A century in the making

 

August 2021 marked the centenary of the Trusts (Scotland) Act 1921 (the 1921 Act), the last substantive act on trust law in Scotland. Despite calls to implement legislative change, it remains to be seen whether the new Trusts (Scotland) Bill (the Bill) will be tabled in the Scottish Parliament in 2022.^[1]

At present, the state of trust law in Scotland is inaccessible to many lay trustees and the requirement for a court action to solve commonplace trust issues may make trusts prohibitively expensive. Those who have had experience of these difficulties are reluctant to create new trusts, even if a trust represents the best option to provide the flexibility and protection sought. This ‘allergy’ to trusts that clients are developing is putting Scotland at a disadvantage, in contrast to other jurisdictions.

These are all issues that the Scottish Law Commission (the Commission), the Law Society of Scotland (the Society) and practitioners have commented on throughout the various consultations that led to the Bill. After a lengthy wait, it seemed that the Bill might finally make an appearance after the Scottish Government wrote to Lady Paton, Chair of the Commission, in October 2021 to advise that it intended to take the Bill forward during the course of the most recent parliamentary session.

In her response, Lady Paton commented that: ‘There will be considerable rejoicing and relief amongst the legal community who deal with clients and find the 100‑year‑old law a major handicap.’

However, the Bill, as it is currently drafted, may not be the simple solution Scottish practitioners hope it will be. Although the Bill aims to modernise Scots trust law and address several of the issues trustees and beneficiaries are facing, particularly with the drafting of older trust deeds, the ever‑changing tax environment will almost certainly continue to impact on attitudes toward trusts and their effectiveness.

This article will review the current state of trust law in Scotland, address some of the common problems and trends seen in practice, and outline how the proposed legislative changes to trusts may provide some assistance.

Background to the Bill

Although trusts may be a foreign concept in other jurisdictions, they have been a part of Scots law for centuries. The main pieces of legislation came in the form of four discrete Acts in 1861, 1863, 1867 and 1891, which were consolidated in the 1921 Act.

The 1921 Act remains the substantive legislative framework for trusts in Scotland. Key areas covered extend from how trusts are defined and created to how they are administered by trustees and their administrative powers. Since its enactment, the following legislation has been introduced in Scotland to modernise some aspects of trust law:

• Trusts (Scotland) Act 1961 (the 1961 Act), which introduced the ability to vary trusts;
• Law Reform (Miscellaneous Provisions) (Scotland) Act 1990, which included provisions for charities and public trusts; and
• Charities and Trustee Investment (Scotland) Act 2005 (the 2005 Act), which broadened the investment and delegation powers of trustees.

As a result, Scots trustees and practitioners must be mindful of all four of the above acts, while always considering the backdrop of UK‑wide tax legislation and common‑law provisions.

In the early 2000s, the Commission undertook an extensive review of trust law and produced various discussion papers, reports and consultations. This led to the comprehensive 2014 Report on Trust Law (the Report),^[2] which set out the Commission’s recommendations, followed by an initial draft trust Bill. The Scottish Government’s response in 2015 confirmed it would give the Report ‘full consideration’ when priorities allowed.

Since then, little had happened until the 100th anniversary of the 1921 Act, when the stagnant Bill garnered attention through various articles in the Society’s Journal and events. One such event was a seminar held by the Edinburgh Tax Network^[3] at which Scottish Cabinet Secretary for Finance and the Economy Kate Forbes MSP, speaking on behalf of the Scottish Government, undertook to make progress. This perhaps led to the Scottish Government’s letter of October 2021, suggesting the Bill would form part of the current parliamentary session. However, at the time of writing, it has not.

The Commission published a revised version of the Bill in December 2018, which is the most up‑to‑date draft. It effectively consolidates the 1921 Act with the later three Acts and some of the common law. It is split into nine main parts:

• Part 1: Appointments, assumption, resignation , removal and discharge of trustees.
• Part 2: Decision‑making by trustees.
• Part 3: Powers and duties of trustees.
• Part 4: Contractual rights, damages and the validity of certain transactions and documents.
• Part 5: Duration of trust.
• Part 6: Private purpose trusts.
• Part 7: Protectors.
• Part 8: Powers of the court.
• Part 9: Miscellaneous and general (including definitions).

