Receivers and revocable trusts: Reserved powers cannot be exercised against the will of the settler

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Endnotes

Section 14 of the Trusts Law (2007 Revision) of the Cayman Islands provides for the validity of a number of powers to be reserved to or granted by the settler of a Cayman Islands trust. The first in the list of such powers is “any power to revoke, vary or amend the trust instrument or any trusts or powers arising there-under in whole or in part.” Similar provisions appear in the trust legislation of other offshore or popular trust jurisdictions

The reservation by a settler of a power of revocation enables the trust structure to be used in a flexible way for different purposes. For example, it enables the trust to qualify as a grantor trust for US tax purposes1. It can be used to make provision for a disabled relative or child with the ability, should such person predecease the settler, for the settler to take back the trust monies previously settled, or, more generally, to provide a ‘living will’ or to avoid probate.

However, the flexibility of reserved powers also carries with it potential consequences. The trust fund will ordinarily be considered to still be under the control of and so ‘belong’ to the settler for tax purposes whether during his lifetime or upon his death. Should he become bankrupt, it is likely that a trustee in bankruptcy will be able to exercise the reserved power so as to make any remaining trust assets available to fall into the bankrupt estate. Section 100 of the Bankruptcy Law (1999 Revision) of the Cayman Islands provides that the property of the debtor vesting in the trustee in bankruptcy for purposes of division among his creditors includes “the capacity to exercise and to take proceedings for exercising all such powers in and over or in respect of property as might have been exercised by the debtor for his own benefit at the commencement of the bankruptcy”.

In TMSF v Merril Lynch Bank and Trust Company (Cayman) Limited and others (26 June 2009) Smellie CJ had to consider whether a judgment creditor was entitled to an order for the appointment of receivers by way of equitable execution to force the judgment debtor to exercise his reserved power as settler of two Cayman Islands trusts to revoke those trusts and apply the proceeds in partial satisfaction of the judgment debt. The judgment debt which was sought to be enforced was a Turkish judgment enforced in the Cayman Islands at common law by action and summary judgment. The settler was a Turkish citizen resident in Turkey.

This issue had not previously been considered and it was therefore necessary for the Court to approach the issue from first principles. In a careful and scholarly analysis, Smellie CJ determined that a receiver could not be appointed. His judgment is an important decision on the nature and extent of reserved powers which is of relevance to other trust jurisdictions permitting wide ranging reserved powers.

The scope of the remedy of receivership by way of equitable execution was recently considered in some detail by the English Court of Appeal in Masri v Consolidated Contractors International SAL3. Lawrence Collins LJ examined the historical development of the remedy since 1873 and concluded that “there is no reason why in 2008 the court should not exercise a power to appoint a receiver by way of equitable execution over future receipts from a defined asset. There is no longer a rule, if there ever was one, that an order can only be made in relation to property which is presently amenable to legal execution. There is no firm foundation in authority for a rule that the remedy is not available in relation to future debts.”

This conclusion would justify the appointment of a receiver over any future appointments by the trustees of capital or income to the settler as beneficiary or to the whole of the trust monies in the event that the settler was himself to exercise his power of revocation. However, as Chief Justice Smellie observed, it is not authority for the proposition that a receivership may be appointed over a power of revocation of a trust so as to bring about its revocation and the revesting of its assets in the settler in circumstances where the settler has evinced no intention to do so himself.

In order to justify the appointment of a receiver, it was argued that the power of revocation was in the nature of property, specifically a chose in action, over which a receivership by way of equitable execution could be made, notwithstanding that such a chose in action would not be available for legal execution5. It was therefore necessary for the Court to consider whether this argument was correct.

The Chief Justice started his analysis by examining the longstanding and fundamental distinction between ‘a power’ and ‘property’ as epitomised in the judgment of Fry LJ in Re Armstrong ex p. Gilchrist (1886) 17 QBD 521, 531-532 where he said:

“No two ideas can well be more distinct the one from the other than those of ‘property’ and ‘power’ … A ‘power’ is an individual personal capacity of the donee of the power to do something. That it may result in property being vested in him is immaterial; the general nature of the power does not make it property. The power of a person to appoint an estate to himself is, in my judgment, no more his ‘property’ than the power to write a book or to sing a song. The exercise of any of these three powers may result in property, but in no sense which the law recognises are they ‘property’.”

The Chief Justice considered all of the subsequent cases and concluded that absent statutory provision there was no authority which would equate a power of revocation or a general power of appointment with ‘property’. All of the subsequent cases in which a ‘power’ was treated as being equivalent of ‘property’ were cases where statute had provided an extended meaning of property so as to include in the definition of property for the purposes of the particular statute the capacity to exercise a power in or over or in respect of property. Smellie CJ considered the various statutory provisions which provided for an extended meaning, in particular legislation governing bankruptcy and wills and concluded “the lesson from…a comparison of the statutory provisions against the background of the history of the common law is simple and compelling: in the light of the well established common law rule that distinguishes power from property, where the law intends to equate them it has been necessary to create express statutory exceptions to the common law rule.”

Smellie CJ also observed that there was a further difficulty with the appointment of a receiver in that the receiver could not be appointed over the power itself, but what was proposed was that the judgment debtor be ordered to exercise the power and if he refused it would be exercised on his behalf by the clerk of the Court under Grand Court Rules Order 45 rule 8. This amounts to a forced delegation of the power for which there was no statutory authority.

In the concluding paragraphs of his judgment, Smellie CJ observed that to grant the relief sought would be to set aside the settled common law principles which have distinguished powers from the property they affect for hundreds of years and would strike at the very heart of the trust concept. He noted that in 1811 Lord Eldon had ruled6 that there was no equity to compel a bankrupt to exercise a general power of appointment in favour of his creditors. Legislation was subsequently passed7 which provided statutory vesting of the powers of the bankrupt in the trustee in bankruptcy to be executed in favour of the creditors and this provision was variously re-enacted in subsequent legislation until the present time.

It would be strange if equity had on the one hand refused to force a power to be exercised in favour of the general creditors of a bankrupt absent statutory provision, and on the other hand were to force its exercise in favour of a particular creditor by appointing a receiver to be appointed by way of equitable execution.

The decision of Smellie CJ is to be welcomed by trusts practitioners not only because it is a useful modern analysis of the continuing distinction between powers and property, but also because it upholds the trust concept. The judgment recognises that the existence of settlors’ reserved powers should not expose the trust assets to attack, save where the legislature has determined that it is appropriate and in the public interest to do so, as in the case of bankruptcy.

This article is not intended to be a substitute for legal advice or a legal opinion. It deals in broad terms only and is intended to merely provide a brief overview and give general information.