K3 Insights

Section 35 of the Trusts Act 2019 imposes a default duty of impartiality on trustees, set out below. In theory, it sounds fair – who wouldn’t want a trustee to treat the trust’s beneficiaries impartially? In reality, the duty of impartiality places an onerous duty upon trustees and can substantially restrict their discretion to make distributions to beneficiaries, alter the list of beneficiaries, and make unimpeded investment decisions. This opens the door for beneficiaries to sue trustees for allegedly breaching their duty of impartiality. Executors also need to be mindful of the duty of impartiality if it is not excluded in the will.

Section 35: Duty of Impartiality

(1) A trustee must act impartially in relation to the beneficiaries and must not be unfairly partial to one beneficiary or group of beneficiaries to the detriment of the others.

(2) This section does not require a trustee to treat all beneficiaries equally (but all beneficiaries must be treated in accordance with the terms of the trust).

The purpose of the Trusts Act, identified in section 3, was to restate and reform New Zealand trust law, clearly stating core principles of trust law in one place. While previously the duty of impartiality may have been more limited, the broad way section 35 defines impartiality allows the duty to apply much more broadly. If in doubt, beneficiaries and trustees are expected to understand trustee duties using the plain words of section 35.

How Do I Exclude the Duty of Impartiality?

The duty of impartiality is a default duty under the Trusts Act. This means that sufficiently clear words will exclude it so it does not apply to the trust. Typically, K3 uses language like “the section 35 duty of impartiality is excluded” to ensure the criteria of sufficiently clear words are satisfied.

It is possible that less clear words could sometimes exclude the duty of impartiality, such as stating that “the trustees have total discretion to distribute trust funds to whichever beneficiary they please”. However, without directly stating that the duty of impartiality is excluded, you open yourself to a disgruntled beneficiary arguing that those words are insufficient and the duty exists. In our opinion, there is no point in opening the trust to a potential challenge by beneficiaries and the duty should nearly always be excluded expressly.

If you have not created a trust yet, you can use language like that preferred by K3 when you create your trust deed to exclude the duty of impartiality. However, if you already have a trust and have not excluded this duty, you will need to amend your trust deed to achieve this effect. Sometimes there are restrictions in your trust deed that limit how you can amend it, so take care to do this correctly.

If you have not expressly excluded the duty of impartiality in your trust deed and it applies to you, you face the consequences described in the rest of this article.

Distributions

It is usually unclear what a trustee must do to satisfy the duty of impartiality in any given situation. This is the crux of the issue. An unhappy beneficiary could threaten to sue the trustee on this basis and, given the uncertainty of whether the trustee has satisfied the duty, many trustees may offer a settlement to avoid the issue proceeding to a likely expensive court case. Why wouldn’t an unhappy beneficiary give this a try?

Trustees can take several steps to minimise the risk of breaching their duty of impartiality. First, clearly identify who the beneficiaries are to consider whether to make a distribution to them. This requires monitoring the beneficiary list in case new people qualify to be beneficiaries or old beneficiaries no longer qualify. This can be difficult when the beneficiary list is vague. For example, in a mixed family situation, we sometimes see trust deeds that are ambiguous whether a person must be a child of both of the settlors or one of the settlors to be eligible to be a beneficiary. Also, future beneficiaries need to be accounted for in this exercise. For example, if a trust deed includes the settlor’s grandchildren as beneficiaries, they must be accounted for even if there are no grandchildren currently born. While clearly identifying all beneficiaries can be complex, it is essential because you must know who the beneficiaries are in order to fairly consider whether to make a distribution to them.

Next, trustees should regularly consider whether to exercise their discretion in favour of beneficiaries and record that they have done so. While trustees are not required to give reasons for their decisions, in reality, it will be hard to justify that the duty of impartiality was not breached without clear reasoning.

When considering a distribution, start by considering an equal distribution to all beneficiaries. That is the simplest way to treat people impartially and hence not being unfairly partial to one beneficiary or a group of beneficiaries which would breach subsection 1. However, subsection 2 identifies that trustees do not need to treat all beneficiaries equally. The immediate and future financial needs of the beneficiaries are the most obvious reasons to not treat them equally. Care is needed when distributing funds to a beneficiary who needs support now to leave enough for people who will need support in future, especially beneficiaries who might not yet exist (such as presently unborn children). Another consideration is how much money has been distributed previously to beneficiaries – someone who received more in the past might receive less now even if they have the same financial needs as other beneficiaries. There will be many more potential factors to consider, but we suggest trustees begin with these.

