into account any memorandum of

wishes but he must exercise his discretion in a proper way after taking

into account all proper considerations. If a trustee were to follow a

memorandum or letter of wishes signed by the settlor in a slavish manner

there would be a risk of the Rahman principle applying and the trust being

set aside as a sham. Alternatively a less drastic result might be for the trust

to be upheld as valid with either the terms of the letter of wishes being

construed as part of the terms of the trust or the acts of the trustees in

slavishly following the letter of wishes being declared invalid as an

improper exercise of the trustee's discretion.

The question of whether a letter of wishes was binding on trustees

was also raised in a Bahamian case, The Bank of Nova Scotia Trust Co

(Bahamas) Ltd v Nelia Ricart de Barletta unreported (11 March 1985). The

dispute related to a family trust in respect of which the trustees Wanted

to sell certain shares in a family company contrary to a letter of wishes

and to reinvest in more profitable assets. The Supreme Court of the

Bahamas, on the application of the trustee, held that the trust instrument

was the superior document and that it contained no binding restraint on

the trustees' discretion to sell trust assets if, in the proper exercise of their

duty to protect the trust and serve the beneficiaries, that was the right

course of action. If the settlor had wanted to restrict the discretion of the

trustees in a legally binding way this could have been done by an express

provision in the trust deed. As it was the letter of wishes clearly stated

that it was not intended to restrict the discretion of the trustees. There

was therefore no possibility of enforcing the terms of the letter of wishes.

Problems with protectors

There have been a number of recent cases concerned with protectors and

some of these have already been discussed in the journal Private Client

Business (see Deborah Hartnett and William Norris, The Protector's

Position — Suggesting Some Basic Principles' (1995) Private Client

Business, No 2, 109 and John Conder, 'Case Note: Some Judicial

Guidance on Protectors: The Star Trusts Case' (1995) Private Client

Business, No 4, 288).

Perhaps the most contentious issue has concerned the question of

whether protectors are fiduciaries and, therefore, whether their powers

must only be exercised in a proper way taking into account considerations

relevant to the interests of the beneficiaries for whom the trust was

established.

In a decision of the Supreme Court of the Bahamas, Ramon Trust v

Pearlman unreported (25 April 1990) the facts were unusual as the

protectors were all beneficiaries. The court was therefore able to hold

that the veto powers given to them were intended to protect the

protectors as beneficiaries. Accordingly the court decided that the

protectors were not fiduciaries and could exercise their powers of veto in

their own interests.

The two leading decisions on protectors as fiduciaries are Von

Knieriem v The Bermuda Trust Co Ltd unreported (13 July 1994),

otherwise known as the Star Trusts Case, and Steele v Paz Ltd unreported

CH 1992/95 (10 October 1995). Both these cases concerned protectors

who were fiduciaries. The Star Trusts case concerned two trusts which

held 29.3 per cent of the share capital of the Bermuda holding company

of a pharmaceutical group. The protector was the plaintiff in the

proceedings, the background to which was a boardroom dispute which

involved the possible removal of the settlor from the board of the holding

company. Von Knieriem, the protector, was not only the protector of the

trusts but also the long-standing legal adviser of the settlor.

There was apparently some uncertainty as to whether the trustee

would cast the votes in respect of the 29.3 per cent in favour of the settlor.

The protector exercised his power to remove the Bermuda Trust Company

from its position as trustee and appointed Grosvenor Trust Company

in its place. There was doubt whether the removal of the trustee was

valid and two issues arose. These were whether the power of the protector

to appoint and remove trustees was a fiduciary one and, if it was, whether

the power had been properly exercised.

