Creation of Trusts Flashcards
Does a trust need property?
Property is an essential requirement for a trust.
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.
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.
What can be held on trust?
Almost every asset or right can be held on trust. 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 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).
Can trust property change?
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.
What is the obligation component of a trust?
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.
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 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.
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.
Can trusts be used for 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.
What are the commercial uses of trusts?
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.
What are the private uses of trusts?
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).
What are implied trusts?
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.
(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) 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.
(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.
What are 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.
What are 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.
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.
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.
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) [2006] 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.
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 [2020] EWHC 3055 (Ch), paras 234, 238).
What are the 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. 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 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.
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.
Self-declaration of trust
Legal title Retained by settlor (now in new capacity as trustee)
Equitable title New equitable interest
created for beneficiary
Beneficial ownership Transfers from settlor to beneficiary
Transfer on trust
Legal title Transferred to trustee (requires constitution)
Equitable title New equitable interest
created for beneficiary
Beneficial ownership Transfers from settlor to beneficiary Transfers from settlor to
beneficiary
What are the formalities of a trust?
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.
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).
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.
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. 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.
