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Legal ownership vested in trustees must be balanced by identifiable equitable ownership.

Critically discuss this statement and the difficulties inherent in it in relation to the interests of beneficiaries under discretionary trusts. What is the practical importance of determining where the beneficial interest lies in discretionary trusts?

The trust is a creature of equity. It has been described as “the paradigm case of equity’s interference with common law rights in pursuit of justice.” The trust imposes obligations on the legal owner of particular property to hold that property for the benefit of others. Thus the opening quotation can be said to identify one of the basic tenets of trust law in England and Wales. The trust has developed over the centuries in England to incorporate various types. One such type is the so-called discretionary trust. However, arguably disparity exists between the need to establish identifiable, beneficial or equitable ownership, and a discretionary trust which, by its nature, evades such identification.

A contrast is seen between the discretionary trust and the fixed trust; although both are types of express trust. Under a fixed trust, the beneficial interests are just that: fixed. Thus the share of the trust property to which the beneficiary is to receive is ‘fixed’ into the trust instrument. However with a discretionary trust, the trustee, in whom legal ownership vests, has a dispositive discretion. Thus under a fixed trust, the trustee must dispose of the trust property in accordance with the terms of the trust; whereas under a discretionary trust he may have discretion as to the precise value of the beneficiaries’ entitlement, or even if they are to receive anything at all. An example of such a dispositive discretion is where a trust is established for a group of beneficiaries “in such portions as the trustee shall in their absolute discretion see fit”.

It is a fixed trusts’ rigidity which seemingly underpins the subsequent reasoning behind the discretionary trust. A fixed trust may become outmoded or outdated due to changing circumstances; whereas a trustee under a discretionary trust can respond appropriately to these changing circumstances by applying his discretion accordingly to the situation. A beneficiary may, for example in the light of his allotted share, decide to forego education or employment and live off the trust property; the so-called “trustafarian”. Under a discretionary trust the trustee would have the power to temporarily sever that beneficiary from the trust property as an incentive to become more self reliant. To take a further example from the common law, the seminal case of McPhail v Doulton (1971) saw Mr Baden establish a trust for the benefit of the staff of his company, their relatives and dependents. He granted “absolute discretion” to the trustees to distribute the trust fund as they saw fit. By 1971, the trust fund had increased significantly, as had the size of the class of potential beneficiaries (the employees alone numbered 1300 in 1941). The nature of the trust was flexible enough to allow the trustees to select which members of the intended class should benefit.

An interesting aspect of the discretionary trust, and a pertinent one to the opening quotation, is that no individual who is part of the class of possible beneficiaries, has any equitable title to or interest in the trust property until such time as the trustee exercises his discretion in that individual’s favour. It is also important to note that despite the discretion granted to the trustee, this does not equate to him having ‘free rein’ to do whatever he wishes with the trust property.He will still be limited by the terms of the trust, and remains under a fiduciary obligation to carry out these terms. Again, McPhail v Doulton is significant here, as the House of Lords in that case held that the trustees, despite their “absolute discretion” to select the beneficiaries, were not at liberty to refuse to carry out the trust. However this does not arguably make it any easier to reconcile the discretionary trust with the opening quotation; rather it highlights the limits of the trustee’s dispositive discretion.

To compare the discretionary trust to the fixed trust and the power of appointment is instructive:no proprietary interest in the fund exists with the objects of a power, unless an appointment is made in their favour. Under a fixed trust, the beneficiaries have an identifiable equitable title to the property: the subject of the trust. However with a discretionary trustit has been suggested that beneficiaries have a “quasi-proprietary” right;that is that the class of beneficiaries as a whole can be seen to have a collective proprietary entitlement to the fund, although individual members of the class cannot claim individual proprietary entitlement. This was highlighted in Gartside v IRC(1968) when Lord Reid stated that “…you cannot tell what any one of the beneficiaries will receive until the trustees have exercised their discretion.”

An important principle in trust law generally is that identified in the case of Saunders v Vautier (1841). Briefly, this principle states that a beneficiary who has an absolute interest under a trust, and who is sui juris (that is, of full age and sound mind) is entitled, at any time, to call on the trustee to transfer the legal title to the trust property in which the beneficiary holds that interest to him. The operation of this principle under a fixed trust is quite straightforward, as the beneficiary’s equitable entitlement will be easily ascertainable. How does it apply to discretionary trusts where the interest is not so easily identifiable? This issue was considered by Romer J in the case of Re Smith (1928). With reference to the earlier case of Re Nelson(1918), Romer J stated that under a discretionary trust where there are two ‘objects’ (the term applied to possible beneficiaries under a discretionary trust), “..You treat all the people put together just as though they formed one person, for whose benefit the trustees were directed to apply the whole fund.” So essentially, Romer J meant thatthe beneficiaries may, acting together as one, require the trustees to transfer the trust property to them as co-owners.

