What to consider when appointing a protector?
Transferring assets to a trustee creates and requires trust. The settlor may wish to appoint a protector to ‘oversee’ the trustee…
There is no ‘one size fits all’ solution when it comes to appointing (or not appointing) a protector. What is certain, is that the settlor and prospective trustee should consider a number of issues before the role is written into the trust instrument.
Whereas trustees have been around since the middle ages, the role of protector is a much more modern one. In most common law jurisdictions there is no statutory definition of the role of “Protector”. This role may be called something else (ie, Power Holder or Advisor). What this role is called is much less important than the powers it confers.
The role of protector is usually (but not always) an office defined in the original trust instrument in order to confer specific powers to someone who is not also a trustee. It is most commonly found in the context of offshore trusts, where the trustee is a professional.
Why have a protector?
Before professional trustees became common, the trustee would often have been the trusted confidante of the settlor. Today, this is less common. In the context of gifting substantial assets to a professional trustee company to manage for years (possibly generations) to come, settlors’ concerns that someone other than the beneficiaries be there to hold trustee to account are understandable.
Typically, a protector might be appointed because:
- the settlor wants someone to monitor the activities of the trustee;
- the settlor wishes to involve someone in the management of the trust who has special understanding of the dynamics of the trust, relating to the beneficiaries and/or the trust assets; and/or
- the settlor wishes to retain a degree of influence over the trust initially or during his or her lifetime, typically by taking the role of the first protector themselves.
The least controversial reason to include a protector is to ensure there is a mechanism to protect the beneficiaries from a trustee that is behaving improperly or that is simply no longer suitable for the circumstances of the trust. The simplest way to achieve this is by giving the protector a power to change the trustee.
A protector can be very beneficial to the orderly administration of a trust when the protector is able to provide a professional trustee with the benefit of specialist knowledge (such as an understanding of a complex or widely flung family or alternatively someone who understands the family business where such assets are settled).
However, the range of the protector’s powers appropriate to achieve these aims may be more limited than one may think. For example, it may be more appropriate for a settlor to request that the trustee consult the protector or to impose consent requirements on dealings only with particular property, rather than giving protectors broad powers to require or veto action by the trustee.
Where a settlor is really seeking to retain a level of control during their lifetime over the assets, more careful thought is needed as to whether a trust is the right vehicle. It is important that the settlor understands the risks associated with retaining control over the trust assets (on which more below).
Who can be a protector?
Subject to the trust instrument, the protector can be any person(s) or entities, but should not also be a trustee. It is possible for the settlor to be the protector, but this comes with risk because it may mean the settlor has retained control over the trust which can have an impact in terms of the validity of the trust itself, the settlor’s tax position and assets protection issues if the settlor faces claims from creditors or on a divorce.
What powers should a protector have?
The powers a settlor might be advised to confer on a protector depend on why the protector is being appointed.
These powers might include:
- Power to change the trustee
- Power to add or remove beneficiaries
- Powers to consent to dealing with particular assets
- Powers to consent to appointments of capital/income
- Powers regarding who should be the successor to Protector (or even the Trustee)
- Approval regarding changes of proper law and jurisdiction
- Consent to early termination of trust
- Consent to amendments to the terms of the trust
- Powers to receive remuneration from the trust fund
- A right to be indemnified or exonerated for any loss that a defective exercise of the protector’s powers might cause to the trust
In general, the more of these powers that are conferred on a protector, the greater the protector’s role and therefore the greater the importance of considering carefully whether the role has arrogated too much control leading to potential future risks to the administration of the trust.
How should a protector exercise these powers?
To avoid any misunderstandings, the settlor should ensure that the trust deed makes clear how the protector is to be expected to exercise these powers – can they be exercised in the protector’s own interests, or are they, like trustees, bound to exercise these powers in a fiduciary manner strictly in the interests of the beneficiaries of the trusts?