Of these, Parts 1 and 2 provide much‑needed assistance to practitioners in dealing with the many issues that occur in practice around trustee appointments, assumptions and removal, particularly where a trustee’s capacity is an issue.

Part 3 of the Bill sets out the powers and duties of trustees in one place, which pulls together the existing legislative position with much of the common‑law duties. Part 8 also consolidates the provisions from the 1961 Act on variations, together with some, but not all, of the common‑law principles, to assist where the Part 3 provisions cannot be used.

Common problems in trust law

Despite trusts being viewed somewhat unfavourably by potential clients, there is no shortage of trust matters coming across practitioners’ desks. The UK Trust Registration Service (TRS) deadline of 1 September 2022 is forcing many trustees to review trusts and seek legal advice when they perhaps would not have done so previously.

With that in mind, there are a few common trends practitioners may be seeing, such as:

• trustees who may have lost capacity to make certain decisions;
• settlors (or protectors) who have lost capacity and have powers exclusively reserved to them;
• trustees who are failing to engage and obstruct the administration of a trust;
• issues with off‑the‑shelf trust deeds that fail without trustees;
• a general breach of trust queries and beneficiaries concerned at a lack of information provided; and
• variations of trusts to avoid vesting dates or to give the trustees additional discretionary and administrative flexibility.

This article will consider each in turn and assess whether the Bill can provide much‑needed assistance to practitioners facing these challenges.

Incapacity and trustees

One of the areas of law that has developed over the past 25 years is that of adults with incapacity (known in Scots law as ‘incapax’). The 1921 Act does not adequately deal with issues where trustees have lost capacity and may be unable to exercise certain necessary powers.

Under s.3 of the 1921 Act, all trusts are held to include the provision that decisions must be made by quorum, which is defined as ‘a majority of the trustees accepting and surviving’. This, however, does not exclude incapax trustees and can lead to issues where trust decisions cannot be made if a majority cannot be achieved.

Some trust drafters have sought to displace the provision within the trust deed by defining quorum to be a majority of trustees ‘surviving and capable’ with provisions as to how capacity is to be determined. However, there are many trusts that have no such provision and those that do often put the onus on the trustees to determine who has, or does not have, capacity.

If a majority cannot be reached, the only alternative is to seek the removal of such a trustee via the court under the 1921 Act. Not only does this come with court expenses for the trust, but it excludes that trustee from ever participating in the trust again. For someone whose capacity is borderline and who may not be able to participate in all decisions, this is a very archaic black‑and‑white approach to capacity.

The Bill addresses some of these issues. First, a definition of ‘incapable’ is included at s.76 of the Bill, which closely reflects the Adults with Incapacity (Scotland) Act 2000, and refers to whether a person is capable of making, communicating, understanding and retaining the memory of decisions. In addition, s.12 of the Bill now states that trustees’ decisions are to be made ‘by a majority of those for the time being able to make it’ and that ‘a trustee is not to be regarded as able to make a decision who … is incapable’.

Capacity can, therefore, be determined on a decision‑specific basis, allowing incapax trustees to continue as trustees and participate, where appropriate, without hindering the administration of the trust. This should cultivate a more inclusive approach and may reduce the number of actions for removal. However, there remain issues of what evidence may be required to prove that a trustee’s removal was legitimate.

The Bill still includes provisions to remove incapax trustees, where appropriate, by a court action. However, it has also extended the ability to remove such trustees (under s.7) to allow a majority of ‘the other trustees’ to do so without recourse to the court and the costs involved with that. As this would exclude the incapax trustee, it would also allow a sole remaining capable trustee to remove their co‑trustee.

Settlor or protector incapacity

Similarly, practitioners will commonly face issues where powers have been reserved to a settlor or protector who has lost capacity. Typical examples include where a settlor has reserved to themselves the power to appoint and remove trustees during their lifetime or where a protector’s consent is required for such changes.

