20 January 2013

In the Matter of the B Life Interest Settlement

This important decision of the Royal Court has addressed whether the doctrine of mistake can apply to voluntary dispositions made by a trustee and has considered for the first time the continued applicability of the rule in Hastings-Bass in Jersey law in light of the decision of the English Court of Appeal in Pitt v Holt and Futter v Futter. The case arose out of restructuring arrangements made by the Trustee at a time when, unbeknown to the Trustee, the settlor had an undiagnosed terminal illness which claimed his life less than three and a half years later.

Background

The B Life Interest Settlement (the "Trust") was established in 1994 under Jersey law, with B as settlor and the representor as trustee (the "Trustee"). The class of beneficiaries included the settlor, his spouse, his children and remoter issue. The settlor, who died in September 2011, was the first life tenant and his wife the successor life tenant. He was survived by his wife, their two sons, and one grandchild.

The case concerned a restructuring arrangement undertaken in 2008, the purpose of which was to mitigate the incidence of inheritance tax in the United Kingdom, and in relation to which extensive UK tax and legal advice as well as Jersey legal advice was taken. On 23 April 2008, the Trustee made a revocable deed of appointment by which the Trustee appointed life interests in one third of the Trust each to the sons, leaving the remainder of the shares held by the Trust for the benefit of the settlor and thereafter his wife as successor life tenant.

The intended effect was to transfer life interests in two thirds of the Trust to the sons free of the life interests of the settlor and his wife, thereby creating new transitional interests under relevant UK tax legislation. The restructuring constituted a potentially exempt transfer and would reduce the value of the settlor's estate for the purposes of UK inheritance tax but would only be fully effective if the settlor survived for a period of seven years from the date of the restructuring.

Unfortunately, it subsequently transpired that the settlor was suffering from an aggressive and ultimately fatal form of Alzheimer's disease which was not diagnosed until November 2008, and as a result of which he died in September 2011. The Trustee gave evidence that it undertook the restructuring in the mistaken belief that the settlor was a fit and healthy 57 year old man with a life expectancy which at that time would have exceeded seven years. If a medical examination had been carried out in April 2008 with the result that the settlor's Alzheimer's disease had been diagnosed, the Trustee would not have undertaken the restructuring, as the risk of it not being tax effective would have been too great.

Mistake

The Court affirmed that the test for whether a voluntary disposition by a settlor can be set aside under Jersey law is different from English law as developed in Pitt v Holt – see Re the S Trust. However, the instant case concerned not a disposition by a settlor as had been at issue in the previous authorities, but various appointments made by the Trustee. The Court noted that it had suggested at an earlier stage of the proceedings that the rule in Hastings-Bass and the law of mistake as developed in English law have separate objects – the former laying down the basis upon which appointments by trustees can be reviewed and set aside by the Court, and the latter rules which go to whether or not a gift into trust by a settlor can be so set aside. The Court said that its own reading of the English authorities did not suggest that that was an appropriate distinction. The rule in Hastings-Bass conferred an additional jurisdiction on the Court to that which it already had in relation to mistake. The Court noted that in various English cases* applications by trustees for relief for mistake were considered on their merits, and were not dismissed on the basis that such relief was not available to trustees.

The Court held that the test for relief for mistake must be reformulated in respect of an application to an appointment by trustees. The Court has to ask itself the following questions:-

  1. Was there a mistake on the part of the trustee?
  2. Would the trustee not have made the appointment "but for" the mistake?
  3. Was the mistake of so serious a character as to render it unjust on the part of the donee to retain the property or interest appointed?

In obiter comments the Court also indicated that the Jersey customary law of erreur, which provides relief for mistake in the formation of contracts, might be applied to voluntary dispositions by a settlor to a trust but not to dispositions by a trustee which must be considered in accordance with the above test.

*Pitt v Holt at first instance: [2010] 1 W.L.R. 1199 (HC); Wyatt v Tyrrell [2010] EWHC 3633. The Court also considered that there was nothing in the comments of Lloyd LJ in Pitt v Holt to suggest that the equitable jurisdiction to relieve against mistake arises only in relation to gifts into trust and does not arise in relation to actions taken by trustees of a validly constituted trust.

Application of the mistake principles to the facts

Unlike in many other cases where adverse tax consequences have flowed from a mistake, the Trustee in this case took all material tax advice. Furthermore, there was not any suggestion that the tax advice was in any sense wrong or misplaced. The alleged mistake was that when the Trustee made the appointments to transfer the life interests, it did so in the mistaken but reasonable belief that the settlor, a man in his mid-50s, was fit and healthy. In fact, unknown to the Trustee, the settlor was already displaying some of the symptoms of undiagnosed Alzheimer's disease from which he died well before seven years had elapsed, thus giving rise to a substantial liability to tax if the transactions could not be unwound.

The Court found that the family of the settlor had been aware in outline of the settlor's health problems in April 2008. Despite the settlor's wife insisting on several occasions that her husband see his general practitioner and the taking of several MRI scans, a diagnosis of dementia was not made until after June 2008 and it was not until 13 November 2008 that a specialist concluded that the settlor was suffering from Alzheimer's disease with a three to eight year life expectancy.

