Arbitration agreements in trust instruments - are they binding on beneficiaries? 1

Briefing note June 2013

Arbitration agreements in trust instruments - are they binding on beneficiaries? Agreements to arbitrate are generally binding only on the parties to the agreement and, accordingly, would not be binding on beneficiaries under many trust instruments. Some jurisdictions have legislated specifically to deal with this. In others, theories such as conditional benefits have been applied. In England, the issue remains untested.

A recent decision of the Supreme Court of Texas, in Rachal v Reitz, provides an interesting insight into how the courts in another common law jurisdiction have approached the issue, concluding that the beneficiaries were bound to bring any claims by way of arbitration.

that beneficiaries can be bound by the Arbitration arbitration agreement is the "deemed Key issues acceptance theory". This proposes provisions in trust that since beneficiaries claim "under  Trust instruments may include arbitration agreements. or through" a settlor, who is a party to instruments the trust deed, they fall within s.82(2)  It is uncertain whether such arbitration agreements are In England and Wales, it is an open of the Arbitration Act 1996, which binding on beneficiaries. question as to whether an provides that parties to an arbitration arbitration provision in a trust deed agreement include a "person claiming  The issue has not yet come can bind all beneficiaries to resolve under or through a party to the before the English courts disputes through arbitration rather agreement".  Guernsey, Liechtenstein and other jurisdictions have than court litigation. It has also been argued that the beneficiaries acquiesce in the legislated to confirm the Arbitration requires the consent of the arbitration agreement by seeking or binding effect of arbitration agreements on beneficiaries. parties and, of course, beneficiaries accepting benefits from the trust, under a trust instrument have not similar to the effect of the Contracts  The Texas Supreme Court (usually) consented to be bound by (Rights of Third Parties) Act 1999 on has recently applied the any arbitration provisions contained in ordinary contracts. theory of "direct benefits the trust instrument. estoppel" to give effect to the In addition, section 8 of the 1999 Act intention of the settlor. Certain theories exist that extend the provides that where a right for a third  Care needs to be taken in binding effect of such arbitration party to enforce a term under that act drafting trust instruments provisions to non-signatories. One is subject to a term providing that governed by English law until theory advanced to support the view disputes be settled by arbitration then, this issue is resolved.