It is always wisest for this to be spelled out in the instrument. If it is not, it is a question of construing the trust deed. A professional protector who charges for their services and has no interest in the trust fund itself is likely to be treated as a fiduciary, but a settlor who retains significant powers over the trust in his or her capacity as a protector may be treated as having personal powers not constrained by fiduciary responsibilities, which may in turn create risks for the integrity of the structure.
What are the risks of a protector having ‘too much’ control?
There are risks if a protector has ‘too much’ control over the Trust. How much is ‘too much’ is fact-specific, so it is helpful to distinguish between risks which jeopardise the characterisation or validity of the trust itself, as opposed to the risks that impact on effective administration of the trust.
At one end of the scale, if the settlor is the protector and the extent of the protector’s powers are such that they retain significant de facto control of the trust assets, there is a risk that the settlor could be treated as having failed to divest him or herself of the beneficial interest in the trust property in the first place. This could have disastrous tax consequences for the settlor, and puts the trustee in a very difficult position. It is not straightforward to provide a ‘menu’ of powers that can safely be provided to a protector or otherwise retained by a settlor. Each case must be judged on its own facts. Specific care is needed if the trust is a revocable trust and independent legal and tax advice is recommended in those instances.
Assuming that the powers of a protector are substantial (but not extensive enough to call into question the validity of the trust itself), then it is important to ensure from a trust governance perspective that there is clarity as to the roles of protector and trustee. If key decisions require protector consent (or can even be taken by the protector unilaterally), there is a risk is that the protector’s role elides with that of the trustee to be a de facto co-trustee or a shadow trustee.
This needs to be considered prior to the creation of the trust. How involved does the protector need to be in the day-to-day operation of the trust? Is it desirable that they should they ‘be in the room’ when the trustee is making decisions? The answers to these questions will need to take into account the costs and administrative logistics involved, and where the relevant fiduciaries and power-holders will be making their decisions. Tax consequences could arise where trust decision-making is being carried on by protectors in one jurisdiction as well as trustees in another.
What if there is a deadlock?
Take a moment to imagine: It is 15 years after the trust was settled. A major decision needs to be made; such as whether to sell a family business or to divide the assets for different branches of the family. If this decision would require consent from the protector, then difficulties arise if both the trustee and the protector have carefully considered the options and reached different conclusions. Both protector and trustee may have reasonably reached differing views on what is the best decision, but how will a deadlock be resolved?
The trust instrument could include provisions to deal with these circumstances, though this is rarely included.
If a trustee considers that its decision is the correct one, it may wish to seek the court’s blessing for its proposed course of action. A fiduciary protector is also likely to be accountable to a supervisory court in a manner comparable to a trustee, so it could remove a protector if appropriate. Similarly, a protector might be able to obtain the court’s blessing to a particular course of action, potentially alongside a trustee. However, the time and costs involved in these routes could be avoided if the protector’s role was clearly delineated, and provision made for breaking deadlock, in the trust instrument at the outset.
Who protects the protector?
If you are invited to act as a protector, then in addition to the points above you should also consider how you might need to protect your own position. This will include reviewing the nature and scope of any indemnities within the trust instrument. These may depend on whether you are being paid for, undertaking role or not. In general, if you are acting in your line of business, then the standards to which you are held to account are likely to be higher.
It is also important to consider if taking on the role of protector gives rise to any conflict of interest; and if the protector is amongst the class of beneficiaries or has another professional role (such as financial adviser), then careful thought is needed to whether this is compatible with taking on the duties and responsibilities of the protector.
When to take advice?
Whilst the creation of a trust can safeguard family wealth for generations to come, a failure to tailor the trust to the specific needs of the family, whilst retaining flexibility for the future, can magnify problems later down the line.
Trusts intended to hold significant assets, family businesses or unusual asset classes will need bespoke legal and tax advice. In our view, including a protector also merits taking legal and tax advice. It is better to take this advice when the trust is being drafted if possible, but it is not too late to do so for existing structures, and ‘triggers’ like a change of trustee or protector, or liquidity event within the trust assets, may prompt a fruitful review of the protector’s role.
