Mental capacity of settlors and trustees

Let's then start with capacity issues in the context of trusts. This article is based on English law.

 

It is only in the last few years that providers (such as life offices and platforms)  of "standard" trust documents for use with their products (such as investment bonds) have been upgrading their draft trusts to include more comprehensive provisions for dealing with incapacity of trustees. This is presumably the result  of ever-increasing incidence of dementia. As usual,  when  encountering such a problem with an exiting trust, the first rule applies, i.e. "read the deed".  If the deed includes provisions that allow, for example , continuing trustees  to remove/replace an incapable trustee, the process should  be straightforward. But often a "standard"  deed will say something along the lines that "the statutory power of appointing new or additional trustees will vest in the settlor during lifetime and thereafter in the trustees".

 

In some trusts there may a provision that allows the settlor to remove a trustee for no reason, as long as at least two trustees remain, Again that will be useful. But what if the incapable person is actually the settlor?

 

Settlor of a trust losing capacity

 

 As long as the settlor was capable when they set up a trust, the trust will be valid. However, the settlor will often retain certain powers under a trust. For example, the settlor may be the appointor under the trust. What happens if there is a suspicion that the settlor is becoming or has become incapable?

 

Since, generally, any powers reserved to the settlor will be expressly reserved in the trust deed, ideally the trust deed should specifically deal with such a situation arising under the trust.

 

For example, a trust will typically provide that the settlor will have certain powers during their lifetime.  The possibility of the settlor becoming incapable can be easily dealt with when the trust deed is being drafted by including a proviso in the trust that the settlor’s powers will apply ‘during lifetime and while the settlor is of full capacity’, with the term “capacity” defined by reference to the Mental Capacity Act 2005 .

 

When setting up a new trust it is therefore important to ensure that the trust deed includes the provisions dealing with incapacity.  If there are no such provisions included in the trust deed, there may be a statutory alternative, as explained below.

 

A trustee losing capacity

 

Similar principles apply when a trustee becomes incapable. Of course, frequently the settlor will be one of the trustees as well even if they have not retained any special powers as the settlor. Because, under English law, trustees must act unanimously, what if one of them has become incapable? If the trust does not provide for such a situation, in some cases it may become impossible for the trustees to make decisions without an application to the court.

 

Section 36(1) Trustee Act 1925 should be of assistance and, given its importance, it is useful to know the details. The provisions, which are self-explanatory, are as follows:

 

‘Where a trustee, either original or substituted, and whether appointed by a court or otherwise:

(a)        is dead;

(b)       remains out of the United Kingdom for more than 12 months;

(c)        desires to be discharged;

(d)       refuses to act;

(e)        is unfit to act;

(f)        is incapable of acting; or

(g)       is an infant

 

then, subject to the restrictions imposed by this Act on the number of trustees,

 

• the person or persons nominated for the purpose of appointing new trustees by the instrument, if any, creating the trust; or

 

• if there is no such person, or no such person able and willing to act, then the surviving or continuing trustees or trustee for the time being, or the personal representatives of the last surviving or continuing trustee;

 

may, by writing, appoint one or more persons (whether or not being the persons exercising the power) to be a trustee or trustees in the place of the trustee so deceased, remaining out of the UK, desiring to be discharged, refusing or being unfit or being incapable, or being an infant, as aforesaid.’

 

As can be seen, the application of this provision depends on there being a continuing trustee and it is essential that a replacement trustee is appointed at the same time. There is also an important qualification in section 36(9), namely that if the trustee in question  is also entitled  to a beneficial interest in the trust property, then  an application to the court (the Court of Protection  (CoP) in this case)  will be necessary.

A further possibility is provided by section 41 of the Trustee Act 1925 under which a court may ‘whenever it is expedient to appoint a new trustee or new trustees, and it is found inexpedient, difficult or impracticable so to do without the assistance of the court, make an order appointing a new trustee or new trustees either in substitution for or in addition to any existing trustee or trustees, or although there is no existing trustee.’

Section 41(1) specifically envisages making an order where a trustee has become incapable by reason of mental disorder within the meaning of the Mental Health Act 1983 of exercising their functions as a trustee, or is bankrupt, or is a corporation which is in liquidation or has been dissolved.

