Wind up

How do you bring a trust to an end when it isn’t needed? Perhaps the trust is no longer useful, either from a tax perspective or for the protection of the beneficiaries. Alternatively, the trustees may feel that the beneficiaries are now old enough to have the assets in their own hands.

Whatever the reason, there may come a time when the trustees or the beneficiaries wish to wind up the trust. This article looks at the various ways this can be done and highlights some of the technical points to consider. I will deal with the tax issues that might arise when a trust is wound up in the next edition of PS.

The trust certainties

In order to create an express trust, there must be certainty of three things:

1. intention (to create a trust)
2. object (who the trust is for)
3. subject matter (what the trust will contain).

The corollary of this principle is that a trust must have subject matter in order to exist (that is, it isn’t possible to have a trust of nothing).

This may mean that the easiest way to bring a trust to an end is simply to appoint out all the assets. Once the trust is ‘empty’, it will cease to exist. From the trustees’ perspective, it is prudent to have something in writing to record the fact that the trust no longer has any assets and has come to an end. Whether this is a trustee resolution or a formal deed will depend on the terms of the settlement. Some trust deeds permit the trustees to record decisions in writing, so that a simple resolution or a minute recording a decision is sufficient. Other trust deeds may require the trustees to record all decisions or actions by deed.

If the trust has been filing UK tax returns, the trustees will need to ensure HM Revenue & Customs (HMRC) is informed that the trust has been terminated. This enables HMRC to take the trust off the system that sends out tax return reminders automatically. Failing to inform HMRC is likely to result in penalties for late filing, or indeed non-filing, of the trust’s tax returns.

Making appointments out

If the trustees wish to terminate the trust by appointing out all the assets, it must first be ascertained whether the trustees have the power to make that appointment. Modern trust deeds will normally have extensive powers of appointment, often in favour of a wide class of beneficiaries. The trustees may have the power to choose which one or more of the beneficiaries to appoint the assets to. Frequently, the trust deed will specify that this choice be made at the absolute discretion of the trustees.

However, in some older deeds there may be only limited, or indeed no, express powers of appointment. One such example might be: ‘I give the Trust Property to my son for his lifetime, and then on my son’s death to his children in equal shares.’

Such clauses are common, particularly for will trusts. This clause would create a life interest for the son (A), followed by a remainder interest for A’s children. The trust deed or will may, however, be silent on whether the trustees have the power to appoint assets out during the son’s lifetime, either for the son’s benefit or his children’s.

Statutory powers of appointment

Fortunately, there are statutory powers of appointment, although these are rarely as extensive as those incorporated into a modern trust deed. Section 32 of the Trustee Act 1925 (TA 1925) originally gave the trustees power to advance up to half of the capital money held in trust, in favour of the person who was contingently entitled or who had a life interest in those assets. Section 32(1) stated: ‘Trustees may at any time or times pay or apply any capital money subject to a trust, for the advancement or benefit, in such manner as they may, in their absolute discretion, think fit, of any person entitled to the capital of the trust property or of any share thereof…’

There were two problems for trustees who hoped to rely on these statutory powers. First, the power of advancement was only expressed to apply to ‘capital money’

(so arguably would not permit a transfer of an asset to the beneficiary), and second, it only permitted an appointment of half the capital money.

The first issue, that of not being able to advance a trust asset in specie, was the subject matter of Re Collard’s Will Trusts, Lloyds Bank v Rees [1961] Ch 293. Here, the trustees wished to advance land held on trust to a beneficiary. However, the statutory power, if interpreted strictly, only gave the trustees power to advance cash to the beneficiary. Clearly, the trustees could advance cash to enable the beneficiary to buy the property from the trust, but that could have adverse tax issues (such as the payment of stamp duty – now stamp duty land tax – by the beneficiary). Equally, it didn’t seem to make sense to force the trustees to sell the land so they could then appoint the cash proceeds to the beneficiary if the beneficiary specifically wanted ownership of the land itself.

