A trust is a relationship between three parties: the settlor, the trustee and the beneficiary. In a trust, the trustee is the legal owner of the trust property, but the beneficial interest belongs to others.
It is to those beneficiaries that the trustee owes obligations and duties. This article explores the role of the trustee and the attendant responsibilities, with a focus on the duties and powers applicable to the investment of trust property. As advisors, it’s important to understand how these duties and responsibilities may affect clients because you may assume the trustee role.
Although the responsibilities are generally discharged by the same person or entity, the law distinguishes between an executor and a trustee. An executor is responsible for the administration of an estate after death. When there is an outright distribution, it is the only role required. However, if the deceased has established one or more trusts under his will, once the estate administration is complete and the trust property established, the executor’s role ends and the trustee’s begins.
An executor must perform tasks ranging from the mundane—cancelling subscriptions, notifying financial institutions—to the more complex and sensitive, such as securing all estate assets, applying for probate, ascertaining tax costs and fair market values for income tax and probate purposes, and dealing with beneficiaries. Most trust companies and financial institutions offer an executor’s checklist that details two or three dozen tasks. When discussing the role of a trustee, the focus shifts from a to-do list to the obligations, duties and powers inherent in the role of trustee.
A trustee is the quintessential fiduciary. A fiduciary is an individual (or company) that stands in a special relation of trust, confidence and responsibility to another (or others). There are four fundamental duties of a trustee that inform all aspects of trust management and administration, including the investment of trust property.
The duty of loyalty
A trustee may not allow personal interests to conflict with duties to the beneficiary. The prohibition on the purchase of trust property by a trustee is based on this duty.
The duty of care
A trustee is subject to a higher and more complex standard of care when entrusted with managing the property of others. This duty is of paramount importance when considering the investment of trust property.
The duty of even-handedness
Each beneficiary is to receive exactly what they are entitled to, no more and no less. No beneficiary receives preferential treatment. Pursuant to this rule, when investing trust property, the trustee must always strive for impartiality between the conflicting interests of income and capital beneficiaries.
The duty not to delegate
The trustee cannot delegate performance of his duties to others. While this duty was historically absolute, it is now permissible for a trustee to delegate administrative duties, such as listing the content of a safe deposit box or writing to financial institutions, which do not involve discretion.
Courts will generally permit delegation to the extent that a reasonable and prudent business person would delegate in the management of their own affairs. This interpretation allows trustees to retain professionals (trust company, lawyer or accountant) to assist them in discharging their executor and trustee administrative duties.
The situation with respect to discretionary decisions is more complex. A discretionary decision involves an element of choice—for instance, whether to grant a beneficiary’s request to encroach on capital or whether to accept a particular offer for real estate owned by the trust.
While certain discretionary decisions, such as a capital encroachment request, remain the sole purview of the trustee, it is now recognized that to best serve the beneficiaries, certain discretionary duties may best be delegated to a professional. The investment of trust property is perhaps the best example of this.
In Ontario, statutory authority to delegate the trustee’s functions relating to investment of trust property is set out in section 27.1(1) of the Trustee Act.
In order to ensure an appropriate standard of care is maintained, the Act defines the trustee’s duty with respect to selecting an agent and also the duty of care required of the agent. It is best practice to include a clause in the will or trust indenture specifically authorizing the trustee to delegate the investment function to a professional.
Power to invest
The trustee distributes trust assets in accordance with the terms of the will or trust indenture and, pending distribution, manages the trust property in the beneficiary’s best interests.
The investment and management of the trust property constitutes one of the most important aspects of trust administration.
The settlor or testator may provide the trustee with broad or limited investment powers. Where the trust document is silent, the applicable provincial trustee statute will govern. So a trustee must invest the trust property in accordance with the terms of the trust and/or the applicable statute.
Preservation of capital has long been the hallmark of trust investing. This initially translated into something akin to risk-free investing.
Over time, trust law has evolved to recognize the need to achieve both capital growth and an acceptable level of income. In most common-law jurisdictions, this has meant an evolution in statutory powers to invest. At one time, in the absence of an express power in the trust document, the trustee had no power to invest. Now, trustees have mostly unrestricted power to invest.
Until the early 1990s, most Canadian provinces followed the legal-list approach to trust investing. The investment options provided were conservative in nature and greatly limited diversification.
All common-law provinces now follow some version of the prudent-investor standard, thus expanding the investment options available to a trustee.
In Ontario, the standard of care is defined in the Trustee Act (section 27.(1)): “In investing trust property, a trustee must exercise the care, skill, diligence and judgment that a prudent investor would exercise in making investments.” This general standard is supplemented by seven criteria the trustee must consider. These include economic conditions, the expected total return from income and the appreciation of capital, and the role that each investment or course of action plays within the overall trust portfolio.
The move to a prudent-investor approach obviously provides the trustee with a broader selection of investment choices and greater latitude. This same lack of restriction makes the job more perilous. Corporate trustees generally rely on in-house expertise to properly discharge the investment function and establish an acceptable standard of care.
Lay trustees should not act alone. While it was almost impossible to go wrong if you followed the prescribed investments set out in the old legal lists, the shift to the prudent-investor approach should cause all but the most investment-savvy trustee to recruit professional assistance.
Whenever we have obligations, we have penalties for failing to meet them. For a trustee, failure to properly discharge the essential duties may constitute a breach of trust. A breach of trust may be defined as a failure by the trustee to carry out the provisions of the trust and governing trust law.
A breach of trust resulting in a loss can result in liability for the trustee. Many trust accounts have faced a loss in value over the past couple of years, but as long as the funds were invested in accordance with the terms of the trust agreement and the prudent-investor standard, such a loss would not constitute a breach of trust. However, where the trustee failed to act prudently and is unable to demonstrate that all mandated criteria were reasonably considered, a loss may translate into potential liability for breach of trust.
Not all estates have a trust component, but many do. As our population ages and incapacity planning becomes top of mind, we can anticipate an increase in inter vivos trusts (while the trustor is still alive).
As an investment advisor, you will likely be appointed as a trustee or called upon to provide investment advice in respect of a trust. You may even settle a trust. Being mindful of the significant duties involved will assist you in performing the role or providing the best possible advice and guidance to your clients.