The judge, after considering a number of authorities, decided that

the power to appoint new trustees was a fiduciary one. He then had to

decide whether the power had been properly exercised. He decided that

such a power would only have been exercised improperly if it had been

exercised for the protector's own personal benefit and that as this was

plainly not the case the exercise of the power was valid. While there was

no evidence that the new trustee had been appointed for an improper

purpose, equally there was no suggestion that the Bermuda Trust

Company had acted improperly. It is therefore difficult to escape the

suspicion that the appointment of the new trustee was not somehow

related to the need to ensure that the voting rights attached to the shares

would be cast in favour of the settlor in the boardroom battle. If this was

the case, it is questionable whether the protector had exercised his power

strictly in the interests of the beneficiaries. Of more general importance

is the question of whether the test applied by the judge of valid exercise

of a power to remove trustees and appoint new trustees was the correct

one. One would have thought that such powers imply an obligation to

consider from time to time whether the trustee was performing his duties

in a satisfactory way and if not to remove him. If this is so the test applied

in the Star Trusts case, that for such powers to be validly exercised the

protector merely should not have exercised them for his own benefit, was

far too narrow.

The issue in Steele v Paz has already been referred to in the context

of trusts that may be void for uncertainty. It will be remembered that

under the terms of the trust certain shares were held for the benefit of the

Red Cross Society of Ireland and for such other persons as the trustees

should appoint with the consent of the protector. No protector had been

appointed and therefore no beneficiaries, who were intended to be

employees of a company, had been appointed. This difficulty was resolved

on appeal by the High Court of the Isle of Man's decision that the power

given to the protector was fiduciary and that, just as the court had

jurisdiction to appoint a trustee to ensure that a fiduciary power was

exercised, it could also appoint a person other than a trustee who was

required by a trust to exercise a similar power. The judgment contains a

detailed analysis of the case law governing powers exercisable in relation

to trusts. While the court indicated that it might not be prepared to

appoint a protector if it were clear from the trust deed that the personality

of a protector was of fundamental importance, this was not the position

with the trust in issue. Under the terms of the trust, the protector was

independent of the settlor's control, had the right to full information from

the trustees, and had the power to give or withhold his consent to each

name put forward by the trustees. It was therefore clear that the protector

was required to give proper consideration to the trustees' proposals and

decide whether to exercise his power of consent having due regard to the

extent of the trustees' enquiries, the basis of their selection, and the

overall purposes of the trust. The power given to the protector was not

conferred on him in his own interests to be exercised, or not, at his whim.

The court therefore had no hesitation in categorising the power as

fiduciary and that it had power to appoint a protector by extension of the

principle that equity will not allow a trust to fail for want of a trustee.

One final, somewhat unusual point on protectors arose recently in

relation to a protector or appointor under a discretionary trust who went

bankrupt. In the Australian case of Re Burton; Wily v Burton (1994) 122

ALR 399 the appointor of a family trust, who was also a beneficiary

under the trust, was adjudicated bankrupt. The appointor had power to

remove a trustee and appoint a new trustee. The trustee in bankruptcy

applied to the court for an order restraining the appointor from exercising

this power because it was feared that the power would be used to

frustrate the appointor's personal creditors by appointing a trustee

whom the appointor beneficiary could control. The application was

dismissed because the power given to the appointor was not property

under the bankruptcy legislation and also because the power was

fiduciary. It could therefore be exercised only in the interests of the

beneficiaries and solely in the furtherance of the purpose for which it was

conferred. The court did, however, hold that if it were shown that the

power was likely to be used to frustrate the bankrupt appointor's personal

creditors an injunction could be granted.

The practical implications of the trend of the courts to hold

protectors to be fiduciaries could have important consequences for

settlors who have appointed protectors for the purpose of providing a

way of influencing the administration of their trusts. Where a protector's

powers are extensive, there is a danger that the protector will be held to

be a quasi trustee. This could be so even though the law purporting to

govern the trust states that a protector shall not be a trustee if the status

of the protector is an issue in another jurisdiction. The other jurisdiction

could infer a trust of locally situated assets of which the protector is a

trustee if the equitable criteria for a trust exist (see, eg, Re the settlements

between X and Blampied and Abacus (CI) Ltd unreported judgments

(Jersey) (28 January 1994) where the Jersey Royal Court was critical of

the degree of interference by a protector and appeared to imply that he

had come close to becoming a trustee). Quite apart from this, the effect

of a provision in a trust law which declares that a protector shall not be

a trustee will be of questionable effect even in that jurisdiction if, in

substance, the protector is clothed with fiduciary powers equivalent to

those of a trustee. In other words, a trustee who is described as a protector

will not cease to be a trustee under legislation which states that a

protector cannot be a trustee. Where the protector's powers are confined

to vetoing decisions of trustees and appointing new trustees it now seems

clear that these powers are fiduciary and must be exercised in the best

interests of the beneficiaries and not necessarily in the way dictated by

the settlor to whom a protector owes no legal duty, fiduciary or otherwise,

If an attempt is made to ensure that a protector owes duties to the

settlor as settlor there will be a serious risk that the trust could be

attacked under the Rahman principle or possibly as an invalid will.