If a settlor or protector loses capacity and the trust deed does not make provision as to what happens in that event, they retain any reserved powers until their death. This can be problematic for trustees who cannot use a power that is at variance with the trust deed. Take, for example, a sole trustee who is keen to resign but is unable to assume a replacement trustee because the power was reserved to an incapax settlor.

Trustees have a few options under the 1921 Act, depending on the reserved power. If it is the power to appoint new trustees, s.19(2) can be used by a sole trustee to apply to the court to resign and have additional trustees or a judicial factor appointed. Alternatively, s.22 can be used to apply to have additional trustees appointed. For other powers, an application can be made under s.5 if the power would be available if not for the terms of the trust deed.

These remedies, however, require a court action, which adds a premium cost to the trust administration simply because the trust deed did not consider capacity when it was drafted.

The Bill does not expressly deal with the above scenario. However, it amends the provisions around trustees’ powers that would possibly solve these problems.

As it currently stands, the statutory powers cannot be used (without a court action) if they are at variance with the trust deed. If the Bill is enacted as currently drafted, it would allow trustees to use any of the new statutory powers (including the power to assume) ‘in a case where there is no trust deed, the context requires or implies otherwise …’

It is unclear what is meant by ‘[if] the context requires’ and this will certainly be open to interpretation. However, one would hope that it would allow trustees to act where a power was reserved to a settlor or protector who has lost capacity and that act is required for the administration of trust to continue. However, as incapacity is decision‑specific, whether the act is required would likely need to be determined in each case.

It is also worth noting that Part 7 of the Bill adds a legislative basis for protectors in Scotland, which would include the power for the settlor or the trustees to appoint a new protector if the existing protector is incapable or untraceable.^[4]

Removal of other trustees

Moving away from incapacity, the Bill also broadens the ability to appoint and remove trustees to avoid the requirement for court action in some, but not all, cases. Given the strains on court business and the continued backlog due to the COVID‑19 pandemic, this may be a welcome change.

As mentioned, the Bill would allow a majority of trustees to remove a co‑trustee without a court action in certain circumstances. Section 7(1) allows a majority of the other trustees to remove a trustee, but only where they are:

'(a) incapable,

(b) untraceable,

(c) convicted of an offence involving dishonesty,

(d) sentenced to imprisonment on conviction of an offence, or

(e) imprisoned for contempt of court or for not having paid a fine.’

In addition, a new power would be introduced to allow the beneficiaries of a trust to remove some or all trustees from office.^[5] However, all beneficiaries must be ‘absolutely entitled to the trust property’, identifiable, aged over 18 and agree, so it may only be beneficial in certain cases where vesting has occurred.

The major difference, and often major difficulty, between court‑sanctioned removal and the trustees’ ability to remove is that the uncooperative, neglectful or capricious trustee who purports to carry out their duties inconsistently with a trustee’s fiduciary duties can still only be removed by a court action. At present, the only recourse is to seek their removal via the nobile officium, which requires a petition to the Scottish Court of Session.

The case law around such removal requires something akin to ‘malversation of office’^[6] or ‘wilful neglect’ of their duties.^[7] The onus is on the petitioners to demonstrate the severity of the non‑engaging trustee’s neglect and why their removal is necessary for the administration of the trust. This can be a high bar for trustees.

The Bill would, however, give a legislative basis for seeking their removal under s.6. Parties can seek such a removal if a trustee ‘purports to carry out those duties but does so in a way which is inconsistent with, or might be inconsistent with, a trustee’s fiduciary duty, [or] … has neglected the trustee’s duties as trustee’. These provisions are an improvement, although it would be good to see reference to mediation as these cases are often caused by a long‑standing disagreement on a decision made years ago.

Unfortunately, even if successful, only a fraction of the expenses can be recovered from the trustee and the cost of pursuit of expenses may outweigh the benefit. It therefore puts a significant cost burden onto the trust.

Although the removal of a trustee ought not to be taken lightly, given the steps to allow the removal of incapax or untraceable trustees, the Bill provides greater assistance in these circumstances but still leaves the only route to remove an ‘unengaging trustee’ via the courts.

