Privy Council clarifies proper purpose rule to Bermuda trustee's powers
The key issue before the formal body of advisers to the UK sovereign was whether the trustee of a settlement “exercised for a proper purpose” an express power contained in the trust deed to add and exclude discretionary objects, having added a purpose trust as an object and removed all family members comprising the entire class of objects.
The trust settlors were two brothers who founded Formosa Plastics Group, one of the largest business conglomerates in Taiwan.
The founders established two Bermuda trusts back in 2001. The first was Global Resource Trust No 1 (GRT). Its principal asset was an investment holding company owning Formosa Plastics Group’s shares, estimated to be worth some USD560 million as of 2019.
The trustee had a discretionary power to apply the whole or part of the capital and income of the fund to, or for the benefit of, the children, and remoter issue of the founders. The power at issue in this dispute was the trustee’s power to add or exclude “any person or class or description of persons” as beneficiary, as set out in clause 8 of the GRT trust deed.
Simultaneously, the founders had also established the Wang Family Trust (WFT) to include charitable and non-charitable purposes. But importantly, it conferred no benefit on members of the Wang family or any other persons.
Although the trustees of GRT and WFT were separate entities, they had common directors, two daughters of one founder and two sons of the other founder.
Subsequently, in September 2005, the GRT trustee resolved to exercise powers to add and exclude discretionary objects and appoint the entire fund to the trustee of WFT. This was immediately followed by the trustee’s exercise of its discretionary dispositive power to appoint the whole trust fund of GRT to WFT, thereby bringing the settlement to an end.
By way of background to this decision, the GRT trustee referred to “the founders’ firm intention to leave the vast majority of their wealth to society, rather than to their children and their wives, all of whom were then enjoying ample wealth and privilege”.
This was the exercise of power by the GRT trustee that was challenged by the founders’ other family members in proceedings commenced in Bermuda in 2018.
At first instance, the Supreme Court of Bermuda held on a summary judgment application that the trustee had invalidly exercised its powers. An appeal against this decision was allowed by the Court of Appeal of Bermuda, which also granted leave to appeal to the Privy Council.
Privy Council Decision
In a unanimous decision, the board of the Privy Council determined that the GRT trustee had exercised its powers for an improper purpose. In reaching this decision, the board revisited various key legal principles, including:
(1) Duties and restrictions imposed on the fiduciary powers of a trustee. It was not disputed that the powers under clause 8 were fiduciary powers, the exercise of which is subject to duties and restrictions imposed by equity. That involved a first consideration, of whether the way the power was exercised was not within, or contrary, to the express or implied terms of the power, namely scope of the power rule. The second consideration was whether the GRT trustee’s use of the power – although within its scope – was for improper purpose, namely the proper purpose rule.
Since the powers under clause 8 had been expressed in very wide terms, the board did not have much difficulty concluding that the challenged decision of the GRT trustee was within the scope of its powers.
The application of the proper purpose rule was more controversial. The board considered the relevant question was whether the purpose for which the power was exercised was outside the purpose, or range of purposes, for which the power was conferred.
(2) Is there a “substratum” rule? The plaintiffs’ principal submission was that trustee powers to add and exclude beneficiaries cannot be exercised to destroy the nature or character, or the substratum, of the trust. This was referred to as the substratum rule.
Having conducted an extensive review of relevant authorities, the board held that there was no absolute substratum rule. While the purpose of the GRT would be of central importance in determining the purpose of power under clause 8, it would not constitute a default overriding factor.
(3) What are the proper purposes of power under clause 8? A natural reading of the GRT trust deed as a whole demonstrated that it established a family trust for the benefit of direct descendants of the founders.
In the board’s view it was very significant that the founders established WFT at the same time as GRT. They were dividing the Formosa Plastics Group’s shares into two parts, with a greater part of the value to be owned by WFT, and only one-sixth in value held in GRT for the benefit of the children and remoter issue of the founders. The evidence revealed that the founders fully understood they were establishing two different trusts for separate purposes.
In light of the focus of the GRT trust deed on the children and remoter issue of the founders – and the circumstances in which the GRT was established – the board concluded that the purpose of clause 8 was to further the interests of the beneficiaries, meaning the children and remoter issue of the founders.
(4) Could GRT trustee validly use its powers to destroy, rather than advance, the interests of identified beneficiaries? It is generally the case that fiduciary powers conferred on a trustee of a trust with identified beneficiaries must be exercised to further the interests of the beneficiaries. This is clearly the case with essential administrative powers, such as the powers of investment.
However, the board considered that the power to add or exclude beneficiaries is a power of a potentially different character, since it had the capacity to effect fundamental changes to a trust. In the case of such a power contained in any particular trust deed, the question to ask is whether it is intended to have that capacity, or indeed have any purpose that goes wider than simply furthering the interests of the identified beneficiaries. This requires the approach of considering the power in the context of the trust instrument, and the circumstances surrounding it.
In this case, the GRT had a clear purpose, which accordingly has a decisive effect on identifying the purpose of the powers under clause 8.
This is a valuable decision exploring the nature and scope of trustee power to add and exclude beneficiaries, which is a power that does not come into the spotlight very often. According to the Privy Council, this is a power of potentially different character compared with administrative powers of a trustee.
The Privy Council also went through a detailed analysis of relevant authorities to discern legal principles for applying the proper purpose rule. Instead of applying a hard and fast substratum rule – or relying on an overriding principle that all powers of the trustee must be exercised in the interests of some or all beneficiaries – the board chose to refer to terms of the trust instrument and circumstances in which the trust was created in deciding the purpose of powers under clause 8.
This is a reminder that every trust settlement is a tailored solution. There is no one-size-fits-all type of rule or principle that determines the purpose of the trustee’s powers.
An original version of this article first appeared in Asia Business Law Journal, June 2023.
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