The Trustee had considered obtaining insurance on the life of the settlor for the requisite period, some nine months before the restructuring took place. The Trustee left arranging such insurance to the settlor.

The Court referred to the English authority of In re Griffiths (Deceased) where a mistake as to a pre-existing fact (undiagnosed lung cancer in that case) was held sufficient to give rise to relief. The Royal Court accepted that a mistake of fact was sufficient to bring into play the Court's equitable jurisdiction to set aside a voluntary transaction on the ground of mistake, however, it was influenced by the comments of Lloyd LJ on that case in Pitt v Holt as follows:

"I wonder whether the judge would have come to the same conclusion on the law (quite apart from the facts) if the case had been argued in a  fully adversarial manner. It seems to me that there would have been a strong argument for saying that, having declined to follow the recommendation that he should take out long-term insurance,  Mr Griffiths was taking the risk that his health was, or would come to be,  such that he did not survive. If that was the correct view, it seems to me that the answer to the Ogilvie-v-Littleboy test would have been that it was not against conscience for the recipients of the gift to retain it.  Ogilvie-v-Littleboy was cited by the judge, but he did not pose the question derived from that case in terms when he came to state his conclusion. I do not criticise the judge, given the limited argument before him, but I do question his conclusion. I do not see what there was in the case that could have justified a favourable answer to the Ogilvie-v-Littleboy test."

The Court held that the requirements of the Jersey law of mistake were not adequately made out such that the various deeds made by the Trustee should be set aside. The Court acknowledged that this came down to "fine margins", but the Court's reasons were:

  1. The burden of proof in relation to each of the three stages of the test for relief for mistake was on the Trustee.
  2. The question of whether or not the settlor would survive for seven years occurred to the parties in the course of making the arrangements, as the question of life insurance was canvassed. It was hard to understand why appropriate life insurance was not put in place.
  3. In the circumstances, although the mistake was of a serious character, it did not appear to the Court to be unjust that the donees of the interests appointed on 23 April 2008 retain the property or interests so appointed. They were aware collectively of the generality of the medical problems which beset the settlor. One or more of them and/or the settlor could have informed either the advisers or the Trustee, but did not do so.
  4. If, conversely, the Trustee was under a specific duty to make enquiry of the settlor's health and be satisfied it was good – a matter which Court did not rule on in case of subsequent proceedings for breach of trust – it could not be said that there was injustice if the donees retained the interests so appointed because the Trustee would have to pay for some or all of the relevant tax.
  5. The Court accepted that the Trustee would not have made the appointments in question had it been aware of the settlor's real state of health at the time in April 2008. However, the Court did not accept that any reasonable enquiry at that time would necessarily have revealed his real state of health. In the circumstances, the possibility of discovery of the illness had a medical examination been insisted on was too tenuous a basis for saying that the dispositions should be set aside on grounds of mistake.

Hastings Bass

The Trustee also sought to set the arrangements aside on the basis that it had failed to take all relevant matters (i.e. the true state of the settlor's health) into account.

The Court first considered the various Jersey cases which had applied the Rule in Hastings-Bass. The Court rejected the Trustee's submission that the cases showed that Jersey law had established its own principle which could continue to survive in its pre-Pitt v Holt form. The Court held that if Pitt v Holt remains good law after the appeal to the Supreme Court, a departure from the line of reasoning in the judgments of the Royal Court based on previous authorities is inevitable – either the Court has to follow the changed approach of the English courts to the Hastings-Bass doctrine, or it has to adopt some other reasoning based on principle for continuing to follow the pre-Pitt v Holt approach.  The Court then considered whether the instant case would have justified relief under the Hastings-Bass principle in its pre-Pitt v Holt form. The Court held:

  • In the circumstances of the arrangements made by the Trustee for saving of inheritance tax, the Trustee had a duty to consider whether the settlor was likely to survive for seven years after the arrangements were made.
  • In the Court's judgment, the Trustee had taken the settlor's state of health generally into account. The Trustee did not take into account that his real or actual state of health was poor, because it did not know that that was so. It would not have been unreasonable for the Trustee to have expected the settlor or his family to bring to the Trustee's attention such of the health problems of the settlor of which they were aware. The Court considered it was unwise of the Trustee to proceed without being satisfied that life insurance on the life of the settlor was available but the Trustee was entitled to rely on the settlor's age and apparent state of good health. Hence, the Trustee had not failed to consider anything which it was under a duty to consider.
  • It was therefore unnecessary for the Court to consider whether the Trustee would have acted differently had it taken relevant matters into account.

Therefore, under the pre-Pitt v Holt principles, relief would not have been granted. The Court was mindful that at some future point in time it may be necessary to resolve definitively whether the Royal Court should reject the pre-Pitt v Holt Jersey case law, at which time the Supreme Court's decision

would hopefully be available. Nevertheless, the Court expressed its provisional views. As these views were not necessary for the Court to  reach its decision in the matter, they are obiter remarks and therefore not binding on our Courts. Nevertheless, they are interesting as they give an indication of the path likely to be followed by the Jersey (and probably also the Guernsey) Court on the important developments relating to the Hastings-Bass jurisdiction.