It is worth considering whether (unusually for Scots law, which tends to favour majority decision‑making) a statutory ability for an unengaging trustee to be removed by all the remaining trustees might be advantageous. There would have to be a minimum number of remaining trustees (say, two) so that at least they are a majority in any event. This would not be of any assistance if the trustees were divided, but at least the remaining trustees can register their dissatisfaction at the lack of or inconsistent activity of the one errant trustee if they all agree to do so.

Issues with pro forma trust deeds

Various investment companies have their own off‑the‑shelf pro forma trust deed to hold investment products (often life policies), which can result in issues where legal advice was not sought.

One of the most common problems occurs when the trustees appointed are also the lives assured. Unless this is addressed and additional trustees are added while they are alive, no trustees will exist to administer the actual trust fund after their deaths.

If the trust is a bare trust, it is possible for the executor of the last surviving trustee to administer the trust under the principles of s.6 of the Executors (Scotland) Act 1900 (the 1900 Act). It allows the executor to take title to the assets and distribute them to the beneficiaries ‘where no other act of administration remains to be performed’. Interestingly, this provision is not included in the draft Bill, so it appears that reference to the 1900 Act may still be necessary in those situations.

Where it is a discretionary trust, it is currently necessary to petition the court to have new trustees appointed under s.22 of the 1921 Act. The cost of doing so can sometimes outweigh the actual trust fund available, so with no economic benefit to appointing new trustees many policies will continue to be held by the providers indefinitely.

Inopportunely, the Bill does not provide any assistance in these circumstances. The ability to appoint new trustees remains with the court^[8] if the settlor is not alive to appoint new trustees.^[9] Although the Bill does give beneficiaries, who are absolutely entitled under s.8, the power to remove trustees, no provision has been added to allow such beneficiaries to appoint trustees. In the case of a bare trust, to which s.8 applies, it would be beneficial for the Bill to facilitate the transfer of assets directly to the absolutely entitled beneficiaries without having to wait on the confirmation (probate) process being completed.^[10] Otherwise, we are left in the same position as we are in now.

Trustees’ duties

Contentious trusts and executries have also been on the rise over the past decade and many practitioners will come across beneficiaries seeking to challenge actions by trustees.

At present, the law around trustees’ duties and breach of trust is cemented in common law. There is no statutory definition of what duty of care is owed; in fact, the word ‘duty’ does not appear in the 1921 Act and ‘duties’ is only mentioned with reference to the s.4A insertion relating to investments in the 2005 Act.

That said, the 1921 Act does provide two defences for ‘breach of trust’ in the form of ss.31 and 32. These give trustees a reprieve from having committed a breach of trust if it was instigated by or done with the consent of the beneficiaries, or where a court deems that the trustees acted ‘honestly and reasonably, and ought fairly to be excused’.

The Bill, if enacted, will give a statutory basis for trustees’ duties while also effectively restating and expanding on the existing defences available. We discuss ss.25 to 31, relating to the duties to disclose, duty of care and fiduciary duties, in more detail opposite.

Duty to inform and disclose

There has always been debate in the profession, which can be seen in the Commission consultations, as to what information trustees have to provide to beneficiaries and when.

The authority we have at present comes from Lord Clyde in Nouillan v Nouillan’s Exrs,^[11] in which he noted ‘trustees [are] bound to give a beneficiary full information about their administration and let [them] see the vouchers as well as the accounts’. The separate Prescription & Limitation (Scotland) Act 1973 makes the duty to account imprescriptible.

Beyond that authority, however, there is very little case law as to what information ought to be given to beneficiaries. The Report considered the English and Welsh position and some of the case law (Schmidt v Rosewood^[12] and Breakspear v Ackland^[13]), but the Commission did not wish to take an approach that would require or encourage trustees to go to court, except where necessary. The recommendation was, therefore, to provide a list of documents that should be made available, including documents confirming who created the trust, who the trustees are, trust accounts and vouchers, and investment reports.

