Trusts Law Workbook PDF

Trusts Law Workbook Published by A note about copyright BPP Professional Education What does the little © mean and why does it matter? BPP House, Aldine Place Your market-leading...

Trusts Law Workbook Published by A note about copyright BPP Professional Education What does the little © mean and why does it matter? BPP House, Aldine Place Your market-leading BPP books, course materials and e-learning materials do not write and update 142-144 Uxbridge Road themselves. People write them on their own behalf or London, W12 8AA as employees of an organisation that invests in this activity. Copyright law protects their livelihoods. It www.bpp.com does so by creating rights over the use of the content. All rights reserved. No part of this publication may be Breach of copyright is a form of theft – as well as being reproduced, stored in a retrieval system or transmitted, a criminal offence in some jurisdictions, it is potentially in any form or by any means, electronic, mechanical, a serious breach of professional ethics. With current photocopying, recording or otherwise, without the technology, things might seem a bit hazy but, prior written permission of BPP Professional Education basically, without the express permission of BPP Ltd. Professional Education: The contents of this course material are intended as a Conversion of our digital materials into different file guide and not professional advice. Although every formats, uploading them to social media or e- effort has been made to ensure that the contents of mailing or otherwise forwarding them to a third this course material are correct at the time of going to party is a breach of copyright. press, BPP Professional Education Group makes no Printing our digital materials in order to share them warranty that the information in this course material is with or forward them to a third party or use them in accurate or complete and accept no liability for any any way other than in connection with your BPP loss or damage suffered by any person acting or studies is a breach of copyright. refraining from acting as a result of the material in this course material. © BPP Professional Education Ltd 2023 Contents Introduction Introduction to Trusts Law iv 1 Introduction 1 2 Creation and requirements of express trusts 13 3 Beneficial entitlement 17 4 The three certainties 29 5 Formalities and constitution 45 6 Purpose trusts 63 7 Perpetuity 79 8 Resulting trusts 85 9 Family homes 89 10 Trustees 109 11 Trustee powers and duties 117 12 The fiduciary relationship 135 13 Liability of trustees 141 14 Protection of trustees 151 15 Equitable remedies and tracing 159 16 Liability of strangers 171 Introduction to Trusts Law Trusts have been described as equity’s most important contribution to English law. They arise when one person, the trustee, is under a duty to apply assets for the benefit of another person, the beneficiary. Trusts are used in a great range of situations, from private trusts used for family planning and shared ownership through to commercial trusts used for investment, real estate development and protection against insolvency. Many trusts are deliberately created but they can also be imposed by law. A particularly important feature of a trust is that the beneficiary has an equitable proprietary interest in the trust assets. Trusts are very versatile and there are many different types of trust used as a mechanism for property management. This Workbook introduces you to the core principles of trusts and the impact of trusts in a variety of legal areas. It will provide you with a foundational knowledge of trust law and skills needed to identify and resolve legal issues relating to trusts, whether those issues arise in the commercial, private client or public law contexts. iv Trusts Law  1 Introduction 1 What is a trust? A trust is an equitable duty relating to property. It is a very useful mechanism for dividing the ownership and management of property. There is no single definition of a trust but there are a number of essential features required for a trust to exist. Crucially, there are two key components: (a) The property component (b) The obligation component 1.1 Property component Property is an essential requirement for a trust. Lord Browne-Wilkinson said that it is a ‘fundamental’ proposition of trusts law that ‘there must be identifiable trust property’. The proposition is ‘fundamental’ because a trust is an equitable duty relating to property. 1.1.1 Legal interest A trustee holds a property ‘on trust’ for the beneficiary. Typically, the trustee has a legal interest in the trust property. This means that, as far as the common law is concerned, the trustee is the owner. This gives the trustee all the rights of legal ownership. They can deal with the property as they wish. 1.1.2 Equitable interest Equity recognises another proprietary interest, that of the beneficiary. The beneficiary’s equitable interest is a property right, just like that of the trustee. This means that the beneficiary can, for example, give away or sell their interest under the trust. What they can’t do is deal with the legal interest, because that is held by the trustee. Thus the ownership of the property is split. The trustee has the formal, legal interest in the property and is responsible for managing that property. The beneficiary has the equitable and beneficial interest in that property. They are, in effect the true owner. 1.1.3 What can be held on trust? Almost every asset or right can be held on trust. As Lord Shaw noted in Lord Strathcona Steamship Co Ltd v Dominion Coal Company Ltd AC 108, 124: The scope of the trusts recognised in equity is unlimited. There can be a trust of a chattel or of a chose in action, or of a right or obligation under an ordinary legal contract, just as much as a trust of land. Chattel: A chattel is a tangible item (other than land). Cars, computers, books, jewellery and KEY TERM clothes are obvious examples. Chose in action: A chose in action is an intangible right such as a debt (eg an amount credited to a bank account) or a company share (giving the shareholder rights such as voting rights and the right to receive dividends). 1.1.4 Changes to trust property A trust ceases to exist if, without any fault on the part of the trustee, the trust property is destroyed or consumed. In the absence of any trust property, there is nothing to which a trust can attach. In fact, it is common for the trust property to change without any breach occurring. In many trusts, the trust property fluctuates. For example, in a standard family trust, a principal function of the trustee is to maximise the financial return from the trust property. This involves the trustee periodically reviewing the trust property and deciding whether to retain it or to sell and invest the proceeds in other property. Selling the property does not destroy the trust. It simply changes the trust assets. In contrast, if the trustee is at fault, they will be personally liable to restore the trust property (using their own funds). If the trustee cannot replace the trust property, they will need to pay compensation instead, and this compensation will be subject to the trust. (In such cases it is likely that a new trustee will be appointed.) This brings us to the obligation component of the trust. 1.2 Obligation component A trust must have a trustee. A trustee owns the trust property and has all the rights and powers of legal ownership. But a trustee must exercise those rights and powers for the benefit of the beneficiary. 1.2.1 Trustee duties The trustee owes equitable obligations to the beneficiary. Although the trustee has the legal right to deal with the property as they choose, equity restricts that right by placing duties upon the trustee. The trustee is required to exercise their legal rights of ownership for the benefit of the beneficiary. And if the trustee does not act in accordance with those obligations, the beneficiary 2 Trusts Law  has personal rights against the trustee. In other words, the beneficiary can sue the trustee for breach of trust. The functions and duties of trustees are not unitary. They can and do vary. The function and duty of any specific trustee is determined by the nature of the trust they are administering. In some cases (for example, a family trust) the trustee has an enduring asset management/investment function and is subject to various duties corresponding to that function. In other cases (for example, a trust of intermediated securities) the trustee’s function may be no more extensive than complying with the beneficiary’s instructions in relation to the trust property. The role of trustee is a voluntary office and is typically unpaid although professional trustees are entitled to remuneration. 1.2.2 Objects A trust must have a beneficiary or be for a permitted purpose. The beneficiaries or purposes of trusts are known as the trust objects. A purpose trust is a trust for the promotion or realisation of a purpose (in other words, a trust without a beneficiary). It is not possible to create a trust for every purpose. It is only possible to create a trust for a permitted purpose. Charitable purposes are the principal category of permitted purpose trusts. There is also a small (closed) category of non-charitable purpose trusts. Purpose trusts are considered in detail in the chapter on ‘Purpose trusts’. 1.2.3 Can a trustee also be a beneficiary? The basic duty of a trustee is to hold or apply trust property for the benefit of the beneficiary. As Sir Joseph Napier said in South Australian Insurance Co v Randell LR 3 PC 101, 110: ‘An indelible incident of trust property is that a trustee can never make use of it for his own benefit.’ Thus, a person is not a trustee of property which they have the absolute right to use for their own benefit. Note that a trustee can be one of the beneficiaries of a trust. They will still owe duties to the other beneficiaries so cannot simply use the trust fund for their own benefit. This would be a breach of trust. The powers, duties and liability of trustees are covered in detail in later chapters of this Workbook. 1.3 Key case law Key case: Customs and Excise Commissioners v Richmond Theatre Management Ltd STC 257 Facts: A theatre company sold advance tickets for performances. The terms and conditions stated that the company would hold the purchase money ‘upon trust’ for the purchaser until the performance took place and would return the money if it was cancelled. There were no restrictions on how the company could use that money and it was not required to account to the customers. Held: The company was not a trustee. Its ability to freely use the money for its own purposes was incompatible with a trust. Key case: Re Bond Worth Ch 230 The ability of a company to use fibres in its manufacturing process was inconsistent with the company holding the fibres on trust for the unpaid seller of them. Slade J stated (at 261) that South Australian Insurance Co and other cases were: clear authority for the proposition that, where an alleged trustee has the right to mix tangible assets or moneys with his own other assets or moneys and to deal with them as he pleases, this is incompatible with the existence of a presently subsisting [trust] in regard to such particular assets or money. 