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17 November 2020

What to consider on a change of trustee - English law issues on a change of trustee in international structures

The decision to change trustee is not taken lightly. Doing so involves upheaval within professional relationships and can be risky in terms of unintended legal and tax consequences, especially where multiple jurisdictions are involved. However, as trusts can last for up to 125 years (under English law), it is not surprising that from time to time a change of trustee is required.

Trusts are often an element of complex structures designed to preserve intergenerational and international wealth. The initial trustee will typically have a close relationship with the settlor and his/her descendants. They may need to balance competing interests across families and between generations spread across multiple jurisdictions. The importance of the choice of trustee cannot be overstated. However, as circumstances evolve, at times a change of trustee is inevitable.

Once this crucial decision has been made, there can be a rush to implement it. However, without due care and attention the results can be disastrous for all concerned; the outgoing and incoming trustee risk reputational damage and negligence claims and the assets of the trust may be depleted in resolving the problems. This note highlights the key consideration and common pitfalls, as avoiding mistakes on a change of trustee is in everyone’s best interests.

1. Why do trustees change?

During the lifetime of the trust certain events may trigger a change of trustee. In each case this will lead to either the appointment, removal, replacement or retirement of the trustee(s) and can either by agreed between the parties (which is the usual course) or achieved by an application to the Court. This note considers only changes of trustee which have been agreed between the parties (as opposed to removals or appointments which are contentious or require approval by the Courts).

Where an individual acts as a trustee, a change may be needed due to their retirement, new employment or due to unplanned events such death, illness or the loss of capacity. Of course, there is also the possibility that the relationship between the beneficiaries and the individual has simply broken down and all are agreed that a change of trustee is appropriate.

A change of corporate trustee, which are often found where structures are more complex, could arise due to a generational shift within the family, a need to update advisors based on the needs and complexities of the structure, a desire to move jurisdictions, or in the event of a disagreement or falling out with the current trustees.

2. Where to find the rules / powers governing a change of trustees

The rules concerning a change of trustee derive from the original trust document (usually a trust or settlement deed) and/or legislation.

The trust instrument

The original trust document should be reviewed as the starting point. It may contain a range of express powers relating to a change of trustees which may have the effect of excluding or modifying statutory powers. For example, it is not a statutory requirement for someone to have the power to appoint trustees (an ‘appointor’) but, particularly in an international context, it is common for the trust document to include an appointor or reserve this power to the settlor during his or her lifetime. Failure to exercise changes with appointor consent may invalidate an appointment or retirement.

Statutory powers

It is also important to be mindful of the statutory powers and restrictions which are relevant on a change of trustee. The Trustee Act 1925 should be carefully considered alongside any conditions imposed by the trust document.

For example, one such ‘trap’ contained in this legislation prevents the discharge of a trustee unless they are replaced by a ‘trust corporation’ or two or more individuals. A trust corporation is a specific legal entity under English law, and is not the same as a ‘trust company’. This pitfall is easily overlooked (see the 2000 case of Adam v Theodore Goddard), and if the new trustee is a single non-UK entity, they are very unlikely to fulfil this requirement.

3. Preparing for a change of trustee

What is the motivation for the change?

Thought should be given to why there is to be a change of trustee. It is possible that a change of trustee is requested by a settlor or beneficiary to facilitate a breach of trust – for instance if the incoming trustee is prepared to do something that the outgoing trustee is not. The current trustee should therefore consider who is requesting the change, and ultimately, if it will conform to their fiduciary duties. If they are asked to retire, they may choose to do so only if replaced by an appropriate professional.

Review previous changes to trustees

As mentioned above, the original trust document should be the starting point but it is often accompanied by supplementary deeds of appointment and retirement of trustee (DORAs). Establishing a chain of trustees from the creation of the trust can be a challenge, but having certainty that the outgoing trustee was validly appointed is in everyone’s best interest (especially the incoming trustee). An unsound appointment or retirement from an earlier DORA can have the effect of rendering the change invalid (see below for consequences and who is on the hook).

4. Indemnities

What is the purpose of the indemnity?

Unlike companies and individuals, trusts are not legal persons. Trustees, whether individuals or companies, act in their personal capacity. This confers personal liability in respect of the obligations of the trust (e.g. contracts and debts), and subject to the terms in the trust deed, the trustee may be personally liable for claims that may be made against the trust.

During their tenure as trustee, any liabilities incurred can usually be met from trust assets (provided the trustee has acted within their powers under the terms of the trust). Upon retirement however, liabilities that have arisen during the period of trusteeship may still arise personally against the retiring trustee. Typically, an indemnity serves to pass this liability to the retiree’s successor(s) in their capacity as incoming and/or continuing trustees, as usually it is agreed that the liabilities of the trust should follow the assets. It would seem unfair, for example, for former trustees to be liable for the trust’s taxes once the trustee no longer had access to the asset with which to pay them. The position may well be different if the liability arises due to a breach of trust (see below).

Chains of indemnity

It is common that the incoming trustee will indemnify the outgoing trustee and promise that if a new trustee parts with trust assets (whether in the context of a further change of trustee or a distribution from the trust), that the incoming trustee will secure an appropriate indemnity for the benefit of the outgoing trustee. Whilst such ‘chains of indemnities’ can be cumbersome (and require careful thought when future distributions are documented), in real terms such assurance is often needed by an outgoing trustee as otherwise there may be no value to the indemnity they are receiving.