The possible liabilities of professional advisers in relation to trusts

It appears from the decision in the House of Lords in White v Jones [1995]

2 AC 207 that, where a trust fails through the failure by a professional

adviser to ensure that a trust is properly established, there may be liability

in negligence to the beneficiaries as well as to the settlor. White v Jones

concerned the failure of a solicitor to alter the will of a seriously ill

testator before the latter's death with the result that certain intended

beneficiaries did not succeed to some of the assets of the deceased. There

seems no reason why this principle should not be extended to apply to the

potential beneficiaries of a trust that fails for uncertainty or on the

grounds that it is a sham or an invalid will.

Other possible liabilities of professional advisers in relation to trusts

should not be overlooked. These include liability where the adviser

assists in a breach of constructive trust (Agip (Africa) Ltd v Jackson [1992]

4 All ER 451 and Royal Brunei Airlines v Tam [1995] 2 AC 378), civil and

criminal liability for conspiracy to defraud the beneficiaries or the

Revenue (see Adams v R [1995] 1 WLR 52 and IRC v Stype Investments

(Jersey) Ltd [1982] Ch 456), and criminal liability for assisting in a money

laundering offence.

If litigation occurs will the trustee be indemnified for legal costs?

In any case involving litigation relating to a trust the trustees will always

be at least indirectly involved. As a result there will be two matters of

immediate concern to the trustees. The first is whether, and if so to what

extent, they should become directly involved and the second is whether

they will be indemnified for their legal costs. These matters were

reviewed recently in Alsop Wilkinson (a firm) v Neary [1995] 1 All ER 431,

a case in which the plaintiffs applied for an order to set aside, as

transactions defrauding creditors, two trusts made by the first defendant

who was a former partner in the plaintiff firm. The principal beneficiaries

of the trusts were the first defendant, his wife, and their children. The

plaintiffs had already obtained judgment against the first defendant for

misappropriation of client account moneys and the remaining defendants,

who were the trustees of the trusts, were applying to the court for

directions whether or not to defend the action and for a pre-emptive

order for costs.

Mr Justice Lightman explained that there were three types of dispute

in which trustees may become involved:

(1) The first... is a dispute as to the trusts on which they hold the

subject matter of the settlement. This may be 'friendly' litigation

involving, for example, the true construction of the trust

instrument or some other question arising in the course of the

administration of the trust; or 'hostile' litigation, for example,

a challenge in whole or in part to the validity of the settlement

by the settlor on grounds of undue influence or by a trustee in

bankruptcy or a defrauded creditor of the settlor, in which case

the claim is that the trustees hold the trust funds as trustees for

the settlor, the trustee in bankruptcy or creditor in place of or

in addition to the beneficiaries specified in the settlement.

(2) The second ... is a dispute with one or more of the beneficiaries

as to the propriety of any action which the trustees have taken

or omitted to take or may or may not take in the future. This

may take the form of proceedings by a beneficiary alleging

breach of trust by the trustees and seeking removal of the

trustees and/or damages for breach of trust.

(3) The third ... is a dispute with persons, otherwise than in the

capacity of beneficiaries, in respect of rights and liabilities, for

example in contract and tort, assumed by the trustees as such

in the course of administration of the trust.

