Feature

posted 26 Sep 2001 in Volume 6 Issue 6

The impact of the Trustees Act 2000 on professional trustees

By Duncan Ellis, Lighthouse Wealth Management

Trustees have a clear duty to act in the best interests of the beneficiaries. Unfortunately many trustees have historically believed that the best method of protecting the interests of their beneficiaries is to protect the capital. They therefore invest in low risk/low income areas which, perversely actually disadvantage beneficiaries over the longer term. Trustees however are not only required to consider the interests of the life tenant(s) but also those of the remaindermen (is this just a US legal term?). This apparent conflict coupled with restrictive investment options has left professional trustees caught between a rock and a hard place and resulted in a number of high profile cases.

The Trustees Act 2000 has given professional trustees far greater investment freedom whilst making them more accountable. In addition, trustees are now required to seek investment advice. This article aims to summarise the salient points of the act and highlight the issues for professional trustees.

The history

Under general law trustees have a general duty of care when administering trust property. In Learoyd v Whitely (1886) this duty was expressed with regard to trustee investments as ‘to make the investment for the benefit of other persons for whom he felt morally bound to provide’. In more recent years this has been refined to read ‘to use such skill and diligence and care in the management of the trust as a businessman of ordinary prudence and vigilance would use in the management of his own affairs’. For professional trustees the duty of care has been taken one step further in that they must select investments with the ‘care of a prudent man of business in looking after the interests of others’. In addition, when investing trust monies, trustees must treat the beneficiaries impartially and thus seek to balance the interests of providing an income for the life tenants and preserving the value of the capital for the remaindermen.

In Nestle v National Westminster Bank (1993) the court emphasised that the trustees should:

Regularly review the investments of the trust;
Take into account the taxation position of the beneficiaries;
Not change the investments too often;
Be judged by modern portfolio theory.

Further, the case put the onus of proof that an investment was imprudent on the beneficiary. The position of the trustee was not made any easier when making an investment because if the trust instrument did not include a wide power of investment, then the trustee was confined to the Trustee Investments Act 1961.

The law, as expressed by the Trustee Investments Act 1961, has prevented trustees in benefiting from good investment opportunities over the years, most especially at the time of the privatisation of companies such as British Telecom and British Airways. The reason for this was the requirement that a company has to have paid a dividend in each of the last five years, something that is not possible before a company becomes listed on the stock market. Thus it was concluded that the Trustee Investments Act 1961 was outdated and that reform was required. As a result, the Law Commission published a report, Trustees ’ Powers and Duties in July 1999, following consultation with relevant parties in previous years.

The report contained a draft Trustee Bill designed to update English trust law and the subsequent Trustee Act 2000 came into force on 1 February 2001.

The Trustee Act 2000

This article is concerned with the areas that are of most interest to those wishing to advise or undertake business with trustees and so will concentrate on the Part I - Duty of Care, Part II –Investments and section 15 of Part IV - Agents, Nominees and Custodians of the Act.

Part I: Duty of Care

The Duty of Care applies when the trustees exercise the powers conferred upon them by the trust instrument and the new powers contained within the new Act. Section 1 of the Act states that whenever the duty of care applies to a trustee he must exercise such care and skill as is reasonable in the circumstances, having regard in particular:

(a) To any special knowledge or experience that he has or holds himself out as having;

(b) If he acts as trustee in the course of a business or profession, to any special knowledge or experience that it is reasonable to expect of a person acting in the course of that kind of business or profession.

Section 2 covers the application of the duty of care for the Trustee Act 2000, with Schedule 1 detailing the provisions for the application of the duty.

The duty of care applies to a trustee not only when exercising the general power of investment or any other investment power, but also when carrying out a review of the investments. Schedule 1 also covers the duty of care for Parts III and IV of the Trustee Act 2000, plus the Compounding of Liabilities. As previously discussed, the level of care expected is higher for a professional trustee than that expected of a lay trustee.

Although with the new duty of care both professional and lay trustees should become more demanding of the service levels expected from their advisers. This makes it important that advisers understand the implication of the Act on trustees and seek to ensure that their business processes are designed to cope with the potential needs of the trustees.

Part II: Investment

The introduction of Part II of the Act is to be welcomed as it enables trusts that do not have wide investment powers to extend the available investment media.

Section 3 covers the provisions for the general power of investment, so that a trustee may now ‘make any kind of investment that he could make if he were absolutely entitled to the assets of the trust’.

Section 3 goes on to say that the general power of investment will not permit a trustee to make investments in land other than loans secured on land. However, Part III of the Act details the provisions for the Acquisition of Land. Section 4 expands section 3 by stating that in exercising any power of investment a trustee must have regard to the standard investment criteria. Further a trustee must from time to time review the investments of the trust and consider whether, having regard to the standard criteria, they should be varied.

