Key trends shaping the landscape of private wealth disputes

This article features in Issue One of our Private Wealth Perspectives Newsletter.

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In this article we explore the key trends which are currently shaping the landscape of private wealth disputes, including mental capacity as a central theme in private wealth disputes, trust insolvency and disputes relating to trustee investments. 

Mental capacity

Mental capacity is increasingly a central theme on the landscape of private wealth disputes. Why? The starting point is that there is, more so than at any point previously, a wider recognition of the seismic consequences of establishing mental incapacity on the part of the relevant decision maker. 

The mechanisms by which the establishment of a trust or an apportionment of trust assets can be invalidated are, absent demonstrating the existence of sham, very limited. Mental capacity, however, is one such mechanism. If it is established that the relevant decision maker lacked mental capacity at the relevant time of the decision, it can result in that decision and the consequences that flow from it, being invalidated. In practical terms, this can mean a return to the position prior to the decision being made. The weight of this consequences has, undoubtedly, led to a greater interest in capacity by those that seeking to challenge trust decisions, particularly where the financial values are significant.

So why is it becoming more prevalent now? The answer is twofold. First, age. People living longer has meant an increase in age related neurological conditions. According to recent statistics from the World Health Organization (WHO), more than 55 million people worldwide have dementia, with WHO describing the disease as 'one of the major causes of disability and dependency among older people globally'. One feature of many of these neurological conditions is that the loss of mental capacity is incremental. What a settlor may have been able to do very capably a week ago, could have changed by the following week. Unless mental capacity is assessed regularly, it can be difficult, when faced with a capacity challenge at a particular point in time, to assess the strength of that challenge.

The second reason for the greater prevalence of capacity disputes is the vast transfer of wealth now and, as expected, over the next decades. It has been reported that somewhere between $60-$100 trillion in generational wealth will change hands primarily from the baby boomers to Generation X and millennials through 2045. The unprecedented passing of wealth on this scale has heightened the focus on how the decisions around the transfers are made. These two factors, combined with the powerful effect of a decision of incapacity, has brought the issue of capacity firmly to the fore in private wealth disputes.

How is mental capacity determined? In Jersey, like many other jurisdictions, it is recognised that capacity is not an all or nothing matter and can be affected by both timing and current circumstances. The Capacity and Self Determination (Jersey) Law 2016 (Law), introduced in 2018, contains a helpful capacity checklist whereby a person will be considered unable to make a specific decision if, at the relevant time, they are unable to understand information relevant to the decision; to retain the information; to use or weigh that information as part of the decision-making process; or to communicate the decision. If it is established that a particular decision cannot be made by that person, then the person with responsibility for making the decision must have regard to the best interests considerations laid out in the Law.

The person with responsibility in those circumstances would, for the purposes of the Law, be a court appointed Delegate. The extent of authority of the Delegate can be stipulated by the Court at the time of appointment, allowing for extra flexibility where desirable (such as for spouses) or providing tailor made limitations if necessary, given the particular circumstances of the person and how best to serve their interests. The Law also enables Jersey residents to plan for the risk of future mental incapacity by granting Lasting Powers of Attorney for health and welfare and property and financial affairs. 

The provisions of the Law will help to mitigate the risk of disputes arising from capacity issues, but there will still be cases where disputes occur, particularly where no such protection measures have been implemented and there is evidence of capacity issues. So what can be done in these circumstances? This is where the trustee and the family advisors need to work together and be proactive. It is harder for a settlor or other decision maker to be taken advantage of if there is already a framework in place to protect them, and trustees and family advisors can implement practical steps to help. This may include building close relationships with the settlor’s other advisers and communicating regularly over patterns of behaviour; arranging in-person meetings without other beneficiaries or family members present; and recording the vulnerable person’s wishes and intentions and referring back to previously expressed wishes for consistency. These steps can be implemented for all beneficiaries who need to be consulted, not just the settlor. This means trustees can get to know their beneficiaries, to be aware of any changes in their personalities to guard against any issues they may have in the future.  

Ultimately, if there is a question regarding an individual’s mental capacity, it is best practice to obtain (with the client’s consent) a formal capacity assessment. This also protects against the risk of future challenges. This is often an arena that is fraught with difficulties, and when families become particularly entrenched the right course of action can be for trustees to seek the assistance of the courts to tread a middle way for the overall benefit of the beneficiaries as a whole. 

For more information on this issue, read our update regarding the matter of the O Trust [2018 (1) CILR 59, Grand Court, FSD – HRKC, where we acted for the intended object of the exercise of a settlor's reserved power of amendment on the determination of the questions whether: (1) the trustee had the power to accept, after the death of the settlor, an exercise of the power by the settlor during the settlor's lifetime; and (2) whether the settlor, at the time of the exercise of the power had the requisite mental capacity to exercise the power. The judgment arising from the case is now the leading Cayman authority on the legal test for the determination of mental capacity for the exercise of a power.  

