Discretionary Trusts: Main Concepts Stavros Pavlou Senior and - - PowerPoint PPT Presentation

Discretionary Trusts: Main Concepts

Discretionary Trusts: Characteristics and Validity Wednesday, 24 October 2018, Cleopatra Hotel, Nicosia Thursday, 25 October 2018, St Raphael Resort, Limassol

Stavros Pavlou Senior and Managing Partner Patrikios Pavlou & Associates LLC

Discretionary Trusts

 Let’s remember the basics….

Discretionary Trusts

 Definition of a trust

Discretionary Trusts

 “A trust is an equitable obligation, binding a person (who is called a trustee) to deal with property over which he has control (which is called the trust property), for the benefit of persons (who are called the beneficiaries) of whom he may himself be one, and any one of whom may enforce the

• bligation”.

(Azinas and another v Police 2 CLR 16/10/1981)

Discretionary Trusts

The Three Certainties:  Certainty of intention: it must be clear from the trust deed that the settlor intended to create a trust and that the trustee does not hold the trust property for its own benefit;  Certainty of subject matter: the trust property must be defined in an objective manner capable of quantification, or, capable of being ascertained;  Certainty of objects: the beneficiaries must be certain, or capable of being rendered certain – individually identified or clearly defined class.

Discretionary Trusts

Participants to a Trust:  Settlor: The legal owner of property who creates a trust by divesting his legal title to the trustee to manage in favour of the beneficiaries.  Protector: The person, other than the trustee, who has the power to restrict key powers of the trustee.  Beneficiary: Receives the beneficial ownership of assets. Age, legal disability, minority is irrelevant.

Discretionary Trusts

Participants to a Trust:

Discretionary Trusts

Participants to a Trust:  Trustee:

• The person who agrees to hold the legal title to the trust

assets in its name for the benefit of the beneficiaries under the terms of the trust.

• Has the legal title to the trust assets, whereas the

beneficiary has the beneficial or equitable title thereto.

• Legal owner and administrator of the trust property.
• Exercises the powers under the law and under the trust

document.

Discretionary Trusts

Participants to a Trust:  Trustee (continued):

• The trustee’s main duties are (a) to administer the trust

property prudently and (b) to strictly comply with the terms of the trust document.

• The trustee owes a duty of care to the beneficiaries to

perform his role properly.

• A

trustee stands in fiduciary relationship with the beneficiaries which entails that he acts in the utmost good faith.

Discretionary Trusts

The fiduciary role of the trustee:  A relationship of trust and confidence.  Core duties: Loyalty and fidelity.  Breach of fiduciary duty connotes disloyalty and infidelity. Mere incompetence is not enough.  Question for consideration: Is the protector also in a fiduciary position towards the beneficiaries?

ff

Discretionary Trusts

Discretionary Trust (1): A trust in which the interest of the beneficiaries in the trust fund is not fixed by the trust document but at the discretion of the trustee.

Discretionary Trusts

Discretionary Trust (2):  Trustees have a duty to apply the trust property for the benefit of the beneficiaries in such proportion as in their discretion think fit.  No beneficiary has a fixed, automatic right to income or capital as it arises.  The trustees have the power to decide who (from a class of beneficiaries named in the trust document) should receive the capital or income from the trust.  All the beneficiary has is an expectation.

Discretionary Trusts

Discretionary Trust (3):  During the period that the trustee has not yet exercised his power to select beneficiaries from a class, beneficiaries cannot terminate the trust and call for a transfer of property. They can only compel the trustee to consider the possibility

• f making a payment.

 The beneficiaries cannot demand payment as they would be able to under a fixed trust, because there is no identifiable value to which the beneficiary is entitled until the trustee exercises his discretion.

Discretionary Trusts

Discretionary Trust (4):  The discretionary power of the trustee is subject to fiduciary

• bligations.

 No individual beneficiary has a right in rem; the equitable title to the trust assets vests in the class of potential beneficiaries as a whole.  In a discretionary trust the beneficiaries are themselves discretionary - they can be removed altogether and other people added.  The court should not interfere unless the trustee took into account “improper, irrelevant or irrational considerations”.

Discretionary Trusts

Right of beneficiaries to be considered (1):  A trustee owes a fiduciary duty to beneficiaries of a discretionary trust to consider them individually as potential beneficiaries and make reasonable efforts to notify all members of a class before exercising his discretion.

Discretionary Trusts

Right of beneficiaries to be considered (2):  The trustees must apply some objective criterion in deciding whether or not to exercise their discretion in favour of a particular beneficiary.  Each beneficiary has more than a mere hope.  But the right of the beneficiary is not a proprietary interest in the assets held by the trustee.

