The gloves are off

The appeal rulings in two cases earlier this year, Futter v Futter and Pitt v Holt [2011] EWCA Civ 197, were widely acknowledged as rewriting our understanding of the decision of the Court of Appeal in Re Hastings-Bass [1975] Ch 25. But will this really change the manner in which trustees' decisions are challenged in court?

In Futter Withers advised trustees (one of whom was a partner in the firm) that exercising their discretions in a certain manner would not incur a charge to capital gains tax. That advice was wrong and the trustees' actions generated a tax bill. In Pitt Mr Pitt's receiver (Mrs Pitt) was not told that settling Mr Pitt's damages award on the trusts suggested to her by her advisers would incur an immediate charge to inheritance tax. This issue was not brought to the attention of the Court of Protection and that court authorised the resettlement causing a large liability to HMRC including for interest and penalties.

Under the old understanding of the law, trustees were able to set aside transactions that caused an unforeseen and unwelcome tax liability on the ground that fiscal consequences of a decision were relevant considerations which the trustees should have taken into account, but which were not in fact taken into account. As a result, the decisions were void (or possibly voidable) and could be undone by the court, thereby removing the liability to tax. That orthodoxy was applied at first instance in both Futter and Pitt (which was an extension of the law in relation to trustees to receivers as analogous fiduciaries).

The Court of Appeal upheld HMRC's appeal. Lloyd LJ said the law had taken a wrong turn '“ even in his own decision in Sieff v Fox [2005] EWHC 1312 (Ch)). Lloyd LJ said that ever since Mettoy Pension Trustees Ltd v Evans [1990] 1 WLR 1587 the courts had failed to apply the Hastings-Bass decision correctly. According to the Court of Appeal, it was a case concerning the extent of trust powers and not about relevant considerations at all. In fact, a decision could only be set aside on the grounds that the trustees had failed to take certain facts or factors into account if they were in breach of trust in failing to do so.

If they had taken legal advice on the matter then they would not be in breach of their duty to take reasonable care and skill in exercising their powers as trustees and therefore would not be in breach of trust and could not undo the past exercise of their powers to avoid the tax and other consequences of their actions. The fiduciaries have applied to appeal to the Supreme Court.

Fresh pleas

The first matter to consider relates to undecided cases that were issued before the decision of the Court of Appeal was handed down. Such cases are likely to have been pleaded under the previous orthodox understanding of the rule in Hastings-Bass; these cases may well need to be reviewed, they may need to be repleaded and if there has been a stay awaiting the decision of the Court of Appeal such a stay may need to continue pending the final resolution of the issue. It is not a forgone conclusion that a stay will be extended as the High Court has already begun to decide cases on the basis of the new law (see Prudential Staff Pensions Ltd v Prudential Assurance Ltd [2011] EWHC 960 (Ch)).

Again, assuming the law is not further altered any allegations which have been made of failure to consider relevant fiscal or non-fiscal issues must be repleaded as allegations of breach of trust, whether failure to take reasonable care and skill, failure of the trustees to acquaint themselves with the terms of the trust or otherwise.

In the past it was often trustees who brought claims for their own actions to be set aside. The trust beneficiaries were the defendants. It was in no one's interest for there to be a large tax bill and therefore the beneficiaries were often supportive of the claim. The litigation would generally be started under part 8 of the Civil Procedure Rules 1998 because there was no substantial dispute of fact (or substantial dispute at all). This remarkably civilised litigation might well have been funded by the insurers of those advising the trustees. It was those advisers who were on the hook for the failure to advise on the tax consequences properly and the claim under the rule in Hastings-Bass was a sensible measure to mitigate the loss.

It is not likely that this genteel form of trust litigation has any future. Trustees will no longer be willing to bring claims because they are not likely to find the prospect of pleading their own breach of trust attractive. A beneficiary will therefore have to be found to bring an adversarial claim which is likely to be pleaded (like all contentious breach of trust cases) under part 7.

It will be much harder to show on the merits that a decision should be set aside because where the trustees have taken advice it will be extremely difficult to show that they have acted in breach of trust because they will have fulfilled the duty of care and skill simply by seeking that advice. This kind of litigation may therefore become more adversarial and therefore more costly. It is unlikely that insurers will be funding the defences of trustees because it is only where trustees have not had the benefit of advice that a claim can realistically expect to succeed.

Owning up

Trustees may become willing to admit their own breaches of trust to avoid causing loss to the trust fund (because as a result of the breach of trust the decision may be set aside). That kind of predicament would put trustees who are still acting as such in a terrible conflict between duty and self-interest and they may well have to consider resigning. Again, this will generally only affect trustees who have not taken professional advice. But it is important to remember that many trustees will have the benefit of wide exoneration clauses and will therefore be unlikely to be personally liable to the beneficiaries in the absence of dishonesty.

There does not seem to be any reason why the decision in Futter should cause trustees to act any differently. Presumably the availability of relief under the rule in Hastings-Bass did not lead trustees to be less cautious and responsible in making decisions than they would otherwise have been. Those who did not have the benefit of legal advice would not have known of the potential loophole. Those who did have advice would have followed it and it is highly doubtful that the quality of that advice would have been affected by the availability of relief especially in circumstances where a claim for relief could cause publicity of the adviser's negligence. There is no reason for trustees to be more or less careful now than they ever were or to seek advice more or less frequently.

The major change caused by the decision in Futter will be a decrease in effectively consensual trust litigation and an increase in trustees and beneficiaries suing advisers in negligence. This will be significantly trickier for trustees and beneficiaries than the previous regime.

It must be shown that the advisers failed to act reasonably carefully in the circumstances and loss must also be proven. If there is no loss to the trust because certain tax liabilities fell on to individual beneficiaries rather than the trust fund, beneficiaries will then have to argue that the advisers assumed responsibility to the beneficiaries individually and it will be those beneficiaries who have to make a claim.

This might well be difficult if they have received a discretionary benefit from the trust. In the end trust beneficiaries are likely to be worse off than they would have been under the old understanding of the rule in Hastings-Bass. There is no reason why the decision should lead to a decrease in litigation or an alteration in forum. If matters of trusts and taxation are in issue the Chancery Division will still be the natural place to bring any proceedings in negligence (rather than the QBD).

There will also be a net transfer from trustees and their advisers (or, where liability in negligence cannot be proven, beneficiaries) to HMRC whose revenues may well increase. This may well cause advisers' insurance premiums to rise and that will either have to be met by an increase in overheads which is soaked up by solicitors' profit margins or it will be a cost which is passed on to the customer (in practice the beneficiaries of the trust funds or clients of solicitors generally).

It seems likely that the net result of the decision in Futter is that the administration of trusts will be more expensive, whereas there will be a net benefit to HMRC.

There is a possibility that lay people will be less likely to become trustees because of the risk of being sued. However, I doubt that will happen because the risks will not increase substantially and these can be reduced considerably by incorporating significant exoneration clauses in trust deeds.

The effect of the Court of Appeal's decision in Futter is not likely to decrease the overall level of litigation. In fact, that litigation is likely to be more complex and more adversarial. The winner will predictably be HMRC but those who lose out are most likely to be trust beneficiaries.