Common Pitfalls In Making Decisions For Family Trusts 09 Dec 2011
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
Parry Field Lawyers provide legal advice on a range of trust matters including entry into and operation of family trusts and charitable trusts.
Best Interests of the Beneficiaries
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). Some common uses of family trust may not properly safeguard the beneficiaries.
For example, it is common for trustees to agree help fund a related entity such as a family company running the family business or operating the family farm. This will often be by granting a bank or finance company a mortgage over trust property and give unlimited liability guarantees to secure loans to the family company. Problems arise when the family company is then unable to meet its loan repayment commitments. The bank might choose to sell trust property to cover the family company debts. This can greatly reduce or entirely wipeout the trust's assets.
Because of such risks, 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 must check the trust deed to ensure there is power in the deed to provide such guarantees and mortgages.
Resettlement of trust assets
Another area of risk relates to resettlement of trust assets.
Trust deeds usually 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
A well drafted trust deed will include provisions that limit trustee liability as much as possible, but that by itself is not enough to protect the trustees.
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.
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.