Appropriate wording for indemnities (especially where there is a chain) will depend on the particular facts in each case and may be the subject of some negotiation. Prior to agreeing its scope, it is important to bear in mind the balancing act between protection of the retiree and the existing trustee’s underlying duty to act within their powers and in the best interests of the trust beneficiaries.

What should an indemnity cover?

It is common for trusts to contain express powers for trustees to give indemnities covered by trust assets but this must be specified in the trust document. Thought therefore should always be given to the extent of indemnity cover, as well as the authority to provide it.

Typically, indemnities aim to provide comfort to the outgoing trustee in respect of possible future liabilities. For example, if it is discovered that a tax liability occurred on the watch of the outgoing trustee, then it is probably reasonable for this tax (and the associated costs) to be met from the trust fund. However, consideration should also be given to other potential areas of challenge, such as claims from beneficiaries, contractual liabilities or other actions from third parties.

Negotiation is often required regarding the terms of the indemnities, including what claims are covered and if such claims are limited in terms of value or by reference to a time limit. It is important to strike a fair balance between a trustee’s duties and their subsequent protection.

5. Practical steps on changing trustee

Identifying trust property and preparing for appropriate transfers

Ideally, a transfer of trustee powers should result in the simultaneous transfer of the trust property to the incoming trustee, but thought should be given to what subsequent steps are needed to ensure specific assets are appropriately transferred. For example, it should be agreed who is responsible for arranging transfers of investments and land, along with any necessary consents and notifications required to effect the legal transfer of the trust property.

As part of the preparatory work, the incoming trustee should take the opportunity to review the status of the trust structure and ensure they are provided with the most up-to-date information. For example, if there are loans within the structure, they should ask for details of the values, repayment dates, interest rates and current balances.

Counterparts

It is common for trustees and others who may be required to be party to a DORA (e.g. an appointor) to be in separate locations. If that is the case, a clause should be included to the effect that the DORA can be signed in two or more counterparts.

6. Continuing liability – who is on the hook?

It is common following the signing of a DORA for all parties to consider the matter closed. The new and/or continuing trustees take control of the trust property to hold and manage it for the beneficiaries in accordance with the terms of the trust, and the retiring trustee(s) are now off the hook. But are they?

Failure to exercise proper formalities can have devastating effects. An ineffective retirement means the outgoing trustee is still subject to the fiduciary duties bestowed to them under the trust. Furthermore, actions taken by an incorrectly appointed ‘new trustee’ may be invalid giving rise (at best) to confusion and (at worst) to substantial disputes. It is therefore imperative that both incoming and outgoing trustees appreciate that without the proper advice and implementation, it may not be clear where the liabilities lie.

6. International elements

Particular care should be exercised if the incoming trustee is not resident in the same jurisdiction as the outgoing trustee. For example, under English law the residence of the trustee is relevant for UK taxes and, at worst, the replacement of a UK resident trustee with a non-UK resident trustee could trigger a deemed disposal of all the trust assets for capital gains tax purposes. Under freedom of establishment laws, it has recently been ruled that such exit charges which failed to qualify for deferment amounted to a restriction and breach of EU law (see the 2017 decision of Panayi v HMRC). This imposes significant trustee protection on the transfer of assets where trusts emigrate to EU jurisdictions, but it remains unclear what effect the decision will have following the UK’s departure from the EU.

This note considers changes of trustee under English law, but often there are multiple jurisdictions in play within complex trust structures. It is important to consider under what law a DORA should be drafted, and whilst this is often the same as the governing law of the trust, it is not always the case (especially if the governing law of the trust has been changed at any point).

English law issues arising on a change of trustee in international structures

Preparatory work

 

1.

Consider motivations for change of trustee

 

2.

Review trust deed for provisions and/or restrictions relating to a change of trustee

 

3.

Is there an appointor? Are any other consents required (e.g. settlor or protector)? Is there a minimum or maximum number of trustees?

 

4.

Confirm where the income trustee is resident, and if tax advice is needed if this is not the same as where the outgoing trustee is resident

 

5.

Are there any restrictions on who can be appointed (e.g. beneficiaries or settlor) and are the statutory provisions regarding replacement by two or more individuals or a trust corporation engaged?

 

6.

Check previous DORAs. Is there a chain of indemnity and/or is a chain required? Do director indemnities exist where retiree (or former retiree(s)) is a trust company?

 

 

Drafting the Deed of Appointment and Retirement of Trustee (DORA)

 

7.

Prepare asset summary to attach to DORA as a schedule (if required)

 

8.

Prepare and agree any indemnity before incorporating it into the DORA

 

9.

Consider whether counterparts are required

 

Post-completion

 

10.

Incoming trustee to conduct thorough review of trust structure, consider obligations and request further information where necessary

 

11.

Practical steps to ensure transfer of trust assets (consider e.g. bank accounts (updated reporting requirements), investments and land)

 

12.

Note obligations for chains of indemnities to be included in future appointments

 

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