Pitfalls in the administration of trusts
Some reminders from the courts
A lengthy article but indicating very important points; that there must be a separation between the donar and the trust and that trustees have fiduciary duties they need to take seriously. One bit of advice, don’t be a “sleeping” trustee, be involved or rather resign.
Extracts of article that appeared in Integritax a while back:
Family trusts have for many years been a well-known feature of the South African estate planning landscape. In the classic situation, a planner establishes an inter vivos trust and sells assets with growth potential to the trust, leaving the trust owing the purchase price to the planner. At a stroke, the planner both freezes the growth of his estate and provides financial protection for his dependants in the event of his death. Some planners also welcome the shelter that trusts provide from market risk.
Unfortunately, because the family trust is by its very nature an intimate part of the financial and personal lives of the family, the planner often loses sight of the fact that the trust, represented by the trustees, and the planner are separate entities. This is especially easy to do when the planner is a trustee, as is frequently the case. The result is that the other trustees, who may be his spouse and a major child, defer to the planner and tend to treat the trust assets as those of the planner. After all, they were his in the first place, so the thinking goes.
In many such instances the trust is drawn into the business dealings of the planner, a practice that tends to negate the very object for which the trust was established in the first place.
This laissez faire approach, which understandably causes distress to the professional advisers of trustees as they try to discipline their clients into complying with the provisions of the trust deeds and the Trust Property Control Act, has received a few blows from the Supreme Court of Appeal (the SCA) in recent months. The decisions discussed below have also led some offices of the Master of the High Court to require that at least one trustee of any new trust be independent of the planner.
The first in this group of decisions is Land and Agricultural Bank of South Africa v Parker & others 2005(2) SA 77 (SCA). As Cameron JA said at the beginning of his judgment,
“this is a battle about a family trust…and…brings to the fore yet again questions about the use and abuse of the trust form of business dealings”.
Mr Parker established the trust in 1992 with himself and his wife together with one Senekal, the family attorney, as trustees. The beneficiaries were the Parkers and their descendants. Senekal resigned in 1996 and was not replaced, despite a provision in the trust deed that “there shall always be a minimum of three trustees in office”. In fact, so laissez faire were the Parkers that it took them two years to inform the Master of the High Court of Senekal’s resignation.
Undaunted by this lack of a quorum of trustees, the Parkers accepted loans for the repayment of which they purported to bind the trust. In particular, between April and October 1998 the bank lent substantial amounts to companies associated with the family business, as security for which the trust was purportedly bound as co-principal debtor and surety. Eventually, prompted by the Master, they appointed their son, DG Parker, as the third trustee. The effect of this was that all three trustees were closely related and all were beneficiaries of the trust. The son testified that he had not been consulted about the last of the loans, for a sum of R30 million, concluded after he had become a trustee.
By September 2000 things had gone awry and the bank sought the sequestration of the trust and Parker. The application against Parker succeeded, but the trust contended that the Parkers did not have the power to bind the trust, because it had not complied with the requirements of the deed. The bank submitted two arguments to support its contention that two trustees acting alone could bind the trust: before the son’s appointment, on the general proposition that trust law permits trustees who are in office, acting together, to bind an estate; and afterwards, on the basis that the trust deed authorised majority decision-making by the trustees.
The court found that the first argument was based on the erroneous assumption that a trust has legal personality. A trust is “an accumulation of assets and liabilities” that vests in the trustees and must be administered by them. It is only through the trustees, specified in the trust deed, that the trust can act. And it is the trust deed that determines the number of trustees, their means of appointment and the circumstances under which they may bind the trust estate. The trust deed is the trust’s “constitutive charter” and the trust cannot be bound outside its provisions. It followed that a provision as to the minimum number of trustees was a “capacity-defining condition” outside which the trust was incapable of acting. The judge made the telling point that the Parkers alone were not “the trustees” as defined in the trust deed; so long as fewer than three trustees were in office, there were no trustees on whose behalf the Parkers could act. The Parkers could not bind the trust, because no one could. However, this did not mean that their duties as trustees ceased; their obligations continued, and amongst these was the obligation to appoint another trustee. When they purported to bind the trust during this period they were usurping a power they did not have, a breach of trust they compounded by failing to appoint a third trustee.