The general rule is that trustees are entitled to an indemnity against

all costs, expenses, and liabilities properly incurred in administering a

trust and have a lien on the trust assets to secure that indemnity. Trustees

have a duty to protect and preserve the trust assets for the benefit of the

beneficiaries and for that reason a duty to represent the trust in a third

party dispute. It follows that their indemnity and lien extend to the cost

of legal proceedings properly brought or defended for the benefit of the

trust assets. It is not, however, always clear whether proceedings are

properly brought or defended and, therefore, to avoid the risk of a

challenge to their entitlement to an indemnity, trustees should first seek

the authorisation of the court before they sue or defend a dispute with the

beneficiaries.

In the case of a dispute as to the trusts on which they hold the trust

assets it is no longer the case that the trustees are entitled to their costs

out of the trust assets whatever the outcome of the proceedings. Where

there is a dispute between rival claimants to the trust assets, the duty of

the trustees is to remain neutral and to submit to the court's directions,

leaving it to the rival parties to fight their battles alone. If this approach

is adopted the trustees will be entitled an indemnity for any costs

necessarily incurred. If, on the other hand, a trustee actively defends the

trust he may be entitled to an indemnity for costs if he wins and succeeds

in preserving the interests of the beneficiaries. Should he fail, however,

he will not normally be entitled to an indemnity for costs because he will

have incurred costs in an unsuccessful effort to prefer one class of

beneficiaries, those named in the trust deed, over others such as creditors

of the settlor.

With regard to the specific application for pre-emptive costs in Alsop

Wilkinson v Neary the judge held that when deciding whether to make

such an order (a Beddoes order) the court had to consider:

• The strength of the party's case

• The likely order as to costs at the trial

• The justice of the application

• Any special circumstances

In the event the application for pre-emptive costs failed all four tests

and was dismissed.

The role and duties of protectors have already been discussed and the

fact a protector will often be a fiduciary who owes obligations that are

comparable to those imposed on trustees has been noted. In a case

decided in Jersey in 1994 the question of whether a protector was entitled

to an order for costs was also considered (see Re X, Blampied and Abacus

(Cl) Ltd unreported (28 January 1994). In that case, the Royal Court

held that the protector in question was not a trustee for the purposes of

Jersey law but nevertheless had acted throughout in the best interests of

the beneficiaries. An order was, therefore, made for the protector to be

paid his costs from the trust fund up to the date of the hearing. The court

did not think that further expenses should be incurred by the protector

and refused to make an order for future costs.

Conclusion: guidelines for settlors, trustees, and protectors

There is no doubt that there is considerable scope for trust litigation over

a wide range of problem areas. Moreover, it seems probable that litigation,

very often on a multi-national scale, will increase, partly because

the settlors of twenty years or so ago are now dying and partly because the

legal fundamentals of trusts have been widely ignored by professional

advisers. It is ironic that the marketing of professional skill in setting up

elaborate trust-based schemes is now almost equally matched by the

marketing of professional skill in blowing such schemes apart. Several

major law firms have trust litigation departments.

In many cases it will not be possible to put right the fundamental

errors of the past but there are a few guidelines which may help avoid

some of the pitfalls for settlors, trustees, and protectors. In preparing

these I would like to acknowledge the assistance I have gained from the

excellent article by John Mowbray, 'Offshore Trusts: Illusion and Reality'

(1994) 8:3 Trust Law International 68.

1 Do not use dummy settlors. They arouse suspicion, are frowned upon

by many judges and achieve little: a person who in substance funds

a trust is, in equity, the settlor.

2 Do not select the Red Cross or any other charity as a beneficiary if

the charity is not to be informed that it is a beneficiary and is never

intended to benefit.

3 Select a trustee that has no connection, such as a branch office or an

associated company, with the settlor's home territory or any other

territory which does not recognise trusts. The trustee should be

resident in a low or no tax territory.

4 The protector should have no connection with the settlor's home

territory or any territory which does not recognise trusts and should

be resident in a no or low tax territory.

5 Keep trust property outside the settlor's home jurisdiction, perhaps

by using a holding company incorporated in a well regulated and

reputable jurisdiction. Avoid holding immovable property in the

settlor's jurisdiction in the trust.

6 Any letter of wishes should be confidential, signed some time after

execution of the trust deed, and not legally binding. It should also be

consistent with the terms of the trust deed but not referred to in the

trust deed.