Trust insolvency

To talk of an insolvent trust is, of course, inaccurate. A trust is not a separate legal entity and cannot, as a matter of law, be insolvent. The accounts of a trust will have been prepared as if it is a separate legal entity, but the assets and liabilities disclosed by those accounts are, in fact, the assets and liabilities of the trustee and it is to the trustee that creditors will have recourse, unless security has been granted by a trustee over the trust assets.

As a matter of Jersey law, trust insolvency is determined on a cash flow basis. In other words, it occurs where the trust assets are not sufficient for a trustee to meet its liabilities as they fall due.  Where insolvency has occurred or is about to occur, the trustee's duties also undergo a shift, with the trustee being required to give primacy to the interests of trust creditors over beneficiaries, reflecting that creditors have the residual economic interests in the trust assets. 

A trust being administered on the basis that it is insolvent, is to be administered for the benefit of the creditors as a class and not for the majority of them, however large that majority may be, in the same way that a liquidator of a company in a creditors’ winding up owes their duties to the creditors of the company as a class, not to individual creditors.

The overriding theme from the recent cases concerning trust insolvency is that a trustee needs to start considering acting when they realise that the trust has become insolvent or is probably insolvent. The biggest risk where insolvency has emerged or is emerging is to do nothing. A reasonably acting trustee should be keeping apprised of the financial position of the trust. They should be working with the beneficiaries and creditors to find solutions to funding problems before they emerge, and when things start to go wrong,  should be mindful of the need to give primacy to creditor interests, and taking appropriate advice and potentially the court's directions.

Issues of conflict often occur for trustees in these situations. If they are one of the major creditors, which they will often be, then the trustee needs to be cognisant of the risk of conflict (i.e. that their motivations may be both personal – to have the fees recovered – and (hopefully) in the interests of the beneficiaries) and to decide whether it can still act, notwithstanding the conflict. In many cases, a trustee can fairly take the view that it is fine to act, but it does need to consider its position.

Where there is a professional trustee in office with no unmanageable conflict, then it would ordinarily be much more cost effective, and therefore in the interest of the creditors, for the trustee to remain in office and to conduct the winding up process under the supervision of the Court. The approach to be adopted will likely depend on the number of claims from third party creditors seeking trust assets to be realised.

A trustee's lien is frequently a key consideration. A trustee is entitled to procure payment out of the trust estate or to be indemnified out of the trust estate in respect of debts properly incurred as trustee. This means that a trustee has a claim on the trust assets for the debts which it has incurred as trustee. In order to satisfy such a claim, the trustee has a right of indemnity which is secured by an equitable lien on the trust assets. That equitable lien does not depend on possession, and it normally survives after it has ceased to be a trustee. A trustee's priority over the trust assets arises by virtue of its office and ranks ahead of beneficiaries and those deriving title from them. Each trustee therefore possesses its own equitable interest and right of lien enforceable as a first charge against the trust assets. Where there are competing trustee claims on the lien, those claims rank pari passu.

As market conditions remain uncertain and growth slows, the prospect of insolvency of trust structures remains very much at large and it is essential that those advising on trust structures have familiarity with the key principles concerning insolvency.

Protectors

A protector is a person who is not a trustee but who is given powers under a trust. The role of a protector is usually considered to be to monitor, oversee or control the administration of the trust by the trustees. In particular, it is common for a protector to be appointed where a third party or institutional trust company is appointed as trustee (as opposed to family members or a private trust company). Often  the idea is that this will give the family a level of control over the trust, or ensure that there is someone who knows the family who has oversight of the trustees' actions or who the trustees can consult with when considering the exercise of certain powers.

The power most commonly given to a protector is to appoint and remove the trustees of the trust. In addition, it is common to provide that the trustees must obtain the protector’s consent (usually in advance and in writing) before they exercise certain powers. For example, their powers to add or remove beneficiaries, make distributions of capital, amend the terms of the trust or make certain investment decisions.

One issue that has created uncertainty in recent years is the proper scope of a protector's powers and, in particular, whether a protector's powers should be construed narrowly or widely. In their simple terms, under the "narrow" view, the protector should only interfere with a trustee's decision where it is irrational or tainted by conflict (basically akin to the court's role in a blessing application), and under the "wider" view, the protector has full discretion to consider the trustee's decision afresh (or, put another way, the power confers on protectors an independent decision-making discretion).

The uncertainty arises often in practice because many trust instruments, as least historically, are not drafted with particularity as to the scope of the power. The proper scope of the power can therefore often lead to conflict between trustee and protector.

In two recent cases, the courts in different offshore jurisdictions reached different conclusions on whether the "narrow" or "wider" view should apply. The correctness of both decisions has been the subject of much academic debate and that is beyond the scope of this discussion. However, it is important to draw out several practical points when settlors, trustees and their advisors are considering protectors in their trust structures. 

The key, threshold, question when drafting new trust instruments, is this: is a protector needed at all? The working relationship between trustees and settlors has, in general terms, evolved to grow closer in many cases, through better communication and better service. Technology has greatly assisted. Appointing offshore trustees does not inevitably mean, as perhaps used to be the case, a distance and disconnect between settlor and trustee. Interposing a protector may, therefore, be seen to be unnecessary. The starting question for trusts drafters, before any discussion over powers, should perhaps be whether a protector is needed at all.

