Rectification: Clarifying the nature of the test

Introduction

A recent decision of the Jersey Royal Court (“the Court”) in The Representation of Vistra Fiduciary Limited re the Maria Trust [2022] JRC 164 has clarified the nature and application of the test for rectification in Jersey, and in doing so has departed from the shift towards the English law test that had been endorsed by the Jersey Court of Appeal. In his judgment, the Deputy Bailiff analyses the development of the test under both English and Jersey law and reaffirms the proper approach to be taken by the Jersey Court. The decision, in offering a detailed review and assessment of the development of the test for rectification in Jersey, provides greater clarity and certainty to the Court and practitioners in this area (both onshore and offshore) in future.

This article reviews the Jersey Court’s articulation of the legal test for rectification and application in the specific circumstances of this case, followed by an analysis of the implications of the judgment for future cases and for practitioners in the UK and offshore. The Court’s decision is of particular relevance to UK-based individuals who utilise offshore trust structures as well as the fiduciaries that administer them. Applications for rectification are not uncommon where complex structures holding significant assets are involved, and where the tax and other consequences of an unrectified mistake can be severe.

Background

The Court was asked to consider an application by Vistra Fiduciary Limited (“the Trustee”), the trustee of a discretionary settlement governed by Jersey law known as the Maria Trust (“the Trust”), to rectify the Trust instrument to include the settlor within the definition of Excluded Person in clause 1 of the Trust instrument.

The settlor and her husband, both non-domiciled individuals for UK tax purposes, had two children, F and G. In 2008, F, who lived and worked in the UK, wished to buy property in the UK for him and his family to live in. F’s parents expressed a wish to purchase a property for him and to set up trusts for the benefit of the children, going so far as to identify a property suitable for F and his family to live in. F’s father died in 2009 before the property was purchased. However, it remained the intention of F’s mother (the settlor) to provide for him in this way.

Advice was sought from a local firm of solicitors, HMG Law, on how the purchase of the property could be structured to give effect to the settlor’s wishes, at the same time as mitigating the settlor’s exposure (as a non-domiciled individual) to UK inheritance tax (“IHT”). HMG Law advised that the property could be purchased through an offshore discretionary trust, with the trust assets used to purchase the property, rather than a direct purchase by the settlor, and that this would mitigate any IHT exposure for the settlor or her estate. F instructed HMG Law to set up this discretionary trust, who in turn contacted the Trustee regarding the establishment of the Trust. A draft trust instrument was provided by the Trustee to HMG Law, which HMG Law reviewed, amended and approved. The beneficiaries of the Maria Trust were F, his wife, and their issue; the Trustee was named as the only excluded person. Crucially, the settlor was not listed as an excluded person. The purchase of the property then proceeded and completed in October 2009.  

Several years later, in November 2016, the Trustee instructed solicitors (Charles Russell Speechlys LLP, “CRS”) to review the Trust structure. In their review, CRS identified that the trust assets may be subject to IHT as although the settlor was not included within the discretionary class of beneficiaries, under the terms of the Trust instrument she was not expressly excluded from the class, and could therefore be added as a beneficiary. In those circumstances, it was likely that HMRC would determine that the settlor had made a gift with reservation of benefit (a “GROB”), such that the value of the trust assets (i.e., the property) would form part of her estate for IHT purposes and so be subject to IHT on her death. The assets in the trust were also subject to a separate IHT charge of 6% every 10 years under the relevant property regime. However, this aspect did not form part of the application.

The settlor died in 2019, thereby giving rise to the IHT charge referred to above.  Following her death, the Trustees brought this application seeking an order to rectify the terms of the Trust instrument to include the settlor within the definition of excluded persons ab initio. If successful, the application would eliminate the GROB charge such that no IHT would be payable on the settlor’s death.

The law on rectification

In its judgment, the Court first set out the three-stage test for rectification in Jersey in Walbrook Trustees v Amethyst Trust [2002] JRC 186 and R.E. Sesemann Will Trust [2005] JLR 421, namely:

• The Court must be satisfied to the civil standard, on the balance of probabilities, that a mistake has been made such that the settlement does not carry out the true intention of the parties, particularly the settlor;
• There must be full and frank disclosure; and
• There should be no other practical remedy.

In R.E. Sesemann Will Trust, in respect of the first requirement, Birt DB distinguished the "transaction itself" from "the objective behind the transaction,” and confirmed that while the court can rectify a deed that does not reflect the transaction the parties intended to achieve, it cannot rectify a deed as a means of permitting the parties to achieve a different transaction to the one intended simply to achieve a more fiscally desirable outcome. 