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beneficiaries are bound by any arbitration of the dispute under the arbitration provision within the trust Texas Arbitration Act. Why arbitration? deed by virtue of the 1999 Act. The Arbitration Provision One of the main advantages to Notwithstanding these arguments, a arbitration is the fact that the 2008 discussion paper prepared for The arbitration provision in the A.F. proceedings are private and any the Trust Law Committee of STEP Reitz Trust instrument upon which decision reached by the arbitrator found that it was "plainly impossible" Rachal sought to rely was very is confidential. In contrast, court under English law for beneficiaries to broadly drafted. litigation is generally open to the be bound to resolve disputes by The provision read: "Despite anything public with the final judgment arbitration in such a way. herein to the contrary, I intend that as being published. Even where the However, to date there has not been to any dispute of any kind involving Court agrees to hear a trust a case before the English Courts this Trust or any of the parties or dispute in private, it is sometimes where consideration has been given persons concerned herewith (e.g., keen to publish the judgment on to this issue. beneficiaries, Trustees), arbitration as an anonymised basis. provided herein shall be the sole and Some jurisdictions have sought to There are a number of other exclusive remedy, and no legal remove any uncertainty by legislation, possible advantages to arbitration proceedings shall be allowed or given but this is not an approach that has which may have a bearing on the effect except as they may relate to yet been taken in England. settlor's decision, including: enforcing or implementing such arbitration in accordance herewith.  Finality - it is very difficult to The Decision in Judgment on any arbitration award appeal any decision reached pursuant hereto shall be binding and by the arbitrator; Rachal v Reitz enforceable on all said parties."  Cost - arbitration may To reinforce the point, the trust sometimes be quicker and In Hal Rachal, Jr., v John W. Reitz instrument also stated that it "shall cheaper; (No. 11-0708 May 3, 2013) the Supreme Court of Texas was asked extend to and be binding upon the  Flexibility - arbitration to determine whether an arbitration Grantor, Trustees, and beneficiaries provides greater procedural agreement contained in the trust hereto and on their respective heirs, and substantive flexibility; instrument of an inter vivos trust executors, administrators, legal  Choice of arbitrator - it is was binding on the beneficiaries. representatives, and successors." possible for the parties to choose an arbitrator with Andrew Francis Reitz established the First Instance and Court particular experience or A.F. Reitz Trust in 2000, naming his of Appeals expertise. sons James and John as sole Notwithstanding the broadly drafted beneficiaries, and himself as trustee. so long as the arbitration agreement arbitration provision, both the trial The trust was revocable during is in writing for the purposes of the AA court and the court of appeals in Andrew's lifetime and irrevocable then "the third party shall be treated Texas rejected Rachal's arguments after his death. Hal Rachal, Jr., the for the purposes of that Act as a party that the dispute should only be lawyer who drafted the trust to the arbitration agreement as resolved by arbitration. instrument, became the successor regards disputes between himself and trustee upon Andrew's death. A divided Court of Appeals held that a the promisor relating to the binding arbitration provision must be enforcement of the substantive term In 2009, John Reitz sued Rachal the product of an enforceable contract by the third party. " individually and as successor trustee, between the parties, reasoning that alleging that Rachal had In light of this, it is open to argument such a contract does not exist in the misappropriated trust assets and that, given that a trust deed is in trust context, in part because there is failed to account to the beneficiaries writing, it falls within the requirements no consideration and in part because as required by law. Rachal denied the of the Arbitration Act and thus the trust beneficiaries have not allegations and later moved to compel 104521-4-1017-v1.8 UK-0010-LDR-AS

Arbitration agreements in trust instruments - are they binding on beneficiaries? 3

consented to such a provision. The instrument could constitute a valid Scope of the Arbitration Provision majority followed the analysis in the arbitration agreement for the Having thus determined that the Schoneberger case from Arizona. purposes of that act. arbitration provision in the trust However, the dissent in the Court of The act states that "a written instrument was binding on Reitz in Appeals noted that the Texas agreement to arbitrate is valid and principle, the Court then had to turn to Arbitration Act does not require a enforceable if the agreement is to the issue of whether the dispute in formal contract to arbitrate, only a arbitrate a controversy that: (1) exists question was within the scope of the written agreement, and that at the time of the agreement; or (2) provision. accordingly the rulings in other arises between the parties after the The Court here had a relatively jurisdictions that the majority had date of the agreement." straightforward task, given that the applied were not, in fact, applicable in The act does not define "agreement", provision was drafted to cover "any this case. so the Supreme Court of Texas dispute of any kind" and also, on its Decision of the Supreme turned to look for a generally own terms, took precedence over any potentially contradictory wording in Court of Texas accepted definition, and noted that the term is broader than "contract" the trust instrument by virtue of the The Supreme Court of Texas and is simply a manifestation of wording "despite anything herein to reversed the judgment of the Court of mutual assent by two or more the contrary". Appeals, holding that the settlor's persons. An agreement, therefore, Accordingly, the Court held that intention had been for disputes to be need not meet all the formal Rachal had demonstrated the settled by arbitration, the trust requirements of a contract, thus existence of a valid arbitration instrument was a valid arbitration bypassing Reitz's argument that the agreement that covered the claims at agreement for the purposes of the lack of consideration invalidated the issue. In light of this, the appeal was Texas Arbitration Act and the dispute arbitration provision. upheld and the trial court was in question was within the scope of However, the agreement must be remanded to enter an order the arbitration provision. supported by "mutual assent". consistent with that opinion. Intention of the Settlor The Court held that a beneficiary who Texan law precedent is clear that seeks to enforce the provisions of a Approaches in when interpreting a trust instrument, trust instrument has acquiesced to its the Court's role is to divine the other provisions – including the other jurisdictions intention of the settlor, not to correct arbitration clause. A beneficiary is not Guernsey or redraft the instrument "under guise able to pick and choose which parts of construction or under general of the trust instrument he or she In Guernsey, where the law relating to powers of equity." Accordingly, the accepts. arbitration is based partly on the Supreme Court of Texas held that English equivalent, any doubt as to Andrew Reitz had "unequivocally Reitz had both sought the benefits the effectiveness of arbitration stated his requirement that all granted to him under the trust and provisions in trust instruments has disputes be arbitrated" and that as a had sued to enforce the provisions of been settled by legislation. the trust; this conduct indicated result of this unambiguous language Article 63 of the Trusts (Guernsey) the Court had no option but to acceptance of the terms and validity of the trust. Law 2007 provides that, so long as "compel arbitration if the arbitration certain conditions relating to the provision is valid and the underlying The Court therefore applied the representation of beneficiaries at any dispute is within the provision's doctrine of direct benefits estoppel. proceedings are met, if the terms of scope." This doctrine provides that where a the trust direct or authorise arbitration Validity of the Arbitration Provision party has obtained, or is seeking to (or if the Court orders it) a decision by obtain, substantial benefits under an the arbitrator is binding on all The Court was required, therefore, to agreement, he is estopped from beneficiaries, whether or not yet interpret the Texas Arbitration Act in simultaneously attempting to avoid ascertained or in existence and order to determine whether a trust the burdens of the agreement. 104521-4-1017-v1.8 UK-0010-LDR-AS

