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Trustees need to be aware of the risks

People need to look, and think, very hard before they agree to become trustees.

Wednesday, June 11th 2003, 7:06AM

by Rob Hosking

The explosion in the number of trusts over recent years has brought with it a welter of new issues and responsibilities – and many trustees may not be aware of what these are.

In particular, the requirement in the Trustees Act, inserted in 1988, for trustees to act in a prudent manner when investing the assets contained within a trust is catching an increasing number of people.

The requirement is not an absolute one. A trust deed can contain a clause which overrides or modifies the prudent investment requirement.

However that needs to be explicitly done. If it is not, the presumption is that any investments need to be prudent.

A farm, for example, may be put into a trust with the explicit purpose of keeping the land within the family.

However if the trust deed does not explicitly say that, and if the value of that farm was to decline, trustees have an obligation to sell up and transfer the money into a more prudent investment.

"It’s taken quite a while for trust drafters and conveyancers to cotton on to that,” says Auckland trust specialist John Brown.

"There’s been quite a number where the intent has been to keep the farm or the house within the family, but it hasn’t been explicitly stated."

That makes the trustees potentially liable. Typically, the trustees will be the parents of the beneficiaries, plus an independent person, whether that be a lawyer, an accountant or a friend of the family.

Usually the beneficiaries do not sue their parents, but it is the other party that cops the writ when the parents have passed on, says Brown.

As to what a “prudent investment” might be, that is still not precise, but there are indications that portfolio theory – spreading the risk of investments – is having a stronger influence on how this phrase is interpreted.

We could see a considerable surge in the number of cases on this point over the next few years, he says.

The slump in world equity markets since 2000 has opened up the door for several cases – beneficiaries have not benefited quite to the extent they have expected and, as a result, have targeted the trustees.

One recent Wellington case, Hansen v Young & Ors, illustrates this, he says. The deceased had provided his solicitor with a list of high risk share investments for the trust and borrowings to buy the shares.

The High Court found that acting in a prudent manner meant the trustee – a solicitor – should have diversified out of those shares in order to lower the risk profile. That would have meant selling an investment in which, over the four month period when investment advice was to sell the shares, the net gain in the value of the shares was from $410,320 to $1,060,868. They then plummeted to slightly above $2000.

New Zealand could yet see similar cases affecting family farms, if the agricultural market turned bad and there was a corresponding slump in land values. There is a large number of trusts in which the main asset is the family farm – the average age of farmers is now in the early 40s and a disproportionate number of farmers are nearing retirement.

Anecdotal evidence suggests there has also been a rise in the number of trusts from the late 1990s, driven by fears that a Labour government would take a more confiscatory tax approach than they have in fact done so far.

Given the size of New Zealand’s population, the numbers of trusts is huge.

As of 31 March this year, there were 210,449 trusts registered with the Inland Revenue Department. In 1967 there were just 6,500 trusts registered in New Zealand.

“The important thing for trustees is to know what you are getting into,” says Brown. An investment that carries a level of risk needs a very clear mandate to be maintained – in the Hansen case, the letter to the solicitor from the deceased was not enough.

Rob Hosking is a Wellington-based freelance writer specialising in political, economic and IT related issues.

« Meeting your client’s concerns head on!Individuals pose risks as trustees »

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