1: Introduction 3  2 The development of trusts law 2.1 History of the trust Throughout the 18th and 19th centuries the paradigmatic trust was the family trust, which enabled a person to make provision for successive generations of their family. A person would make a will giving property to trustees and instructing them on how it should be applied. In a standard case, trustees were instructed to distribute income to the deceased’s spouse and (after the spouse’s death) to the deceased’s children and (after the children’s deaths) to distribute the capital to the deceased’s grandchildren. Imagine that the trust property was land. How did the trust operate? Ordinarily trustees would be given legal title to the land by the deceased and they would enjoy all the powers of legal ownership. In the exercise of those powers, the trustees would create tenancies and receive rent from the tenants. The trustees would pay the rent (income) to the deceased’s spouse and then (after the spouse’s death) the deceased’s children. After the children’s deaths the trustees would transfer the land (capital) to the deceased’s grandchildren. Then the trust would cease to exist. 2.2 Expansion of trusts to other contexts The family trust illustrates two important attributes of a trust. First, a trust allows the separation of the powers of the legal owner (held by trustees) from the benefits resulting from the exercise of those powers (enjoyed by beneficiaries). Secondly, a trust can confer different types of rights on different beneficiaries at different times. The family trust is still in common use today. But trusts have expanded beyond this paradigmatic model. Today, trusts are used in many contexts and for various reasons. To take just one commercial example, the market in listed securities is underpinned by the trust. Most listed securities are in a ‘dematerialised’ or ‘uncertificated’ form. This means that legal ownership of UK-listed securities requires registration in an electronic register called CREST. Securities are registered in the names of CREST members (usually banks or other financial institutions). The members are the legal owners of securities registered in their names. But they generally acquire and hold the securities for the benefit of their clients. In other words, they hold them on trust. Figure 1.1: Crest sub-trust structure 4 Trusts Law  3 Benefits of using trusts There are many benefits to using trusts. These include the following. 3.1 Separation of ownership and management of property This is something we have touched on already. There are many reasons why you might want to have someone other than the beneficial owner managing property. One simple reason is that they don’t have the time to manage it themselves. 3.2 Expertise Another reason is that someone else may be an expert in the management of that sort of property eg a fund manager. 3.3 Protection Another reason is that the beneficial owner may be incapable of managing their own property. For example, they may be a minor who is unable to look after the property themselves (or, in some cases, even hold legal title to that property). And this rationale extends beyond minors to other individuals who, for some reason, are not able to manage the property themselves. 3.4 Flexibility Flexibility is another key reason why you might want property to be held on trust. It is possible to create interests in equity that are not recognised at law. You can divide a piece of property up in different ways, giving different beneficiaries different sorts of interests in that property. Trusts can also be used to give people conditional interests in property, or give someone (perhaps the trustee) the power to determine the rights of the beneficiaries later (perhaps based on their need). This means trusts are very useful for creating future interests, not just immediate interests. 3.5 Control Trusts are also useful for enabling the original owner of property to retain a degree of control even after divesting themselves of their interest in the property. This is something you cannot do if, for example, you are instead making an outright gift of that property. 3.6 Ringfencing on insolvency Trusts can be very powerful when it comes to protecting individuals against the risks of insolvency. As a beneficiary has an equitable proprietary interest in trust property, the property does not form part of the trustee’s estate for the purposes of the bankruptcy and insolvency regimes. It therefore cannot be distributed to the trustee’s creditors. Thus a beneficiary enjoys ‘priority’ over the unsecured creditors of the trustee in the event of the latter’s bankruptcy or insolvency. This can be illustrated by an example: Example: Treatment of bankrupt debtor’s unsecured creditors X owes B, C, D and E £50,000 each. B, C, D, and E are unsecured creditors of X. £100,000 is credited to X’s bank account. X is made bankrupt. Assuming X has no other creditors or assets, the claims of B, C, D and E abate rateably. Each will receive £25,000. The beneficiary’s interest is protected against the trustee’s insolvency because the trustee does not have a beneficial interest in the trust property. It is also possible to set trusts up in a way that ensures the property is protected against the risk of insolvency of beneficiaries. Example: Treatment of bankrupt trustee’s beneficiary Vary the example: X owes B, C and D £50,000 each. B, C and D are unsecured creditors of X. X is a trustee of £50,000 for E. £100,000 is credited to X’s bank account: £50,000 of it is trust money. X is made bankrupt. 1: Introduction 5  The trust money (£50,000) is not part of X’s estate for the purposes of the bankruptcy and cannot be distributed to X’s creditors. It continues to be held on trust for E. Assuming X has no other creditors or assets, B, C and D’s claims abate rateably. Each will receive £16,667. A comparison of E’s position in the examples demonstrates the importance of a beneficiary’s equitable proprietary interest in the event of the trustee’s bankruptcy or insolvency. 3.7 Tracing and proprietary claims In Akers v Samba Financial Group UKSC 6, Lord Sumption noted that a beneficiary’s interest in the trust property ‘possesses the essential hallmark of any given right in rem, namely that it is good against third parties into whose hands the property or its traceable proceeds may have come’. Thus, if a trustee misapplies trust property (for example, by giving £100 to their spouse, who is not a beneficiary) the beneficiary can assert their interest in the money against the spouse and demand that it is restored to the trust. Moreover, if the spouse uses the money to buy a painting, the beneficiary can assert an interest in the painting (the ‘traceable proceeds’ of the money) and demand that the painting is added to the trust. Thus, a beneficiary’s equitable proprietary interest is important because it can be enforced against third parties. However, unlike legal proprietary interests, it cannot be enforced against everyone. More particularly, equitable proprietary interests cannot be enforced against a purchaser of a legal interest who does not have notice of the trust. So, if in breach of trust, a trustee transfers legal title to trust property to a purchaser who is unaware that they are purchasing trust property, the transfer extinguishes the beneficiary’s equitable interest. Tracing and proprietary claims are considered in detail in the chapter on ‘Equitable remedies and tracing’. 3.8 Tax benefits Trusts can also have tax benefits although it is important to note that trusts can also trigger taxes. This is beyond the scope of this Workbook but something that must be considered in practice. You will find that many cases you come across when studying trusts arise out of either tax or insolvency litigation. 4 Key uses for trusts As we have already seen, there are many benefits to using trusts, making them a useful mechanism in both the commercial and private, family contexts. 4.1 Commercial arrangements Some commercial uses for trusts include: (a) Share ownership: Publicly traded shares are usually held via trust arrangements. (b) Investment funds: Investment funds commonly involve trusts. (c) Pension funds: Pension funds are a particularly good example of this which demonstrate many of the benefits we have already seen. They are a way of delaying payments to individuals, making use of the expertise of fund managers and also have tax benefits. (d) Other forms of tax-efficient employee remuneration: Trusts can also be used for other forms of employee remuneration. A common example is something called an ‘employee benefit trust’. These are often used by employers alongside more typical salary payments as they have tax benefits. (e) Corporate tax avoidance: Tax avoidance, more generally, is also a common use for trusts. 6 Trusts Law 4.2 Private arrangements Trusts are also commonly used by individuals. In fact, the traditional trust was a mechanism for ensuring property was enjoyed by several generations of an individual’s family. Testamentary planning: You will often see trusts created in wills, as a way of the testator trying to control the use of their property after they die, and ensure that it benefits the right people. Land ownership: Joint ownership of land takes place via a trust arrangement. Trusts can be very useful for the purposes of land ownership, as they allow more individuals to have rights in land than can be recognised as legal owners. They can also be used to rectify unfairness in land transactions. Tax planning: Again, tax planning is a common use for trusts in the private context, particularly inheritance tax planning (although care has to be taken not to trigger an unwanted inheritance tax charge when doing this). 4.3 Charitable purposes As we have already noted, it is possible (in limited circumstances) to set up a trust for a purpose rather than a person. By far the most common, and most useful, example of this is a charitable trust. 5 Categories of trusts Trusts can be categorised in various ways. Some commonly recognised categories of trust are set out below but please note that this list is not exhaustive. 5.1 Express trusts compared with trusts arising by operation of law Probably the most common way of categorising trusts is as either express or implied. 5.1.1 Express trusts An express trust is one which is deliberately created. In other words, it is a trust which arises in response to a person’s intention to create it. The rules for the creation of express trusts are introduced in the chapter on the ‘Creation and requirements of express trusts’. 