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whether or not they are all of full age Jersey courts have to consider the influencing court decisions in and sound mind. effectiveness of an arbitration California amongst other jurisdictions provision in a trust instrument, (including the Texan court of appeals Jersey because the rationale that the in Rachal v Reitz), before being Whilst on many issues relating to beneficiaries have not agreed to settle rendered nugatory by the Arizona trusts the two main jurisdictions in the their disputes in the manner set out in state legislature, which amended Title Channel Islands are quick to follow the instrument is just as applicable to 14 of the Arizona state code to permit each other's legislative developments, arbitration provisions as to jurisdiction trust deeds to prescribe mandatory Jersey has not yet followed clauses. dispute resolution procedures. Section 14-10205 reads "A trust Guernsey's example. The position Liechtenstein remains open as to whether it is instrument may provide mandatory, possible for a Jersey trust deed to In Liechtenstein, legislation passed in exclusive and reasonable procedures compel the beneficiaries to resolve 2010 permits the submission of to resolve issues between the trustee disputes by arbitration. practically all disputes in relation to and interested persons or among trusts to arbitration, whilst the 1926 interested persons with regard to the In EMM Capricorn Trustees Limited v Law on Persons and Companies in administration or distribution of the Compass Trustees Limited [2001] Liechtenstein makes it mandatory for trust." JLR 205, the Royal Court of Jersey any disputes between the settlor, the held that beneficiaries were not bound Florida trustee and the beneficiaries to be by an exclusive jurisdiction clause in a settled by arbitration where a trust is The Florida legislature has taken a trust deed to which they were not created and registered in similar approach to that in Arizona, parties. Liechtenstein but governed by foreign amending the state code to include a The Court reasoned that "If A and B law. provision which states that a agree in a contract that they will refer "provision in a will or trust requiring any dispute to the courts of a The Bahamas the arbitration of disputes, other than particular country, one can well In 2011, The Bahamas introduced the disputes of the validity of all or part of understand why they should generally Trustee (Amendment) Act 2011. a will or trust, between or among the be held to their bargain. They have Section 91A of that act enabled a beneficiaries and a fiduciary under the agreed it; why should one of them dispute or administration question will or trust, or any combination of then be allowed to go back on what relating to a trust to be resolved by such persons or entities, is has been freely agreed? But the arbitration if the trust instrument enforceable." position is very different in relation to allows. a trust. The exclusive jurisdiction Others The arbitration provision in the trust provision of a trust deed will have Malta and the state of Washington instrument will bind all parties been agreed only between the settlor also allow the enforcement of including beneficiaries, regardless of and the original trustee. Actions in arbitration provisions in trust deeds, whether or not those beneficiaries relation to the trust may be brought by whilst Singapore has introduced have been ascertained or are in beneficiaries who were never parties enabling legislation closely similar to existence at the time, as if they were to the trust deed; indeed they may not that introduced in Florida. even have been alive at the time of its parties to an arbitration agreement. execution. The policy considerations Arizona The future in which lead to a party to a contract being held to his choice of exclusive The Arizona Court of Appeal had, in England and jurisdiction cannot apply to a Schoneberger v Oelze (No. 1 CA-CV beneficiary who played no part in the 03-0490), declined to enforce a Wales choice of exclusive jurisdiction made arbitration provision in a trust deed, in in the trust deed." part because the Arizona statute in The validity of arbitration issue required that the arbitration provisions in trust instruments has It seems likely that this decision would provision be in a "written contract". not come in front of the courts in be applicable by analogy should the The case was widely cited, 104521-4-1017-v1.8 UK-0010-LDR-AS

