Differing expectations

28 February 2017

Written by Michael Betley

It is important to be aware of retiring trustees' indemnity requirements when domesticating a foreign trust, writes Michael Betley, Group Chairman at Trust Corporation International.

Taxation policy changes in the US, as in other Western economies, have achieved the desired effect of encouraging the repatriation of assets. A combination of heightened international tax reporting together with the cumulative and penal effects of tax non-adherence in foreign trusts has created a wave of international trust and estate planning, with an increasing number of foreign trusts being domesticated.

While the transfer of trusteeship from an incumbent trustee to its successor is both common and simple, by the time you add the international cross-border element and the differences between the onshore and o shore practices and law, the complexity of the process increases significantly.

In the context of the offshore world, an outgoing trustee will require a full indemnity before releasing any trust assets. Similarly, a US trustee will want a full reconciliation of the accounting history and conduct of the trust before agreeing to act. As such, the differing positions of a US successor trustee and a retiring foreign trustee need to be understood to avoid unnecessary delay and a mismatch in expectations.

Transferring trustee risk

Foreign trusts often hold complex financial investments and may have a multinational class of beneficiaries. As trusts cannot contract in their own right, it is the trustee who takes on the contractual liabilities with third parties and, in doing so, is personally liable. This liability also extends to other acts and omissions by the trustee, and to beneficiaries for any breaches of trust. The trustee will have primary liability for any taxes arising in respect of the trust and for any tortious claims stemming from trust fund assets.

Trustees rationalise the acceptability of these risks based on being remunerated; holding assets to off set liabilities; and the inherent protection afforded to them either by law or the terms of the trust.

While trustees retain control of the trust property, they can meet any properly incurred liabilities; however, when a trustee is removed or replaced, they no longer have control of the asset base but continue to be personally liable for matters arising during their trusteeship. It is the risk of not being able to meet unforeseen liabilities from the trust fund or from assets no longer under the trustee’s control that drives retiring trustees to seek, and in some cases strengthen, protective indemnities before relinquishing trusteeship and the control of the trust assets.

The handover

The usual starting point is that the retiring trustee should remain entitled to the same degree of protection they had during the course of their trusteeship. A trustee has a general right to be indemnified out of the trust fund for administrative expenses and other liabilities that are properly incurred to mitigate personal liability, both while in office and subsequently. A trustee may usually rely on their ‘lien’, should that option be available,1 which often takes priority over the rights of the beneficiaries, and the extent to which there are assets sufficient to cover the right of reimbursement or exoneration.

While relying on the right of reimbursement through the trustee’s lien is helpful and a trustee’s primary protection regarding costs and liabilities properly incurred, it is customary in the off shore arena to seek more specific protection.

In many offshore jurisdictions, there is no statutory lien for a former trustee to rely on. In addition, enforcing non-possessory liens when the successor trustee is in another jurisdiction presents other challenges. It is therefore standard practice in the offshore world for an outgoing trustee to seek express contractual covenants for indemnities from the incoming trustee.

One would expect professional trustees to behave reasonably in respect of the protections sought, but it will depend on the likely nature and quantum of any potential liabilities; the nature of, and risks associated with, the trust fund assets; the scope of activity undertaken; and the relationship between the outgoing trustee and the beneficiaries.2

The scope of any indemnity will be limited and – in Guernsey, for example – will not extend to liabilities arising from breach of trust or fraud, wilful misconduct or gross negligence, for all of which the trustee remains personally liable without a right of reimbursement. In all other circumstances, an outgoing trustee can seek to be exonerated.3 Any continuing or incoming trustee’s liability will usually be limited to the value of the trust fund and any capital distributed to beneficiaries or transferred to successor trustees who themselves have not entered into like-for-like indemnities. These covenanted or chains of indemnities are common offshore, but the scope is usually limited in time or value by allowing a proportion of the capital to be periodically distributed within the restricted period.

Traps to look out for

For US trust and estate advisors, it is standard practice to manage the tax issues surrounding the use of passive foreign investment companies, and the need to regulate the attribution and payment of annual distributable net income. Most foreign trustees, however, are unfamiliar with these concepts and potential tax traps for US beneficiaries.

How then, in these circumstances and when considering domestication, will US successor trustees and beneficiaries view the rights and entitlement to indemnification applied to retiring trustees? It may be that the only way an incoming US trustee is willing to take on such a trust and provide a release and waiver of liability to the outgoing trustee is by petitioning the relevant state court to issue an order for accounting and seek its blessing of the indemnities to be given.

The Uniform Trust Code (UTC) offers direction on the extent to which trustees (including retired trustees) can be exonerated and indemnified.4 While 34 states have enacted the UTC,5 the relevant provisions of each state need careful examination to allow for the differing approach that it may have adopted.

A question worth posing at the outset is: will an incoming trustee under the relevant state law be able to give the same degree of indemnity or exoneration that either the retiring trustee expects or is entitled to under the current law and forum?

Situs of the trust

Trust domestication, or the shift of the situs of the trust, is the change from one jurisdiction to another. In the US context, domestication usually helps reduce future income tax liabilities of the US-based beneficiaries and often occurs on the death of the grantor or as part of a family’s pre-immigration planning programme.

What is relevant in the context of the relationship between the outgoing (foreign) and US successor trustee is whether the trust remains intact and changes its situs, or the original trust is decanted into a new US trust, thereby changing its characteristics. The differences between jurisdictional statutes and the increasing use of private trust companies result in a series of new issues that need to be addressed. There is also a trend in the US towards ‘directed trusts’, and a desire to separate functions to regulate investment management and control distributions.

This change in the trust architecture might only be achieved through decanting into a new trust or a change in proper law, rather than a situs shift.

So, what would an outgoing trustee expect or be entitled to? The aim of an indemnity is to relieve the retiring trustee from liabilities from which they would have been properly entitled to indemnify themselves out of the trust fund had they remained as trustee. As such, the right of the outgoing trustee must be to maintain a position where they are no worse off than they would have been had they remained as trustee and maintained control of the trust assets. They should not be placed in a better position than they would otherwise have been or if they had never been trustee in the first place. As a consequence, although an incoming and continuing trustee may be aware of the aims and expectations of an outgoing trustee, as regards indemnities, differing jurisdictional and case-specific constraints may affect what can reasonably be given by a US successor trustee.

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1 Trusts (Guernsey) Law, 2007, s44. Jersey, meanwhile, does not have liens embedded in its statutory trust law

2 The process of negotiating indemnities is a well-trodden path. The book A Practical Guide to the Transfer of Trusteeship is a useful reference for retiring and successor trustees and their advisors

3 Trusts (Guernsey) Law, 2007, s39

4 Uniform Trust Code (as amended in 2010), article 10

5 Uniform Law Commission, www.uniformlaws.org

An original version of this article was first published by the STEP Journal, February 2017.

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