Family trusts - some common pitfalls [Apr 09]

In the course of trusteeship, trustees make decisions that will impact on the assets of the trust. If made incorrectly, trustees’ decisions can lead to personal liability if the trust suffers a loss.

Potential problems could arise, especially in the current economic climate, due to such issues as:

·            A drop in asset values

·            Excessive trust borrowings

·            Loss of income from trust assets, or from a beneficiary’s company

·            Trust assets used as security for company/personal borrowings of a beneficiary/person who established the trust

Trustees are obliged by law to have the best interests of the beneficiaries at the core of decision making, not the best interests of the settlors (the people who established the trust).

Trust secures family company borrowings

It is common for trustees to agree to provide mortgages over trust property and provide corresponding unlimited liability guarantees in favour of another entity/borrower, such as the family company, which might run the family business or operate the family farm.

The problem arises when the company is then unable to meet its loan repayment commitments and the bank is required to sell trust property to pay for non-trust borrowing. The decision to provide guarantees and mortgages to the bank for company borrowing can be the trust’s undoing.

Before they provide guarantees and mortgages the trustees must consider whether this is actually in the beneficiaries’ best interests. For example, was the trustees’ decision prudent in light of the financial situation of the company, and was the guarantee and loan structure reviewed on an ongoing basis?

Also, before guarantees and mortgages are given, the trustees are required to check the trust deed to ensure there is power in the deed to provide such guarantees and mortgages.

Resettlement of trust assets

Trust deeds should contain a provision to allow the trust to resettle its assets on another trust provided the resettlement is for the benefit or advancement of one of the beneficiaries of the trust. If the trust deed has a power to resettle, and the trustees are asked to resettle, they are required to conclude that it would be in the best interests of the beneficiaries to do so and that it is a proper exercise of the power of advancement to resettle trust assets on one, or a group of, beneficiaries.

This is a decision not to be made lightly as the remaining beneficiaries may be interested in the details of the resettlement, not to mention the Inland Revenue Department. The trustees are less likely to be personally liable if they turn their mind to the best interests of the beneficiaries before making the decision.

Minimising the chances of an incorrect decision

Trustees minimise the likelihood of making incorrect decisions if they consult and meet regularly with their independent trustee, accountant, and lawyer to review the current position. Communication is vital and provides an extra level of security. Trustees who proceed to administer the trust without seeking external assistance do so at their own peril.

Trustee decisions would be made easier by the existence of a regularly updated settlor memorandum of wishes that sets out the settlor’s intentions regarding the trust fund. It should be easily accessed by the trustees and kept up to date.

Conclusion

In short, trustee obligations are not simple and require careful thought. It is always best to consult with professionals if unsure and to ensure there is a clear set of trust documentation to avoid problems in situations such as the above.

The contents of this newsletter are of a general nature only. While the information is believed to be correct no responsibility is accepted for its accuracy. Readers are advised to establish the applicability of information in relation to specific circumstances and not to rely solely on the text of this newsletter.

View Simon Kember Profile

Search Publication Library