Trust property refers to assets that have been placed into a fiduciary relationship between a trustor and trustee for a designated beneficiary. Trust property may include any type of asset such as cash, securities, real estate or life insurance policies.
Trust property is also referred to as “trust assets” or “trust corpus”.
The opening quotation can be said to identify one of the basic tenets of trust law in England and Wales. The trust is a creation of equity, and has developed over the centuries in England to incorporate various types. One such type is the so-called discretionary trust. This type of trust will be introduced, and analysed. The importance of the need to balance legal ownership with beneficial, or equitable ownership, will then be considered.
The discretionary trust can be contrasted with the fixed trust; both of which are types of express trusts. Under a fixed trust, the beneficial interests are fixed. That is to say that the share of the trust property that the beneficiary is to receive is established, or ‘fixed’, in the trust instrument. Under a discretionary trust, however, the trustee, in whom legal ownership vests, has a dispositive discretion. The trustee’s dispositive duties under a trust require the trustee to dispose of the trust property in accordance with the terms of the trust. Under a discretionary trust, the trustee may have a discretion as to the precise value of the beneficiaries’ entitlement, or as to whether certain beneficiaries receive anything at all. An example of a trust term that would grant this dispositive discretion to the trustee is where a trust is established for a group of beneficiaries “in such portions as the trustee shall in their absolute discretion see fit”.
BREAKING DOWN Trust Property
Trust property is typically tied into an estate planning strategy used to facilitate the transfer of assets and to reduce tax liability. Some trusts can also protect assets in the event of a bankruptcy or lawsuit.
The trustee is required to manage the trust property in accordance with the trustor’s wishes and in the beneficiary’s best interests. A trustee can be an individual or a financial institution such as a bank. A trustor sometimes called a “settlor” or “grantor” can also serve as a trustee managing assets for the benefit of another individual such as a son or daughter.
Regardless of the role a trustee plays, the individual or organization must abide by specific rules and laws that govern the functioning of whichever type of trust is established.
Types of Trusts
There are several different types of trusts individuals can establish. But they typically fall under two categories which are revocable trusts and irrevocable trusts. In a revocable arrangement, the trustor maintains legal ownership and control of trust assets. For this reason, the trustor would be responsible for paying taxes on the income those assets generate and the trust may also be subject to estate taxes should its value breach the tax exempt threshold at the time of the grantor’s death.
With an irrevocable trust, the trustor passes legal ownership of the trust assets to a trustee. However, this means those assets leave a person’s property effectively lowering the taxable portion of an individual’s estate. The trustor also relinquishes certain rights to mend the trust agreement. For example, a trustor usually can’t change beneficiaries of an irrevocable trust after they have been established. This is not the case with a revocable trust.
Trusts can be created during an individual’s lifetime or they can be established following the grantor’s death. This situation applies to Payable on Death (POD)trusts, which transfer assets to a beneficiary following the death of the trustor. Generally speaking, this type of trust and similar ones are called testamentary trusts because property is actually transferred following the trustor’s death. Assets in these trusts flow directly to the intended beneficiaries following the trustor’s death, which means they avoid the often long and expensive process of probate. These trusts can also be outlined in a person’s will.
Assets within living trusts, however, can be transferred during the trustor’s lifetime. For example, several individuals open accounts in trust with banks for the benefit of their children or to help fund their college expenses. A trustee carefully manages the assets held in the account to achieve this goal, but the children don’t have complete access to the funds or the freedom to spend income from the fund as they please. An example of this type of arrangement is a unified gift to minors act (UGMA) account. In some cases, beneficiaries such as children would have access to the trust’s assets and the income they generate only after reaching a certain age.
The reasoning underlying the discretionary trust is that a fixed trust may become inappropriate due to changing circumstances. The trustee, under a discretionary trust, can respond appropriately to these changing circumstances by using his discretion accordingly. Favourite examples of where it may be useful for a trustee to have a discretion include circumstances where the beneficiary decides to live exclusively off the trust property and forego education or employment; the so-called “trustafarian”. Under a discretionary trust, the trustee would have the power to cut that beneficiary off for a period as an incentive for the trustee to become more self-reliant.
An interesting aspect of the discretionary trust, and a pertinent one to the opening quotation, is that no individual who is part of the class of possible beneficiaries, has any equitable title to or interest in the trust property until such time as the trustee exercises his discretion in that individual’s favour. If this is the case, how can the legal ownership vested in the trustee be balanced by an identifiable beneficial ownership? This will be considered further, but it is important that under a discretionary trust, the trustee is not wholly at liberty to do whatever he wishes with the trust property. He will still be limited by the terms of the trust, and remains under a fiduciary obligation to carry out these terms. This does not, of course, make it any easier to reconcile the discretionary trust with the opening quotation; rather it highlights the limits of the trustee’s dispositive discretion.
An important principle in trust law generally is that identified in the case of Saunders v Vautier (1841). Briefly, this principle states that a beneficiary who has an absolute interest under a trust, and who is sui juris (that is, of full age and sound mind) is entitled, at any time, to call on the trustee to transfer the legal title to the trust property in which the beneficiary holds that interest to him. The operation of this principle under a fixed trust is quite straightforward, as the beneficiary’s equitable entitlement will be easily ascertainable. How does it apply to discretionary trusts where the interest is not so easily identifiable? This issue was considered by Romer J in the case of Re Smith (1928). With reference to the earlier case of Re Nelson (1918), Romer J stated that under a discretionary trust where there are two ‘objects’ (the term applied to possible beneficiaries under a discretionary trust), “you treat all the people put together just as though they formed one person, for whose benefit the trustees were directed to apply the whole fund.” What this means is that the beneficiaries may, acting together, as one, require the trustees to transfer the trust property to them as co-owners.