However, perhaps the Saunders v Vautier principle is not entirely applicable to discretionary trusts; namely because the beneficiaries are not treated as having a vested interest in the trust property. Only after the beneficiaries, acting as one, have demanded the transfer of the trust property using the Vautier principle, do they acquire their indefeasible interests in the trust property. This was established in Vestey v IRC (No 2) (1979), but had already been considered by Lord Reid in Gartside v IRC (1968). Here Lord Reid stated that the individual interests of the objects of a discretionary trust are actually in competition with each other until such times as the each object has his own individual right to retain whatever income is appointed to him.

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To return to the rights of objects of discretionary trusts, how can they enforce a possible interest if that interest is not ascertainable because the trustee has not exercised his discretion? It is well established that objects of discretionary trusts have locus standi to sue trustees in order to enforce the trust. It is, however, difficult to control trustees in exercising their discretions. Trustees are under a duty to survey the range of objects, or the members of the class of potential recipients. Lord Wilberforce considered this matter in McPhail v Doulton, stating that “…Any trustee…would surely make it his duty to know what is the permissible area of selection and then consider responsibly, in individual cases, whether a contemplated beneficiary was within the power, and whether, in relation to other possible claimants, a particular grant was appropriate”. Thus the rights and interests of objects of a discretionary trust have caused considerable academic debate. Commentators such as Harris have suggested that under a discretionary trust, the trustees “appear” to be the legal owners, subject to the equitable rights of enforcement of the beneficiaries (as the objects will then become).

If necessary, the courts will construe the terms of the trust to determine the boundaries of the trustee’s discretion. In Gisborne v Gisborne, the trustee had been granted an “uncontrollable authority” by the trust instrument. When the beneficiary received less of the trust property than she had hoped for, the court did not intervene because the trustee had acted within his authority as granted by the trust instrument. In addition, the discretion shown by the trustee must be exercised in good faith, and in the best interests of the objects or beneficiaries. Thus while this does not aid in establishing the beneficial interest, it does provide a crucial limit on a trustee’s discretion.

An interesting development in recent years in the area of the validity of a trustee’s discretion is the application of the Wednesbury principle, which was established in the case of Associated Provincial Picture House Limited v Wednesbury Corporation (1948). This was applied in Edge v Pensions Ombudsman (1998), in which it was established that a court should not interfere unless the trustee took into account “improper, irrelevant or irrational considerations”. Again, although this provides a useful limit to the unfettered discretion of a trustee, it does not necessarily assist in identifying the beneficial interest to counterbalance the legal interest vested in the trustee.

A discussion of the beneficial interest under a discretionary trust must consider the important distinction between a trust and a power. As Martin simply puts it, “trusts are imperative; powers are discretionary.” That is to say the trustees are obliged to carry out their duties under the trust, whereas donees under a power may or may not exercise the power as they see fit. This highlights the essential problem with the opening quotation’s applicability to discretionary trusts, even though the beneficiaries as a whole, or as one, own the interest to equitable title in the trust property, and can even compel the trustees to transfer the legal title to them under the principle in Saunders v Vautiers (1841). This approach was subsequently adopted by Romer J in the Court of Appeal in Re Smith (1928), in which he said that the principle should be to “treat all the people put together just as though they formed one person, for whose benefit the trustees were directed to apply the whole of a particular fund.” The beneficiaries cannot demand payment under a discretionary trust as they would be able to under a fixed trust, because there is no identifiable value to which the beneficiary is entitled until the trustee exercises his discretion. The beneficiaries can, however, compel the trustee to consider what he will do, although they cannot compel him to distribute. This was established in McPhail v Doulton, and also demonstrates where the distinction between a discretionary trust and a power exists: under the latter there is no such duty on the donee to make an appointment.

McPhail v Doulton was also significant because of Lord Wilberforce’s criticisms of the rule set out in IRC v Broadway Cottages Trust (1955) in relation to the validity of discretionary trusts. That rule, he stated, ought to be discarded, and the new test ought to be “that the trust is valid if it can be said with certainty that any given individual is or is not a member of the class” (at 456). The test in IRC v Broadway Cottages Trust was known as the “complete list” test, and suggested that a discretionary trust would fail for lack of certainty of objects if a “complete list” of the potential beneficiaries could not be drawn up. Lord Wilberforce’s criticisms focused on the fact that this was only really appropriate where the discretionary trust was a “family-style” trust under which the class of potential beneficiaries was small, and was inappropriate given the changing social functions of the discretionary trust. In McPhail v Doulton, however, as Lord Wilberforce identified, this test was simply unworkable, since that case would have demanded a complete list be drawn up of all employees, ex-employees, relatives and dependents. This highlights the administrative difficulties of the original test. As amended by Lord Wilberforce, however, the test becomes more manageable.