The court held that it was not necessary to advance cash for the beneficiary to buy the property, and permitted an advancement of the land.

Fortunately, the Inheritance and Trustees’ Powers Act 2014 (ITPA 2014) removed any doubt on this point. This amended section 32 of the TA 1925, to make it clear that trustees have the power, under section 32, to advance any capital assets, not just money. This change applies to all trusts, no matter when created. Thus trustees can use

the statutory power of advancement to give any asset in specie to a beneficiary.

The ITPA 2014 introduced a second change to the section 32 powers of advancement. Trustees now have power to advance all the trust assets under section 32, rather than the original half. However, this change only applies to trusts set up on or after 1 October 2014. For will trusts, this means the extended section 32 powers apply where the death occurred on or after 1 October 2014.

The amendments to section 32 will also apply to any interests that are created or arise by virtue of the exercise by the trustees of a trust power on or after 1 October 2014. This would apply to the exercise of a general or special power of appointment, or a power of advancement.

It might be questionable how many trust deeds will have incorporated such powers where the trustees still need to rely on the section 32 statutory power of advancement. The statutory powers only apply if, and so far as, there is nothing contrary in the trust deed (see section 69(2) of the TA 1925). It follows that if the trust deed has specifically excluded section 32 of the TA 1925 from applying, or has amended its scope, then the amendments made in 2014 may have no relevance.

It also follows that careful drafting of the trust deed is preferable to relying on the statutory powers of advancement under section 32.

Giving reasons for appointment decisions

The traditional rule, deriving from Re Londonderry’s Settlement [1965] Ch 981, is that trustees do not have to give reasons for the exercise of their discretionary powers of appointment. The rationale was that it could cause discord amongst the beneficiaries if they knew why one person was preferred to another, or give rise to disputes between the trustees and any ‘aggrieved’ beneficiary.

Indeed, trustees may well be best advised not to give any reasons at all for their decisions if they have discretionary powers of appointment. If they do give reasons, these might potentially be challenged. The most likely ground would be that the trustees have breached their fiduciary duties, by taking into account irrelevant considerations or not taking relevant considerations into account, when exercising their discretion. The recent case of Futter and Pitt v HMRC [2013] UKSC 26 described this as ‘inadequate deliberation’. Careful trustees will make sure they have obtained all relevant facts (such as each beneficiary’s financial situation and needs) and consider each beneficiary’s potential entitlement, before exercising their discretionary powers of appointment. Ironically, although the trustees may be best keeping a record of these deliberations (just in case the exercise of their discretion is ever challenged), they will also be advised not to give a copy voluntarily to any of the beneficiaries (in case that increases the risk of litigation).

There may also be a letter of wishes from the settlor, giving guidance to the trustees as to whom should benefit when the trust comes to an end. This can lead to a separate cause for potential dispute as to whether the trustees were right to follow the letter of wishes, which is not legally binding.

In Futter and Pitt, the court agreed that trustees can choose to follow letters of wishes, as long as they can show they considered matters for themselves. Lord Walker held: ‘The settlor’s wishes are always a material consideration in the exercise of fiduciary discretions. But if they were to displace all independent judgment on the part of the trustees themselves (or in the case of a corporate trustee, by its responsible officers and staff) the decision making process would be open to serious question.’

The reverse situation is where trustees decide not to follow the terms of the letter of wishes. This may be because circumstances have changed in a way the settlor never envisaged: a classic example would be a beneficiary developing a drink or drug problem. It should be relatively easy for trustees to substantiate departing from a letter of wishes where it is clear that following its terms would not be in the beneficiaries’ best interests. The problem is that not all beneficiaries will agree that a decision to withhold funds, or to reduce the amount distributed, may be in their best interests.

A separate query arises as to whether any letter of wishes has to be shown to the beneficiaries. There may well be reasons why the trustees would prefer not to show the letter to all or some of the beneficiaries (particularly if it is uncomplimentary in its description of a beneficiary’s ability to look after money). Again, the traditional view was that the letter of wishes was not part of the ‘trust documents’ that a beneficiary was entitled to see.