If a new trust instrument is to be drafted with protector provisions, what should the drafter include? To avoid uncertainty the nature of the protector’s role and any veto powers must be clearly defined. The position must be explained to the settlor, instructions sought, and the trust instrument drafted accordingly. If, for instance, the "narrow" view is to be adopted deliberately, then exactly what that means needs to be clearly spelled out in the trust instrument.

In respect of existing trusts, it would be prudent for trustees to  active consider whether they should be amending trusts to make the position clear, at least where the settlors are still living and can therefore be consulted as to their wishes (and there is no existing dispute).

Mistake

What is the mistake jurisdiction and why does it matter? Put simply, the mistake jurisdiction is the ability to apply to court on equitable grounds to set aside a transfer of assets into or out of a trust where, typically, the settlor or trustee, has made a mistake. Typically, the mistake is a tax mistake and unravelling matters can provide a more straightforward remedy for the settlor than potentially costly and uncertain litigation against advisors. The volume of mistake applications in Jersey has risen significantly in recent years, perhaps in partial of reflection of the increasing complexity of tax related decision making onshore and the ease and efficiency of remedying mistaken decisions in Jersey.

The width of the mistake jurisdiction varies from jurisdiction to jurisdiction, but in Jersey it is defined very broadly and includes a mistake as to the effect or consequences of the action concerned and any advantage to be gained from it. It also expressly includes a mistake of law as well as fact. It has been confirmed many times that this includes mistakes relating to tax; indeed practically all the applications to date have been tax-related. 

When will mistake applications be refused? Such instances are rare in Jersey. However, the Jersey courts have highlighted delay and clear attempts at improper tax avoidance as grounds to refuse such applications. In terms of delay, there are no set time limits to bring an application but to avoid difficulty applicants should act promptly on becoming aware of the mistake. In one case, a delay of a year was said to be "on the margins of what is acceptable". In another, there was a delay of over five years but the Jersey court did not consider it would be right to penalise the applicants, who had been badly let down by advisers and had not acted unreasonably.

In terms of tax avoidance, the court will look at the position of the parties closely; it will consider the question of justice on the facts and in the round. Even in a case where the applicants had negotiated an indemnity from their negligent tax advisers the court was prepared "by a small margin" to grant the relief. More recently the court has emphasised that it has a real discretion to exercise.  Much clearly depends being able to present a persuasive case based on the overall justice to the individuals concerned.   

In most jurisdictions, the effect of a mistake is that the relevant disposition is voidable, rather than void, but its exact effect is subject to the discretion of the court. The Jersey court may declare that the disposition (i) has such effect as the court may determine or (ii) is of no effect from the time of its exercise. Which order is appropriate is fact-dependent and requires close analysis. The court will also allow a trustee acting in good faith to retain fees and absolve it from liability arising solely from the court's order setting aside the disposition in question.

Trustee investments

Disputes relating to trustee investments have risen over the past few years. What are the risks and what do those advising on trusts need to know? 

The starting point when considering any investment of trust assets is whose duty is it? Is it properly a power in the hands of the trustee or is it in the hands of another? Many statutory regimes, and most modern trust instruments, give trustees a wide power to invest in such investments as they think fit. For the purpose of this discussion, we will assume that the trustees have this wide power of investment, although in practice it will be necessary to check the trust deed for any specific restrictions.

Second, trustees have an overriding duty to exercise their investment powers with care and prudence, seeking to establish a suitable level of risk across the entire portfolio. Commonly understood as acting a prudent person with respect to investments. 

Third, trustees have a duty to balance the interests of different beneficiaries and to act fairly when making investment decisions which could have different outcomes for beneficiaries with competing interests. Therefore, trustees must have regard to this duty when deciding to what extent they will invest for income returns or capital growth in circumstances where the beneficiaries entitled to income and capital respectively are different.

Different types of investment warrant different considerations. Investments in private equity, for instance, are more prevalent than they have ever been. But trustees must consider whether the proposed investment is a suitable one given the wide range of investment options, many of which are lower risk, open to them. Considering the needs of the beneficiaries, the purpose of the trust and the spread and type of existing investments, trustees must consider whether it would be more appropriate to invest in other categories of investment.

The investment, whether it is private equity, artwork, real estate, fixed interest bonds or something else, should follow any investment strategy imposed on the trustee. But subject to that, a prudent trustee will typically need to diversify, namely, maintain a spread of investments with a view to reducing the overall risk profile of the trust. If most of the investments are already alternative investments and there is no particular investment strategy dictating otherwise, then it may be appropriate to invest in something less risky than, for instance, artwork or classic cars.

Depending on how and what the trustee invests in, it may be prudent for the trustee to appoint a professional advisor or manager to manage the investments for them. This may involve providing the manager with a written policy statement providing guidance as to how they should carry out the role. In addition, the trustees must review (and revise, if appropriate) the investment policy statement at regular intervals. By extension, trustees must review the trust investments from time to time and consider whether they should be varied.