Discretionary Trusts

Right of beneficiaries to be considered (3):  “a trustee with a duty to distribute, particularly among a potentially very large class, would surely never require the preparation of a complete list of names… He would examine the field, by class and category; might indeed make diligent and careful inquiries… as to the composition and needs of particular categories and of individuals within them; decide

• n

certain priorities

• r

proportions, and then select individuals according to their needs or qualifications.” (McPhail v Doulton [1971] a.c. 424).

Discretionary Trusts

The class test:  Question for consideration: Is it necessary for the trustee to identify all potential beneficiaries?

• Merely

required to survey the field

• f

potential beneficiaries.

• The issue is whether it could be said with certainty of any

given individual that he is or is not a member of the class.

• “Equal division is surely the last thing the settlor ever

intended: equal division among all may, probably would, produce a result beneficial to no one” (McPhail v Doulton [1971]).

Discretionary Trusts

Right of information of beneficiaries :  Trustees should inform potential beneficiaries

• f

discretionary trusts of the existence and nature of their interest BUT there is no need to inform all objects but only real potential candidates for benefit.  Beneficiaries are not entitled to disclosure as of right, but have a legitimate expectation of disclosure.  A beneficiary needs to prove that his prospect of benefiting under the trust is sufficient to warrant the disclosure of

• information. A theoretical possibility of benefit is not enough.

Discretionary Trusts

Letter of Wishes:  Usually accompanies a discretionary trust.  Guidance provided by a settlor to the trustees as to how they should exercise their powers and discretions.  Not binding on the trustees: it should not fetter the duty of trustees to exercise their powers under the trust.  Confidential: the beneficiaries do not enjoy a right to inspect a letter of wishes. It can only be disclosed by order of the Court if there are good grounds for doing so.

Discretionary Trusts

Validity of Discretionary Trusts: Sham Trusts (1)  A trust that may have apparently been created but in reality is not a trust but some other arrangement or simply an empty pretence.  " it means acts done or documents executed by the parties to the "sham" which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual rights and obligations (if any) which the parties intend to create." (Snook v London and West Riding Investments Ltd [1967] 2 QB 786)

Discretionary Trusts

Validity of Discretionary Trusts: Sham Trusts (2)  Intention is important - It must be created with an intention to mislead, but the fact that the documents is never deployed to mislead does not stop it being a sham.  “The test of intention is subjective, the parties must have indented to create different rights and obligations from those appearing from the relevant document, and in addition they must have intended to give a false impression of those rights and obligations to third parties.” (Hitch v Stone [2001]).  A document is a sham if it is not intended to be acted upon in accordance with the terms set out in it.

Discretionary Trusts

Validity of Discretionary Trusts: Sham Trusts (3)  The settlor has given the false impression that a trust has been created.  A trust may be set aside as sham if the truth of the matter is that the settlor retains full beneficial entitlement and there is no intention that the apparent beneficiaries are to obtain any benefit.  The settlor retains the full beneficial interest in the trust assets – the trust is a mere fiction, a mere device or cloak.

Discretionary Trusts

Validity of Discretionary Trusts: Illusory Trusts  The term “illusory trust” was recently used in the decision of the High Court of Justice in the Pugachev case to describe situations where the control of the settlor over the trust fund and its income is so extensive that the trust is actually invalid.  A trust under which the settlor retains such control that the proper construction is that he did not intend to give or part with control over the property sufficient to create a trust is an illusory trust.

Discretionary Trusts

So, why set up a discretionary trust???  To address future needs that cannot be predicted.  To address possible changes in the circumstances

• f

beneficiaries.  To protect financially unsophisticated beneficiaries.  To benefit persons not in existence yet.  To benefit minors or persons with disabilities.  To benefit larger groups (e.g. employees, graduates of a particular university, supporters of a particular team etc.).  It offers flexibility – can reflect changes in the circumstances and needs of beneficiaries.

Discretionary Trusts

What to have in mind:  The settlor must be willing to divest his interest in the trust

• assets. If not, then there is no reason to set up a trust.

 The settlor’s control over the discretion of the trustee will render the trust void.  The letter of wishes is just for guidance – the trustee is not

• bliged to follow it.

 The class of beneficiaries should be clearly defined for the trustee to be able to identify potential beneficiaries.

Discretionary Trusts

What to have in mind:  A part of the trust property should be placed in the trust upon its settlement for the trust to be properly created.  Trustees, upon their appointment, should be informed about their rights, powers and obligations under the law and the trust documents.  The discretion of the trustees is always subject to their fiduciary duties.  The settlor must in fact trust the trustee and let him do his job!

Discretionary Trusts

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