The Court then went on to consider the Jersey Court of Appeal decision in B & C v Virtue Trustees (Switzerland) AG [2018] JCA 219, in which the Court of Appeal relied on the slightly different 4-stage test for rectification of a voluntary settlement summarised in Lewin on Trusts (“Lewin”) and applied by English courts because the 3-stage test set out above was “too summarily expressed”:

• There must be convincing proof to counteract the evidence of a different intention represented by the document itself;
• There must be a flaw (that is an operative mistake) in the written document such that it does not, on its true construction, give effect to the settlor’s intention;
• The specific intention of the settlor must be shown; it is not sufficient to show that the settlor did not intend what was recorded; it must also be shown what he did intend; and
• There must be an issue capable of being contested between the parties affected by the mistake notwithstanding that all relevant parties consent.

The Court considered Murray v Camerons Limited [2020] JRC 179 to conclude that it was not bound by the propositions of law considered by the Court of Appeal in B&C, as these propositions were not the subject of argument. The Court identified various inconsistencies in the 4-stage test proposed in B&C as compared to the preferable 3-stage test adopted in Walbrook Trustees v Amethyst Trust [2002] JRC 186 and R.E. Sesemann Will Trust [2005] JLR 421. In particular, the Court found that:

• The reference to “convincing proof” in the first stage of the test in B&C appeared to be inconsistent with the usual civil burden of proof;
• The second element of the test in B&C was captured by the first element of the three-stage test; and
• The third element of the test in B&C, namely, a consideration of the parties’ intentions, would naturally form a part of the Court’s analysis as to whether a mistake has resulted in the settlement failing to carry out the true intention of the parties, the first element of the three-stage test.

The Court dissected the fourth limb of the test set out in B&C, which is often referred to as the Whiteside v Whiteside principle, from the English Court of Appeal case from which it derives ([1950] Ch. 65). It expressed criticism at the approach employed by the English Courts to try to “fit” applications for rectification within the fourth limb of the test. The Court identified cases where English courts considered that to satisfy the fourth limb of the test, there simply needs to be “practical consequences of benefit to one or more parties to the application.” The Court considered that such a broad approach to the fourth limb rendered it completely “unnecessary,” as all decisions of the Court will naturally have practical consequences of benefit for one or more of the parties. The Court, therefore, upheld the three-stage test from Walbrook Trustees v Amethyst Trust [2002] JRC 186 and R.E. Sesemann Will Trust [2005] JLR 421 as the correct test to apply in Jersey cases concerning rectification.

Application in Re the Maria Trust

Applying the three-stage test, the Court found that a mistake had been made with the effect that the Trust instrument did not carry out the true intention of the settlor. The Court identified that the settlor's intention was not only to gift property to her son, F, via a discretionary trust, but also not to benefit from the Trust, which, upon receiving advice, also resulted in an intention to be excluded from receiving any future benefit from the Trust. The Court was assisted in this respect by the evidence documenting the settlor’s intention and understanding, which it described as “extremely clear” and evinced in HMG Law’s file notes from meetings with the settlor. These notes recorded that the settlor appeared to understand that she would have “no future access” to the assets being settled onto the Trust and that the alternative of an outright gift was explored and swiftly rejected. The Court held that the settlor’s desire had been to effect the purchase of the property in a way that excluded her from the benefit of the property and in the most tax-efficient manner.

As to the third limb, after briefly considering whether the Trustee would have a cause of action against HMG Law in professional negligence, the Court reaffirmed that litigation against professional advisers can generally not be regarded as a practical remedy, especially when compared with “the clear and clean outcome of an application to rectify an instrument." The Court exercised its discretion and ordered that the definition of “Excluded Persons” in Clause 1 of the Trust instrument be rectified to include the settlor. The effect is that there was no IHT liability on the settlor’s death.

Legal analysis

The Court’s criticism of the “issue capable of being contested” limb of the test, as set out in Lewin is not the first time this criterion has been heavily scrutinised. The principle that “equity will not act in vain,” revisited in the leading case on mistake, Pitt v Holt [2013] UKSC 26, is considered to be one of the foundations for the fourth limb of the test whose principle was first articulated in Whiteside. However, as noted in Re the Maria Trust, the requirement for there to be an issue between the parties has been relaxed in English courts over the years. In Racal Group Services Limited v Ashmore [1995] S.T.C. 1151 the Court of Appeal accepted that it is sufficient if there is an issue capable of being contested between the parties and that rectification could still be granted even if all parties involved are agreed on rectification.