The Court expressed sympathy with the criticism of the Hastings-Bass principle as a 'get out of jail free card' for trustees, to be applied whenever convenient. In its pre-Pitt v Holt form, the principle could be relied on regardless of whether the trustees had been substantially at fault, or indeed at fault at all. The principle could be applied when the transaction into which the trustees have entered could not possibly have been undone had they not been trustees. The Court remarked that, in theory, the rule encourages sloppy decision taking by both trustees and their professional advisers.

In the Court's judgment the approach of the Royal Court should be to ensure that loss lies where it should. If trustees take a decision which is outside their powers, there is no basis in law for it, and the Court should void it. If the decision taken by the trustees is one which they are entitled to take, it may nevertheless constitute a breach of their duty in one form or another or they may have made a mistake in respect of which the court in equity will grant relief. At that point, if there has been a breach of duty or a mistake made, the law will provide a remedy.

The Court took the example of tax considerations, and considered that trustees are under a duty to their beneficiaries to have regard to material tax considerations in exercising their trustee powers and discretions. If trustees fail to do this, they may be in breach of trust, and, if so, have to make good losses sustained by the trust as a result. The Court considered that such an approach puts the responsibility for what may be an avoidable loss where it belongs. But where the fault lies not with the trustees who have correctly identified that they have a duty to have regard to material tax considerations, but with their professional tax advisers who have given them the wrong advice, on which the trustees have acted, the trustees should sue the professional advisers and claim the damages which the trust has sustained as a result. The Court expected that trustees would routinely ensure that the professional advisers would be retained by them and perhaps as well by the beneficiaries and that the terms of engagement would ensure that actions for compensation could be taken on their merits without artificial exemption clauses in respect of the advisers' culpability.  

The Court accepted that the strongest argument against this line of reasoning is that the focus of the Royal Court should be on protecting beneficiaries, which was accepted as a very proper focus for the Court. However, an exclusive focus on the rights of beneficiaries would be potentially unfair to trustees and third parties, and could lead to confusion where the rights of beneficiaries conflict. Further, if loss arises from negligent advice, then on the principle that the loss lies where it should, the beneficiaries themselves will not be taking steps to enforce their rights because the trustees will do it on their behalf. In that way, the beneficiaries are protected, and indeed the trustee would personally be at risk if it did not take proper steps in such circumstances.

The Court considered there to be no reason in principle why a person should be in any better position as a beneficiary of a trust where the trustees have taken a particular step than he would have been in had he taken the same step personally in relation to his own legal interests.

Beneficiaries are entitled to proper administration of the trusts of which they are beneficiaries. This is an important policy consideration especially in Jersey (and Guernsey). The law should strive for a position where more beneficiaries will obtain more benefit from well administered trusts, and it is counter intuitive to permit a rule where sloppy trust administration is forgiven and the consequences put right whenever necessary if an application is made to Court.

Finally, it seemed to the Court that the Jersey law of mistake will provide equitable relief in the cases where it should (i.e. where there was a serious mistake but for which the trustee would not have made the appointment and it is in just for the donees to retain the property or interest appointed).

For all of these reasons, had the Court been required to decide the point in the light of the Jersey and English authorities as they currently stand, the decision would have been that the previous decisions of the Royal Court in connection with applications under Hastings-Bass were clearly wrong. However, the Court stated that if the Supreme Court in Pitt v Holt was to endorse the Hastings-Bass principle as it existed pre-Pitt v Holt or something similar to that principle, then the rationale previously adopted by the Royal Court for its decisions on this point could not be impeached and one would expect that the Court at first instance would continue to follow them.

Comment

The facts of this case were difficult and the result, at least as concerns mistake, was finely balanced. It seems the Court was ultimately influenced by its sense that there had been conscious risk-taking by the settlor and his wife and, to a lesser extent, by the Trustee. The result is a harsh one for the settlor's family, given the admirable frankness of the settlor's widow as to her concerns for her husband's health, the subtle development of those concerns over a period of time, and an impression from the evidence that the settlor's widow had done everything she could to ensure that her husband was appropriately diagnosed. Notwithstanding that the possibility of dementia had been appreciated, none of the parties to the arrangements had any inkling that the settlor had impaired life expectancy due to a terminal illness and they acted in implicit reliance on his apparent good health.

As far as the Hastings-Bass principle is concerned, the Royal Court, as constituted, has indicated that it is not in favour of the principle. It is far from clear that all of the Court's concerns with the principle are addressed by the reformulation in Pitt v Holt. However, given the Court's rejection of any separate Jersey law principle, it appears that the Court would be inclined to follow the re-formulation of the Hastings-Bass principle in Pitt v Holt if it is confirmed by the Supreme Court, or to abolish the principle entirely if that is the outcome of the appeal. The future of the principle in Hastings-Bass in Jersey and Guernsey, as well as in England, now rests with the Supreme Court.

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