NOTE: This article was published in July 2012 and reflects the law as it stands on the date of publication and not at any later date.

PITT v HOLT AND THE RULE IN HASTINGS-BASS

THE RULE IN HASTINGS-BASS

The so-called rule in Re Hastings-Bass [1975] Ch 75 was stated in the following terms in Sieff v Fox [2005] 1 WLR 3811, at [119]:

Where trustees act under a discretion given to them by the terms of the trust, in circumstances in which they are free to decide whether or not to exercise their discretion, but the effect of the exercise is different from that which they intended, the court will interfere with their action if it is clear that they would not have acted as they did had they not failed to take into account considerations which they ought to have taken into account, or taken into account considerations which they ought not to take into account.

There have been a line of cases, supposedly applying the rule in Hastings-Bass, involving mistakes by trustees. Many of the cases involved the exercise of discretionary powers of appointment or advancement by trustees who have failed to understand the consequences (usually the tax consequences) of the appointment. The appointment has given rise to an unforeseen tax liability.

The trustees would apply to the court to set aside the appointment on the basis that they had, mistakenly, failed to take into account a relevant consideration, e.g. the tax effect of the appointment; and, if they had taken that consideration into account, they would not have acted as they did. This was a convenient way of avoiding a large tax liability, and a possible consequent negligence claim against the trustees’ advisers.

It was irrelevant to such a claim that the trustees were not at fault. They often took and acted upon apparently competent tax advice. However, if that advice was wrong, and they would have acted differently if they had received the correct tax advice, the appointment could be set aside.

The so-called rule was reviewed by the Court of Appeal in two conjoined appeals: Pitt v Holt and Futter v Futter [2011] EWCA Civ 197. It was held that there was no such rule.

FUTTER v FUTTER

Futter v Futter involved two offshore discretionary trusts containing the following powers:

(a) a power of enlargement (to enlarge the interest of a life tenant to an absolute interest in capital) and

(b) a power of advancement (to advance capital to remainder beneficiaries).

The trustees exercised these powers to transfer capital to beneficiaries in the U.K. There were “stockpiled gains” in the trust. The transfer of assets onshore gave rise to a CGT liability in respect of those gains.

However, the trustees mistakenly believed that the recipient beneficiaries could set off their personal losses against the gains. One of the trustees was a solicitor, and his firm wrongly advised the trustees that personal losses could be set off.

The trustees brought proceedings seeking declarations that the enlargement and advancement were void, or that they were voidable and should be set aside, on the basis that they had made a mistake as to the CGT consequences of their dispositions, and that they would not have made the dispositions that they did, had they taken into account the true tax position. The trustees succeeded at first instance.

PITT v HOLT

Mrs Pitt was the receiver, appointed by the Court of Protection, for her husband, Mr Pitt, who had been injured in a road accident. She received a lump sum and annuity under the compromise of a damages claim. Exercising her fiduciary powers as receiver, she settled the lump sum and annuity on discretionary trusts for the benefit of Mr Pitt and his family.

Mrs Pitt received general tax advice that there were no adverse tax consequences. However, no consideration was given to IHT. In fact, the settlement on discretionary trusts was a chargeable transfer, giving rise to an immediate IHT liability of £100,000. The trust would also suffer 10-year and exit charges. Such liabilities could have been avoided by a settlement on a disabled person’s trust.

Mrs Pitt applied to set aside the settlement on the basis of the rule in Hastings-Bass. She was a fiduciary in the same position as a trustee exercising a discretionary power. She claimed that, if she had appreciated that a transfer into a discretionary trust gave rise to a substantial IHT liability, she would not have entered into the settlement. She succeeded at first instance.

COURT OF APPEAL DECISION

The Court of Appeal declined to set aside the relevant dispositions, despite their unfortunate and unanticipated tax consequences. The analysis is as follows:

(1)  A crucial distinction must be drawn between the exercise of powers that are void, rather than voidable. The exercise of a power will be void if it is outside the scope of the power because of:

1. a procedural defect, e.g. a failure to obtain a necessary consent, or where the power must be exercised by deed, but is not;
2. a substantive defect, e.g. an unauthorised delegation, or appointment to a non-beneficiary; or
3. a legal defect, e.g. an appointment infringing the rule against perpetuities.

(2)  Pitt and Futter were not cases where the trustees/fiduciary had exceeded the scope of their powers. In order to set aside the exercise of a discretion, within the scope of the powers of the trustees, it was necessary to establish that the trustees had exercised their powers in breach of trust. If so, the exercise of the power would be voidable at the instance of a beneficiary.

(3)  Trustees are under a duty to take into account relevant matters, and not to take into account irrelevant matters. Where tax matters are relevant, the duty of the trustees, pursuant to their duty to take care and skill, will be to take proper tax advice. However, if they take tax advice from appropriate and reputable advisers, the trustees will have discharged that duty. That is so even if the tax advice turns out to be wrong, and even though they could be said to have failed to take into account a relevant matter.

