Asset Protection

“Disappointed” Protectors

By Shân Warnock-Smith QC and Andrew De La Rosa, Attorneys and Barristers at Law, ICT Chambers, Cayman Islands (01/06/2016)

At the start of a trust structuring exercise, there are often very good reasons for considering and, if thought fit, including provision for someone to fulfill the role of trust protector or for the constitution of a protector committee. A very wide range of powers may be conferred on a protector or protector committee although it is relatively common for authority to be limited to the protector’s right to grant or withhold consent to certain trustee decisions and/or to remove and replace the trustee.


Two related reasons often encountered in practice for making this or other such provision are that it can (a) facilitate the maintenance of settlor control over the operation of the structure, whether or not the settlor him or herself is appointed protector or a member of such a committee, and (b) assist in reassuring a settlor that certain dispositive powers of the trustee, such as a power of advancement, will be exercised in accordance with the settlor’s own design for the longer term operation of the structure.


Point (b) reflects what is often a tension between a settlor’s fairly fixed and definite ideas about how a trust structure should work in the future and the need for flexibility to deal with changes in circumstances. This is particularly important in a climate where the increasing fiscal and regulatory burdens on trusts and trustees may require the structure to be adapted over time in order more effectively to fulfill its basic objectives - or indeed to fulfill them at all.


So the appointment of a protector may in fact be something of a compromise, that is, a means to accommodate a settlor’s wish for certainty with enough flexibility to ensure that the structure does not run aground, perhaps especially after the settlor is off the scene and the beneficiaries’ respective situations are different from what they were thought likely to be when the trust was created.


In light of the above, perhaps it goes without saying that the identity of the protector (or identities of members of the protector committee) and how succession to the protectorship is determined can be just as critical as the exact scope of the authority conferred and whether in a given case it has been validly exercised.


In that context, it is unsurprising that issues as to who is entitled to act as protector as well as the proper exercise of a protector’s powers have been the subject of litigation, some of it truly hostile in character and other cases more in the nature of a co-operative effort to resolve an uncertainty affecting the trust’s administration.


There is no shortage of examples of litigation of both kinds. We refer to four cases below including three that are very recent. But a useful starting point, both in terms of relevant principles and as an illustration of how litigation of this kind can and does arise, remains the Grand Court’s decision in Re the Circle Trust [2006] CILR 323, a decision of Henderson J.


The underlying dispute was an all too typical family conflict between the various beneficiaries of a trust of a paper manufacturing business that had been founded in China and Hong Kong. The trustee, HSBC International Trustee Ltd., sought the court’s determination of a number of preliminary issues, which included some that related to the nature of the duties of the protector of the trust. The terms of the trust included provisions permitting a majority of the beneficiaries who were of full age and capacity to appoint an additional protector where an original protector had not been appointed. The majority, comprising the wife of the founder of the business and two of his children, purported to appoint the founder as protector of the trust. Their practical purpose in taking this course was to seek wrest control over the litigation from the trustee. The minority beneficiaries, comprising the founder’s other two children, contended that the appointment of their father as protector was invalid, principally on the grounds that it had been carried out irrationally and not in good faith.


Mr Justice Henderson took the view that while under the express terms of the trust and in the particular circumstances it was indeed open to the majority of beneficiaries to appoint a protector, that was a power that was fiduciary in character, in the same way that a power to appoint a trustee is normally a fiduciary power, the exercise of which is controlled by ordinary equitable principles, including the obligation of the appointor to act in good faith. The judge did not see any relevant distinction between the two powers and proceeded to consider the appointment and the related question of the protector’s power to remove the incumbent trustee and appoint a replacement in the light of those equitable principles. In the event the judge held that the protector could only exercise that power in the interests of the beneficiaries as a whole. The judge also went on to express the view that the court has an inherent equitable jurisdiction to remove and replace a protector if he or she failed to exercise a fiduciary power.


The strategy of appointing the founder as protector thus failed to achieve its practical object. An opportunistic or tactically motivated appointment of this kind is likely to be open to challenge for falling foul of the basic rule that trustees and other fiduciaries acting in the administration of a trust must exercise their powers for the benefit of the trust as a whole and not for one particular faction of the beneficiaries.


A rather similar factual background lay behind the Royal Court of Jersey’s decision in the recent case of Re Piedmont & Riviera Trusts; Jasmine Trustees Ltd. v.  L [2015] JRC 196.