5.1.2 Implied trusts Unlike express trusts, resulting and constructive trusts arise by operation of law. Resulting and constructive trusts are often together described as ‘implied trusts’. (a) Resulting trusts: Resulting trusts are perhaps the less sophisticated of the two types of implied trust, arising in a fairly limited set of circumstances. Broadly, they arise where a legal owner has transferred ownership of their property to a third party but, for some reason, equity recognises that the transferor should retain or regain the beneficial interest in that property. They can be further subdivided into (i) automatic resulting trusts and (ii) presumed resulting trusts. These categories are considered in further detail in the chapter on ‘Resulting trusts’. (b) Constructive trusts: Constructive trusts are more complex and varied in nature. There are many different types of constructive trust, which arise in quite different circumstances, but it is considered that all constructive trusts arise to correct unconscionability. This module considers three broad situations where constructive trusts arise: (i) Institutional constructive trusts: These are the orthodox form of constructive trust that arise because the conscience of the legal owner is affected in some way, preventing them from denying the beneficial interest of another person. This type of constructive trust is imposed automatically in response to a qualifying event. There are many qualifying events but in this module we focus on constructive trusts arising to prevent fraud or to perfect an imperfect gift or trust (see the chapter on ‘Formalities and constitution’). (ii) Constructive trusts as remedy: Constructive trusts can also be awarded by a court as a remedy in a range of circumstances, such as 1: Introduction 7  (1) Following a successful proprietary estoppel claim (see the chapter on ‘Family homes’). (2) When a fiduciary makes a personal profit in breach of the no-profit rule (see the chapter on ‘The fiduciary relationship’) (3) At the end of the tracing process, following a breach of trust or fiduciary duty. (See the chapter on ‘Equitable remedies and tracing’). (iii) Common intention constructive trusts: The final category of constructive trust considered is the common intention constructive trust. These trusts are used to resolved disputes over the beneficial ownership of land occupied by unmarried cohabitees. They are considered in detail in the chapter on ‘Family homes’. 5.1.3 Other trusts arising by operation of law Resulting and constructive trusts are not the only types of trust which arise by operation of law, as there are also statutory trusts (ie trusts which are neither resulting nor constructive but which arise as the result of the application of a specific statutory rule). No statutory trusts are covered in this Workbook but you may come across them in practice 5.2 Testamentary and inter vivos trusts You will also see trusts classified as either testamentary or inter vivos. Testamentary trusts are those created via a will whereas inter vivos trusts are created in the lifetime of the settlor. 5.3 Fixed and discretionary trusts Another key distinction is between fixed trusts and discretionary trusts. Fixed trusts involve the trustee knowing exactly what they need to give to each beneficiary. The interests of the beneficiaries are fixed. In contrast, under a discretionary trust, the trustee knows who the potential beneficiaries are but has the power to determine who benefits and in what shares. This makes them very flexible. Fixed and discretionary trusts are considered in further detail in the chapter on ‘Beneficial entitlement’. 5.4 Charitable and non-charitable purpose trusts We have already seen that it is possible to create trusts for charitable purposes. This is an exception to the general rule (known as the beneficiary principle) that a trust must have a beneficiary. There is a much smaller, more limited class of exceptions known as non-charitable purpose trusts. These are private trusts set up for very specific purposes. They are considered in the chapter on ‘Purpose trusts’. 5.5 Bare trusts The final distinction to make is between bare trusts and trusts where the trustees have active management functions. A bare trust involves the trustee simply holding legal title on trust for the sole benefit of a beneficiary. The trustee has no discretion and no active management duties. They are merely required to follow the instructions of the beneficiary. This is most common when dealing with things like shares, where a stockbroker may hold legal title to the shares on trust for the beneficial owner. Note that the categories above are not mutually exclusive. Trusts can, and often do, fall into more than one category. 5.6 Comparisons and distinctions 5.6.1 Comparing trusts with contracts At first glance, a trust might seem similar to a contract. Both involve the creation of obligations which, if not performed, can give rise to a personal liability (often to pay compensation). It is also important to note that it is possible to contract to create a trust, and this does happen regularly in practice. But a trust is fundamentally different to a contract, both in the way it is created and in the nature of the relationship between the parties. 8 Trusts Law  A contract arises as a result of an agreement between its parties, each of whom owes obligations to the other. It is a creation of the common law. Trusts are more complicated arrangements, which are the creation of equity. There is no requirement for an agreement between any of the parties (whether settlor and beneficiary, trustee and beneficiary or settlor and trustee). An express trust arises as a result of intention manifested by the settlor alone. And the only obligations that arise are from the trustee to the beneficiary. The trustee must be willing to act but there is no requirement for an agreement in the contractual sense. If the appointed trustee is unwilling to perform the role, they can be replaced. 5.6.2 Comparing trusts with debts A debt is an obligation to pay a sum of money. The person who must pay is the ‘debtor.’ The person to be paid is the ‘creditor.’ Unlike a trust (which is a duty relating to specific property) a debt does not relate to specific assets or funds. A debt is merely an obligation to pay a sum of money and the debtor may use any of their available resources to effect the payment. Unlike a beneficiary, a creditor cannot compel the debtor to apply any specific asset or fund for their benefit. A loan is the most common example of a transaction giving rise to a debt: the borrower (debtor) must repay the loan to the lender (creditor). The beneficiary of a trust has an equitable proprietary interest in the trust property. By contrast, a creditor has a mere personal right to payment. If the debtor is unable to pay, the creditor does not have recourse to any of the debtor’s assets to discharge the debt – and, thus, is significantly affected by the debtor’s bankruptcy or insolvency. Key case: Foley v Hill (1848) 11 HLC 28 Perhaps the most familiar example of a debtor-creditor relationship is that between a bank and its customer. In Foley v Hill 11 HLC 28, the House of Lords held that a bank is not a trustee of money deposited by its customers. The following is an extract from the speech of Lord Cottenham LC: Money, when paid into a bank, ceases altogether to be the money of the principal. […] The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal, but he is of course answerable for the amount, because he has contracted, having received that money. Thus, a debt is a different legal concept from a trust. But they are not mutually exclusive. They can be combined in a single transaction. Quistclose trusts The best example of a device which combines a debt and a trust is a Quistclose trust. The name derives from the case in which such arrangements were first recognised. Key case: Barclays Bank Ltd v Quistclose Investments Ltd AC 567 Facts: Quistclose Investments Ltd agreed to lend money to Rolls Razor Ltd. The parties agreed that Rolls could only use the money to pay a dividend to its shareholders and that it could not be used for any other purpose. The money was paid into an account which Rolls had opened with Barclays Bank Ltd especially for the deposit of the money. Before it was able to pay the dividend, Rolls was put into liquidation and, as a result, was precluded from paying the dividend. The issue was whether Barclays could set off the sum credited to the account against Rolls’s indebtedness to Barclays on its other accounts. Held: The sum credited to the loan account was held on trust for Quistclose. Since Barclays had notice of the trust, it could not set off that sum against money owing on Rolls’s other overdrawn accounts. 1: Introduction 9 Lord Wilberforce reasoned that, since it was agreed that the money could only be used to pay the dividend, it was not part of Rolls’s general assets. As Rolls couldn’t pay the dividend, it had to return the money to Quistclose. In other words, Rolls held the money on trust for Quistclose. He expressly rejected the argument that the loan to Rolls excluded the possibility of a trust, stating that there was ‘no difficulty in recognising the co-existence in one transaction of legal and equitable rights and remedies’ and that ‘the flexible interplay of law and equity’ was perfectly able to facilitate such transactions. The Quistclose trust has been considered in many subsequent cases, the most important of which are discussed below. Key case: Twinsectra Ltd v Yardley UKHL 12 Twinsectra is the most important case on Quistclose trusts as it makes clear that it is not sufficient to demonstrate that money was advanced to the borrower for a particular purpose. Rather it is necessary to demonstrate the parties’ mutual intention that the money could only be applied for the purpose and was not at the free disposal of the borrower. It is this feature of the transaction which generates the trust in favour of the lender. Twinsectra also provides helpful guidance on the requirement for certainty of purpose: (a) The borrower’s power to apply the money is valid only if the purpose is sufficiently certain. (b) A purpose is certain if it is possible to determine whether any given application of the money does or does not fall within it. (c) If the purpose is uncertain, the borrower cannot make any use of the money and simply holds it on trust for the lender. The following explanation of as to the basic operation of a Quistclose trust is provided in Twinsectra: When the lender advances the money to the borrower, the borrower holds the money on trust for the lender, with a power to use it for a specified purpose. To the extent that the borrower uses the money for the purpose, the lender’s equitable interest is extinguished. The relationship changes from trustee-beneficiary to debtor-creditor. To the extent that the borrower applies the money for any other purpose, the borrower commits a breach of trust. The lender can assert their equitable proprietary interest in the misapplied money (or its traceable proceeds). If it becomes impossible to apply the money for the purpose, the borrower must return the money to the lender. Key case: In Re Farepak Food and Gifts Ltd (in administration) EWHC 3272 (Ch) Facts: Farepak ran a Christmas savings scheme. It agreed with its customers that, in return for 11 monthly payments, it would obtain retail vouchers for customers and distribute them in November. Farepak went into administration in October. Held: The court concluded that the money paid by customers to Farepak was not subject to a Quistclose trust. In particular, Mann J rejected the argument that the money was held on trust because the customers had paid it to Farepak for a particular purpose (ie the provision of retail vouchers): crucially, there is no suggestion that the money ought to have been put on one side by Farepak pending the transmutation from credited money to goods or vouchers. If there were a Quistclose trust then that obligation would have been inherent in it, but the business model would have made no sense. It would have required Farepak to have kept all customer moneys in a separate account from January until November, untouched until the time when the goods or vouchers were acquired and then sent out. That is completely implausible. 