The Proper Purpose Test: fettering the unfettered discretion
Implications of Grand View Private Trust Co Ltd v Wong
The recent decision by the Board of the Privy Council in Grand View Private Trust Co Ltd and another v Wong and others (Bermuda)  UKPC 47 should worry trustees and encourage disgruntled beneficiaries to challenge the exercise by their trustees of apparently unfettered discretions.
Grand View is a rare case on what used to be called ‘fraud on a power’ but is now referred to as ‘the Proper Purpose Test’. The case concerned two trusts set up by two Taiwanese businessmen (the ‘Founders’) who built up Formosa Plastics Group (FPG), one of the largest business conglomerates in Taiwan. One trust was for the benefit of the Founders’ family, the other a purpose trust for charitable and philanthropic purposes. In accordance with the settlors’ wishes, the trustees of the family trust subsequently exercised their power to add and remove beneficiaries to exclude the family beneficiaries and include the trustee of the purpose trust. They then appointed the trust fund of the family trust to the purpose trust. The children challenged the exercise of these powers in the Bermuda courts.
The two trusts
The Founders set up two trusts on 10 May 2001. The first was the Global Resource Trust (GRT) which was a discretionary trust in conventional form. The discretionary beneficiaries were the children and other descendants of the Founders. The ultimate default beneficiaries, who would take at the expiry of the Trust Period, were the children and other descendants of the Founders living at the time.
The second trust was called The Wang Family Trust (WFT). Despite the name, this was, in fact, a purpose trust intended to implement the Founders’ strong views that one should give back to society. The purposes of the WFT included holding and acquiring FPG shares to ensure the continued growth and prosperity of FPG, providing mutual assistance to mankind and help to those in need, through charities established by the Founders, and improving the standard of living for mankind.
The trusts were funded largely with FPG shares. The initial value of the GRT was $90 million which had grown to $560 million by the time of the appeal. The May 2001 value of the WFT was $567 million which became $3.5 billion by the time of the hearing.
The Founders retained substantial shareholdings in FPG, worth $1.8 billion, but they made it clear that these assets were not intended to form part of their estates on death and were not to be inherited by their heirs. These shares were to be used to fulfil their joint vision of giving back to society.
The intention in establishing the GRT was to align the interests of the children, as potential beneficiaries of the GRT, with the continued growth of FPG.
A change of plan
In May 2005 the Founders decided that it would damage the public’s confidence in FPG if the Founders gave away the majority of their personal holdings in the group, as they had originally intended to do, and so they decided to keep their remaining shares. This meant that on their deaths, their children and other heirs would inherit wealth greatly in excess of the amount they were intended to inherit via the GRT. They concluded that there was no longer any need for a trust for the benefit of their children in addition to the FPG shares and other assets which they would ultimately inherit.
Informed by these decisions of the Founders, the trustee of the GRT considered that there had been a change of circumstances which altered the basis on which the GRT had been formed. It decided that the most appropriate course of action (which was consistent with the wishes of the Founders) was to distribute the trust fund of the GRT to the WFT.
How the trustee exercised its powers
The trustee had powers to declare that:
- ‘any person or class or description of person shall…be included as a Beneficiary for the purpose of this Declaration’; and
- ‘any person or class or description of person shall…cease to be a Beneficiary for the purposes of this Declaration.’
The trustee also had a wide power of appointment and was to hold the Trust Fund:
…upon such trusts in favour of all or any one or more exclusively of the other or others of the Beneficiaries…as the Trustees shall in their discretion appoint…
The trust expressly stated that, ‘every discretion and power conferred on the Trustees is absolute and unfettered’.
In September 2005, the trustee of the GRT exercised its powers by:
- including Grand View, as trustee of the WFT as a discretionary Beneficiary of the GRT;
- excluding all the other current and future discretionary objects of the GRT as Beneficiaries; and
- appointing and distributing the assets of the GRT to the WFT.
Some of the Wang family members challenged these actions as a breach of trust.
The Privy Council decision
The Privy Council agreed with the trustee that the power of exclusion and addition was very wide in scope. The trustee was entitled to include as a Beneficiary any ‘person’. This term expressly included ‘any person acting in a fiduciary capacity’ which clearly includes trustees.
The Privy Council decided that the addition of Grand View, in its capacity as trustees of the WFT, was within the scope of the GRT trustee’s powers. The critical question was whether the power of inclusion was exercised for a proper purpose. The relevant question was ‘whether the purpose for which the power was exercised was outside the purpose, or range of purposes, for which the power was conferred’.
The GRT trustee’s purpose in exercising the power was to exclude the family beneficiaries and to substitute the WFT with a view to appointing the trust fund to the WFT and terminating the GRT. The reason for doing this was that there had been a change of circumstances which altered the basis on which the GRT had been settled, and the GRT was no longer needed.