As for the second argument, the court found that the failure to consult the son after his appointment constituted a further usurpation of power and a further breach of their obligations. The bank’s argument that, after the appointment of the son, the Parkers were acting within their powers as a majority of the trustees was defeated by the fact that no meetings had ever taken place at which the majority will of the trustees was determined by vote.
Cameron JA discussed at some length the increase in the use of trusts for business purposes over the past two decades. He was at pains to point out that there was nothing inherently wrong with using so flexible an instrument as a trust for such purposes, but drew attention to the great scope for violation of the functional separation between control and enjoyment that is at the core of trust law and the basis on which it has developed. In a trust such as the one in question, there was no such separation, and the rupture of the divide between control and enjoyment invited abuse – as was evident in the present matter. Even when Parker’s estate had been sequestrated, so that he was no longer qualified to act as a trustee, the family had perpetuated its contempt for the separation principle by appointing their daughter in his stead.
The way out of this state of affairs was via the powers of the Master and, as stated earlier, several of the Masters’ offices have taken this comment seriously and now require that at least one trustee be independent of the founder where the trustees are beneficiaries and the beneficiaries are related to each other.
The bank therefore failed to foreclose on its security because it was fatally defective. Thus far it would appear that the Parkers had escaped the consequences of their dealings with the bank by the very fact that their conduct had been improper. Happily, however, the court went further.
The first action in this matter had been an application by the bank to the High Court for the sequestration of Parker and the trust, which Roux J granted. On appeal by the trust, the full bench of the High Court found in favour of the trust on basis of the lack of capacity of the two trustees and it was as an appeal against this judgment that the matter came to be considered by the SCA. Cameron JA, having found that the two trustees had lacked the capacity to bind the trust in favour of the bank, then proceeded to hoist the trustees on their own petard. Following Roux J’s sequestration order against Parker, his trusteeship was automatically terminated in terms of a clause in the trust deed. Nevertheless, “inattentive as ever to the trust deed”, Parker signed the trust’s petition to appeal in his purported capacity as a trustee. It followed therefore that, based on the very arguments about lack of capacity that had prevailed in favour of the trust, the appeal to the full bench had been invalid and should have been struck from the roll. There had therefore never been a valid appeal against Roux J’s sequestration order, and it stood against the trust in favour of the bank.
There are many lessons to be learnt from this judgment. Trustees ignore the provisions of trust deeds, including procedural and administrative requirements, at their peril; persons dealing with trusts should not assume that the trustees have complied with the procedural requirements of the trust deed; trusts where the trustees are related to each other and also number among the beneficiaries should be viewed with circumspection; and founders who treat their trusts as their alter egos are playing with fire.
A founder who treated his trust as his alter ego suffered the consequences in the next case to come before the SCA, Badenhorst v Badenhorst 2006 (2) SA 255 (SCA). In the Parker judgment Cameron JA had said presciently:
“It may be necessary to go further and extend well-established principles to trusts by holding in a suitable case that the trustees’ conduct invites the inference that the trust form was a mere cover for the conduct of the business ‘as before’, and that the assets allegedly vesting in trustees in fact belong to one or more of the trustees and so may be used in satisfaction of debts to the repayment of which the trustees purported to bind the trust. Where trustees of a family trust, including the founder, act in breach of the duties imposed by the trust deed, and purport on their sole authority to enter into contracts binding the trust, that may provide evidence that the trust form is a veneer that in justice should be pierced in the interests of creditors.”
This in effect is what happened in Badenhorst’s case, although outside creditors were not involved. This was a divorce matter, and the crisp issue was whether, when making an order for the redistribution of assets in the course of the divorce, the court should take into account the assets of an inter vivos trust created during the marriage. During the marriage the trust was created. The husband explained to the wife that the purpose was to protect them against creditors and avoid estate duty. The husband’s father was the founder, but he then had no further connection with the trust. The trustees were the husband and his brother, while the discretionary capital beneficiaries were the children of the marriage and those of any subsequent marriage entered into by the husband. The wife was a discretionary income beneficiary.
