Trustees need to ensure they comply with the prudent investor rule and take steps to ensure the trust they manage is set up to avoid potential claims by beneficiaries, says trusts lawyer Tammy McLeod

Understanding the terms of the trust deed is one of the fundamental obligations of a trustee.  Another is clearly understanding trust law and how it relates to the trust deed and the trustees’ duties to the beneficiaries. One commonly misunderstood legal duty of a trustee is to invest the trust assets prudently.  On the face of it, this would seem to be a logical duty.  However, the legal onus is somewhat more complicated than that. 

Under section 13B of the Trustee Act 1956, there is a high onus on all trustees to ensure that they deal with the trust assets as if they were dealing with assets which belonged to somebody else.  This, of course, is the case because trustees are dealing with the assets of the trust on behalf of the beneficiaries. 

Section 13C of the Trustee Act puts an even higher onus on professional trustees or those having some specialised skill by reason of employment or business, providing that professional trustees must exercise a standard of care that a prudent person in the trustee’s profession, employment or business, would exercise in managing the affairs of others. 

The new Trusts Act 2019 which comes into force at the end of January 2021, carries over this default duty in section 30 of the Act. 

Both of those tests are stringent tests and in many family trust situation would be difficult to fulfill given that many family trusts have invested their assets in a small number of investments rather than in a diversified portfolio which the prudential obligations require.

Fortunately, section 13D of the Trustee Act provides that a prudent person test in sections 13B and 13C can both be limited by a specific contrary intention in the trust deed.  Likewise in the new Act, s28 provides that the trust deed can modify the default duties under the Act which includes the duty to diversify the trust assets. 

However, many trust deeds in New Zealand do not have a section 13D contrary intention in them, putting the trustees at risk of being sued in the future by disgruntled trustees, claiming that trust funds have not been invested prudently.  In difficult times this could become more of a risk.

Take, for example, a typical family trust which owns the family home and shares in a closely held company.  If a trustee was given $1.5m to invest on behalf of beneficiaries, then in order to meet the trustees’ obligations, there would be an obligation to diversify, take investment advice and place some of the funds in cash, some in shares and some in property. 

The reality is that assets worth $1m in a family trust may be invested in a family home for say $1m (in which beneficiaries are living rent free, and consequently the capital is not producing any income) and the balance may be invested in a family business.  This clearly is not going to stand up to the scrutiny of beneficiaries who are claiming that the trust funds have not been invested prudently.  The risk is greater at the moment, as the family home may decrease in value and the business may be more precarious and the investment in that not that strong in an economic downturn.

Further, the premise of the new Act is to make trust law more accessible – this means that more beneficiaries will know their rights and will be looking to enforce them. Coupled with the theme of entitlement that we are seeing more and more of, this could spell troubles for many trustees.

It is incredibly important then to understand the terms of the trust deed – can the trustees be held accountable to the very high prudent person or investor test, or is there provision in the trust deed which negates that duty?  Even if there is what is known as a “contrary intention” to the prudent person/investor duty, is this worded in a way which will stand up to scrutiny under the provisions of the new Trusts Act 2019. 

There is still time to review your trust deed and make sure that it will stand up to scrutiny. 

If you are the independent trustee of a friend or relative’s trust, it is even more important that you check the terms of the trust deed and make sure that there is no avenue for you to be sued further down the tack because you didn’t diversify the assets of the trust.  I personally would never be a trustee of a trust which didn’t have a contrary intention to the prudent person test in it. 

In summary, these are uncertain times.  More beneficiaries are looking to enforce their rights under trust deeds and hold trustees to account.  If you are a trustee of a trust in order to protect yourself you need to:

• Review the terms of the trust deed to check that this is a contrary intention to the prudent investor rule
• If there isn’t, can the terms of the trust deed be varied to include it
• If there is no ability to vary, can the trust be resettled onto a new, modern trust.

Tammy McLeod is the is the managing director at Davenports Harbour, specialising in the areas of personal asset planning, trust law and Property (Relationships) Act.