Dog legs and diversification

The judgment in Gregson v HAE Trustees & others [2008] EWHC 1006 (Ch) gives rise to a number of points of interest to a wide audience of trustees, beneficiaries and their advisers. It also serves as a reminder of the perils of family trusts, where emotion and tame trustees no longer seem like such a great idea once the wheels have come off the gravy train.

The case concerned a trust, established in the 1960s, by one of the brothers who founded the Courts furniture chain. The trust was created, along with others within the Cohen family, to hold Courts shares; the shares had significant value for many years until the company went under in 2004.

The trustee of the trust, and of other trusts within the family, was HAE. HAE was a company limited by guarantee, and, itself, had no value. HAE was run by individuals within the extended Cohen family and a company of this type was almost certainly appointed with a view to it protecting those individuals from personal liability to other family members.

On the failure of Courts, the trust assets became worthless and the beneficiaries looked to sue for the loss. The first issue was over who could be claimed against. The second issue, not fully rehearsed by the court, was the basis of the claim. Put another way, in time honoured fashion, who to blame and what to blame them for ?

The first issue involves the use of the so-called dog leg claim. The obvious claim, being against HAE, would be pointless, given that HAE had no assets, and could not be compelled to sue its own directors. So, could the beneficiaries sidestep HAE and, instead, sue its individual directors ?

The possibility of the law allowing such a claim has been floated in recent years, although with more enthusiasm in the Channel Islands than in the UK. The court held that a claim was not possible, requiring, inter alia, various company and employment law principles to be jettisoned if the corporate veil was to be pierced successfully.

It remains to be seen whether the decision will be appealed. On the one hand, the inability to make a dog leg claim seems sound at first blush, and especially so in an instance where the settlor was seemingly desirous of affording protection to the individual family members acting as directors of a corporate trustee. But, on the other hand, the ability of trust services providers to protect themselves commercially does not sit so comfortably, in policy terms, with the notions of minimum fiduciary obligations and limitations on trustee indemnities, neither of which have any real value to the beneficiary if an action in contract or tort has to be brought only against a company made of straw.

The well advised prospective settlor can protect against the consequences of an empty vessel trustee by dictating the nature of trustee appointments or by making it a requirement for trustees to maintain indemnity cover. Adult beneficiaries of an existing trust might be able to use their Saunders v Vautier rights to strong-arm an existing trustee to bring about equivalent results. Notwithstanding, with many trusts, and especially those in commercial environments such as personal pensions, being run on the cheap, it does seem that the law is in need of some development if beneficiaries are to be afforded the protection they might otherwise expect.

Having found against the claimant on the first issue, the court commented on the second, at least to a certain extent. In particular, could there have been a breach by the trustee of its statutory duty to consider a diversification of the trust investments under the Trustee Act 2000 ?

With many family trusts being established, as here by the Cohen family, to own a business founded by the settlor's generation, the subsequent management of a trust as the generations pass, and the beneficiaries become more remote from the settlor, remains something of an imprecise art. As grandchildren or great grandchildren come on stream as trust beneficiaries, the continued appropriateness of the trustees retaining shares in a company, where there is no longer the emotional attachment held by the previous generations, can often cause concern when it comes to the duty to consider selling and diversifying trust investments.

Here, with the benefit of hindsight, there can, of course, be no financial argument that the trustee should have sold at least some of its Courts shares and, further, that reinvestment into just about anything else, save for Marconi or Northern Rock, would have left the beneficiaries better off. This despite a diversification being contrary to the express wishes of the settlor.

The court held that shares were investments of the trust, albeit that the trustee had not purchased the shares but were, rather, given them by the settlor. Having established that the 2000 Act was in point, the court did not bother to examine the circumstances further with a view to establishing whether the requirements of the Act were breached; in the event, we suspect that the alleged consent of the beneficiary to the continued holding by the trustee of the Courts shares would, if proven, have saved the trustee. Absent such an indemnity, it would be six to five and pick 'em.

There are many family trusts with a not dissimilar profile to that considered here. With the economic outlook being less than brilliant, the case serves as a timeous reminder that trustees need to be reviewing the continued merits of the lopsided investment of trust funds.