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England and Wales. Accordingly it settlors to be able to elect to make whether arbitration provisions in remains open to debate as to use of it as a method of dispute English law trust instruments are whether such provisions would be resolution, describing it as "a valuable binding on beneficiaries. considered to be effective by the alternative resource." Accordingly, absent change in the English Courts. Concerns were also raised that as legislation as proposed by STEP, In light of the 2008 discussion paper arbitration provisions in trust deeds there is a real risk that the English prepared for the Trust Law Committee are binding in some other jurisdictions, courts would conclude that arbitration of STEP which had indicated that it these jurisdictions may be more agreements are not in fact binding on was not possible for arbitration attractive venues for the arbitration of the beneficiaries, who may therefore provisions in trust instruments to bind disputes that could more be able to bring their claims in the the beneficiaries under English law as appropriately be arbitrated in England courts instead, notwithstanding the it stands, a paper was prepared by and Wales. The paper noted that this apparent intention of the settlor to the the Executive Committee of the TLC would be to the detriment of the contrary. development of trust law within in April 2012 to consider whether In light of this, trustees and other England and Wales. changes to the law were desirable. wealth management professionals will The paper suggested that the The paper noted that consideration need to consider carefully whether Arbitration Act should be expressly would need to be given to ensuring their beneficiaries are compelled to amended to confirm the enforceability the protection of interests of minor arbitrate rather than litigate by any of arbitration provisions in trust beneficiaries or unborn and arbitration provision in the trust deed. instruments in a manner similar to the unascertained beneficiaries, as is If the circumstances of a particular legislation introduced in Florida in provided for in the Guernsey trust mean that arbitration is 2007. legislation. preferable then, subject to other The Law Commission has also given In the absence of a doctrine of direct considerations, a trustee may want to support to such a proposal, although benefits estoppel, and in consider whether they should seek to no such steps have been taken to circumstances where the analogous change the governing law of the trust date. statutory provisions of the Contracts to Guernsey law, or the law of another The paper noted that the merits of (Rights of Third Parties) Act may not jurisdiction which offers certainty that resolving disputes by way of be applicable to trust instruments, it beneficiaries will be bound by the arbitration mean that it is desirable for remains open for debate as to arbitration provisions.

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6 Arbitration agreements in trust instruments - are they binding on beneficiaries?

Authors

Jeremy Kosky Audley Sheppard Jason Fry Richard Coopey Partner Partner Partner Lawyer E: jeremy.kosky E: audley.sheppard E: jason.fry E: richard.coopey @cliffordchance.com @cliffordchance.com @cliffordchance.com @cliffordchance.com

Helen Carty Max Mossman Ellen Lake Simon James Partner Partner Lawyer Partner E: helen.carty E: maxine.mossman E: ellen.lake E: simon.james @cliffordchance.com @cliffordchance.com @cliffordchance.com @cliffordchance.com

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