10 Trusts Law  Extension of Quistclose trusts outside loan context Finally, it is worth noting that although most of the case law involves loans or transactions involving money, Quistclose trusts are not restricted to such circumstances. They arise in any situation where property is transferred to a person whose use of the property is restricted to a specified purpose: to any case where the property is not at the free disposal of the transferee (Ali v Dinc EWHC 3055 (Ch), paras 234, 238). 5.6.3 Comparing trusts with charges Proprietary security interests secure the performance of an obligation, usually the payment of a debt. A charge is the most common security interest. The chargor (debtor) creates a charge over their property in favour of the chargee (creditor). If the chargor is unable to pay the debt, the chargee can compel a sale of the property and use the proceeds of sale to discharge (or reduce) the debt. Both a beneficiary and a chargee have a proprietary interest in (respectively) the trust property and the charged property. However, there are important distinctions: Unlike a trustee, a chargor can use charged property for their own benefit. For example, it is common to acquire residential land using a secured loan (ie a mortgage). This does not prevent the owner occupying the land as their home. Trust beneficiaries are entitled to the beneficial enjoyment of the entire trust property. A chargee’s interest is limited to the amount of the debt secured. A defining characteristic of a charge (but not a trust) is a right of redemption, ie the chargor’s right to unencumber their charged property by paying the debt. 5.6.4 Comparing trusts with agency Agency is a relationship in which the agent has authority to create legal relations between the principal and third parties. An example of an agent is a person who sells goods on behalf of someone else. The agent enters into the sale contract and receives payment from the purchasers. They are required to account for the proceeds to their principal. A feature which is common to agents and (some) trustees is that both are subject to fiduciary duties. The essential difference between agents and trustees is that, unlike an agent, a trustee cannot commit a beneficiary to a contract with a third party. A trustee acts as a principal in their transactions with third parties. The relationship between agent and principal is ordinarily a debtor-creditor relationship. However, it is possible for an agent to become the trustee of money or property received on behalf of the principal. Whether or not a trust relationship has arisen must be determined on the facts of the individual case, by reference to the parties’ intentions, expressed or inferred. 5.6.5 Comparing trusts with bailment Bailment is the transfer of possession of chattels from one person to another. The transferor is the ‘bailor’ and the transferee is the ‘bailee’. So a person who leaves their clothes with a dry cleaner is a bailor and the dry cleaner is a bailee. There is a superficial similarity between a trust and bailment. However, there are significant distinctions between a trust and bailment: Only tangible personal property (chattels) can form the subject matter of a bailment whereas (with one or two exceptions) any asset or right can be held on trust. Bailment involves transfer of possession but does not impact the bailor’s legal title to the property. In contrast, the transfer of assets to a trustee completely divests a settlor of their interest in the property. A bailor’s interest (generally) survives a misapplication of the bailed property to a third party because a bailee has a possessory right to the property but is not the legal owner. In contrast, a trustee can transfer legal ownership, meaning that a beneficiary’s interest will not survive a misapplication in favour of a purchaser without notice. 1: Introduction 11 5.6.6 Comparing trusts with companies Another comparison which it is useful to draw is between trusts and companies. Both can be used as vehicles for holding property, and there are some similarities between the roles of trustee and director (both of which are fiduciary in nature). One crucial difference is that, unlike a company, a trust does not have legal personality. This means that a trust cannot bring or defend a legal action in its own name. It is the trustees who, as legal owners of the trust property, must carry out these functions. And, when exercising their rights as legal owners, trustees must act in the best interests of their beneficiaries. Unlike trust beneficiaries, shareholders of a company do not have a proprietary interest in the company’s assets. Their interest is in the company itself. Similarly, the obligations of the company directors are generally owed not to the shareholders but to the company. 5.6.7 Comparing trusts with estate administration A personal representative is responsible for the administration of a deceased person’s estate. There are two types of personal representatives: Executors: appointed by deceased Administrators: appointed by court A personal representative must distribute the deceased’s estate in accordance with their will or the intestacy rules. There is a striking similarity between a trust and the administration of a deceased person’s estate. In both cases one person holds property for the benefit of others, but there are two key distinctions: As a practical matter, the function of a personal representative is to administer and distribute the deceased’s estate as quickly as is practicable (ideally within a year). By contrast, express trusts are commonly created to endure for many years, meaning trustees often have enduring asset management functions. Unlike the beneficiary of a trust, a person interested in a deceased person’s estate does not have an equitable proprietary interest in any of the estate assets. Instead, they have a personal right against the executor relating to the proper administration of the estate. 12 Trusts Law  2 Creation and requirements of express trusts 1 Introduction This chapter introduces the rules on creation and requirements of express trusts that are explored in later chapters of this Workbook. 2 Methods of creating express trusts An express trust is a trust which has been intentionally created. Before the trust is created, the settlor is the full legal owner of the asset. After the trust has been created, legal title will be held by a trustee and equitable (and beneficial) title will be held by a beneficiary. A settlor can create a trust by (i) declaring themselves as a trustee or (ii) transferring property to a third party trustee. Settlor: The person who creates the trust is called the ‘settlor’ of the trust. KEY TERM Full legal owner: A ‘full legal owner’ of property owns it both legally and beneficially. Note. It is also possible to declare a trust over an equitable interest, including a beneficial interest under a trust (ie a sub-trust). For simplicity, the examples in this chapter only focus on trusts where the settlor begins as the full legal owner of the trust property. Self-declaration of trust: A self-declaration of trust requires the settlor to manifest an intention KEY TERM to hold one of their assets on trust for the beneficiary. Once the trust has been created, the settlor remains the legal owner of the asset but is divested of their beneficial interest in it. The settlor becomes the trustee. Transfer on trust: A transfer on trust requires the settlor to transfer property to a third party and to manifest an intention that the third party should hold the property on trust for the beneficiary. The trustee becomes the legal owner of the property and a new equitable interest is created for the beneficiary, who becomes the equitable and beneficial owner. Self-declaration of trust Transfer on trust Legal title Retained by settlor (now in Transferred to trustee new capacity as trustee) (requires constitution) Equitable title New equitable interest New equitable interest created for beneficiary created for beneficiary Beneficial ownership Transfers from settlor to Transfers from settlor to beneficiary beneficiary Note. The examples in this chapter use a simple scenario involving a sole trustee and sole beneficiary. In practice it is common (and usually advisable) to have more than one trustee. It is also common to have multiple beneficiaries. We will consider more complicated examples later in this Workbook.  2.1 Self-declaration of trust A self-declaration of trust involves the transfer of beneficial ownership while legal ownership remains with the settlor. The settlor starts as the full legal owner. They retain the legal title but now hold it in a new capacity (ie as trustee, meaning they have legal but not beneficial ownership). A new equitable interest is created for the beneficiary (who becomes equitable and beneficial owner). 2.2 Transfer on trust A transfer on trust involves the settlor transferring legal title to a trustee, who then holds for a beneficiary. This is more complicated than a self-declaration because it involves changes in both legal and equitable title. As with a self-declaration, the settlor starts as the full legal owner. They then transfer it to a third party, to hold as a trustee. The settlor therefore parts with legal title and a new equitable interest is created for the beneficiary (who becomes the equitable and beneficial owner). There are two slightly different scenarios to consider here: (a) A transfer on trust for a thirty party (b) A transfer on trust for the settlor 2.2.1 Transfer on trust for third party The settlor may have chosen to create a trust for a third party. In this case, the settlor will part with both legal and beneficial title to the trust property. The trustee now holds the trust property on trust for the beneficiary and the settlor now has no interest in the property at all. 2.2.2 Transfer on trust for settlor A transfer on trust will not always be to a third-party beneficiary. It is possible for a settlor to transfer property to a trustee to hold on trust for the settlor themselves. This would still be a transfer on trust, involving the transfer of legal title to a third-party trustee, but in this scenario the trustee would be holding the property on trust for the settlor (who now becomes the beneficiary). The settlor therefore changes from having legal and beneficial ownership to having equitable and beneficial ownership. Unlike in our previous scenario, the settlor has not completely divested themselves of all interest in the trust property. The settlor divests themselves of the legal interest in the property but retains the beneficial interest. This necessarily involves the creation of a new equitable interest because previously the settlor held legal title only. Remember that a full legal owner does not have equitable title because they do not need it. They have the full legal and beneficial interest in the property. 