Altering Beneficiaries

Most trust deeds include a power to alter the list of beneficiaries. Trustees often are entrusted with this power, but not always. A trustee who has the power to change the beneficiary list will have issues if they are subject to the duty of impartiality. By definition, removing a beneficiary harms that beneficiary because they can’t receive anything else from the trust, and it benefits the other beneficiaries. Without very good reasons like that beneficiary already receiving substantial trust funds, a trustee removing a beneficiary will likely breach the duty of impartiality.

Similarly, adding more beneficiaries harms existing beneficiaries who might receive a smaller portion of the trust fund. This too likely breaches the duty of impartiality unless there are very good reasons such as an error when originally drafting the beneficiary list. In short, the duty of impartiality likely prevents a trustee with a power to alter the beneficiary list from exercising that power in most circumstances.

Cases such as McLaren v McLaren [2017] NZHC 161 contemplate that removing beneficiaries could breach a fiduciary duty in circumstances where there is a relationship of trust and confidence, with the duty of even-handedness (i.e., impartiality) creating even more restrictions on the power to remove beneficiaries. The clear words of section 35 may extend this restriction even further. Adding or removing beneficiaries is by definition not impartial. The Trusts Act 2019 was intended to restate and reform the law, emphasising clearly stating duties which mean precisely what they say so the general public can understand and rely on them. Therefore, it seems very likely that unless the duty of impartiality is excluded, section 35 will severely restrict trustees from exercising powers to change the beneficiary list.

Investment Decisions

Trust investment decisions can be heavily influenced by a duty of impartiality if it is not excluded by the trust deed. When investing, trustees must balance the rate of capital growth of trust assets against how substantial an income they seek to earn from trust assets. For example, imagine a trustee choosing between two shares to invest into where one offers a higher dividend but probably provides a smaller capital gain compared to the other.

The duty of impartiality limits trustee discretion if it applies, requiring impartial decisions properly accounting for the interests of all beneficiaries instead of favouring one class over another. This arose in Re Mulligan [1998] 1 NZLR 481 (HC) where a duty of impartiality prevented trustees from investing a trust fund solely in fixed mortgages over 25 years. This is because while it provided a good income for the life tenant, it seriously reduced the capital left to other beneficiaries, hence breaching the duty of impartiality.

Estates and Executors

The duty of impartiality is important in the context of wills as well as discretionary trusts. When an executor is dealing with an estate, they are acting as a trustee for the benefit of the beneficiaries, meaning that the default duties under the Trusts Act such as the duty of impartiality apply unless the will expressly excluded them. K3 has observed that most wills do not expressly exclude these default duties which can create problems, so please check yours!

Unlike discretionary trusts, there is typically little discretion in what is paid to whom from an estate, but the timing of the distributions is very important. For example, imagine an executor knows there may well be a claim from a disgruntled family member excluded from the will, but they push ahead with distributing all of the estate’s assets. That potential claimant may well lose out on a distribution from the estate. Therefore, acting impartially would likely require waiting until the claim is resolved before making a distribution.

In Sadler v Public Trust [2009] NZCA 364, (2009) 28 FRNZ 474 the Court of Appeal summarised the relevant case law. It identified the duty of impartiality applies to potential claimants against the estate if the executor is aware of their intention to make a claim. In addition, this duty means that an executor cannot actively and dishonestly conceal information about the estate from potential claimants. This was extended by the High Court in AB v RT and ST [2015] NZHC 3174 which held that the duty of impartiality applied to potential claimants the executor ought to be aware of.

Therefore, executors who owe a duty of impartiality need to be very careful before making a distribution that there are no potential claimants that they should be aware of. Steps like signalling intentions to distribute to the family well ahead of time and delaying distributions when in doubt are practically very important.

K3’s Private Wealth Team

Protect your current and future wealth with K3. Our team will help you create robust legal structures to safeguard your current and future wealth. Setting up robust legal structures now helps ensure they produce the effects that you intended, simplifies management, and safeguards you from potential liability in future. We are experts in the interlocking areas of law required to make these structures effective such as trusts, wills, relationship property, powers of attorney, immigration, and overseas investment. This is our private wealth team’s sole focus.

We can assist you in creating, resolving disputes with, or managing structures like trusts, wills, and contracting out agreements. We are well-versed in creating family trusts and charities that are fit for purpose, helping you manage them effectively, and dealing with any potential disputes. We work extensively with accountants, tax experts, financial advisers, insurers, and other experts to protect your current and future wealth.

Helen Edwards (Director)

027 9443405
Helen@k3.co.nz

Andrew Coffin (Solicitor)

021 0634267
Andrew@k3.co.nz

This article is intended as a guide with general advice only.  Please contact your regular K3 advisor for legal advice of how this article applies to your trust’s specific circumstances.