This view has been challenged in some recent cases, such as the decision of the Court of Appeal of New South Wales in Hartigan Nominees Pty Ltd v Rydge (1992) 29 NSWLR 405. This case concerned an application for disclosure of a memorandum of wishes to the trustees, made by the economic settlor of the trust (as opposed to the nominee settlor named in the trust deed). The court held that it could order disclosure of a memorandum of wishes under its inherent powers to supervise the trustees.

This case was quoted with approval in Schmidt v Rosewood [2003] UKPC 26, which agreed that a beneficiary does not need to prove a ‘proprietary interest’ in a trust document in order to gain sight of it. This has led some professional trustees to record any wishes of the settlor in a file note of a meeting with the settlor, rather than in a formal letter of wishes. To date, there do not appear to have been any published cases to confirm whether such a file note would equally be open to disclosure upon application by a beneficiary.

The Saunders v Vautier rule

There may be times when the beneficiaries wish to wind up the trust, but the trustees disagree or have insufficient powers to bring the trust to an end. In such circumstances, the case of Saunders v Vautier (1842) EWHC Ch J82 may assist.

The Saunders v Vautier principle is that if all the beneficiaries are adults (and have full legal capacity), they can act unanimously to wind up the trust and distribute the trust assets. They can effectively go against the original wishes of the settlor in setting up the trust, and against the wishes of the trustees.

The rule has been followed in many other jurisdictions, such as Canada, where the Ontario Superior Court held in Kos v Dobrowolsky 2007 CanLII 182: ‘The broader statement of the rule is this: if there is only one beneficiary, or if there are several (whether entitled concurrently or successively), and they are all of one mind, and he or they are not under any disability, the specific performance of

the trust may be arrested, and the trust modified or extinguished by him or them without reference to the wishes of the settler (sic) or the trustees.’

In the example above then, where the trust gave a life interest to A and the remainder to A’s children in equal shares, the trust could potentially be wound up under the Saunders v Vautier rule. All of A’s children would need to be adults, all the beneficiaries would need to have legal capacity, and they would all need to agree that the trust be wound up and on how the trust assets should then be distributed.

It follows that the Saunders v Vautier rule won’t assist if A’s children are minors, or if A has lost mental capacity.

Trust variations

Occasionally, if all else fails, it may be necessary to apply to court to vary a trust. The Variation of Trusts Act 1958 (VATA 1958) confirms the court’s inherent jurisdiction to vary trust instruments. Section 1(1) confirms the court may vary any trust, regardless of whether it came into existence before or after the act came into force.

The court can give consent to the variation on behalf of minor beneficiaries (who cannot otherwise agree to a Saunders v Vautier termination), and unborn or future beneficiaries. The court can give its consent to ‘any arrangement … varying or revoking all or any of the trusts, or enlarging the powers of the trustees of managing or administering any of the property subject to the trusts’.

There is one overriding proviso, namely that the court can only give its consent to a variation on behalf of someone if the court is satisfied that doing so is for the benefit of that person. The notion of ‘benefit’ is widely defined and can include non-financial benefits, such as educational or social benefit (see Re Weston’s Settlement Trusts [1969] Ch 223) or moral obligations (see Re CL (1969) 1 Ch 587).

This usually means that where a trust variation application is made to the court, each class of beneficiary needs their own legal representation, including someone acting on behalf of any minor or unborn beneficiaries. Needless to say, this means that a trust variation application is rarely inexpensive.

Conclusion

There is no doubt that careful drafting of the trust deed will give the trustees maximum flexibility when ending a trust. However, the extended statutory powers of advancement may now assist, as well as the Saunders v Vautier principle that lets the beneficiaries agree to bring the trust to an end.

The final option of a VATA 1958 application to court may be the most expensive route, but could be useful if the trustees have no other option, perhaps because of minor or unborn beneficiaries who cannot give their consent to the trust being wound up.