LEVEL 6 – UNIT 5 – EQUITY AND TRUSTS SUGGESTED ANSWERS – JANUARY 2018 Note to Candidates and Tutors: The purpose of the suggested answers is to provide candidates and tutors with guidance as to the key points candidates should have included in their answers to the January 2018 examinations. The suggested answers set out a response that a good (merit/distinction) candidate would have provided. The suggested answers do not for all questions set out all the points which candidates may have included in their responses to the questions. Candidates will have received credit, where applicable, for other points not addressed by the suggested answers. Candidates and tutors should review the suggested answers in conjunction with the question papers and the Chief Examiners’ reports which provide feedback on candidate performance in the examination. SECTION A Question 1 Fiduciaries include trustees, partners in business, company directors and solicitors. They must not put themselves in a position where their personal interest might conflict with their duty. The court will order fiduciaries to surrender any profit without enquiring into the circumstances of the case. The strict liability of fiduciaries has been the subject of criticism on the grounds that it is unfair to penalise honest fiduciaries in the same way as guilty fiduciaries and that the strict rule may discourage people from accepting the post. Trustees are subject to the strictest fiduciary duties. A more relaxed version of the rules applies to company directors by virtue of the Companies Act 2006. Boardman v Phipps (1967) was a classic illustration of the principles set out in Lord Russell’s statement. The trust property included a substantial shareholding in a private company. Mr Boardman (the trust’s solicitor) investigated the affairs of the company, initially on behalf of the trust, and gained useful information. Subsequently, with the knowledge of the active trustees, Mr Boardman purchased shares in the company with his own funds on his own account. Through skilful management he was able to reorganise the company and make large distributions to all shareholders, including the trust. The majority of the House of Lords held that the Mr Boardman had to account to the trust for his profits because he had profited from information which came to him in his fiduciary position. A further ground for the decision was that, had he been asked to advise whether the trustees should obtain a court order allowing them to buy the shares for the trust, he would have had a conflict of interest. The slightest possibility of a conflict was sufficient to make the trustees accountable; it did not matter that the possibility was extremely remote. Mr Page 1 of 14 Boardman had to surrender his shares and profit after being reimbursed with the purchase price. Mr Boardman had been honest. The active trustee gave evidence that he would not have invested trust money in additional shares and therefore, the possibility of a conflict of interest was extremely unlikely. The trust suffered no loss and actually benefited from the distributions which the company made as a result of the defendant’s reorganisation. Nevertheless, the defendant had to surrender his profit to the trust. In Regal (Hastings) Ltd v Gulliver (1967), directors of a company were liable for having exploited an opportunity which came to them in their position as directors. Their honesty and the fact that the company could not have taken the opportunity due to lack of funds were irrelevant. Wright v Morgan (1926) is a further example of the harsh operation of the rule; the conflict of interest arose because a trustee purchased trust property; the beneficiaries were allowed to avoid the transaction at a later date despite the fact that the trustee had paid the full market price. As was the case in Boardman v Phipps, it was irrelevant that the beneficiaries had suffered no loss. In Keech v Sandford (1726), the court justified the strict approach by saying that it is difficult for the courts to ascertain whether trustees have been honest and whether the trust could have secured the profit had it been given the opportunity. It has also been argued that strict liability does not prevent honest fiduciaries from making a personal profit; trustees, for example, can obtain the consent of the beneficiaries (assuming all the beneficiaries are adults) or the court or settlors may grant powers for trustees to make profits in the trust instrument. The advantage of strict liability is that it acts as a deterrent for other trustees. If trustees know that they cannot retain profits under any circumstances, they will not be tempted to exploit trust opportunities for themselves. Removing all temptation ensures that in all cases, trustees are incentivised to act in the best interests of the beneficiaries and that they are not swayed by their personal interests. However, the strict approach of the courts may not be as entrenched as would at first appear. In Boardman v Phipps, the House of Lords ordered the trust to pay the defendant generous remuneration for his hard work in changing the company’s fortunes. In a powerful dissenting judgment, Lord Upjohn suggested that fiduciaries should not be liable unless there was an actual conflict between their interest and duty e.g. if they deprived the trust of an opportunity which it would otherwise have taken up. In Murad v Al Saraj (2005), Lady Justice Arden doubted whether there were evidential difficulties in determining a trustee’s honesty. She remarked (obiter) that evidential problems could be avoided by throwing the burden on to the fiduciary to show he was honest, that the trust could not have gained the profit and that the trust suffered no loss. The strict approach may deter people from becoming trustees or taking up fiduciary roles (especially commercial positions such as company directors). It is likely to stifle entrepreneurism which can be to the detriment of the beneficiaries or those who are owed fiduciary duties. Had Mr Boardman decided not to risk breaching his fiduciary duty by seeking to make a personal profit, the trust would have been denied the profit which it actually derived from the defendants’ activities. This was the reason why the Companies Act 2006 adopted a less stringent regime for company directors. The Act provides that directors are not Page 2 of 14 liable if there is no reasonable possibility of a conflict of interest which is closer to Lord Upjohn’s more relaxed approach. Some Commonwealth jurisdictions have adopted a more lenient regime; for example, a director is not liable for profiting from an opportunity if the Board of Directors has already rejected the opportunity on behalf of the company. There are signs that the inflexible rule of equity might be relaxed in the future. Question 2 Section 9 of the Wills Act 1837 provides that dispositions intended to have effect on a person’s death should be contained in a written will signed by the testator in the presence of two witnesses who then sign the will in the presence of the testator. Secret trusts do not comply with s9 because all the terms of the trust are not set out in the will. Fully secret trusts arise where a will contains an absolute gift to a legatee; outside the will the legatee agrees to hold the legacy on trust. In half secret trusts, the will indicates that there is a trust but does not set out its terms. In both fully and half secret trusts, the testator must communicate the terms of the trust to the legatee and the legatee must agree. In fully secret trusts, the terms must be communicated before the testator’s death (Wallgrave v Tebbs (1855); Re Boyes (1884). In half secret trusts, the terms of the trust must be communicated before or at the time the will is executed (Re Keen (1937); Re Bateman (1970)). In McCormick v Grogan (1869), it was held that fully secret trusts should be enforced because equity will not allow statute (s.9) to be used as an instrument of fraud. If a fully secret trust were not enforced, the legatee would take beneficially in accordance with the absolute gift in the will. This would be a fraud when the legatee has agreed to act as a trustee and, in reliance on the legatee’s agreement, the testator has made a will leaving the legacy to him or her or has left the legacy unrevoked. However, this does not explain why the secret beneficiary is allowed to benefit. Where the secret trustee refuses to abide by his or her agreement, the secret beneficiary is not defrauded; the secret trustee did not give the secret beneficiary a promise to hold on trust and the secret beneficiary did not rely on the promise to his or her detriment. There is an alternative suggestion that the fraud consists of the trustee’s refusal to keep the promise made to the testator on which the testator has relied. Fraud would thus be prevented by refusing to allow the trustee to take beneficially by imposing a resulting trust for the testator’s estate. The prevention of fraud theory does not justify the enforcement of half-secret trusts. The fact that the legatee is to be a trustee is apparent on the face of the will. There is no possibility of X taking beneficially and therefore, no possibility of fraud by X. The modern explanation why secret trusts are enforced is the ‘dehors the will’ theory (Blackwell v Blackwell (1929)). This explanation runs as follows: The testator communicates to the secret trustee the terms of the intended trust, and the secret trustee accepts the obligation.