The wife submitted that the trust was the alter ego of the husband and, as such, its assets should be taken into account in determining an equitable split of the estates that the couple had built up during the marriage. The High Court had rejected this submission, upon which the wife appealed to the SCA.
After setting the facts and the judgment of the High Court, Combrinck AJA built on the theme of Cameron JA in the Parker case, stating that, whilst the de iure control of a trust is in the hands of the trustees,
“very often the founder in business or family trusts appoints close relatives or friends who are either supine or do the bidding of their appointer. De facto the founder controls the trust. To determine whether a party has such control it is necessary to first have regard to the terms of the trust deed, and secondly to consider the evidence of how the affairs of the trust were conducted during the marriage.”
Pointing out that the present matter was a classic instance of one party, the husband in this case, having full control of the assets of the trust and using the trust as a vehicle for his business activities, the learned judge identified the factors that had led him to this conclusion:
the husband had the right to discharge his co-trustee and appoint someone else;
the trustees had an unfettered discretion to do with the assets and income as they saw fit;
all that was needed to alter the terms of the trust was the consent of the children;
the deed provided for the husband to be compensated for his duties as trustee, thereby ensuring an income stream should he wish to make use of it;
the husband seldom consulted or sought the approval of his brother, the co-trustee;
in an application for credit facilities with the local co-operative he listed the trust assets and liabilities as his own;
he insured a beach cottage owned by the trust in his own name;
he received an income of R50 000 per month from an estate agency owned by the trust.
Two of these factors are common to trusts and, in the absence of the others, would not be exceptionable, namely, the discretion of the trustees as to the assets and income and the need for consent of the beneficiaries for changes to the terms of the trust. However, taken together with the other factors, it was evident to the court that, but for the trust, ownership in all the assets would have vested in the husband. He had de facto control of the assets and treated the trust as his alter ego. The court therefore directed that the assets of the trust should be taken into account in determining the redistribution amount. One can only respectfully agree with this decision.
The third case on this subject is Thorpe v Trittenwein 2006 SCA 30 (SCA). Thorpe was the founder and a trustee of a family trust, together with Sharon Thorpe and Allen Dixon. He signed an offer to purchase fixed property on behalf of the trust. For various reasons the transaction was considerably delayed, until finally the seller sought to cancel the contract, arguing that the documents did not comply with the requirements of the Alienation of Property Act, section 2 of which provides that agreements for the sale of fixed property must be in writing.
The trust deed provided for three trustees, which was the situation in the present matter. It provided further that decisions of the trustees were to be taken on a majority vote, and also that any trustee could delegate his or her powers to any other person. However, the deed did not provide for one trustee to act on behalf of the others without their authority. On the contrary, it contemplated them acting jointly.
It was common cause that Sharon and Dixon were party to the decision to enter into the agreement of sale and that they had authorised Thorpe to do so. However, this authority had not been reduced to writing, a fact that turned out to be crucial to the case. The court found that in the absence of a joint decision, the assent of a single trustee to a contract will not bind the trust. Because the present matter dealt with the alienation of fixed property, all relevant decisions had to be reduced to writing; and because the authority of Sharon and Dixon for Thorpe to sign the agreement was not in writing, the agreement was found to be void and of no force and effect.
Scott JA concluded his judgment by applying the comment of Cameron JA in Parker to the actions of the trustees in the present matter: that the trust was typical of the modern business or family trust in which there was a blurring of the separation between ownership and enjoyment, a separation that is the very core of the idea of a trust. He concluded with a warning that all trustees and their professional advisers should take to heart:
“Those who choose to conduct business through the medium of trusts of this nature do so no doubt to gain some advantage, whether it be in estate planning or otherwise. But they cannot enjoy the advantage of a trust when it suits them and cry foul when it does not. If the result is unfortunate, Thorpe has himself to blame.”
The court suggested that the Master of the High Court should ensure that there is adequate separation of enjoyment and control in every trust by insisting on the appointment of an independent outsider as trustee to every trust in which the trustees are all beneficiaries and the beneficiaries are all related to one another. The court said that the independent trustee does not have to be a professional person, such as an attorney or accountant.