3 Requirements for creation of express trusts Each of the scenarios we considered above is subject to a series of requirements which must be fulfilled in order to bring a valid, enforceable trust into effect. These will depend on the type of trust, the method of creation of the trust and on the nature of the trust property. 3.1 The three certainties In order to create a valid express trust, it is necessary to comply with the rules known as the three certainties. These rules are covered in detail in the chapter on ‘The three certainties’ but, briefly: (a) Certainty of intention: It is necessary to show that a trust arrangement is intended, as opposed to some other arrangement relating to the property (such as a gift or loan etc). (b) Certainty of subject matter: It must be possible to identify or ascertain (i) the trust property and (ii) the beneficiary’s interest in the trust property. (c) Certainty of objects: It must be possible to identify or ascertain the beneficiaries of the trust (or, in the case of a purpose trust, the purpose of the trust). 14 Trusts Law  3.2 The beneficiary principle Closely related to certainty of objects is a requirement known as the beneficiary principle. As with the certainty requirement, the rationale behind the beneficiary principle is the need for a trust to be enforceable. Without identifiable beneficiaries or objects, there is nobody who can enforce the trust (ie hold the trustee to account for the performance of their obligations). The beneficiary principle therefore requires the objects of a trust to be legal persons (whether individuals or other legal persons). This means that generally a trust which is created purely for purposes is not permissible but there are limited exceptions to this rule. The most common exception is charitable trusts, which have charitable purposes as their objects and are in the public benefit. There is also a much narrower class of anomalous exceptions known as ‘non-charitable purpose trusts’ or ‘private purpose trusts’. Purpose trusts are considered in the chapter on ‘Purpose trusts’. 3.3 Formalities Additionally, there may be further formalities to be satisfied to bring the trust into existence. The relevant formalities rules will depend on whether the trust is created during the lifetime of the settlor (inter vivos trusts) or by their will (known as testamentary trusts). In the case of inter vivos trusts, the relevant formalities rules will also depend on whether there is a self-declaration or a transfer on trust. 3.3.1 Self-declaration of trust As we have already seen, a self-declaration of trust only involves a change in equitable title. Legal title does not change. For a self-declaration of trust it is therefore only necessary to consider whether there are any specific formalities required for the declaration of trust (in other words, the creation of the beneficiary’s interest). 3.3.2 Transfer on trust In the case of a transfer on trust, we have seen that there is a change in both legal and equitable title. In addition to considering whether there are any formalities necessary for creating the beneficiary’s equitable interest, there will also be rules relating to the transfer of legal title to the trustee. This is known as ‘constitution’ of the trust. There are different rules applicable to different types of property but in all cases it is necessary to validly transfer legal title to the trustee in order to bring the trust into effect. The formalities and constitution rules are considered in the chapter on ‘Formalities and constitution’. 3.4 Perpetuity rules A trust is not intended to be a permanent way of holding property. Trusts are therefore subject to rules known as the ‘perpetuity rules’ which limit the duration of the trust. These rules are considered in the chapter on ‘Perpetuity’. 2: Creation and requirements of express trusts 15 16 Trusts Law  3 Beneficial entitlement 1 Beneficiaries Traditionally, trusts were established to benefit individuals. The core trust concept involves splitting the ownership and management of property, allowing the trustee to take on the burden of ownership while the beneficiary obtains all the benefit. As we saw in the ‘Introduction’ chapter, trusts work by having both a proprietary and an obligation component. From the perspective of the beneficiary this means that they have both equitable proprietary interests in the trust property and personal rights to enforce the trust against the trustee. This ability to enforce the trust is crucial and gives rise to two interrelated principles which highlight the importance of beneficiaries. (a) The beneficiary principle As a general rule, a trust must have a beneficiary. This is because the beneficiary is the person who is able to hold the trustee to account. Without someone who has the ability to take the trustee to court if they do not perform their obligations, the obligation component of the trust is meaningless. And if there is no enforceable obligation, the trustee can effectively do whatever they want with the property, effectively making them the absolute owner of that property. This is incompatible with the notion of a trust. (There are some exceptions to the beneficiary principle, namely charitable and non-charitable purpose trusts, which are covered in the chapter on ‘Purpose trusts’. (b) Certainty of objects A related principle is that of certainty of objects. Generally, the objects of a trust will be the beneficiaries (or in the case of a discretionary trust, the potential beneficiaries). It is essential that there is certainty as to who those objects are. Again, this is key to enforceability of the obligation component. If the objects are uncertain, the trustee does not know to whom they owe their obligations. The objects themselves may therefore not know of their rights and are unable to enforce them. And, of course, the court cannot enforce obligations if those obligations are not clear. It is therefore important for the proper administration of a trust that the objects and their rights are ascertainable. Certainty of objects is covered in the chapter on ‘The three certainties’. The precise rights of the objects of a trust will depend on the terms of that trust. However, there are some broad rights which will always apply, because they go to the very nature of the trust. These rights vary depending on whether the trust is fixed or discretionary. 1.1 Proprietary rights Fixed trust: A trust in which the entitlement of the beneficiaries is fixed by the settlor (also KEY TERM known as a ‘fixed interest trust’). Discretionary trust: A trust under which the trustees have a discretion to distribute between the objects of the trust. 1.1.1 Fixed trusts The beneficiaries of a fixed trust have equitable proprietary rights. These rights are assets which are capable of sale or other forms of transfer and can be asserted against third parties (for example, if a trustee gives away the trust property, the beneficiary can assert their equitable rights against the new legal owner). The beneficiaries’ right may be vested (in other words they have a current right) or contingent (meaning their right is conditional). 1.1.2 Discretionary trusts In contrast, the objects of a discretionary trust do not have proprietary rights, at least not in the true sense, although some of their rights are akin to proprietary rights. Until the discretion is exercised, all the objects have is a hope that that discretion will be exercised in their favour. They cannot assert their rights against third parties although they do have sufficient interest in the trust property to compel its return to the trust fund. 1.2 Personal rights The objects of trusts also have personal rights. The beneficiaries of a fixed trust have the right to compel the proper administration of the trust by the trustees, meaning they can direct the trustee to take action such as suing a third party on behalf of the trust. Beneficiaries can always sue the trustees for breach of trust if they act outside their powers or in breach of their duties (although any compensation will be paid back to the trust fund rather than the individual). They also have the right to be informed of their entitlement under the trust once their interest has vested. The objects of discretionary trusts have similar rights although they are more limited because they do not have proprietary interests in the trust fund, at least not in the true sense. They can enforce the trust by asking the court to ensure that the discretion is exercised (whether by the trustees, by appointment of new trustees or by the court itself) but they have no right to request that it is exercised in a particular way. Once a discretion has been exercised in favour of an individual, they have the right to be informed of their entitlement. Like the beneficiaries of fixed trusts, they can also sue the trustee for breach of trust and require the trustee to personally compensate the trust fund for any loss. In this chapter we will explore the rights of beneficiaries in more detail. 2 Fixed and discretionary trusts In this section we will explore beneficial entitlement, focusing on the difference between the rights of beneficiaries under fixed trusts and discretionary trusts. We will also compare discretionary trusts with powers of appointment. 2.1 Fixed trusts The trustees of a fixed trust have no discretion in relation to the distribution of the trust property. They must distribute as directed by the settlor. A fixed trust can have one or more beneficiaries, and those beneficiaries may have very different entitlements in respect of the trust property. The following examples will introduce you to some common forms of fixed trust. Example: Fixed trust - sole beneficiary The simplest example of a fixed trust involves the trustee(s) holding the entire trust property for one beneficiary. The trustee has the legal right to deal with the trust property as owner but they must exercise this right for the beneficiary. The beneficiary has personal rights against the trustee and can sue to enforce them. They also have an equitable proprietary interest in the trust property. They are the sole beneficial owner of the trust property (including any income produced by that property). 