ABOUT THE AUTHOR: Nigel Reid is Consultant to Linklaters LLP and its former Head of the Trust Department in London

One of the most interesting areas of developing trust law at the moment is the question whether or not a valid trust can be declared over the benefit of a contract in the face of a restriction on the assignability of the contract.

What will be considered is a declaration of trust by A (the transferor or trustee) in favour of C (the transferee or beneficiary) over the benefit of a contract between A and B. In the context of commercial securitisations, where this issue arises not infrequently, A would be the originator/lender, B the borrower and C the issuer.

A phrase often met in this context is ‘a trust over the fruits of a contract’. This can be used, both in cases and in articles, to mean a number of different things, but the two main meanings appear to be:

The critical distinction between these two types of trust is that the second only creates a binding trust when the fruits of the contract are received by the transferor. Up to that point, any legal rights vested in the transferee are contractual rather than proprietary. Only the first is capable of giving the transferee a proprietary interest in the contract. This distinction is critical in the context of a securitisation because the main concern of the transferee (issuer) is whether the declaration of trust is effective in the event of the insolvency of the transferor (originator). In the second case, it will not be.

An appreciation of this distinction is also critical to the understanding of the case of Re Turcan², which is sometimes analysed as a trust of the second type but which, I believe, is a trust of the first type.

Turcan has to be read in its historical context. The Policies of Assurance Act 1867 for the first time allowed an insurance policy to be assigned legally. Prior to that, the benefit of a policy could only be assigned in equity (i.e. by way of an equitable assignment) or a trust could be declared over the policy. In Turcan, the Court of Appeal considered the effect of a covenant in a marriage settlement to assign after-acquired property. The after-acquired property included an insurance policy with a restriction on assignment which the Court treated as designed to counter the effects of the 1867 Act.

The Court held that the effect of the covenant was to create a trust in favour of the trustees of the marriage settlement in the same manner and with the same effect as the type of trust which would have been created before the 1867 Act. Although Cotton LJ refers to ‘all the benefit of the money when it was received’, it seems clear both from the terms of the judgment as a whole and from the reported arguments of counsel that the court was not considering a trust simply over the monies once received, but an immediate binding trust over the full benefit of the policy. The analysis of Turcan by Rix LJ in Barbados Trust Company Limited v Bank of Zambia³ at para 84 of his judgment seems entirely correct.

The current state of the law seems reasonably clear.

Turcan, Don King Productions Inc v Warren⁴ and Barbados Trust are all authority for the proposition that it is possible to declare a valid trust over a contract which is expressed to be non-assignable. In Turcan, the non-assignability provision stated that the policy ‘should not be assignable in any case whatever.’ In Don King, the relevant restrictions were not cited but were referred to in the judgments either as stemming from the general law rule that contracts involving personal services are not assignable or as express provisions ‘probihiting any assignment’. In Barbados Trust the restrictions were implied from a provision which allowed the banks to ‘assign’ their rights only to other banks or financial institutions in the same group as the assignor.

Two questions, however, arise:

As Professor Roy Goode wrote in his note on Helston Securities Limited v Hertfordshire County Council in the Modern Law Review⁷, a restriction on assignment is simply a way for the obligor to make it clear that the contract is intended to be personal to the obligee. Using my terminology, B wishes to be in a contractual relationship only with A and not with any other person.

If, however, A subsequently declares a trust over its rights under the contract for the benefit of C, C, as the sole absolutely entitled beneficiary, will be able to direct A as to how A exercises its rights under the contract.

But this creates a tension, because B only wanted to deal with A, yet if A is able to pass the benefits of its rights under the contract to C, then B is no longer dealing only with A but is also subject to the rights of C as beneficiary of the trust.

It is this inherent tension between, on the one hand, allowing A the freedom to declare a trust over the benefit of the contract in favour of C, and, on the other, recognising that B, through the assignment restriction, only wanted to be in a contractual relationship with A, that may have led Lightman J in Don King to limit C’s rights under the trust:

‘A beneficiary cannot be allowed to abrogate the fullest protection that the parties to the contract have secured for themselves under the terms of the contract from intrusion into their contractual relations by third parties. A declaration of trust cannot prejudice the rights of the obligor. If the contract requires any judgment to be exercised whether by the obligor or the obligee, an assignment cannot alter who is to exercise it or how that judgment is to be exercised or vest the right to make that judgment in the court. The rule in Saunders v Vautier (1841) Cr and Ph 240 (which enables the sole beneficiary or beneficiaries to give directions to the trustee) only applies if the beneficiary is entitled to wind up the trust and require the trustee to assign to him the subject matter of the trust. If the trust cannot be determined because the trustee has under the contract held as a trust asset outstanding obligations and has no power to transfer the trust asset to the beneficiary or his order, the rule does not apply… Accordingly in a case where the subject matter of the trust is a non-assignable contract and there are outstanding obligations to be performed by the trustee, the beneficiary under the trust cannot interfere.’

In other words, the effect of such a trust is that the beneficiary benefits from the fruits of the contract but cannot interfere in the operation of the contract.

This approach was not developed either by the Court of Appeal in Don King or by either court in Barbados Trust, but it might be regarded as an entirely sensible one. It both protects the rights of A to declare a trust over A’s asset and manages the tension with B, and there are precedents for the type of ‘modified’ bare trust proposed by Lightman J: for example, the trust which comes into being on the making of a specifically enforceable contract for the sale of land – see Lord Walker in Jerome v Kelly [2004] UKHL 25 at para 32 of his judgment. The precise nature of the trustee’s obligations and the beneficiary’s rights under such a modified trust await further judicial clarification but what seems beyond doubt is that the beneficiary will obtain a proprietary interest in the rights under the contract⁸.

As to the so-called Vandepitte procedure (which would allow C to sue B under the contract if it joins A as a party), Lightman J, consistently with his other views, considered that the courts would be ‘astute to disallow use’ of it. This was also the view of Langley J at first instance and of Hooper LJ in the Court of Appeal in Barbados Trust. However, a majority of the Court of Appeal in that case approved the use of the procedure. The majority statements were clearly obiter dicta and since use of the procedure would not be consistent with the type of modified trust proposed by Lightman J, as it interferes with the relationship between A and B, some may prefer the minority view.

Also of concern to B will be the preservation of its rights of set-off against A. If A is free to alienate its rights under the contract, even in the face of a restriction on assignability, why should B’s rights of set-off be prejudiced by the loss of mutuality? The answer is surely that they should not be, so a necessary corollary of the court being willing to countenance the modified trust should be a total preservation of all of B’s rights of set-off. So far as I am aware, there is as yet no legal authority directly on this point.

Finally, what if the non-assignability provisions expressly cover, or are interpreted to cover, declarations of trust? This throws into relief the tension between (a) B’s right to freedom of contract and (b) A’s right to alienate its property. Professor Goode, in his note on Helston, suggests that the right to alienate should prevail. Similarly in Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd⁹, Lord Browne-Wilkinson, after referring to Professor Goode’s note, suggested such a restriction on alienability might ‘be ineffective on the grounds of public policy’, but expressed no concluded view on the point¹⁰ If the modified trust proposed by Lightman J is adopted, and B’s rights of set-off are preserved, then there seems no good reason why A’s ability to declare a trust over the contract in favour of C should be in any way restricted by the terms of the contract. In commercial situations this would then remove any need for C to conduct an onerous due diligence exercise into the ability of A to declare a trust over the contract before giving full consideration for its interest.