For the purposes of the Act the standard investment criteria are:

(a) The suitability to the trust of investments of the same kind as any particular investment proposed to be made or retained and of that particular investment as an investment of that kind;

(a) The need for diversification of investments of the trust in so far as is appropriate to the circumstances of the trust.

When combining the provisions of the general power of investment with those of the duty of care it is clear that there is potential for litigation by beneficiaries where clear and accurate records are not kept by the trustees as to what and, more importantly, why investment decisions were taken. Also, it is no longer possible for a trustee to make an investment and not review the investment from time to time.

In the Nestle case a period of at least once a year was suggested. Section 5 of the Act provides for even more reason as to why a trustee will, in future, wish to work with another adviser in relation to the trust’s investments. Before exercising any power of investment and when reviewing the investments of a trust, a trustee must obtain and consider proper advice about whether, having regard to the standard investment criteria, the power should be exercised or the investments varied.

There is an exception, in that a trustee need not obtain such advice if he reasonably concludes that in all circumstances it is unnecessary or inappropriate to do so. An example of this could be where the sole asset of the trust is the family business.

Proper advice is the advice of a person who is believed by the trustee to be reasonably qualified to give it by his ability in, and practical experience of, financial and other matters relating to the proposed investment. Finally, it should be noted that section 6 provides that the general power of investment is in addition to powers conferred on trustees and can be made subject to any restrictions or exclusions imposed by the trust instrument.

What is an investment?

One of the difficulties associated with the Act is that it has not provided a definition of an investment. This could provide fertile ground for trustees to challenge the use of a non-income producing asset such as a policy of life insurance. The reason for this potential mischief making can be traced back to a 1919 case, Re: Wragg. In this case it was held that the meaning of ‘invest’ is ‘to apply monies in the purchase of some property from which interest or profit is expected and which property is purchased in order to be held for the sake of the income which it yielded.’ Thus to invest in land would not be permitted, but to invest in land for the rent it would yield is permitted. Generally the approach of the courts has been to construe investment clauses liberally and cases can now be found to demonstrate that investment for growth rather than immediate income is also valid providing the investment is in keeping with the trust objectives.

The seventeenth edition of Lewin on Trusts agrees that a non-income producing asset is an investment within the meaning of the Trustee Act 2000. In fact the book’s authors state, ‘we consider that a single premium unit linked or with-profits life insurance and endowment bonds, where income is rolled up within the bonds, come within an ordinary wide investment power even without any express reference to investment in non-income producing property or life insurance or endowment policies’.

Part IV: agent, nominees and custodians

Part IV of the Act deals specifically with the matter of trustees employing agents, nominees and custodians. The Act allows trustees to delegate to an agent, but imposes a number of restrictions. There are four matters where delegation is not possible:

Dispositive powers;
Power to decide whether payments should be made out of income or capital;
Power of appointing new trustees;
Power of delegation, use of nominees.

Of these the function of not being able to appoint new trustees could raise a few eyebrows. Although it should be remembered that it is the delegation of the function of appointing new trustees that is prohibited, rather than a specific power enabling the settlor to appoint new trustees.

The other area of interest to those advising trustees in matters of investment will be Section 15, Asset Management: Special Restrictions. In this section a trustee may not authorise a person to exercise any of their asset management functions as their agents except by agreement that is in, or evidenced in, writing. Further, a trustee may not authorise a person to exercise any of their asset management functions as their agent unless:

They have prepared a statement that gives guidance as to how the functions should be exercised (a policy statement);
The agreement under which the agent is to act includes a term to the effect that he will secure compliance with;
The policy statement;
If the policy statement is revised or replaced, the revised or replacement policy statement.

The trustees must formulate any guidance given in the policy statement with a view to ensuring that the functions will be exercised in the best interests of the trust. Moreover, the policy statement must be in, or evident in, writing.

For the purposes of the Act the asset management functions of trustees are their functions relating to:

The investment of assets subject to the trust;
The acquisition of property which is to be subject to the trust;
Managing property, which is subject to the trust and disposing of, or, creating or disposing of an interest in such property.

Clearly all of the above will only be of interest to advisers who are appointed as agents of the trustees to manage trust assets. Where this is the case it would be prudent for the asset manager to proactively approach trustees to ensure that the current agreement is in line with the Act.

Given that the Act provides for a regulator’s dream, a written policy statement, it would also be prudent for the asset manager to ensure that procedures are in place to ensure that the management of the assets is within the guidelines provided by the policy statement.

Summary

The Trustee Act 2000 provides a comprehensive update in a number of areas of trust law. The scope and detail of the Act have surprised many within the professional community. As a result they will be looking at the impact of the Act from a wider perspective than just purely investment.

Given the increased emphasis to ensure that the investment mix of the trust adheres to modern portfolio theory and the requirement for trustees to seek advice there has never been a greater need for professional trustees and qualified financial planners to work together.

Thanks to David Morley of Canada Life International

Duncan Ellis

Lighthouse Wealth Management

020 7065 5666