The entrepreneurial trustee does not have to be a contradiction in terms; options exist to accommodate a more aggressive investment approach when it is appropriate, argues Vistra Jersey Ltd.

The last two years of global economic downturn have,
amongst other things brought about fundamental reassessment of the importance
of the concept of risk and indeed, in many cases have resulted in an increased
aversion to any loss.

Yet at the same time, this same market turmoil
has produced a range of buying opportunities for those ready to exploit them.
Such opportunities are likely to be of interest in the main to those with a higher
risk appetite, given that risk free alternatives (cash deposits) continue to
deliver historically low returns.

Opportunities

Being entrepreneurial
in the current environment is relatively easy for an individual if they control
assets directly. They have the ability to exploit opportunities as they see fit and make sure that the cash/leverage
is in place to help progress their plans.

If the assets (or the
majority of the assets) are held in trust, where the assets are not controlled
directly by the beneficiaries, then the beneficiaries need to request that the
trustee consider making such investments. This requires the trustee to consider
risks and be more adventurous than they ordinarily might. As a result, trustees
may refuse these types of requests.

However, if the
trustees agree the principle, a myriad of tactical opportunities present
themselves including:

-- Purchasing land,
product and stock at bargain prices;

-- Buying up assets
from distressed firms;

-- Acquiring the
competition to increase market share.

Commercial

Unlike fund managers,
trustees are not paid a performance fee for taking risks. It is a moot point as
to whether remuneration based on performance would or should make a difference
to trustees’ decision making. Fund managers have a different focus to trustees,
which is performance driven, while trustees have a primary duty to protect and
enhance trust assets. So, the prudent trustee must be risk averse by nature.

In the future,
inflation may well cause assets to depreciate faster in real terms. Cash and
gilts may be low risk investment solutions for clients in the current climate
but will they be regarded as prudent in hindsight by beneficiaries when there
has been below market performance in the trust fund?

If trust assets are
illiquid then leveraging the trust assets is a possibility to generate liquidity
for investment purposes. However, taking on debt must be considered carefully
by a trustee, although many have experience of leveraging portfolios and
property for this purpose and of course the trustee can usually appoint an
expert to advise the trust on such matters.

In circumstances where a trustee has concerns that
the entrepreneurial project or loan proposed is too onerous, it is possible for
the trustee to make a distribution to a beneficiary, so as to allow the
beneficiary to use the money as he sees fit. However, such a step would require
a consideration of the tax consequences for the beneficiary.

Problems
for trustees

Assuming access to funds had been resolved, other
issues will need to be addressed before a project is undertaken. Such questions
might well include:

-- Are all the beneficiaries ascertained as a
class and are they all considered in the request, and what are their views of
the proposed investment? If the beneficiaries are not considered in their
entirety or don’t have a consensus view, can this course of action be
considered to be in their best collective interests? If not, the trustee may
risk being considered to be in breach of trust.

-- Are the trustees demonstrating control of
their structures? If a trustee agrees too readily or with insufficient
information then how are the trustees demonstrating independent control?
Moreover, is governance actually resting with the client where he is resident?
If the governance of the structure is found to be tax inefficient, then the
underlying structure may well be considered to be resident for tax purposes where
the client is, which may leave the trust open to investigation from the
relevant fiscal authorities.

-- If the settlor dictates how the assets within
the trust are used and the trustee administers the trust strictly in accordance
with his directions, then the question of sham comes into play. If found to be
a sham, there are potentially painful consequences, as the trust assets may need
to be redistributed back to the settlor.

Of course, settlor directed trusts get around
these problems, but many trusts are not created as such for tax purposes. In
addition, in In Re Esteem Settlement the
court held that both settlor and
trustee intended that the assets should be held on terms different to those in
the trust deed and that the trustee went along with the settlor’s intention in
a reckless manner, so the test is no longer unilateral. 

All three scenarios have the potential to lead to
a trustee’s worst nightmare, that of being sued by the beneficiaries for breach
of trust.

Risks,
rewards

The heart of the problem lies in the risk/reward
matrix. The law tends to punish the trustee who takes risks that are
subsequently proven to fail, but is unlikely to punish the risk averse trustee
irrespective of subdued performance.

In Bartlett,
Brightman J expressed the opinion that “a professional corporate trustee is
liable for breach of trust if loss is caused to the trust fund because it
neglects to exercise the special care and skill which it professes to have”. The
trustee was held not to have discharged its duties in supervising the new
ventures of the company, and was ordered to make good all losses within the
trust.