(4)  In Pitt and Futter tax advice had been taken. It may have been wrong, or incomplete. However, there was no breach of trust. Therefore, the dispositions stood.

(5)  It is, therefore, no longer possible to set aside an exercise of a fiduciary power, which has unintended consequences, unless the trustees acted in breach of trust in failing to foresee those consequences, e.g. by failing to take proper advice.

(6)  There was no such thing as the rule in Re Hastings-Bass. The question in that case was whether the trustees had acted beyond the scope of their power of advancement in advancing capital otherwise than for the benefit of the intended beneficiary. If so, the exercise of the power was void. The case had nothing to do with the situation where trustees have acted within their powers, but failed, for whatever reason, to take into account relevant considerations, such as the true tax consequences of the disposition. The law had taken a wrong turn in setting aside dispositions, which were within the scope of the trustees’ powers, merely on the basis that the trustees had, innocently, failed to take into account relevant considerations.

PRACTICAL CONSEQUENCES

(1)           The number of claims to set aside the exercise of a discretionary power by trustees, for failure to take into account a relevant consideration etc, is likely to decrease. Where the trustees have not been at fault, there will be no basis for a claim.

(2)           There may still be a claim if the trustee has failed to take into account a relevant consideration (such as tax) or taken into account an irrelevant consideration, where the trustee has acted in breach of trust. The classic case would be where the trustees have failed to appreciate the tax consequences of their disposition, having neglected to take any tax advice at all; or where they have received the correct advice, but failed to follow it; or where they have acted on out-of-date advice.

(3)           It may still be possible for an aggrieved beneficiary to apply to set aside the exercise of a discretion by trustees which involves a culpable failure to take advice on a relevant (non-tax) matter; or where there has been a failure to have regard to relevant matters, such as the financial circumstances of the beneficiaries, or the wishes of the settlor. Equally, the taking into account of irrelevant matters, in breach of trust, could found a claim, e.g. the trustees’ personal prejudices.

(4)           The proper claimants should be the beneficiaries of the trust, alleging a breach of trust. They should bring a breach of trust claim in the usual way, claiming that the exercise of the trustees’ discretion be set aside on the grounds of breach of trust.

(5)           It is not for the trustees to initiate proceedings by coming to the court putting their hands up, admitting a breach of trust. It would only be proper for the trustees to commence proceedings where they are seeking the directions of the Court when a beneficiary has alleged breach, but delayed in commencing proceedings.

(6)           Strangely, it may be easier for a trustee to set aside a disposition and to avoid a tax liability if he has acted in breach of trust, e.g. by failing to take tax advice that should have been taken, than where he has not. Beneficiaries may be in a worse position as a result. If there is no breach of trust, there will be no cause of action against the trustees. The disposition will stand. Tax will be payable. However, if the trustees were at fault, the beneficiaries may be able to have the disposition set aside. It is almost an incentive to trustees not to take appropriate advice! This is a valid criticism of the decision.

(7)           The decision is likely to give rise to claims by trustees, or beneficiaries, against the professional advisers who have given wrong tax advice. However, it would be necessary to establish not just that the advice was wrong, but that it was negligent. There are also complex issues as to whether it is the trustees or the beneficiaries who should have the right to sue the professional advisers, and/or as to the losses which they can respectively claim.

(8)           It is not clear whether the court would accept an admission by the trustees that there has been a breach of trust without further investigation. They might have an incentive to do so, so that the disposition will be set aside (in which case no loss will have been suffered for which they could be responsible on a breach of trust claim). Even if the disposition is not set aside, but the trustees have acted in breach of trust, the trustees may be able to rely upon a clause in the trust deed exempting them from liability for breach of trust, unless they have acted fraudulently.

(9)           The disposition will not be set aside if there is a valid defence to the claim on the basis that the beneficiary has acquiesced in the breach of trust, or if third party rights have intervened.

(10)        Third parties, such as HMRC, will not be able to argue that the exercise of the trustees’ discretion should be set aside on the grounds that the trustees have failed to take into account a material, non-tax matter (where this may lead to more tax being paid). They have no standing to bring a breach of trust claim.

APPEAL

On 1 August 2011 the Supreme Court gave permission to appeal both decisions.

It seems to me to be unlikely that the Supreme Court will overturn the decision of the Court of Appeal. It makes sense that a disposition by trustees, within their powers, should only be open to challenge if the trustees have acted in breach of trust, and that there is no breach of trust if apparently competent, professional advice is taken.

Furthermore, in England and Wales, a voluntary disposition by an individual cannot be set aside if it gives rise to unforeseen tax consequences.

There is also a policy consideration that trustees and their tax advisers should not be able to wriggle out of liability for negligent decisions.