In that case the incumbent protector of the trust was the father of the beneficiaries, who included two of his sons and a daughter. The father purported to exercise express powers under the trusts to appoint both new trustees and new protectors as his successors. This was done against the background of a long-running dispute between his children, the sons on the one and the daughter on the other.


The Royal Court overturned the decision of the father to appoint new trustees and new protectors on the basis that the decisions made were irrational and a breach of fiduciary obligations.   One particular point on which the court laid some emphasis was that in purporting to appoint a new trustee, the father had failed to take into account the lack of expertise, experience and financial substance of the new trustee.   Accordingly, the original trustees remained in office.  We comment further on this point below.


The father also sought to appoint his two sons as the new protectors but as the daughter was engaged in litigation with her brothers and as her brothers had historically acted in a way that was not independent from their father, the relationship between the parties had irretrievably broken down. In those circumstances, the Royal Court held that the purported appointment of the brothers as protectors was likely to have a seriously detrimental effect on the administration of the trusts, with the daughter inevitably challenging any decision taken by her brothers in the future.


The Royal Court stated that when exercising such a fiduciary power of appointment, the appointor is under a duty to act as follows:


  1. in good faith and in the interests of the beneficiaries as a whole;
  2. reasonably;
  3. taking into account relevant matters, and only those matters; and
  4. not for an ulterior purpose.


The test for irrationality was that the challenged decision should be: “outside the band within which a reasonable disagreement is possible and is accordingly a decision to which no reasonable appointor could come.”


While we see no difficulty with the Royal Court’s overall approach in this case, and it is not difficult to see why it reached the decision it did on the facts before it, we have some reservations about the emphasis laid on the alleged lack of standing and substance on the part of the new trustee. Where one professional trustee is appointed in place of another, in the great run of cases it is likely to be unproductive to contend that the incumbent trustee is in some way better qualified to carry on the trusteeship from which it is sought to be removed than the proposed replacement trustee. This strikes us as a recipe for the court to be drawn into side issues that do not bear directly on what is in the best interests of the trust as a whole and whether the test for irrationality referred to above is satisfied or not.


A protector seeking to maintain herself in office was part of the essential background to the Guernsey case of In the matter of the K Trust (unreported as yet so far as we are aware, Guernsey judgment 31/2015, 14 July 2015).


Following the death of the settlor of the trust, the relationship between the settlor's widow (the primary beneficiary) and protector, initially friendly, began to break down. Eventually, various requests for the protector's resignation were made by the widow and by other family members who were also beneficiaries under the trust to the protector and to the trustee.  The protector, who was not herself a family member, initially refused to entertain the idea of her removal. She confirmed that it was her understanding that she had been chosen as protector precisely because of her separation from the family members, but that she would be willing to retire so long as a properly chosen, suitably qualified replacement was found.


Ultimately, the Deputy Bailiff was satisfied that the breakdown in the relationship between the beneficiaries and the protector was such that both the administration of the trust and the beneficiaries' welfare were being adversely affected. The application for removal was granted on that basis.


Finally, and most recently, the Grand Court has again been concerned with issues concerning the appointment of a protector in the unreported decision in Re the Y Trust No. 1, per Smellie CJ, 19 January 2016. In that case, a trust created in December 1982 named as first protector of the trust the settlor, a foreign company, on terms that (a) required the protector’s consent to the appointment of new trustees and (b) permitted the trustees to appoint a new protector but only if there had been a vacancy in the office of protector for one month. In fact it had been intended that another foreign company other than the settlor be appointed first protector and a deed purporting to appoint that another company as protector was executed on the same date that the trust was created. Unfortunately, the deed was invalid under the terms referred to above as there had been no vacancy in the protectorship. The mistake was not discovered until some 30 years after the creation of the trust, by which time there had been purported retirements and appointments of additional trustees.


The upshot was that potentially every act of trust administration over a 31 year period, including distributions to beneficiaries and investments of trust assets, was invalid. Fortunately the Chief Justice held that the relevant retirements of two of the original trustees had been validly achieved without protector consent. The result was a victory for common sense and a huge relief all around.


As usual, the Caribbean region is at the forefront of leading cases in this area.  Protectors have for many years been a very popular weapon in the armoury of planners in the region and when the arrangements work well, as they usually do, they offer a high level of comfort for all concerned.   When they don’t ….. well, watch out for trouble.