The Bill, however, does not provide a list of documents that ought to be given, other than trustee names and contact information. Instead, it states that trustees have a duty to disclose ‘information requested by the beneficiary … unless the trustees consider it would be inappropriate’, leaving the onus on the trustees. It does go on to confirm at s.25(6) that certain information can generally be excluded, including information on other beneficiaries, reasons for decisions and letters of wishes.

Subsections 25(7) and 25(8) then allow recourse to the court for directions from the trustees on a disclosure or for beneficiaries to query a disclosure that was denied. This appears to encourage the use of the court, in contrast to the Commission’s previous commentary. Given the sheer volume of contentious matters arising, this may have the unwanted effect of court actions being raised or threatened to force trustees’ hands in the matter to avoid the costs of litigating.

Interestingly, there is also no duty to account specifically mentioned within the Bill. It therefore appears that the existing common‑law requirements will continue to prevail and that the Bill is merely silent on this.

A higher bar for professional trustees

Section 27 inserts the duty of care owed, reflecting the common‑law test that trustees should ‘exercise such care and diligence as any person of ordinary prudence would exercise in managing the affairs of another person’. However, it goes further to add a higher bar for professional trustees.

The Report did recommend that professionals should owe a higher duty of care, but the responses from the profession were divided. The Bill, as currently drafted, states such parties need to ‘exercise such skill, care and diligence as it is reasonable to expect from a member of the profession in question’. The Report suggested using the Hunter v Hanley test,^[14] and it may be that is how the duty will be considered in practice, if enacted.

This could cause issues where professional trustees are, unbeknownst to them, appointed to a trust that has been inactive for a number of years and therefore fail to provide advice that would be expected from their profession.

Take, for example, a solicitor who is asked to accept office as a trustee for a client who created a discounted gift trust but has never had any ongoing involvement. Would that solicitor still be held to owe a duty to advise on legal and tax requirements? It would appear so. A court may take a dim view if the solicitor claimed they did not know of the appointment or the duties owed having signed to accept office.

Contrast this with a will trust, where a professional is named as executor, that comes into effect on death regardless of whether the trustee knows or accepts office. The trust may be in existence without the professional trustee’s knowledge. The usual defences should, therefore, be available. However, if the solicitor knew of the death and the terms of the will, the higher duty of care appears to put the onus on the solicitor to ensure advice is given.

Therefore, any professional or business with a trustee company may need to consider risk‑management strategies for these scenarios if this is indeed enacted. The TRS should, however, address issues where trusts are effectively dormant due to the type of asset held, as trustees will be reminded about registration.

Trustees with conflicts of interest

Because trusts are such a useful planning tool, they are often used in will drafting. However, the choice of trustees for trust‑law purposes is often not considered. This is commonly seen with trusts created for a spouse or civil partner after a first death, where they are appointed as trustee or where children are appointed as the only trustees on a second death. Such parties would have a conflict of interest if they wished to appoint in favour of themselves.

If there are no non‑conflicted trustees, or not enough to reach a majority, problems can arise. In practice, there are ways around this: appointing additional trustees, replacing the conflicted party or doing multiple appointments to multiple conflicted parties. Some wills will also include provisions that conflicted parties may participate in a discretion in their favour, provided there is at least one other trustee not so favoured.

If appointments have been made from a will without conflicts of interest being considered, a trustee who has appointed the trust fund to themselves is, effectively, in breach of trust. If that occurred, a trustee could perhaps rely on the s.32 defence and claim they acted honestly and reasonably, particularly if legal advice was sought or if they were following a letter of wishes, but trustees ought to avoid finding themselves in this position.

The Bill incorporates sections specifically on breaches of fiduciary duty at ss.28 to 31, although it does not define fiduciary duty. Section 29(2) confirms that the statutory position applies ‘without prejudice to any provision of a trust deed which authorises a particular transaction, or a particular class of transactions, which but for that authority would constitute a breach of a fiduciary duty’. This should, therefore, mean that provisions in trust deeds allowing conflicted parties to participate in such decisions will continue to be permissible, albeit the section refers only to ‘transactions’ rather than trustee decisions.