EXPRESS CLAUSES

It may be sensible to consider the incorporation of a clause in the trust deed to the effect that the exercise of the trustees’ powers is conditional upon them taking into account the true tax consequences thereof, provided that the trustees are protected by an exemption clause absolving them from liability otherwise than in the case of fraud, wilful misconduct or gross negligence. If the trustees act on wrong tax advice in exercising a discretion, they may then claim that the exercise of that discretion is void.

MISTAKE AND VOLUNTARY TRANSACTIONS

In Pitt v Holt there were two claims:

(a)  a Hastings-Bass claim on the basis that Mrs Pitt was a fiduciary, and that a disposition by a trustee or fiduciary which mistakenly fails to take into account relevant considerations should be set aside; and

(b)  an alternative claim that Mrs Pitt was an individual who had made a voluntary disposition acting under a serious mistake as to the tax effect of the transfer into the trust, with the result that the settlement should not be allowed to stand.

Traditionally, it has been easier for trustees to set aside transactions on the grounds of mistake than for individual donors or settlors to do so. A trustee is not acting in his own interest, but for the benefit of beneficiaries. The trustee must take into account a range of relevant factors when exercising a discretion (such as tax considerations). If he does not do so, it may be justifiable to set aside the exercise of the discretion.

Arguably, it is different where an individual makes a gift, or settles property upon trust. The individual is not exercising a discretion for the benefit of a number of beneficiaries. He or she has no duty to take into account any factors for the benefit of a third party.

The law has allowed individuals to set aside voluntary transactions on the grounds of mistake where there is a mistake as to the legal effect of the transaction, but not where the mistake is as to its consequences, such as its tax consequences (see Gibbon v Mitchell [1990] 1 WLR 1304). If, for example, a settlor settles property upon trusts, wrongly believing that he has a right to revoke those trusts, or to benefit thereunder, there may be a mistake as to legal effect justifying the setting aside of the trust.

However, the courts have been reluctant to allow settlors and donors to set aside transactions just because, with the benefit of hindsight, they do not like its consequences, in particular its tax consequences.

In addition, the Court will allow a voluntary disposition to be set aside if there is a material mistake as to a pre-existing fact. In Ogden v Griffiths Trustees [2009] Ch 162 Mr Griffiths made a number of PETs into trust. He died within 3 years, with the result that the transfers were chargeable to IHT. He was, at least when he made the last and largest transfer, suffering from lung cancer, of which he was unaware. His executors sought to set aside the transfers on the grounds that they had been made under a mistake. This had a tax advantage since, if the transfers were set aside, the property would fall into residue for the benefit of Mrs Griffiths by way of an exempt transfer.

Lewison J held that that was no mistake as to fiscal consequences. The relevant mistake (at least in respect of the last transfer) was a mistake about Mr Griffith’s state of health. He was at that time unaware that he was suffering from lung cancer, such that his chance of surviving for 3, let alone 7, years was remote. He would not have made the transfer, if he had known this.

In Pitt v Holt the Court of Appeal upheld the distinction between legal effect and consequences. The test was whether there was :

(a)  a mistake;

(b)  which is sufficiently serious that the donor would not have entered into the transaction, but for the mistake; and

(c)  as to the effect of the transaction itself, or as to an existing fact which is basic to the transaction, and not merely as to its consequences or the advantages to be gained by entering into it.

In Pitt v Holt the Court of Appeal held that:

(a)   Mrs Pitt was acting under a mistake;

(b)  The mistake was sufficiently serious, in that she would not have transferred property to the settlement if she had known of the adverse tax consequences;

(c)  But the mistake was as to the tax consequences of the transaction, and not as to its legal effect.

The mistake was not as to the legal effect of the transaction: Mrs Pitt intended to set up a discretionary trust. The mistake was as to the tax consequences of transferring property to a discretionary trust. A mistake as to consequences is outside the jurisdiction to set aside for mistake.

The Court of Appeal criticised decisions of foreign courts (such as Jersey courts, see below) which ignore the distinction between “effect” and “consequences” as being too relaxed for a donor who seeks to recover his gift.

This decision is under appeal to the Supreme Court.

JERSEY AND MISTAKE

The Jersey courts have adopted a different approach. The distinction between “effect” and “consequences” has been rejected. It is sufficient (Re the A Trust [2009] JLR 447) that:

(a)  there is a mistake;

(b)  the settlor/donor would not have entered into the transaction but for the mistake; and

(c)  the mistake was of so serious a character as to render it unjust on the part of the donee to retain the property.

This test was affirmed in Re S Trust [2011] JRC 117 where the Court of Appeal’s judgment in Pitt v Holt on mistake was considered, but not followed. A disposition into a trust, which has serious and unforeseen tax consequences, can, therefore, be set aside, even if it is categorised as a mistake as to “consequences” rather than “effect”.

This has some justice where the tax consequences are so severe that the beneficiaries are deprived of substantial benefit.

It may be that the Supreme Court will overturn the Court of Appeal’s decision in this respect.