Despite this application of the Saunders v Vautier principle to discretionary trusts, the situation is somewhat different, because the beneficiaries are not treated as having a vested interest in the trust property. Their indefeasible interests in the trust property are only acquired after the beneficiaries have, acting together, demanded the transfer of the trust property using the Saunders v Vautier right. This was established in Vestey v IRC (No 2) (1979). As Lord Reid pointed out in Gartside v IRC (1968), the individual interests of the objects of a discretionary trust are actually in competition with each other until such times as the each object has his own individual right to retain whatever income is appointed to him.
A particular type of discretionary trust is that named after the case of Burrough v Philcox (1840). This relates to the issue of certainty of intention, and the certainty of objects, that are requisites of any trust. The rule is that the object, or each member of a class of objects, must be known and identifiable with certainty. Where this requirement is not met, the trust will fail. In the case of a Burrough v Philcox discretionary trust, the test for certainty is the so-called ‘complete list test’, which demands that a complete list of the objects be drawn up. Under such a trust, if the trustee fails to appoint the trust property, each individual object will take an equal share. This can be said to represent, then, an identifiable beneficial interest in the trust property to counterbalance the legal interest vested in the trustee. it is, to some extent, illusory, however, as this equal share will only apply in the case of default by the trustee.
To return to the rights of objects of discretionary trusts, how can they enforce a possible interest if that interest is not ascertainable because the trustee has not exercised his discretion? It is well established that objects of discretionary trusts have locus standi to sue trustees in order to enforce the trust. It is, however, notoriously difficult to control trustees in exercising their discretions. The courts will construe the terms of the trust if called upon to establish the limits of the trustee’s discretion. In the case of Gisborne v Gisborne (1877), the trustee had been granted an “uncontrollable authority” by the trust instrument. When the beneficiary received less of the trust property than she had hoped for, the court did not intervene because the trustee had acted within his authority as granted by the trust instrument. A crucial limit on the discretion of the trustee, although it does not aid in the establishment of the beneficial interest, is that the discretion must be exercised in good faith and in the best interests of the beneficiaries or objects. It is very difficult, however, to prove that a particular decision by a trustee was not in the best interests of a beneficiary however.
An interesting development in recent years in the area of the validity of a trustee’s discretion is the application of the Wednesbury principle, which was established in the case of Associated Provincial Picture House Limitd v Wednesbury Corporation (1948). This was applied in Edge v Pensions Ombudsman (1998), in which it was established that a court should not interfere unless the trustee took into account “improper, irrelevant or irrational considerations”. Again, although this provides a useful limit to the unfettered discretion of a trustee, it does not necessarily assist in identifying the beneficial interest to counterbalance the legal interest vested in the trustee.
A discussion of the beneficial interest under a discretionary trust must consider the important distinction between a trust and a power. As Martin simply puts it, “trusts are imperative; powers are discretionary.” That is to say that trustees are obliged to carry out their duties under the trust, whereas donees under a power may or may not exercise the power as they see fit. While this should be a simple distinction, the existence of the discretionary trust complicates it somewhat. As mentioned above, the beneficiaries or objects of a discretionary trust have no interest in a specific part of the trust property until such time that the trustee has exercised the discretion in favour of that particular beneficiary. This highlights the essential problem with the opening quotation’s applicability to discretionary trusts, even though the beneficiaries as a whole, or as one, own the trust property. The beneficiaries cannot demand payment under a discretionary trust as they would be able to under a fixed trust, because there is no identifiable value to which the beneficiary is entitled until the trustee exercises his discretion. The beneficiaries can, however, compel the trustee to exercise that discretion. This was established in McPhail v Doulton (1971). This is where the distinction between a discretionary trust and a power exists; under the latter there is no such duty on the donee to make an appointment.
Under a fixed trust, the beneficiary has a proprietary interest in the trust property to which he is entitled (that is, he owns the identifiable equitable interest). As was highlighted in Re Gulbenkian’s Settlement (1970), however, an object under a discretionary trust who is reliant upon the discretion of the trustee in his favour can renounce his position as a class member. A further difficulty with the opening quotation in relation to discretionary trusts is that no individual of a class of discretionary beneficiaries can claim any entitlement to the income of the trust where there is even a possibility that another member could come into existence. This was highlighted in Re Trafford’s Settlement (1985).
Lord Reid’s comment in Gartside v IRC noted above perhaps gives the best illustration of the position of discretionary beneficiaries in relation to identifiable beneficial interest in the trust property. He stated that “two or more persons, cannot have a single right unless they hold it jointly or in common. But clearly the objects of a discretionary trust do not have that: they have individual rights, they are in competition with each other and what the trustees give to one is his alone.” The same principle was applied in Re Weir’s Settlement (1969) and Sainsbury v IRC (1970).
The difficulties of applying the principle outlined in the opening quotation to discretionary trusts have been considered. Fundamentally it is problematic because the whole purpose of a discretionary trust is to allow the trustee to use his discretion to assign a value of the trust property to a particular beneficiary. Although the class of potential beneficiaries as a whole own the beneficial interest, there is no way of identifying the individual shares until the trustee has exercised his discretion.