Mistakes can and do occur, occasionally with potentially catastrophic consequences for the best laid estate and succession plans.
The Grand Court in the Cayman Islands has recently considered two facets of the mistake jurisdiction: rectification and excessive execution, allowing in one case a settlor, and in another, the trustees, to effectively roll back time and undo their mistakes.
Not surprisingly, this has made the law of mistake a particularly hot topic for advisers and their clients.
Rectification is an equitable jurisdiction. The court can remedy a mistake in the drafting of a document so that it reflects the intention of the parties to it. In the case of a voluntary settlement, the party concerned will be the settlor of the trust.
In Re Golden Trust1, the settlor instructed a firm of London solicitors to draft a trust deed so that he could settle his assets on an offshore trust prior to becoming deemed domiciled in the U.K. and his estate thus liable to U.K. tax.
The solicitors kept a clear record of their instructions, their advice and the settlor’s intentions. The finalizing of the documents was done in something of a rush and the deed executed only days before the deadline. As a result, loans that the settlor had made to two of the family’s companies were omitted from the schedule of assets transferred into trust. The mistake was not spotted for many years but when it was, the potential tax liability was likely to be in the region of US$8 million. What could be done?
Rectification of course is a form of relief which operates retrospectively, meaning that the trust deed once rectified is read as if it had been in the correct form from the outset, properly reflecting the settlor’s intentions. In this case, the trust was originally governed by Liechtenstein law which did not provide for equitable relief such as rectification. The governing law was changed to that of the Cayman Islands and new Cayman Islands’ trustees were appointed.
This raised the interesting question as to whether the trust was capable of rectification given that it started life as a Liechtenstein trust. The chief justice looked to the ‘firewall legislation’, found at sections 89 and 90 of the Cayman Islands Trusts Law (2011 Revision), and concluded that it could be rectified.
On the evidence before him, the chief justice found that rectification was the appropriate remedy and the fact that the trust had started out governed by Liechtenstein law did not operate to prevent him reaching that conclusion.
In so finding, the chief justice held that he would order rectification notwithstanding the fact that it was required for a tax advantage and due to the law firm’s negligence.
“I do not consider that the requirement of the identification of a non-fiscal issue operating as a fetter upon the court’s jurisdiction or discretion to grant rectification forms any part of Cayman law … this appears to be a fetter adopted by the U.K. courts in deference to the imperative of domestic fiscal policy … such imperatives of fiscal policy do not arise in this jurisdiction to justify the fetter upon the exercise of the remedial jurisdiction that is rectification.”
In Schroder Cayman Bank and Trust Co Ltd v Schroder Trust AG (unreported), the court held that three separate appointments of capital from an employee benefit trust (EBT) established in the Cayman Islands to three employee financed retirement benefit schemes in Jersey were void as a result of excessive execution of powers contained in trust deed and on the grounds of mistake.
The EBT was originally settled by a U.K. company for the benefit of a class of beneficiaries defined in the deed as “‘the employees and the wives, husbands, widows, widowers and children or step-children and remoter issue, of the employees.’”
The deed contained a prohibition on the trustees transferring trust property to the trustee of a new settlement unless the beneficial class of the new settlement was identical to the beneficial class of the original settlement.
In early 2011, the trustees sought legal advice regarding the potential fiscal implications of a draft U.K. Finance Bill. They were advised it would be tax efficient to make appointments of capital from the EBT to employee financed retirement benefit schemes (EFRBSs). Consequently, they made three transfers of capital to three EFRBSs in Jersey.
The trustees subsequently became embroiled in a dispute with HMRC about whether the appointments triggered a liability to U.K. tax. During the course of this dispute, it became apparent that the appointments had been made incorrectly because they purported to benefit a class of beneficiaries wider than was permissible pursuant to the provisions of the trust deed. The appointments were also executed in the mistaken belief that a) the classes of beneficiaries in the EFRBSs and the EBT were identical, and b) no tax liability would arise.
Upon realising their error, one of the trustees applied to the Cayman Islands court seeking a declaration that the three appointments were void and of no effect, or alternatively, seeking to set aside the appointments on the grounds of mistake.
The court first had to decide whether the application should be determined under the laws of the Cayman Islands or Jersey; the EBT was subject to Cayman Islands law and the EFRBSs were subject to the laws of Jersey. Ostensibly conflicting provisions in the Cayman Islands and Jersey Trusts Laws provided that questions relating to trusts established in that jurisdiction should be governed by the laws of that jurisdiction, regardless of any other jurisdictions with which such trusts might be connected.
It was argued that in those circumstances, the parties should fall back on principles of private international law, requiring the identification of the jurisdiction most closely connected with the transactions in question to decide which set of laws should apply; in this case, the Cayman Islands.
The chief justice approved of this reasoning, adding that it was possible that the conflict of laws issue did not arise, because if the appointments were invalid from inception, the assets were never transferred out of the EBT and the question of jurisdiction would not arise. Further, the shares transferred into the EFRBSs were considered ‘choses in action,’ and under applicable common law principles, the governing law of the transaction would be the law of domicile, in this case, the law of the Cayman Islands.
The chief justice also found, based upon expert evidence, that applying Jersey law would result in the same conclusions, the relevant principles underpinning Jersey trust law being much the same as those of the Cayman Islands.
There were at least two ways in which the appointments affected the validity of the transfers to the EFRBSs. The chief justice referred to the first as the ‘excessive execution’ issue.
The power of appointment in the trust deed could only be exercised for the beneficiaries as defined in it, and did not include the wider class of dependants in the EFRBSs. Similarly, the power to transfer trust property contained in the trust deed only permitted assets to be transferred to a ‘qualifying settlement,’ defined as a settlement under which every beneficiary was also a beneficiary of the EBT.
The chief justice adopted the following dictum from the case of Harvey v Stacey2:
“… if the appointment is to a class, some of whom may, and others who may not, be objects of the power, and there is nothing to point out what portion is to go to those who are within the power, and what to those who are not, the whole fails.”
He found that the appointments fell into this category, because the EBT and the EFRBSs were fully discretionary trusts, making it impossible to determine the precise entitlement of each of the beneficiaries.
The chief justice also held that because the appointments purported to benefit a class of beneficiaries wider than the class defined in the EBT, the appointments were a wholly excessive execution of the power. As the impermissible execution of the power could not be severed from the permissible execution of the power, the entire exercise was deemed a misuse of the power and ‘void ab initio.’
As to the alternative argument, the chief justice held that there had been three mistakes in exercising the power of appointment: the extent of the class of beneficiaries, the tax consequences of the exercise and the revocability of the appointments. He accepted the trustees’ evidence that, had they been aware of any of these, they would not have exercised their powers in this way.
The chief justice was satisfied that the trustees’ reliance on the erroneous advice and drafting caused severe consequences which were never intended, and the appointments would never have been made but for those mistakes. The mistakes were of sufficient gravity to engage the court’s jurisdiction to set them aside, and it would be ‘unconscionable’ to leave them uncorrected.
The court’s jurisdiction to step in to remedy mistakes which have a detrimental effect on the interests of the beneficiaries is an essential tool in the court’s supervision of the administration of trusts in the Cayman Islands.
This does not mean that the court will grant such orders automatically; there remains a heavy evidential burden on the applicant but in appropriate cases, it can be good news indeed for trustees, settlors and beneficiaries alike.