However, the decision offered some potential for
the trustee to make commercial choices, by making clear that liability will not
be attributed to a trustee who has committed no more than an error of judgment
from which no business man however prudent can expect to be immune. The court
went out of its way to say that a trustee is not 'bound to avoid all risk and
in effect act as an insurer of the trust fund’.

The
way forward?

All may not be lost for trustees who have
entrepreneurial demands being made of them and possibilities exist that allow them
to be more active with the trust funds. However, a process must be established
whereby the trustee can take a degree of risk within the trust, without
abdicating his responsibility as a “prudent man”.

If a settlor is aware of a need for
entrepreneurial decision making within the trust prior to a structure being
created, it is possible to create a structure that keeps the settlor,
beneficiaries and trustee aligned with this objective. However, standard
structures and drafting are unlikely to be suitable.

Jurisdictions,
structures

One of the obvious possibilities is to select a
combination of jurisdiction and structure that allows the trustee (and in
certain circumstances the settlor) more flexibility in how they manage the
trusts assets:

-- Private Trust Company. Many consider the PTC as
the most appropriate and flexible structure for family businesses. The board of
the trust company can comprise family members, advisors, and fiduciaries. The
settlor’s family are usually closely involved with the trust company, and can influence
the underlying structures.

-- Special Purpose Trust. BVI Vista trusts which
can be created for the sole purpose of holding shares in a BVI company, which
is run by its directors, without any power of intervention being exercised by
the trustee. The settlor’s family can comprise the directors of the board.

In comparison, Cayman’s
STAR trust regime allows trusts to be created for a pure purpose or beneficiaries
or both. The trust deed can be drafted so as to exclude the rights of
beneficiaries to information. The STAR trust can be used for holding operating companies
which are principally comprised of the director’s family as the board.

-- Settlor reserved powers. Jersey
also offers Purpose Trusts which allow settlor reserved powers within the trust
deed. These powers can provide the settlor with a high degree of influence over
the trust and assets. In reality their application is normally for sophisticated
hybrid purpose trusts or business purpose trusts where an investment advisor
(usually a client controlled company) is appointed pursuant to a business plan
which the trustee is bound to follow. In most cases the settlors are usually
experienced investors.

-- Foundations: Entrepreneurial families may find
foundations an effective way of exercising influence over a structure. Although
Jersey foundations must have at least one Jersey
regulated person on the council, the other council members can include the
founder or family members.

One of the key features
of a Jersey foundation is that the council is
answerable to a guardian (who can be the founder or his representative) rather
than the beneficiaries. The council does not have a fiduciary duty to the
beneficiaries (and the beneficiaries have no right to information) and
accordingly, a foundation may be able to undertake more entrepreneurial activity
than a trustee.

-- Using corporate structures: Trustees often use
a standard structure of trust, holding company and subsidiary companies (such
as operating companies).  

The Bartlett case comes into play here. But where there is an existing family business that
is not substantially changing the direction of its long held business
activities, many trustees would consider it unnecessary to have one of their
representatives on the board. In reality, most trustees would be happy with
regular shareholder reporting to meet their fiduciary responsibilities.

For riskier business, where
the trustee is unlikely to have any particular expertise of the industry, having
a representative on the board of the operating company is an option which can
help the trustees fulfil their fiduciary duties.

Trust
drafting and settlor’s investment profile

Many trusts have clauses within their deeds which
exonerate the trustee from loss within the trust. However, as West v Lazard Brothers Co. (Jersey) Limited 1993 shows, trustees cannot lose
significant trust assets and expect exoneration, if the clause has not been
adequately explained initially.  

Nowadays, professional trustees cannot
realistically expect a court to view charges of negligence and gross negligence
more leniently, as the professional trustee is deemed to be more qualified than
his lay counterpart.

Yet where a settlor has a trust drafted from
scratch, provisions can be included that allow the trustee to set aside a
portion of the trust assets which then can be used by the trustees as part of a
more adventurous investment path. Assets could then be invested in a range of
classes  including higher risk equities,
residential and commercial property and even buying into operating companies.

The entrepreneurial trustee needn’t therefore be
an oxymoron. Drafting options exist to accommodate a more aggressive investment approach
and appropriate advisors and specialists can always be retained to help shape
an investment strategy that can take maximum advantage of commercial
opportunities.

Marc
Farror TEP, is the Private Client and Family
Office Director of Vistra Jersey Limited, website www.vistra.com, telephone +44 (0)1534 504753