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.
Terminology
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:
1an immediate binding trust over the benefit of the
contract; and2a trust over the
fruits of the contract when received.
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 Turcan, 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 Zambia at para 84 of
his judgment seems entirely correct.
The current law
The current state of the law seems reasonably clear.
Turcan, Don King Productions Inc v
Warren 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:
1What is the nature of this trust?2Would the result have
been any different if the restrictions on assignment had gone so
far as to refer expressly to declarations of trust
or had been worded in a way which the court might interpret as
prohibiting declarations of trust?
The nature of the trust
As Professor Roy Goode wrote in his note on Helston
Securities Limited v Hertfordshire County Council in
the Modern Law Review, 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 contract.
The Vandepitte procedure
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.
Rights of set-off
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.
‘No declarations of trust’
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 Ltd, 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
point 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.