Harris has described McPhail v Doulton as a watershed in the law in this area. This was largely because of its effect on the existing law as set down in IRC v Broadway Cottages Trust, which stated that to be valid, a discretionary trust had to specify an ascertainable class of cestuis que trust. As Harris argues, this was a welcome development as many judgments, applying the previously existing law, had expressed regret as to the position of the law on policy grounds. An example of this is in the Broadway Cottages case itself, in which Jenkins LJ admitted that the rule was contrary to common sense.

What other factors contribute to the practical importance of establishing where the beneficial ownership lies in discretionary trusts? Under the complete list test, the beneficial ownership would necessarily be shared equally by the entire class of beneficiaries in the event that the trustee defaulted in his duty. Lord Wilberforce also addressed this issue in McPhail v Doulton. “Equal division is surely the last thing the settlor ever intended: equal division among all probably would produce a result beneficial to none…” (at 451). As Gardner points out, this recognised the evolution of the social function of the discretionary trust to enable property owners to “confer benefits on deserving cases amongst large constituencies – in the same sort of way as charitable trusts.” Where the beneficial ownership lies in discretionary trusts is also important in the context of “administrative unworkability”, another concept to arise out of McPhail v Doulton. This applies to situations where, again in the words of Lord Wilberforce, “the meaning of the words used is clear but the definition of the beneficiaries is so wide as to not form “anything like a class” so that the trust is administratively unworkable…” (at 457).

Lord Reid’s comment in Gartside v IRC noted above perhaps gives the best illustration of the position of discretionary beneficiaries in relation to identifiable beneficial interest in the trust property. He stated that “two or more persons, cannot have a single right unless they hold it jointly or in common. But clearly the objects of a discretionary trust do not have that: they have individual rights, they are in competition with each other and what the trustees give to one is his alone.” The same principle was applied in Re Weir’s Settlement (1969) and Sainsbury v IRC (1970).

The difficulties of applying the principle outlined in the opening quotation to discretionary trusts have been considered. Fundamentally it is problematic because the whole purpose of a discretionary trust is to allow the trustee to use his discretion to assign a value of the trust property to a particular beneficiary. Although the class of potential beneficiaries as a whole own the beneficial interest, arguably there is no way of identifying the individual shares until the trustee has exercised his discretion. Even this assertion is contentious, however, as Pettitt, for example, has argued that the beneficial interest under a discretionary trust remains “in suspense” until the trustees exercise their discretion. The more significant right of the members of the class of beneficiaries is the right to be considered as a potential recipient from the fund by the trustees. This was highlighted by Lord Wilberforce in IRC v Gartside (at 606). Furthermore, the members have the right to have the trustees use their discretion “bona fides”, “fairly”, “reasonably” and “properly”. This falls some way short of the rights of a beneficiary under a fixed trust, and again, highlights the fundamental problem with the application of the opening statement to the operation of discretionary trusts.

BIBLIOGRAPHY

Cases

Associated Provincial Picture House Limitd v Wednesbury Corporation [1948] 1 KB 223

Burrough v Philcox (1840) 5 My & CR 72

Edge v Pensions Ombudsman (1998)

Gartside v IRC [1968] AC 553

Gisborne v Gisborne (1877) 2 App Cas 300

IRC v Broadway Cottages Trust [1955] Ch 20

McPhail v Doulton [1971] AC 424

Re Gulbenkian’s Settlement [1970] Ch 408

Re Nelson, ex parter Dare and Dolphin [1918] 1 KB 459

Re Smith, Public Trustee v Aspinall [1928] Ch 915

Re Trafford’s Settlement [1985] Ch 32

Re Weir’s Settlement [1969] 1 Ch 657

Sainsbury v IRC [1970] Ch 712

Saunders v Vautier (1841) 4 Beav 114

Vestey v IRC (No 2) [1979] Ch 198

Secondary sources

Gardner, S (2003) An Introduction to the Law of Trusts, 3rd Edition (Oxford: Clarenden)

Harris, J. (1971) ‘Trust, Power or Duty’, 87 Law Quarterly Review 31

Harris, J. (1970) ‘Discretionary Trusts, an End and a Beginning’, Modern Law Review, 33, 6

Hudsdon, A. (2007) Equity and Trusts, 5th Edition (London: Routledge)

Martin, J.E. (2001) Hanbury and Martin – Modern Equity, 16th Edition (London: Sweet & Maxwell)

Pearce, R. and Stevens, J. (2006) The Law of Trusts and Equitable Obligations, 4th Edition (Oxford: OUP)

Penner, J.E. (2004) The Law of Trusts, 4th Edition (London: LexisNexis)

Pettit, P.H. (2001) Equity and the Law of Trusts, 9th Edition (Oxford: OUP)

Watt, G. (2007) Todd and Watt's Cases and Materials on Equity and Trusts, 6th Edition (Oxford: OUP)

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