Dealings in trust property by interested trustees
– Fenwick v Naera (SC)
An important principle in the law of trusts is that a trustee must not, with some very limited exceptions, place themselves in a position in which duty and interest conflict. This is known as the rule against self-dealing.
The Supreme Court has recently considered this rule in a decision in the context of ahu whenua trusts established under the Te Ture Whenua Maori Act 1993 (Act). While some aspects of this decision deal with the particular scheme of the Act, the decision also provides a useful illustration of how, in certain contexts, trustee can fall foul of the rule against self-dealing despite having no improper intentions.
The case involved three Maori trusts, including a trust called the Tikitere Trust. The trusts resolved to enter into a joint venture arrangement with each other and with a company owned by one of the trusts. The joint venture related to geothermal power generation and benefits to the trust parties included lease payments for the use of trust land as well as shares and/or royalty options.
As is common in the ahu whenua trust context, some trustees also held beneficial interests in, or links to, the other trust parties. Beneficiaries of the Tikitere Trust brought an action against some of the trustees alleging that their participation in decision making in relation to the proposed joint venture was in breach of the Act and of the common law rule against self-dealing.
The alleged conflicts
Three trustees were alleged to have been in a position of conflict:
- Mrs Emery was alleged to be conflicted because her husband was a trustee of one of the other trusts involved. The Supreme Court did not consider that this was a conflict as neither she nor her husband had any beneficial interests in any of the trust.
- Mrs Fenwick, as well as being a trustee of the Tikitere Trust, was a trustee and beneficiary of one of the other trusts (holding around 4.71% of the shares of that trust). The Supreme Court considered that Mrs Fenwick had a conflict between interest and duty and should not have participated in the decision-making.
- Mr Eru was a trustee of the Tikitere Trust and another of the involved trusts. He also held an interest in the Tikitere Trust of 0.12%, and had a beneficial interest in a trust that held a very small interest in another of the trusts involved. The Supreme Court considered that Mr Eru may have been conflicted and remitted the matter to the Maori Land Court to determine.
The trustees' arguments on appeal
The trustees argued that the Act provided a complete scheme for dealing with trustee participation in decision making and the common law rules were therefore inapplicable. However, the Supreme Court considered that general principles of trust law were applicable in the ahu whenua context. The trustees then sought to narrow the application of the rule against self-dealing by arguing that:
- The rule should be confined to purchases only;
- A "limited beneficial interest exception" applied; and
- The trustees should be excused because they were placed in conflict by the terms of the Trust Deed.
Is rule against self-dealing confined to
The trustees argued that the rule against self-dealing was only applicable in contexts in which the transaction in question was a purchase. The Court rejected this argument.
The Court said that there are cases in which it had been applied more widely (for instance, loans or leases of trust property to trustees) and such a limitation was not consistent with the language in the Act. Further, there was no principled reason to limit the rule in this way: "at its most basic level, the self-dealing rule is based on the no-conflict rule: having an interest or duty on both sides of a transaction".
Does the "limited beneficial interest exception" apply?
The self-dealing rule is not applied strictly by the courts in circumstances where:
- The trustee has a very small minority shareholding in a company involved in the transaction or has only a limited beneficial interest in another trust involved in the transaction and is not in the position of negotiating on both sides of the transaction (i.e. is not a trustee or director of both contracting parties); and
- The consideration given for the transaction was adequate.
The rationale behind the exception is that, where the interested is very small, it is unlikely to have influenced the trustee in question. The Court observed, however, that cases applying this exception are hard to find and those that did exist involved specific and not easily generalizable factual circumstances. It also noted that some judges have doubted the existence of the exception entirely.
Here, the Court considered that the exception could not apply to Mrs Fenwick as she was a trustee on both sides of the transaction. This meant she was in the position of negotiating on both sides of the transaction and the rule against self-dealing was intended to prevent this type of conflict. The Court considered that the exception might apply in the case of Mr Eru and remitted this issue to the Maori Land Court for further consideration.
Were the trustees placed in a position of conflict by the
terms of the Trust Deed?
Finally, the trustees argued that the conflict could be excused because they were put in the position of conflict of interest and duty either expressly, or by necessary implication by the settlor or the terms of the Trust. Here, there relevant terms were those of the Act, which the Court agreed supported owner control, meaning that trustees would often be in a position of being both a trustee and beneficiary under a Trust.
The Court considered the situation was different, however, when the conflict involved a trustee who had an interest or trusteeship in another trust rather than both in the same trust). There was nothing in the Act mandating cooperation between (as opposed to within) ahu whenua trusts and the Act expressly prohibited conflicted trustees from participating in decision-making. The Court did consider though that there would need to be an assessment of whether there was a "real sensible possibility" of a conflict, which should be assessed in a practical manner.
Guidance for trustees
While these principles are long established, this case does provide useful illustration of trustees' obligations and of possible pitfalls.
Some particular points to bear in mind are:
- The court takes a fairly strict approach to determining whether a conflict exists. The test is objective and is designed to avoid the appearance and risk of conflict rather than any assessment of whether the trustee actually acted improperly. This means that a trustee could inadvertently breach the rule against self-dealing without having consciously turned their mind to the possibility of a conflict.
- When entering into any type of transaction with a third party (i.e. including loan arrangements, leasing arrangement and other transactions and not limited to purchases) it is good practice for trustees to think carefully about whether they hold any conflicting duties and/or conflicting interests and whether these are authorised by the Trust Deed.
- While trustees are usually aware of the obvious examples of self-dealing, such as sale of trust assets to themselves personally, an apparent conflict can sometimes be less obvious. Trustees should be particularly aware of situations in which they are involved in negotiation on both sides of the deal (e.g. trustees of two trusts involved in the transaction, or a trustee of a trust on one side of the transaction and a director of a company on the other side of the transaction), or involved as a trustee on one side of the transaction but with an interest (even if small) in one of the parties involved on the other side of the deal).
- Even quite small interests in parties on the other side of the transaction can be problematic for trustees. The "limited beneficial interest exception" is a high threshold to meet, particularly in the case of a major transaction.
- A trustee who thinks he or she might be in a position of conflict should disclose the conflict and refrain from participating in decisions relating to the conflict, unless there are very clear terms in the Trust Deed allowing for a trustee to act despite the conflict in question existing. In the absence of authorising terms in a trust deed, it is no answer to say that the transaction was at fair value.
- It is common for family trust deeds to include a clause in relation to dealings by "interested" trustees because of the practical reality, which is that in many cases it is both intended and desirable for beneficiaries to also act as trustees in a family trust context. Often, these clauses are drafted very broadly to authorise any and all sorts of potential self-dealing by a trustee. However, trustees should review the Trust Deed carefully to ensure that both the conflict of interest and duty in question is covered and that the particular type of transaction proposed is captured by the authorising clause.
- The consequences of breaching the rule against self-dealing are serious. It is likely to form grounds for removal of the trustee in question and it will also mean that the transaction in question is voidable at the insistence of any of the beneficiaries (subject to the interests of any innocent third party).
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.