7 Ideally, do not have a letter of wishes signed by the settlor but instead

a trustees' memorandum or file note of the settlor's wishes.

8 The trust deed should exonerate the trustee from the need to give

information, documents, or accounts to beneficiaries unless the

court so orders. When giving information give as little as possible

and avoid giving reasons for the exercise of discretions.

9 A provision could be included automatically cutting out any beneficiary

who challenges the trust. This provision should not be discretionary

because this might render the trustee guilty of contempt of

court.

10 Consider settling the trust property in accordance with the forced

heirship entitlements of the related beneficiaries.

11 Where assets are to be held in a company, consider incorporating in

a different jurisdiction to that of the trustees if confidentiality is

particularly important. Ensure that the assets are correctly transferred

to the company and, where relevant, the appropriate stamp

duty is paid. Ensure that the shares in the company are correctly

transferred to the trustees and that the transfer documents are, where

this is relevant, correctly stamped and registered with the company.

12 Be wary of jurisdictions which offer incorporation of companies that

is cheap but unregulated. Remember the flight from Panama in the

1980s and think long term for a trust structure.

13 Be very wary of jurisdictions which offer user-friendly trust laws

which enable the settlor to retain control: they may not create valid

trusts in the view of other jurisdictions.

14 Be wary of so'called asset protection trusts and the jurisdictions that

peddle them. Most trusts have always been set up to protect assets in

the general sense and it is only in recent years that the term 'asset

protection trust' has acquired a particular meaning in relation to

protection of debtors from creditors. So-called asset protection trusts

are really debtor protection trusts and should be recognised as such.

15 As a trustee be very wary when taking over from an existing trustee.

Unless it is clear that the trust has been properly administered and

all the assets are under the control of the trustee, do not be tempted

to take on the responsibility for commercial reasons without a

thorough assessment of the risks involved.

16 Remember that once assets have been transferred to a trustee the

settlor should no longer have direct control over them irrespective

of what the trust law of the Island of Utopia may say. Too much

indirect control through a protector should also be avoided as this

may put the trust at risk of being held to be a sham, an invalid will,

or some other legal relationship which is not a trust.

17 If the settlor wants to retain extensive control consider using a

guarantee company with a share capital. These can be incorporated

in the Isle of Man, Alderney, and Guernsey, as well as in some of the

Caribbean jurisdictions. Remember that there will often be entirely

different tax considerations if a company rather than a trust is used.

On the other hand, jurisdictions that do not recognise foreign trusts

usually recognise foreign companies.

18 Administer trusts conscientiously and meticulously. Do not cut

corners. Hold proper meetings regularly and keep minutes and

records, but do not refer to the settlor as the 'client' or the 'customer'

in relation to an existing trust because this may indicate that the

trustee is a mere nominee for the settlor. Investment strategies

require very careful consideration, take expert advice if in doubt, and

remember the modem importance of portfolio risk management,

19 Trustees should administer asset-holding companies meticulously

and hold proper board meetings. Avoid paper meetings as these

usually indicate artificiality which could be attacked under tax antiavoidance

legislation. Keep complete file notes of discussions. Require

full reports of family companies where the trustee holds shares.

Intervene if the directors decide to embark on risky ventures.

20 When the settlor dies look out for applications by an heir for a grant

of representation to the estate which might affect the trust assets.

21 Where a trustee is sued by any heirs, especially if any of them are

beneficiaries, an early application should be made to the court for

directions whether to defend at the trust's expense.

The overall approach has been excellently summarised by Anthony

Travers in a paper delivered at a seminar in Hong Kong in November

1996, 'Misplaced Trust: Trustees and Fiduciaries under Attack.' His

advice to settlors and trustees was as follows:

If a settlor and trustee are to guard effectively against the risk of a

'sham' attack, the trust must be designed and implemented with

integrity at every stage, which can be ensured by following a three

stage process: first, identify the conceptual nature of the intended

transaction and ensure that it is a true trust; secondly, draft the

documentation so as to embody the conceptual nature of the

transaction; thirdly, administer the trust consistently with its conceptual

nature and legal form. If such a threefold process is followed,

the risks of a 'sham' attack are negligible.