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Title Research

Doing your duty

  • Author : Adam Carvalho
  • Author : Madeleina Loughrey-Grant
  • Date : March 2010
ABOUT THE AUTHORS: Adam Carvalho is an Associate and Madeleina Loughrey-Grant TEP is a Partner at Farrer & Co.

During the lifetime of a trust, trustees will be asked to consider a variety of investment options. The recent difficulties in markets have left trustees and beneficiaries alike questioning investment policies and decisions. This has highlighted the need for trustees to have a good appreciation and understanding of their powers and duties in relation to investments.

What are these powers and duties?

Most modern trust instruments will contain a wide power of investment which, although it may appear to be unlimited, may be somewhat restricted by statute and by the trustees’ obligations to meet the standard imposed by the duty of care. The Trustee Act 2000 (the Act) includes a wide general power of investment (section 3), which enables the trustees to invest in such investments as they think fit. This power is restricted not only by the trustees’ obligation to meet their statutory duty of care, but also in relation to land by the terms of section 3(3) of the Act. Thus trustees will need to establish whether the power of investment is restricted in any way.

The common law duty of care

A chain of Victorian case law established the principle that a trustee making investment decisions must act as a ‘prudent businessman’ would act in the management of his own affairs.

‘As a general rule a trustee sufficiently discharges his duty if he takes in managing trust affairs all those precautions which an ordinary prudent man of business would take in managing similar affairs of his own.’ (per Lord Blackburn Speight v Gaunt (1883) LR 9 App Cas 1). The test is an objective one weighed against the standard of an ‘ordinary prudent man of business’ where he is making an investment for the benefit of other people for whom he felt morally bound to provide. (Learoyd v Whiteley(1887) 12 AC 727).

A higher standard of care may be expected of trustees who profess particular levels of expertise, such as professional trustees (Re Waterman’s Will Trust [1952] 2 All ER 1054) and a higher standard still has come to be expected of trust corporations (Brightman J, Bartlett v Barclays Bank Trust Co Ltd [1980] 1 All ER 139).

This tiered test, where the extent of expertise has a direct effect on the standard of care required, is likely to be applied by the courts if faced with a question relating to duty of care.

Statutory duty of care

Section 1 (1) of the Act requires a trustee to exercise such care and skill as is reasonable in the circumstances, having regard in particular:

ato any special knowledge or experience that he has or holds himself out as having, andbif he acts as trustee in the course of a business or profession, to any special knowledge or experience that it is reasonable to expect of a person acting in the course of that kind of business or profession.

The statutory duty of care applies to the functions (including investment) set out in Schedule 1 of the Act and the duty applies to the extent that it is not excluded by the terms of the trust instrument (paragraph 7, Schedule 1 of the Act). The effect is that the statutory duty will apply to investment functions carried out after the Act came into force (1 February 2001) in relation to any trust, whenever created. This will mean that the common law duty of care will continue to apply to investment acts carried out prior to that date and to any case not covered by Schedule 1, or where the trust instrument has been modified accordingly.

In addition to the duty of care set out in section 1(1), the Act also requires the trustees to have regard to ‘standard investment criteria’ when exercising any power of investment, that is:

1the suitability to the trust of the proposed investment; and2the need to diversify to an appropriate level.

Trustees must also carry out periodic reviews of the investments of the trust and consider whether, having regard to the standard investment criteria, they should be varied.

The provisions of the Act do more than simply place the ‘prudent businessman’ test upon a statutory footing; taken together, sections 3 and 4 of the Act mark a shift away from the ‘prudent businessman’ rule (which expected trustees to act cautiously, restricting investments to a range of authorised investments) towards the ‘modern portfolio theory’, which states that trustees should seek to establish a suitable level of risk and diversification across all assets.

The standard investment criteria
Suitability

Trustees must consider whether the proposed investment is a suitable one given the whole range of investment options that are open to them, taking account of the needs of the beneficiaries, the purpose of the trust, the spread and type of existing investments and whether it might be more appropriate to invest in other categories of investment. 

The question then arises as to whether it is absolutely necessary for the investment to turn a profit. The term ‘investment’ was considered in the case of Re Power [1947] Ch 572 as referring to assets from which a profit or an income is envisaged. Thus, hazardous ‘investments’ would not usually fall within the definition.

What if the trust expressly authorises speculative or hazardous investments? This will provide the trustees with some comfort, but should not be relied on absolutely. The key point will be to look at the particular investment and establish whether it is justified as a holding in the context of the overall portfolio.