It was common ground that the purpose for which a power is granted has to be determined as at the date of the instrument conferring the power ie as at May 2001 in this case. In order to do this, the Privy Council looked at the power in the context of the GRT trust deed as a whole and in the context of the circumstances in which the GRT was established.
The Board took the view that the GRT was a family trust for the benefit of the direct descendants of the Founders. The emphasis was on its family nature. The discretionary objects were family members and the ultimate default beneficiaries were family members. Other clauses, such as a provision that trustee fees were to be agreed by adult beneficiaries indicated, in the Board’s view, that it was not envisaged that the trust would be without individual beneficiaries.
This was contrasted with the sort of discretionary trust established for confidentiality, tax or asset protection purposes where there is a very wide class of discretionary objects and random charities as ultimate default beneficiaries.
The context of the establishment of the GRT was a strong indicator of the intention to limit the purpose of the power to add and exclude beneficiaries. The Founders set up two trusts. One, by far the larger, to achieve their social vision and the other to incentivise the family members to support the continued growth of FPG and align their interests with that of the company. There was nothing in the terms of the trust or the surrounding circumstances in May 2001 to indicate that the interests of the family should be terminated if the trustee considered that the need for the trust to achieve such alignment and motivation had changed.
In the light of the focus of the GRT trust deed on the children and other descendants of the Founders and the circumstances in which the GRT and WFT were established and assets divided between them, the Privy Council concluded that the purpose of the powers of addition and exclusion was to further the interests of the family beneficiaries or one or more of them.
The Board said that generally, fiduciary powers conferred on a trustee of a trust with identified beneficiaries must be exercised to further the interests of the beneficiaries. This is not, however, an inflexible principle and the intended purposes of a particular power, such as a power of addition and exclusion, must be determined in the context of the particular trust. Where, as here, the trust has a specific purpose, that purpose must be found by taking account of all the trust terms and the circumstances in which the trust was created.
The purpose of the GRT, which was to benefit the Wang family, had a decisive effect on identifying the purpose of the powers of addition and exclusion. The Privy Council concluded that the trustee had exercised the powers of inclusion and exclusion for an improper purpose and that the exercise was, as a result, void.
This is, perhaps, a surprising decision, given that the trustees acted following a significant change in the circumstances applicable to the trusts and in accordance with the settlors’ changed wishes. In many cases, a change of circumstances may result in trustees deciding to benefit one beneficiary or group of beneficiaries rather than another. One would expect this to be within the original purpose of most family trusts, but there can be situations where trustees legitimately want to make more radical changes. They will now need to consider carefully the original purpose of the settlor in establishing the trust and the Grand View case may limit the ability of trustees to react to changing circumstances, even where the settlor wishes them to do so.
It is important to note that a breach of the proper purpose rule results in the exercise of the power being void, not voidable. It would be dangerous for trustees to ‘take a view’ on the basis that the settlor requested them to act, or a challenge was unlikely, or even if the current beneficiaries agreed with the proposed course of action.
A solution, at least for new trusts, is for trustees to discuss purpose with prospective settlors at the outset. They should also consider with the settlor whether the settlor would be content for the trust to be recast and used for different, appropriate, purposes if there are unforeseen changes in relation to the situation of the settlor or the beneficiaries, or external circumstances. The trust deed and the settlor’s letter of wishes can then build in the flexibility to adapt the trust to such future changes.
Disgruntled beneficiaries seeking to challenge the exercise of a trustee’s power on the basis of improper purpose may feel more emboldened post Grand View. The Privy Council has made clear that, even where the trustees’ powers are broadly drafted, this will not mean the trustees’ discretion is unfettered. The Trustees must have regard to the whole of the context within which the trust was established, as this context will inform the Court’s view as to whether the power is being exercised for a proper purpose or not. Here, the Board held that the purpose of the power to add and exclude beneficiaries was to ‘further the interests of the beneficiaries, or more than one of them’. Logically, removing all the family members who had, until then, comprised the entire class of objects, and transferring all of the trust’s assets to a new beneficiary cannot be in the interests of the existing beneficiaries: the only beneficiary benefiting was the new object.
Trustees who are in doubt as to whether their decision may be subject to challenge should seek the Court’s blessing or directions before taking the decision. The Board in Grand View was scathing of the trustees’ failure to take this step as a precursor to what was obviously a momentous decision. Given that a decision to exclude one or more beneficiaries is likely to be seen as more capricious than a decision not to appoint to those beneficiaries, trustees seeking to avoid claims might consider ways in which they can avoid an outright exclusion of beneficiaries when seeking to react to a change of circumstances.
Our Private Wealth team would be happy to advise further, from the trustee’s or beneficiaries’ perspective, and to help with the practical implications.