Last month we looked at the application of some general principles for establishing mental capacity and how the loss of capacity impacts decision making, in particular in the context of will making and deciding to marry. We also looked at some recent guidance as to when attorneys can make gifts as part of IHT planning on behalf of the donor who has lost capacity.
This month we look more specifically at capacity issues in the context of trusts. This could relate to the capacity of the settlor as well as the capacity of a trustee.
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 (where English law applies).
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.’
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.
It is also very important to remember that it is not possible to use the above provisions if the mentally incapable trustee is also entitled to a beneficial interest in the trust property. In such a case an application to the court will be necessary.
A better option, when a trust deed is being drafted, is for the trust deed itself to expressly provide for the settlor or other trustees to have powers to dismiss a trustee other than under the above-mentioned section 36. This may also be a useful addition if a mentally capable trustee refuses to co-operate but does not wish to retire voluntarily. The above-mentioned statutory provisions allow for a trustee to be dismissed only in the prescribed circumstances and there is no provision under general trust law to dismiss a trustee who is simply obstructive or uncooperative. Therefore, a dismissal in such circumstances is only possible if an express provision to this effect is included in the trust deed.
What if the settlor or trustee has made a power of attorney?
Powers of attorney are definitely becoming more popular, especially since the fees for registration have been reduced. 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.
Although an LPA can include some specific directions on what an attorney can and cannot do, an LPA cannot ever include power for the attorney to:
- sign a will;
- act as trustee for the donor; or
- act as a personal representative of a will in place of the donor.
There are a number of provisions, though, depending on the circumstances, allowing a trustee to delegate their powers.
The first, section 25 Trustee Act 1925, enables a mentally competent trustee to delegate authority to act to another person for a maximum of 12 months. A special form of power of attorney is needed for this. However, the attorney automatically loses the authority to act on behalf of a trustee if that trustee loses mental capacity.
The subject of powers of attorney is often raised when the trustees of a particular trust need to take some action, for example to distribute trust assets, often following the death of the settlor. Since a trust may have existed for a number of years and, if the sole asset of the trust was a life assurance policy the trustees would not have had anything to do until the death benefit has been paid, at that time it may be found that, say, one of the trustees has become non-UK resident and so it may be difficult for them to sign documents (say a deed of appointment or deed of advancement to a beneficiary) in a timely fashion. This is where delegation to another trustee may be appropriate.
In practice, a parent will often name all their children as trustees as well as executors of their will and if, following the parent’s death, one executor is out of the country, there will be inevitable delays. So the absent executor may also want to appoint an attorney to act in probate (unless they want to renounce the executorship or have the power reserved to them). As with trusteeships, a normal LPA or EPA does not cover executorships. The appointment of an attorney has to be done in a specific form just for the executorship. There is an additional restriction under English law though that the attorney of one executor cannot take a grant jointly with an executor acting in their own right.
Finally, just because there is an attorney acting it does not necessarily follow that the donor has lost capacity, unless it is an enduring power of attorney (EPA) which has been registered. This is because an EPA would only be registered on the onset of incapacity. In such a case the EPA will be treated as evidence that an individual is no longer mentally competent.
As regards an LPA, since it is possible to register an LPA at any time, its registration is not evidence that the donor is not mentally competent to act.
If there is a known risk that a donor who is 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 does not assist (often because of the trustee’s beneficial entitlement under the trust).
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.
Any adviser who recommends a life assurance policy as part of IHT planning also needs to be familiar with certain fundamentals of trusts. When a trust of a life assurance policy is being set up, this will often be a “standard” draft provided by the life office. Naturally, not all these trusts are the same. At this stage it is important to check that the proposed draft trust includes all the relevant express provisions so that should, for example, one of the trustees lose capacity, there will be no need to involve the court.