It would appear that trustees have, in recent times, been moving away from more speculative investments and structured products towards more traditional and somewhat conservative investments.

Diversification

Ordinarily this will involve trustees maintaining a spread of investments with a view to reducing the overall level of risk run by the beneficiaries. It will be important for trustees to keep up to date with investment philosophies at the relevant time (which is, of course, in line with the duty to continue to review and assess the suitability of investments).

What about a trust established for the sole purpose of holding shares in the settlor’s private company? Where such a trust exists, it may not always be possible or practical to consider diversifying the trust fund. Trustees can consider the family and business circumstances and can be guided by the settlor’s wishes in deciding whether to diversify. The terms of a trust instrument might provide some comfort to trustees where, for example, it includes a power to retain assets for as long as may be deemed advisable and to invest without being limited in the selection of any investments. However, trustees must avoid strictly adhering to the investment policy without questioning whether it is appropriate in all the circumstances to do so and must be careful to at least consider the need to diversify (and note the motivation behind any decision taken).

Management of investments

Trustees must review the investments within their portfolios regularly, having regard to the standard investment criteria, to ward against the type of situation which arose in Nestle v National Westminster Bank,1 where the trustees failed to conduct regular reviews of a trust fund of equities and gilts for around 60 years, and where, as a consequence, the investments had become ‘of little value except as wall paper.’

However, where trustees own a large or controlling share in a company, simply reviewing the performance of those shares will not be enough - trustees have a duty to supervise and to enquire.

In Bartlett v Barclays Bank, the trustees of a trust, which held 99.5 per cent of the shares in a company, left the management of that company in the hands of its directors, contenting themselves with the information they received at that company’s AGM and not seeking any further information. Brightman J was clear that ‘the bank, as trustee, was bound to act in relation to the shares and to the controlling position which they conferred, in the same manner as a prudent man of business. The prudent man of business will act in such manner as is necessary to safeguard his investment’ by securing the fullest possible information with a view to taking remedial action to correct any perceived problems in the management of the company.

The surest way of achieving this end may be for the trustees to seek a non-executive or nominee position on the board of directors.2 Depending on the investment strategy, it might be prudent for the trustees to ensure that they receive timely copies of board agendas, minutes of board meetings and monthly management accounts.3

However, in many modern trusts, trustees might hold significant shareholdings in diverse companies and are unlikely to be expert in the business of the companies in which they hold shares. Alternatively, the trustees might hold the majority of shares in a family company, and the family may not wish them to have a presence on the Board, or to be actively involved in the business of the company.

Trustees must avoid strictly adhering to the investment policy without questioning whether it is appropriate

For these reasons, ‘anti-Bartlett’ clauses have become common. Such clauses exclude trustees from their duty to enquire and supervise and are effective, provided the wording is such that both duties – supervision and enquiry – are modified. It is important to note that the existence of this clause will not exonerate trustees if they become aware of a situation indicating that they should use their powers of intervention and they fail to intervene.

By the same token, the appointment of an Investment Advisor Committee under the terms of the Trust Deed, to which the trustees have delegated their investment functions, will not mean that the trustees can abrogate their duties and responsibilities. They must ensure that they are kept up to speed regarding the activities of such a committee and intervene where appropriate.

Although the subject of exclusion clauses merits an article in its own right, it is worth highlighting that trustees can guard against personal liability for all breaches of duty on the part of the trustee, and even for gross negligence, although trustees cannot exclude liability for actual fraud.4

Advice

It is of course unusual for trustees to take investment decisions without obtaining investment advice, as is now required by the Act,5 both when reviewing the investments of the trust and when exercising their power of investment. This does not mean that trustees can follow advice blindly. Trustees must consult a suitable advisor, ensure that they receive intelligible advice, obtain any information necessary to understand that advice and consider the advice which they receive. Robert Walker J summarised the position: ‘It is... for advisers to advise and for trustees to decide.’6

Conclusion

When considering whether to invest in assets, trustees should act as a prudent man would do when looking after assets on behalf of others. Take care, act reasonably, carry out due diligence, consider the needs of all those with an interest in the trust fund and above all take appropriate advice.

([1993] 1 WLR 1260).
Re Lucking’s Will Trusts, Renwick v Lucking [1967] 3 All ER 726.
Re Miller’s Deed Trusts [1978] LS Gaz R 454.
Armitage v Nurse [1998] Ch 241. Such clauses were examined by the Law Commission (Trustee Exemption Clauses (Law Com no 301) (2006)) who reaffirmed the position that they are effective.
(section 5)
Scott v National Trust [1998] 2 All ER 706.

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