Among a trustee's numerous powers, the exercise of its power of appointment is one it will most often be asked to consider exercising. It is also the power that will come under the most scrutiny from beneficiaries.
This article seeks to provide an overview of the key considerations for trustees when deciding whether to exercise their power of appointment, along with practical steps to ensure compliance with the trust instrument.
When first considering the exercise of any power, it is essential that the trustee review the settlement instrument (and any variations) to confirm both the scope of the power and any potential limitations. This will usually include checking:
- Who can exercise the power? Although it will usually be the trustee, it is possible for the settlor to reserve the power of appointment in certain circumstances.
- Is consent from a third party required? For instance, the trustee may need to obtain the consent of a protector before exercising their power. If so, there may be a specific process that must be followed to obtain the protectors consent, for example the trust instrument may detail how consent is to be given and the timing of such consent.
- What formalities must be complied with? Even if formalities appear to be purely administrative (for example, certain signing requirements), these formalities must be strictly followed to avoid any risk of invalidating the exercise of the power.
- Appointments to another trust - If the trustee wishes to make an appointment to another trust, the trustee should check for any restrictions on appointing assets to another trust, such as the degree of commonality of beneficiaries that is required, and how excluded persons are to be treated.
- Beneficiaries who are minors - If the exercise of power is to benefit a minor, the trustee should review the terms of the trust instrument to determine if distributions can be made directly to a minor or whether the appointment must be made to a parent or guardian.
At an early stage the trustee should also consider whether there will be any tax implications on either the trust or the beneficiary receiving the funds. In these situations, the trustee should obtain appropriate tax advice before finalising their decision.
Trustees will also need to consider whether an indemnity is required, particularly when distributing assets to beneficiaries and if there are any chain indemnity obligations. Where there is any doubt about the scope of the power under the Trust Instrument or the need for indemnities, advice from the trustee's legal advisors should be obtained as early in the decision-making process as possible.
Once the trustee is satisfied that it has the power to make an appointment and any limits on the exercise of power are understood, the trustee must then decide whether it is appropriate to exercise the power of appointment. In making this decision, factors for the trustee to consider include:
- The financial status and needs of all beneficiaries, including any anticipated future needs of the beneficiaries (not just the intended recipient beneficiary). For instance, if the trust has relatively low liquidity and the trustee is aware one of the beneficiaries is going to require financial assistance in the near future, the trustee may decline a distribution to a more financially stable beneficiary until it has more fully assessed the needs of the financially vulnerable beneficiary.
- What is the rationale for the establishment of the trust, and would the appointment be consistent with the rationale of the trust?
- Any letter of wishes or similar guidance from the settlor, which may include guidance on when and in what circumstances distributions should be made.
- The size of the potential distribution comparative to the trust fund and the trustee's ability to meet ongoing trust expenses.
- The trust's liquidity and whether it can accommodate the distribution.
- The purpose of the appointment and what the most appropriate way to the pay the funds are. For example, when considering whether the pay school fees of a minor beneficiary, it may be more appropriate for the trustee to pay the fees directly to the school as opposed to a parent, particularly if that parent is not a beneficiary of the trust.
This is not an exhaustive list and ultimately the factors relevant for the trustee to consider will be dependent on the particular trust, its beneficiaries and its assets. The relevance of these factors can also change over time, so what may have been a relevant consideration for one distribution, may not be relevant to a future exercise of power.
In all cases, the trustee must be careful to avoid irrelevant considerations and remain impartial, taking care not to favour one beneficiary over another improperly unless this is expressly permitted by the terms of the trust.
Even if beneficiaries are pressuring the trustee to decide, the trustee must take the time to gather all relevant information before making a decision. Where distributions are made regularly, it is also important that the trustee undertakes a fresh assessment each time, as although it may have previously been appropriate to make an appointment to a beneficiary, it may not continue to be appropriate if circumstances change.
Finally, once a trustee has made its decision, it should ensure that it has fully documented its decision and the factors it relied upon in making its decision. This is ordinarily done by way of a trustee minute or resolution. Taking these steps will ensure any decision by the trustee has been fully considered and will reduce the risk of the trustee's decision being challenged in the future.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