18 Trusts Law  Figure 3.1: Fixed trust: sole beneficiary Example: Fixed trust - beneficiaries with fixed shares A fixed trust can also have multiple beneficiaries. A simple example is a trust where the trust property is held for A and B in equal shares. As with the previous example, this is a fixed trust because the beneficial entitlement is fixed by the settlor and the trustees have no discretion as to how the trust property is distributed. Both beneficiaries have proprietary rights in the trust property, and both have personal rights against the trustee to enforce the trust. Together, they are entitled to the entire beneficial interest in the trust property but separately each is only entitled to a 50% share (of both capital and income). Figure 3.2: Fixed trust: beneficiaries with fixed shares 2.1.1 Successive interest trusts Successive interest trusts are another type of fixed trust. They give some beneficiaries a right to income while others are entitled to capital. 3: Beneficial entitlement 19  Successive interest trust: A trust involving a series of consecutive interests in the same trust KEY TERM property. Life interest trust: A common type of successive interest trust, involving a beneficiary receiving income during their lifetime, with another beneficiary or beneficiaries becoming entitled to the capital after the income beneficiary’s death. Income beneficiary: The beneficiary entitled to the income produced by a successive interest trust. (Traditionally the income beneficiary of a life interest trust is known as the ‘life tenant’.) Capital beneficiary: The beneficiary entitled to the capital held on a successive interest trust. (Traditionally the capital beneficiary of a life interest trust is known as the ‘remainderman.) Example: Life interest trust A house on trust to A for life, remainder to B. In this example, A receives the income produced by the house during their lifetime. When A dies, B receives the house itself. Together they hold the entire beneficial interest in the house, but A is only interested in the income and B is only interested in the capital. This is a common way to leave property via will, as it allows testators to provide for their spouse but ensures that the spouse cannot disinherit their children when they die. In our example, A would have a right to live in the house during their lifetime but could not leave the house to anyone in their own will because they only have a life interest. It is helpful to consider two further examples of successive interest trusts. Example: Successive interest trust with multiple capital beneficiaries A house on trust for A for life, remainder to B and C in equal shares. This example is a combination of two examples we have looked at previously. In this case, A is entitled to the income produced by the trust property. When A dies, the capital is shared equally between B and C. Together, A, B and C have the entire beneficial interest in the trust property, but A is only entitled to income while B and C are entitled to capital. Example: Successive interest trust with contingent capital interest A house on trust for A for life, remainder to B if he survives A and, if not, to C. This example is more complicated as it involves a ‘contingent’ interest. As in the previous example, A is entitled to the income produced by the house. What happens to the house on A’s death depends on whether B is still alive. If B is alive, B receives the house. If B has died, C receives the house. (If C has also died, C’s estate will receive it.) Although it is not known from the outset of the trust whether B or C will receive the capital, this is still a fixed trust. There is a clear mechanism for determining who receives the capital. At the point when the capital must be distributed (A’s death), the trustees can determine entitlement. 2.2 Discretionary trusts As we have seen, the trustees of fixed trusts do not have a discretion in relation to the distribution of the trust property. By way of contrast, the trustees of a discretionary trust do have a distributive discretion. Although the settlor determines the potential beneficiaries of the trust (known as the ‘objects’ of the trust), the trustees must determine who from within that class of objects is to receive what sum. (Discretionary trusts are sometimes described as a ‘power in the nature of a trust.’) 20 Trusts Law  Discretionary trusts are flexible. They enable a settlor to make provision for different beneficiaries according to their future needs. The objects of a discretionary trust are only potential beneficiaries. They have no equitable interest in the trust property until the discretion is exercised in their favour. They do, however, have a right to ensure that the trustees exercise their powers properly. Example: Discretionary trusts Consider the example of a settlor who leaves £10,000 in their will on discretionary trust for their wife and three children. The wife and children are the objects of the trust. It is up to the trustees to decide how to divide the property between them. The trustees must exercise their discretion and must do so within a reasonable time. (The trust document may specify the time by which the discretion must be exercised. If not, what is ‘reasonable’ will be determined on the facts.) If the trustees do not exercise their discretion, any of the objects can sue to enforce the trust and ensure that the discretion is exercised. However, the objects cannot compel the exercise of the discretion in their favour as they do not have proprietary rights in the trust property. They merely have a hope that they will receive something. The objects also have a right to ensure that the trust is administered properly. This means they can sue the trustees for breaches of trust such as improperly investing the trust fund or making distributions to non-objects. Any compensation awarded as a result of such a breach will be payable to the trust fund, not the claimant objects. 2.3 Powers of appointment It is helpful to contrast discretionary trusts with powers of appointment. Power of appointment: A right to choose who, from within a specified class of objects, receives KEY TERM property. Donor: The person who confers the power. Donee: The person who receives the power. Fiduciary power of appointment: A power of appointment given to a trustee. The trustee does not need to exercise it but must periodically consider whether to do so. Personal power of appointment: A power of appointment given to someone who is not a trustee. They are not even required to consider exercising it. The essence of a power is the donee’s complete discretion. They can choose whether to exercise the power. If exercised, they have a discretion as to which member(s) of the class of objects should benefit from its exercise. The objects of a power therefore have even more limited rights than the objects of a discretionary trust. They cannot compel the exercise of the power but can constrain an improper exercise. Powers are not trusts but it is common for trusts to include powers. Often (but not necessarily) the trustee will be the donee. 2.3.1 Powers of appointment: Key features As we have seen, the key difference between a power of appointment and a discretionary trust is that there is no obligation on the donee to exercise a power of appointment, whereas the trustees of a discretionary trust must exercise their discretion. Because a power does not have to be exercised, it is good practice for the donor to make clear what will happen to the property if it is not. This is sometimes described as a ‘gift-over’ in default of the exercise of the power. When analysing an arrangement to determine whether it is a power of appointment or a discretionary trust, the following are helpful indicators: 3: Beneficial entitlement 21  (a) Imperative wording such as ‘must’ suggests a discretionary trust whereas permissive wording such as ‘may’ suggests a power of appointment. (b) If discretion has been given to a third party (not a trustee) it is a power of appointment, not a discretionary trust. (c) The presence of a gift-over indicates a power of appointment (because it means the power does not need to be exercised) but lack of a gift-over is not determinative. Activity 1: Trusts and powers You will find a suggested analysis for each example at the end of this chapter. (Note that in practice terms such as ‘trust fund’ and ‘trust period’ would be defined.) Required Consider the following examples. Can you identify the nature of each arrangement? 1 ‘My trustees must distribute the trust fund between such of my children as they, in their absolute discretion, determine.’ 2 ‘My trustees must distribute the trust fund between such of my children as my wife may determine within 12 months of my death and, if no such determination is made, in equal shares.’ 3 ‘My trustees must hold the trust fund for my children in equal shares. During the trust period, my trustees may pay any or all of the trust fund to such of my wife and children as they see fit.’ 3 Vested and contingent interests In order to understand the rights of beneficiaries under a trust it is important to appreciate the difference between vested and contingent interests. Vested interest: A current right to property. Nothing more needs to happen for the beneficiary KEY TERM to become entitled to the property. Contingent interest: An interest in property which is conditional upon the occurrence of an uncertain future event. Contingent interests become vested if the condition is satisfied. The beneficiary has no entitlement unless and until the condition is satisfied. 3.1 Vested interests As we have already seen, a vested interest is a current entitlement to property. Vested interests may be sub-divided into interests which are vested ‘in interest’ only and interests which are vested ‘in possession’. Vested in possession: A current right to current enjoyment of the property. KEY TERM Vested in interest: A current right to future enjoyment of the property. This is best illustrated by an example. Example: Vested interests A common example which involves both types of vested interest is a successive interest trust, involving both life and remainder interests. Take a situation where a house is held on trust for a woman for life, with the remainder to the woman’s son. Both the woman and her son have vested interests: 22 Trusts Law  The woman’s interest is vested in possession. She has a current right to current enjoyment of the property. Her son’s interest is vested in interest. He has a current right to the property but he is not entitled to the enjoyment of that property until the woman dies. Note that the son’s interest is not contingent. He does not obtain the house if the woman dies but when she dies. You may query what will happen if the son dies before the woman. Is his interest not contingent on living longer than his mother? The answer is no. The son’s interest forms part of his estate (and can pass under his will or intestacy). 