There is also another option provided by section 20 (1) of the Trusts of Land and Appointment of Trustees Act 1996 which may be relevant to some trusts. Under this Act the beneficiaries of a trust may give a written direction appointing a new trustee if:

‘1(a)     a trustee lacks capacity (within the meaning of the Mental Capacity Act 2005) to   exercise his functions as a trustee,

 

   (b)    there is no person who is both entitled and willing and able to appoint a trustee under section 36 (1) of the Trustee Act 1925, and

 

   (c)     the beneficiaries under the trust are of full age and capacity and (taken together) are absolutely entitled to the property subject to the trust.’

Clearly, therefore, there are some remedies available to deal with the incapacity of a trustee using the statutory provisions. However, if a client needs to resort to these it would be necessary to seek professional advice and assistance in the preparation of an appropriate deed. Obviously, this would involve costs.

What if the trustee has made a power of attorney?

One of the questions frequently asked at Technical Connection is whether an attorney, say under a Lasting Power of Attorney (LPA), can act on behalf of a trustee (or an executor).

 

The short answer is that, although an attorney has wide powers to deal with both the donor’s personal financial affairs and their investments, an attorney cannot act on behalf of the donor when the donor is acting as trustee.

 

This is subject to one important exception, namely  if  the incapable  trustee has a beneficial  interest in land, it is in fact possible for the attorney(s) under the LPA to step into the trustee’s shoes in relation to the sale of the property and dealing with the sale proceeds (section 1(1) Trustee Delegation Act 1999).

 

We have had several questions relating to just how far the power of the attorney to exercise the trustee's functions in such a case may go. Here some background information will be useful.

 

The purpose of  section 1(1) of the 1999 Act was to allow for conveyance of land subject to a trust (typically with a life tenant occupying the house) without the need to appoint a replacement trustee and for the attorney to be able  (with at least one other trustee) to give valid receipt for the proceeds. It is generally  accepted that “exercising function” of dealing with the capital proceeds will include investment of the said  proceeds however there is  little authority on how far this authority to “exercise trustee functions”  can go in the ongoing management of the trust fund.

Especially given that the 1999 Act actually refers to “doing an act in relation to (a)land, (b)capital proceeds of a conveyance of land, or (c)income from land”, general view is that  the attorney would not be within section 1 of the 1999 Act if he were to  exercise trustee powers, such as advancing capital or appointing income or capital  to other beneficiaries or even subsequent reinvestment  or distribution. So, for those “powers” (i.e. subsequent dealings with the trust fund)  as opposed to “functions or acts within the scope of the legislation”  the incapable trustee should still be replaced under s 36(9)  Trustee Act 1925 with an application to the CoP.

There is one more important point to mention in relation to the above, namely  that the above-mentioned subsection 1(1) only applies "(a) if and so far as a contrary intention is not expressed in the instrument (if any) creating the trust, and (b)have effect subject to the terms of such an instrument". So again, before reaching any conclusions  "Read the Deed". I have in fact only recently dealt with one of the "probate" trusts, where the trust deed expressly excluded section 1(1) of the 1999 Act from applying. As this was one of the "off the shelf" probate trusts, there are probably similar exclusions in many of them. What this meant in that particular case was that the trustees could not in fact sell the property without first replacing the incapable trustee with the help from the CoP.

 

Conclusions

 

Any adviser dealing with estate planning should be aware of the rules applying when a person loses capacity as well as the rules applying to powers of attorney. In particular, those advisers who deal with trustees or who assist with dealing with estates of deceased clients also need to have some knowledge of what happens if any relevant party loses capacity.

 

If there is a known risk that a trustee is at risk of losing mental capacity it is preferable for them to resign. If they have already lost the mental capacity to act, the other trustees will have to apply to the court to remove the incapable trustee if there is no express power in the trust deed to do this and section 36(1) does not assist (often because of the trustee’s beneficial entitlement under the trust).

 

When setting up a new trust, remember to ensure that comprehensive provisions are included on dealing with incapable trustees.