Trusts and Incapable Trustees – Pitfalls and Procedures
When we discuss capacity in a legal sense, we are usually talking about the mental capacity to make a decision or act.
What is capacity?
Capacity is decision dependant in that you may have the understanding to make day to day decisions about yourself, but when it comes to more complex matter such as finances, you struggle.
This might mean you fail to understand your financial worth or cannot retain information – even if you understand your assets when in discussion.
In legal terms this has been defined in case law as being of unsound mind.
Today, age or infirmity might also play a role. If a person lacks capacity for the purposes of the Mental Capacity Act 2005 (MCA 2005) then they are likely to be considered unsound for the purposes of section 36 Trustee Act 1925 (TA 1925), an important clause that we will come to later on.
Now imagine the situation if it were not your own funds, but assets in a trust that you are responsible for (either alone or with other people – your co-trustees). The trust funds do not belong to you, but perhaps to a family member whether under a lifetime settlement or a will trust. You might be concerned about a co-trustee who has started to experience memory problems or be that trustee yourself.
A trustee who lacks the necessary capacity to make decisions will be unable to exercise powers to effectively manage the trust and its assets. An incapable trustee cannot exercise powers to change trustees or transfer property to his successors. An incapable trustee cannot simply retire or be voted out but must be formally removed from the trusteeship. The trust cannot be run effectively as all trustees, not just a majority, must consent to any action in relation to the trust. It flows that there may be adverse tax consequences and financial loss should the trust not be properly managed.
The trust deed itself may also stipulate that a trustee may delegate his trustee functions. The office of a trustee is, as its name would suggest, a position of trust and should be held by a person who has capacity to both act and decide when and what functions to delegate. Any delegation should be temporary and with clearly defined limitations. It is always better to remove a trustee who cannot properly perform his duties than to risk exceeding the bounds of authority, resulting in any decision being invalid.
Prior to 1925, there are a number of cases exploring trustee powers and definitions of capacity and being long winded and expensive along the way. Thankfully, the law now sets out defined means of arranging for the incapable trustee to be removed from their position.
Procedures for removal
Express Powers in the Trust Deed
The trust deed itself may contain provision for a trustee to be removed. This is more common in off-shore trusts and rarely found in domestic trusts. As capacity issues are becoming more prevalent, it is advisable to consider including such provision in any future trust deeds, or as an addition to an existing trust deed where the current provisions allow such amendments. An express power would ideally state that a trustee automatically ceases to be a trustee on losing the mental capacity to act.
The most common method of removal is the implementation of section 36(1) of the TA 1925. This allows the original appointor of the trustees or the current co-trustees to remove the trustee as being incapable of acting having lost mental capacity. Where the trustee has an interest in possession in the trust property and co-trustees are making the appointment, they must obtain the permission of the Court of Protection under section 36(9) TA 1925. The power allows another person to take the place of the original trustee who can no longer act. It is not possible to use this power to simply ‘force retire’ an incapable trustee as there must be someone willing to take over the role.
In the event that there is no suitable replacement for the trustee to be removed section 36(1) cannot be used.
It is possible for a new trustee to be appointed as a replacement and immediately retiring under section 39 TA 1925 in order to simply remove the problem of having an incapable trustee, however as the TA does not provide a direct route for this to occur this does not suit well and it must be considered whether there are any grounds for any claims against any of the trustees in these circumstances, such as a fraud on power.
Beneficiary Directed Removal
In the event that there is no one entitled, willing and able to replace the trustee under the replacement procedure in section 36(1) TA 1925, section 20 Trusts of Land Appointment of Trustees Act 1996 enables beneficiaries to direct the replacement of a trustee who lacks capacity. The beneficiaries must all be over 18, all have capacity to make the decision themselves, and as a group, they must all be absolutely entitled to the trust property. Once in agreement, the beneficiaries can promote an attorney, deputy or other person authorised by the Court to act as a new trustee in their place.
Lasting or Enduring Powers of Attorney (LPA/EPA)
Many people will find that they are a trustee of land, even if they were not aware. If you own a property with any other person, you are holding the land on trust for the beneficiaries. The beneficial owners of the land (those who have the can benefit from the funds held in the property and the right to live there) might be the trustees or other people. Consider the common example of a couple (whether married, in a civil partnership or unmarried) who own a property together for themselves. If one of them should lose capacity, the co-owner cannot sell the property or raise a mortgage secured on that property. In limited circumstances, the attorney of a trustee co-owner who is incapable can use a registered LPA or EPA to appoint an additional trustee. Ideally the EPA or LPA will have a second independent person appointed so that this is possible immediately.
Powers of the Court
The Court has the power to replace or remove the trustee under section 36(6) TA 1925. This is the safest route where there is doubt over whether the trustee lacks capacity. The Court can also use its inherent jurisdiction but this it is considered to be an extreme remedy and inappropriate in most cases. The Court will only consider the matter as a last resort after all other avenues have been explored and rejected. There are also time and cost implications to consider when approaching the Court to resolve an issue.
I have discussed these issues from the point of a trustee who has to deal with the problem of incapacity. It is possible for a Testator of a Will or a Settlor of a Trust to anticipate these problems.
A Donor of an LPA can add ensure that their attorneys have the power to act.
Look at your Will, LPA or Trust Deed – is it fit for purpose? Does the document enable your trustees to act swiftly in the event of the loss of capacity of one of their number? If there is any doubt, have your documents reviewed by one of our team – it can save a lot of heartache and money in the future.
Lindsay Taylor is a Solicitor in our Wills, Trusts and Probate team.