3.2 Contingent interests Contrast the example above with the case where a settlor creates a trust of a house for a woman for life, remainder to her son if he survives her, and if not, to charity. In this example the son’s interest is contingent. His interest will only vest if he is alive when his mother dies. His contingent interest cannot pass to his estate if he dies before the woman. Instead the charity would be entitled to the house on the woman’s death. The provision in favour of the charity is known as a ‘gift-over’. It is a clear indication that the son’s interest was intended to be contingent. Lack of a gift-over will not be fatal to the creation of a contingent interest. In this example, even without the gift-over, the use of the word ‘if’ makes it very clear that the son’s interest will not survive his death if he predeceases his mother. The remainder interest will return to the settlor on a resulting trust. 4 Capital and income In this section, we consider beneficial entitlement to both capital and income. If you are unsure of the distinction between these terms, a helpful way to think of it (which is often given in case law) is that capital is like a tree whereas income is the fruit produced by the tree. Just as a tree produces fruit on a regular and recurring basis, a capital asset may produce income. A common example is land, which is a capital asset that may produce rental income. Similarly, money held in a bank account is capital which produces interest. Shares are also capital assets, which produce dividends. Capital Income Land Rent Bank account Interest Shares Dividends 4.1 Trusts with a sole beneficiary Example: Sole beneficiary, absolutely entitled Let’s start by considering the very simplest example of a trust involving a sole beneficiary who is absolutely entitled to the trust property. So we are considering the situation where a trustee is holding the entire trust property (in our case a piece of land) on trust for one beneficiary. The trustee is clearly holding the capital (ie the land itself) on trust for the beneficiary. Nobody else has any beneficial entitlement to this trust property. It follows that if the trust is producing income (ie if the trustee is renting the land out), the beneficiary is also beneficially entitled to this income. If the beneficiary is an adult, they are entitled to receive that income as it arises. In other words, the trustee must pay it to them when it is received. If the beneficiary is a minor, the position is more complicated. They will not be entitled to receive the income as it arises, but the trustees may 3: Beneficial entitlement 23  have a power to apply it for their benefit (known as a power of maintenance). The dispositive powers and duties of trustees are considered in more detail in the chapter on ‘Trustees powers and duties’. Example: Sole beneficiary, future interest ‘My trustees must hold my house on trust for my daughter until she reaches age 21, and then transfer it to her absolutely.’ Here, we have the trustees holding a house on trust for the settlor’s daughter until she reaches age 21, after which they are required to transfer it to her. The daughter has a vested interest in the capital ie the house itself. The trust is intended to subsist until she reaches age 21 but there is no condition imposed upon her right to the capital. Her interest in the capital is therefore vested in interest now and will vest in possession when she reaches the age of 21. The daughter’s entitlement to the income is the same as the beneficiary in our first example. Nobody else has been given an interest in the income which arises in the time period between the trust being established and the beneficiary’s capital interest vesting in possession (known as the ‘intermediate income’). The capital interest is therefore described as ‘carrying’ the intermediate income, meaning it attaches to the capital interest. Like in our previous example, the daughter will be entitled to the income as it arises if she is 18 or older. If she is under 18, the position will depend on the dispositive powers and duties of trustees, which are considered in the chapter on ‘Trustee powers and duties’. So far we have looked at examples where the beneficiaries have vested interests in the capital. But what about contingent interests? Example: Contingent interests ‘My trustees must hold my house on trust for my daughter if she reaches the age of 21.’ This time, we have the trustees holding the house for the daughter if she reaches the age of 21. Her interest in the capital is therefore contingent. Nobody has been given a separate interest in the income, meaning the capital interest therefore carries the intermediate income. If the daughter is over 18, she is entitled to receive the income as it arises. If she is under 18 it will be accumulated. 4.2 Successive interest trusts As we have already seen, a successive interest trust involves separate beneficial interests which follow each other. The beneficiary with an entitlement to the income receives their interest first (for a designated period of time), followed by the beneficiary with the interest in the capital. Although we have given the example of a life interest trust, it is also important to note that this is not the only way to create a successive interest trust. An interest in income does not have to be created for the lifetime of the beneficiary. It could be limited in some other way. For example, it could be a trust of income for A until they reach the age of 18 and then payment of the capital to B. Or even a series of interests in the income over time, perhaps to a settlor’s children, then grandchildren, but ultimately the trust must provide for an interest in the capital to vest in a beneficiary (or charity) within the statutory perpetuity period of 125 years. (Perpetuity is considered in the chapter on ‘Perpetuity’.) 5 The rule in Saunders v Vautier The basic principle in Saunders v Vautier is that a sole adult beneficiary of sound mind, with a vested interest in the trust property, is entitled to direct the trustee to transfer legal title to them, thereby bringing the trust to an end early. 24 Trusts Law  A beneficiary is only able to do this if they are absolutely entitled to the trust property. If someone else could obtain a beneficial interest (eg the beneficiary’s interest is contingent or could be affected by the exercise of a power of appointment) the beneficiary has no entitlement to have it transferred to them and become the absolute owner. Key case: Saunders v Vautier (1841) 4 Beav 115 Facts: Under a testamentary trust, shares were held for Vautier until he reached the age of 25, with a requirement to accumulate the income from the trust (ie the dividends) until then. There was no gift-over. When he reached the age of majority (21 at the time), Vautier claimed a right to have the trust property transferred to him on the basis that he had a vested interest in it. Held: Vautier’s interest was vested. The intention was not to make his interest conditional upon surviving until age 25 but merely to delay enjoyment of the property until such time. The absence of a gift-over indicated that the testator had not intended the property to pass to anyone else. If Vautier wished to receive it early, that was his right. 5.1 Extension of the rule in Saunders v Vautier 5.1.1 Beneficiaries with vested interests The rule has subsequently been extended to cases involving multiple beneficiaries. If each beneficiary has a distinct interest in the trust property, which can be severed without impacting the others, they can separately exercise their Saunders v Vautier rights. A simple example is a fixed trust in equal shares, where one beneficiary is an adult and the other is a minor. As long as the trust fund is easily divisible, the adult beneficiary can require the trustee to transfer their share to them. They cease to be a beneficiary and the remaining half of the fund is held entirely for the minor. Saunders v Vautier rights can also be exercised by the beneficiaries of more complicated fixed trusts, such as successive interest trusts. However, because the rights of the beneficiaries under such trusts are not easily severable, it can only be done if all the beneficiaries agree (and they must all satisfy the conditions relating to age and capacity). In such circumstances, the beneficiaries may direct the trustee to transfer the trust fund to them (in such shares as they choose). This is because collectively they are absolutely entitled to the trust property. Example: Multiple beneficiaries with severable interests A trustee holds £2,000 for A and B in equal shares, to be distributed when they reach the age of 25. A is 17. B has just turned 18 and has asked the trustees to transfer their share of the trust fund to them. Should the trustees transfer B’s share as directed? A and B both have vested interests in the trust fund. They have fixed shares (£1,000 each). As an adult beneficiary with a vested interest, B has Saunders v Vautier rights so the trustees must comply with B’s request, bringing the trust to B for an end. They must continue to hold A’s £1,000 on trust. Once A reaches 18, they will also have Saunders v Vautier rights and can request the capital if they choose to do so. If they do not, it will be held on trust until they are 25. Example: Multiple beneficiaries with successive interests A trustee holds property on trust for A for life, remainder to B. A is 50 and B is 17. They have asked the trustees to share the trust fund equally between them. Should the trustees distribute the trust fund as directed by A and B? A has a vested interest in the income and B has a vested interest in the capital. Their interests are not severable and neither can exercise Saunders v Vautier alone. 3: Beneficial entitlement 25  As B is a minor, A and B cannot yet exercise Saunders v Vautier together and the trustees must not distribute the capital in accordance with their request. Once B reaches the age of 18, they will have Saunders v Vautier rights. If A and B make the request once B turns 18, the trustees must transfer the fund as directed. 