Nevertheless, the Jersey Court’s conclusion that there is no merit in maintaining the fourth limb of the test is striking, particularly in view of the comments made by the Jersey Court of Appeal. The Court’s view was that the types of applications this limb seeks to exclude from the court’s consideration (namely applications for rectification motivated solely by fiscal considerations) can easily be identified by the court without the need for such a rigid and long-winded test. This assessment may be difficult in certain cases, although the approach allows the court greater flexibility in exercising its discretion, particularly where there are no parties contesting the application (as is not uncommon in cases of this nature). In fact, in this case, as in many other similar cases, HMRC (as a potentially interested party) were notified of the application.  However, they declined to participate actively, instead asking to be notified of developments in the proceedings and requesting for certain cases to be brought to the attention of the Court. 

Practical considerations

In one sense, the decision in Re the Maria Trust serves as a clear steer to practitioners preparing or contemplating an application for rectification in Jersey on the test that the Jersey Court will apply and which will need to be satisfied in order for rectification to be granted. Conversely, although at face value the refined test has removed a hurdle that is required to be overcome, the Court in Re the Maria Trust emphasised that the Jersey Court will continue to scrutinise cases brought purely on tax grounds (which the now defunct fourth limb sought to address) and will exercise its discretion as to whether there is evidence of a specific intention which has failed to be put into effect. In that sense, the decision brings the fourth limb of the test expressly within the realm of the Court’s discretion, which although offering more flexibility, may be less straightforward for practitioners to address in preparing an application for rectification. In Re the Maria Trust, the evidence of the relevant intention was easily identifiable in the contemporaneous documents. However, there are many cases resulting from defective tax planning where the intention will not be as clear-cut.

In other respects, by the refinement of the test for rectification in Re the Maria Trust the Court has sought to negate the requirement for the Court to contrive the definition of an “issue capable of being contested” to grant a particularly meritorious application for rectification. In practical terms, this should reduce the hesitation of practitioners, counter-intuitive though it may seem, to immediately put right errors requiring rectification without or prior to the involvement of the Court, solely to ensure that an issue remains between the parties so as not to prejudice the fourth limb of the former test.

Whether the English courts could adopt a similar approach and dispense with the fourth limb of the test for rectification under English law remains a matter for discussion. As noted above, the fourth limb of the test in English law came to be established following the decision in Whiteside v Whiteside. The principle derived from that case is that if the sole motivation for seeking rectification is a fiscal advantage, the Court should not grant rectification because there is no issue before the Court. In the authors’ view, it could be argued that the Court in Whiteside could simply have declined to exercise its discretion to grant rectification in the circumstances of the case rather than adding a further limb to the test.

Equally, however, there are cases where the fourth limb has helped the English Court identify the purpose behind applications for rectification and justify the exercise of its discretion or a refusal to do so. In MV Promotions Ltd and Michael Vaughan v Telegraph Media Group Ltd and HMRC [2020] EWHC 1357 (Ch) the Court rejected an application for rectification of a bilateral contract on the grounds that the deed of rectification entered into by the parties after their discovery of the mistake had resolved all issues between the parties. The fourth limb in this case arguably assisted the Court in reaching its conclusion that, in the absence of any live issue between the parties, the sole purpose of the application was to ensure the tax benefits of the deed of rectification applied retrospectively to the original contract. Ultimately, it remains to be seen whether the fourth limb might be entirely dispensed with in England in a future case.

Separate to the Court’s findings on the fourth limb of the test, which has drawn most attention to this case in the industry, the Court gave helpful confirmation on the third limb of the test and the requirement to establish that there is no other practical remedy. Specifically, the Court reiterated that the availability of a professional negligence claim from the same set of circumstances giving rise to the rectification application would generally not be viewed as another “practical remedy”, in view of the uncertainty, time and costs that such claims involve versus the certainty that a rectification application affords, if successful. That said, careful thought will still need to be given around how to pursue such a claim in conjunction with a related negligence claim (both from a strategic and timing perspective).

Conclusion for practioners

In addition to its significance as an instance of the Jersey Court departing from the views expressed in the Jersey Court of Appeal, Re the Maria Trust serves both as a clear and unequivocal restatement of the test for rectification under Jersey law as well as a reminder to practitioners of the key hurdles that need to be overcome in order for a rectification application to succeed. One might wonder whether the English courts will follow a similar path in due course.

Previously published in TELTJ.