The Scottish Law Commission’s Trust Law Review

In September the Scottish Law Commission issued the first two discussion papers in its review of trust law. The review is concentrating on those areas which cause difficulties in practice. The Law Society, the Society of Trust and Estate Practitioners, our Advisory Group and many other bodies and individuals have helped identify the problem areas. The first paper, Breach of Trust (No 123) deals with breach of trust, the standard of care expected of lay and professional trustees, and relief from liability via immunity clauses or the courts. The second, Apportionment of Trust Receipts and Outgoings (No 124) looks at the more technical area of apportionment and allocation of trust receipts and outgoings between different classes of beneficiaries, such as liferenters and fiars. Both may be downloaded from the Commission’s website (www.scotlawcom.gov.uk) or bought from The Stationery Office. The consultation period lasts until the end of the year.

A third discussion paper is to be published early next year, completing the first phase of the review. It will examine trustees’ powers in administering the trust estate (apart from investment powers), the appointment and removal of trustees and the role of the courts in the administration of trusts. Trustees’ powers to invest and to buy land have already been the subject of a report, Trustees’ Powers and Duties, issued jointly with the Law Commission in 1999. The English recommendations were speedily implemented by the Trustee Act 2000, but the Scottish recommendations have not been acted on. Next year the Commission intends to move on to the second phase of the review and look at trusts and whether they should have legal personality, accumulation of income and the remedies of beneficiaries.

Breach of Trust paper

Breach of trust may occur in many different ways. Thus trustees may act outwith their powers, carry out authorised acts carelessly or fraudulently, or profit in an individual capacity from their position as trustees. Should a breach occur, the beneficiaries will seek to recover any loss to the trust estate from the trustees or to claw back unauthorised profits from them. The paper looks at the various breaches in turn, the standard of care expected of lay and professional trustees, and relief from liability by means of immunity clauses in trust deeds or application to the courts. The main principle underlying the Commission’s proposals is that trustees should be personally liable only if they were at fault, and conversely that if they were at fault they should not escape liability.

At present, when trustees commit a breach of trust, for example by making over trust property to somebody not entitled to it, they are liable for this breach. Save in very narrow circumstances, the trustees will not escape liability even where they have acted honestly and in good faith. The Commission suggests that this rule is unduly harsh and proposes that a trustee should not be personally liable if he or she had in fact acted in good faith and after taking all reasonable steps and making all reasonable enquiries believed that the action was within his or her powers. The beneficiaries’ rights to recover the property from the person to whom it had been distributed in error would remain unaffected.

Trustees may also commit a breach of trust by carrying out their duties carelessly and so causing loss to the trust estate. For example, they may invest rashly or fail to insure valuable trust property. Lay trustees are expected to use the same degree of care that a prudent person would use for his or her own affairs. The paper suggests a slightly higher standard – the care a prudent person would use in looking after the affairs of others. Many trusts are now administered by professional trustees, but it is not clear that the law requires any greater degree of care from them than from lay trustees. Given the higher level of skill and expertise that professional trustees hold themselves out as possessing, the Commission considers this anomalous. It therefore proposes that persons who act as trustees in the course of their business or profession, such as solicitors, should in addition have to use any special knowledge or expertise that it is reasonable to expect of a member of that business or profession.

Trust deeds often contain a clause which purports to grant the trustees immunity from specified breaches of trust, such as neglect of management. Under the present law such clauses are effective in protecting trustees, lay and professional, unless they have been grossly negligent or fraudulent. The Commission suggests changes to the legal effectiveness of immunity and other clauses which restrict liability. It proposes that professional trustees should not be able to rely on immunity or other clauses to avoid liability for their own negligence, let alone for gross negligence or fraud. The position of lay trustees is different and for these it is suggested that the present law should remain as it is. The paper also asks whether trustees should be able to protect themselves against liability for their own negligence by obtaining indemnity insurance at the trust estate’s expense. This might be a power implied by statute in every trust deed or available only on application to the court.

At present, trustees are absolutely forbidden, by reason of their fiduciary position, from obtaining any personal benefit from the trust estate or from allowing a conflict to arise between their own personal interests and those of the trust estate, unless permitted to do so by trust deed or all the beneficiaries. Any profit derived from the trust estate, even inadvertent profit or profit gained from dealings with the trust estate in good faith and at generous commercial rates, must be accounted for and paid back into the trust funds. The Commission suggests that the current rules are too strict. The paper asks whether the court should be able to relieve trustees of the consequences of acting in breach of their fiduciary duty (or as auctor in rem suam) so long as their actions were of benefit to the beneficiaries and the trust estate as a whole and the transaction’s terms were at least as favourable to the trust estate as those in a comparable arms-length transaction.

Another aspect of the auctor in rem suam rule is that trustees are forbidden from receiving remuneration for their services to the trust unless the trust deed specifically authorises this or all the beneficiaries agree. Modern trust deeds normally contain a “charging clause” authorising the trustees to appoint one or more of their number to carry out trust business at usual professional rates. For example, a legally qualified trustee may be appointed solicitor to the trust and do all the legal and administrative work. The law is out of step with current practice, so the Commission asks whether trust deeds should be deemed to include a charging clause, unless a contrary intention is indicated.

Apportionment paper

Where a trust has different classes of beneficiaries the trustees have to apportion payments made to or from the trust estate between the various classes. The rules on apportionment are complex and sometimes fail to achieve a fair balance between the various classes of beneficiaries. For example, in company mergers or demergers very large payments may be made that are regarded as income in the hands of the trustees who hold shares in the company. The beneficiaries interested in the income of the trust estate therefore receive a disproportionate benefit at the expense of the capital beneficiaries. Another example of the current rules not working well is where a man creates a trust giving his widow the income of his estate for life with the children as capital beneficiaries getting the estate on her death. A yearly dividend on trust shares payable shortly after the man’s death is apportioned mainly to the children as capital beneficiaries. The widow does not become entitled to the whole of a dividend until it is payable in respect of a period wholly after the deceased’s death. The result is that she is short of income when she needs it.

The Commission proposes that the trustees should have a discretionary power to apportion any receipts or outgoings of the trust estate differently from that required by the present rules to maintain a balance between the various classes of beneficiary.

Trust law is not glamorous or vote-catching. Nevertheless it is important that Scots trust law is modernised and kept up to date. Trusts play a substantial role in wealth creation, wealth retention and wealth distribution. They are a very useful piece of legal machinery in the commercial and private client fields. If Scotland cannot provide a trust law that meets the demands of the 21st century then people and their money will go elsewhere to a more progressive and forward-looking country.