5.1.2 Objects without vested interests The effect of the extension above means that Saunders v Vautier rights are not strictly exercisable only by beneficiaries with vested interests. Beneficiaries with contingent interests may exercise those rights but only if they act together with all the other persons who share the beneficial interest in the property. In the case of contingent interests, this will include the objects of any gift-over. This means that Saunders v Vautier can also be exercised by the objects of a discretionary trust or even the objects of a fiduciary power which has a gift-over in default of appointment. Even though none of the objects have vested interests in the trust property, together they can be treated as a single object in whom the interest subject to the discretion or power is vested. Again, as long as they are all adults of sound mind, they can agree to collapse the trust and share the property between them. Practical limitations: Large and complex trusts Although all the objects of a large, complex trust could exercise Saunders v Vautier together, this is very unlikely to happen in practice, particularly in the case of large discretionary trusts where the objects may not all be identifiable let alone able to reach a consensus. It is more likely to occur in the case of very small discretionary trusts with a closed class of objects (such as testamentary trusts for the children of the testator, who could decide to collapse the trust once they are all over 18). Legal limitations There are also legal limitations on the rule in Saunders v Vautier, which stem from the nature of the trust itself. The rule acknowledges that the objects of trusts are the true owners of the property and should not be denied the right to manage their own property should they wish to. However, it does not mean that they are able to interfere in the administration of a trust while it subsists. They have a choice between the following: (a) Exercising their Saunders v Vautier rights by directing the trustee to transfer the property out of the trust (whether to them or to a third party); or (b) Remaining objects of the trust and allowing the trustees to continue to act in accordance with trust terms. If the beneficiaries are not happy with the administration of the trust, they may seek appropriate remedies (including removal and replacement of the trustee) but they cannot tell the trustee how to perform their role. If they wish to vary the trust terms, they could exercise the Saunders v Vautier rights and create a new trust on those terms. 6 Beneficial entitlement: Consolidation Now that we have reached the end of this chapter, let’s think about how to analyse a fact pattern in an assessment. Firstly, if the question requires you to distinguish between vested and contingent interests, make sure that you look out for conditional wording such as ‘if’. This indicates a contingent interest. The presence of a gift-over is also good evidence of a contingent interest but is not essential. If an interest is vested, it could be either vested in possession or vested in interest. If it’s vested in possession, you can expect the beneficiary to be obtaining the benefit of the property immediately. Like the life tenant in a life interest trust. A right which is vested in interest only is 26 Trusts Law  an unconditional right to benefit in the future. Like the remainder interest under a life interest trust. If a question requires you to consider the rule in Saunders v Vautier your analysis will depend on the terms of the trust. If it is a straightforward trust for a sole beneficiary, it is important to check whether they are over 18, of sound mind and have a vested interest in the property. If these conditions are met, they can collapse the trust. If there are multiple beneficiaries, you need to look more closely. If there is a fixed trust, a key question will be whether the interests of the beneficiaries are severable. If not, they will all need to meet the conditions for exercising Saunders v Vautier and agree to do so. This will always be the case for successive interest trusts. The same is true of discretionary trusts and trusts where a beneficiary has a contingent interest. It is necessary to identify all the people who are potentially entitled to the property, including anyone who has an entitlement under a gift-over. They must all be over 18, of sound mind and agree to collapse the trust. No single beneficiary can do so alone in such cases because they do not have vested interests. 3: Beneficial entitlement 27 Activity answers Activity 1: Trusts and powers 1 This bears all the hallmarks of a discretionary trust: The discretion is held by the trustees. The wording ‘in their absolute discretion’ indicates that the trustees have a distributive discretion. The wording ‘must’ indicates that they are under an obligation to exercise their discretion. There is no gift-over in default of exercise because the trustees are required to exercise their discretion. 2 The discretion conferred on the wife bears all the hallmarks of a power of appointment: The power is held by a third party ie the settlor’s wife. The word ‘may’ indicates that the wife is not under an obligation to exercise the power. There is a gift-over in default of the exercise ie the property must be distributed in equal shares amongst the children if the wife does not exercise the power. The trustees have no discretion. They must distribute as directed (either by the wife or in equal shares). Beneficial entitlement will be determined 12 months after the settlor’s death, or earlier if the wife exercises the power. 3 This is another power of appointment but this time it is fiduciary in nature because it is held by trustees. The word ‘may’ indicates that the trustees are not under an obligation to exercise the power but they must hold the property on a fixed trust unless and until they exercise the power. This is sometimes described as a fixed trust coupled with a power. The trustees hold the trust fund on a fixed trust for the children but also have the power to pay some or all of the property to a wider class of objects (the children and the wife). It is very common for trusts to be coupled with powers as it provides for a greater degree of flexibility but imposes no obligation on the trustees to actually exercise the power. It is there if needed but, if not, the property will be distributed in accordance with the terms of the fixed trust. 28 Trusts Law  4 The three certainties 1 Introduction This chapter explores the three certainties. Certainty is an essential component of an express trust. Rights and obligations need to be certain to be enforceable: If a trustee does not know what their obligations are, how can they comply with them? If a beneficiary does not know what their rights are, how can they tell whether they are being breached? If the court is not able to determine those rights and obligations, how can it enforce them? In order to create a valid express trust, it is necessary to comply with the rules known as the three certainties. They are: (a) Certainty of intention (b) Certainty of objects (c) Certainty of subject matter This chapter will explore each of the three certainties in more detail. 2 Certainty of intention Certainty of intention is one of the three certainties necessary for the creation of an express trust. Its rationale is quite simple. By definition, an express trust is one which is brought into existence by an intention to create it (unlike, for example, some resulting and constructive trusts which arise independently of the parties’ intention). Thus, an intention to create a trust is a necessary requirement for (in fact, it is the defining feature of) an express trust. 2.1 Requisite intention For these purposes, the requisite intention is an intention to impose or assume the duty which is characteristic of a trust, ie a duty to hold property for, or apply it for the benefit of, a beneficiary (or purpose). Re Oldfield 1 Ch 549 is a simple illustration. By her will, a woman gave property to her daughters and expressed her ‘desire’ that they should make some provision for her son. Kekewich J held that the woman had not created a trust, saying: A desire carries no obligation except a moral one. To desire a person to do a thing is entirely different from telling him to do it. 2.2 Ascertaining intention A person’s intention can be ascertained from their words (spoken or written) and conduct. Most trusts (other than trusts of land and testamentary trusts) have no prescribed formalities, meaning they can be created formally or informally, whether in writing or otherwise. The courts adopt an objective approach in determining whether a person intended to create a trust. If they manifest an intention to impose or assume the duty which is characteristic of a trust,  they intend to create a trust. It is irrelevant that they do not actually (ie subjectively) intend to create a trust or are unaware that such a thing even exists. 2.2.1 Written documents In some situations, intention is reduced to writing; for example, in a contract or a will. The intention of the author(s) of a document is ascertained by identifying the meaning of the words which they have used. And the meaning of words is ascertained by reference to: Their natural and ordinary meaning Any relevant contextual features of the document The facts which were known to or assumed by the author(s) of the document when it was created Common sense 2.2.2 Use of the word ‘trust’ Generally, the use of the word ‘trust’ is a good indicator that a person intends to create one. However, it is not determinative, either by its presence or its absence. In particular, the fact that a transaction is characterised by the transacting parties as a trust is not conclusive as to its nature. Conversely, the fact that a transaction is characterised as something other than a trust does not prevent it taking effect as a trust if it generates the duty which is characteristic of a trust. Crucially, the nature of a relationship or transaction is determined by reference to the substantive rights and duties which it creates and not by reference to how it has been characterised by the parties. 2.2.3 Segregating/earmarking assets A key determining factor in several important cases has been the segregation of funds in a separate bank account which has been earmarked for a particular person or purpose. This is often good evidence of an intention to create a trust but is neither necessary for the creation of a trust nor is it conclusive evidence that a trust is intended. Like all other factors, segregation and earmarking of assets must be considered within the specific factual context. 2.2.4 Importance of context In the seminal case Paul v Constance 1 WLR 527 (discussed in further detail below), the court was persuaded that a bank account was held on trust (jointly for the legal owner and his partner) based largely on the repeated use of the words ‘this money is as much yours as mine’. Another significant factor was the way in which the account was used (with the couple paying joint bingo winnings in and withdrawing funds for joint use). Of particular importance to the decision was the fact that the couple were ordinary people who were unfamiliar with the legal concept of a trust. The account holder could not be expected to use terminology he did not understand but this did not preclude a finding that he intended a trust relationship. This decision provides an important reminder that certainty of intention is a question which will turn on the very specific facts of a case. Words and conduct must be interpreted in context. 2.3 Relationship with other certainties In some situations, there is a significant interaction between certainty of intention and the two other