As more wills incorporate trusts to offer flexibility on death, the more such issues will arise. Practitioners ought to take this into consideration at the will‑drafting stage, but also latterly when any trust decisions are made.

Variation of trusts

Part 3 of the Bill also includes the general powers of trustees from the existing 1921 Act and 2005 Act. However, much like at present, the terms of the trust deed will prevail, so the Bill will not remedy issues with historic and inflexible trusts. As explained, trustees will be able to use powers where ‘the context requires’ even if they are at variance with the trust deed, but there are still various powers that can only be conferred within the trust deed.

The variation of trusts has become increasingly common of late. On discussion with counsel, this is typically to delay a vesting date and avoid triggering a capital gains tax charge. However, there are many variations required because the terms of the trust deed are restrictive and the trustees need the flexibility or powers to effectively manage the trust and plan efficiently for payments to beneficiaries or for tax reasons.

There are several ways that trustees can currently vary a trust:

• unilaterally, if they have the power to vary expressly given to them in the trust deed;
• with the agreement of all of the beneficiaries under the common‑law ability to vary;
• using one of the 1921 Act sections to avoid a full‑scale variation; or
• petitioning the court for a variation under the 1961 Act.

Where agreement cannot be reached because there are parties who cannot consent to it, s.1 of the 1961 Act allows the court to approve a proposed variation, but with the caveat that the court ‘shall not approve an arrangement … unless it is of the opinion that the carrying out thereof would not be prejudicial to that person’.

This is slightly different to the position in England and Wales, which requires the court to be satisfied that the proposed variation would benefit the beneficiary. Under Scots law, there is no requirement to show any such positive benefit.

The drawback to a variation is that it must be done in the Inner House of the Scottish Court of Session (which acts as a court of appeal). Even if all parties lodge minutes of consent, the court tends to require a hearing and counsel for all parties are still required to appear (per Findlay, Petrs).^[15] Finding a date when the court can convene a three‑judge bench and when all counsel can attend can be challenging and add unnecessary delays.

Although the same firm of solicitors may act for multiple parties, different counsel are required to represent their interests with the court (per Lord Clyde in Robertson Petr).^[16] With multiple parties involved, all of whom need to appear for the hearing, the costs soon mount up.

Variation is covered within Part 8 of the Bill, which includes a section to replace the common‑law position to allow variation with the agreement of a beneficiary at s.55, provided the beneficiary is over 18. Usefully, s.55(4) also confirms that attorneys or guardians (or other jurisdictions’ equivalents) can approve a proposed arrangement, albeit this will depend on the powers they have.

If agreement cannot be reached, s.55(5) replaces the 1961 Act provisions to allow the court to approve on behalf of persons who cannot consent. Section 56 also reflects the wording that approval can be given if ‘the arrangement in question would not be prejudicial to the person on whose behalf the approval is sought’, so it thankfully does not raise the bar required.

It also adds a statutory basis for the position set out in Phillips Petrs,^[17] regarding remote or contingent beneficiaries whose potential interest in the trust is negligible within s.57, which confirms trustees will not be liable to such persons.

The main reprieve to trustees from the Bill is that such actions can now be raised in the Outer House of the Scottish Court of Session (generally the court of first instance). This should lessen time delays, as it will not require a three‑judge bench. However, the Bill does not go so far as to detail whether counsel will be required to attend a hearing or if separate counsel would be required to represent different interests. The current common‑law provisions will likely continue to be relevant when pursuing variations via the court.

Summary

Although an overhaul of Scotland’s trust law is long overdue and the Bill will go a long way to consolidate much of it in one place and bring it up‑to‑date with incapacity laws, there will continue to be generic problems practitioners face that will still require court intervention.

As has been identified within this article, the Bill, if enacted, will not be the one‑stop‑shop for trust law, as hoped, and reference to various common law and other Acts may still be necessary.

That said, it remains to be seen whether this Bill will be progressed (as promised) in this parliamentary session, or if it will be shelved once again, leaving practitioners and other users of trusts to continue to cope with the raft of issues highlighted.