The Law Commission

PART III

THE ECONOMIC IMPLICATIONS OF REGULATING TRUSTEE EXEMPTION CLAUSES

3.1      The economic impact of any legal regulation of trustee exemption clauses is an important consideration in deciding whether reform should be recommended.
3.2      Obtaining accurate information about trust practice is a difficult exercise, as trusts are not publicly recorded or registered. Although it is possible to seek information and the views of those who hold themselves out as professional trustees, it is much more difficult to ascertain the views of settlors, and (even more so) beneficiaries. In an attempt to understand as fully as possible the role of trustee exemption clauses in practice, we commissioned independent socio-economic research on the subject.
3.3      There are several major issues which need to be addressed:

(1) The prevalence of trustee exemption clauses in practice;

(2) The attitude of both trustees and settlors to the existing law;

(3) The attitude of both trustees and settlors to regulation of trustee exemption clauses;

(4) The unique position of lay trustees;

(5) The perceived consequences of regulating trustee exemption clauses; and

(6) The perceived availability and effectiveness of alternative protections from liability, in particular indemnity insurance.

3.4      Having conducted a preliminary survey of views of trusts practitioners concerning the use of trustee exemption clauses, we commissioned Dr Alison Dunn of the University of Newcastle-upon-Tyne to conduct research into the economic implications of trustee exemption clauses and the potential consequences of regulation of such clauses.
3.5      In this Part we outline the research conducted by Dr Dunn between February and May 2002, and the results obtained from that research.
3.6      The research focused on four different types of trustee. For ease of reference these types of trustee are denoted in this Part by group names:^[1]

(1) Group one refers to professional trustees in a trust corporation or company, representing those groups of trustees who work specifically as trustees in an incorporated trust organisation;

(2) Group two refers to professional trustees in private practice, representing those groups of trustees who work specifically as trustees, but are not in an incorporated trust organisation;^[2]

(3) Group three refers to professionals holding a trusteeship, representing those who are professionals in their own right and work in a professional field other than the trust field, but who have been appointed to a trusteeship; and

(4) Group four refers to lay trustees, representing those who are not professionals and do not work in a professional field, but who have been appointed to a trusteeship.

Method of research

3.7      For the research, the specialist knowledge and views of two target groups were sought:

(1) trustees;^[3] and

(2) legal advisers to trustees and settlors.

3.8      The investigators employed both a quantitative and a qualitative approach to data collection.

Quantitative approach

3.9      Quantitative data was collected through the use of two main questionnaires. Each questionnaire was tailored specifically for one of the two target groups.

Trustees

3.10      As regards the trustees (the first target group), questionnaires were sent to a sample group of 2,050. Of the questionnaires, 276 were returned, representing a 13 per cent response rate. Given the low response rate the questionnaire responses cannot be regarded as representative of the group taken as a whole. However, the survey was useful in indicating trends within current trust practice.
3.11      There was anecdotal evidence that some members of the target groups were reluctant to contribute towards research which they saw as a threat to their legal position and which might remove a critical element of trustee protection. This may have contributed towards the low response rate.
3.12      Despite the low response rate, the actual number of trusteeships held by the trustee respondents totalled 14,455. The trusteeships held included 10,938 pension trusts,^[4] 203 charitable trusts, 26 non-charitable purpose trusts, 1,254 private family trusts, 56 private trusts of a different nature,^[5] 4 unit trusts, 605 debenture trusts, 226 employee benefit trusts and 1,103 trusts of other types.
3.13      The trustee respondents fell into each of the four groups: 18 per cent of the respondents belonged to group one; seven per cent belonged to group two; 27 per cent belonged to group three; and 42 per cent belonged to group four.
3.14      Although on the bare statistics, the highest proportion of trustee respondents were lay trustees, it should be noted that those respondents falling into group one (professional trustees in a trust corporation or company) responded on behalf of their organisation as a whole, and so are representative of a much larger number of individual trustees.

Legal advisers

3.15      As regards the legal advisers to settlors and trustees (the second target group), questionnaires were sent to a sample group of 400. Of the questionnaires, 69 were returned, representing a 17 per cent response rate. Again, as a result of the low response rate, the results of the questionnaires cannot be regarded as representative of the group taken as a whole and therefore must be treated with some caution.^[6]
3.16      The trustee clients whom the respondents advised fell into each of the four groups. Almost all respondents advised more than one group: 44 per cent of the respondents advised trustees in group one; 68 per cent advised trustees in group two; 68 per cent advised trustees in group three; and 92 per cent advised trustees in group four.
3.17      The questionnaires to both target groups contained a mix of close- ended and open- ended questions. The close- ended questions sought both factual and attitudinal information in order to generate statistical data about respondent characteristics, attitudes and perceptions. The open- ended questions gave the respondents the opportunity to raise specific socio- economic issues regarding trustee exemption clauses.

Qualitative approach

3.18      Qualitative data was collected through interviews with respondents in both target groups. A total of 65 interviews, ranging in length from 10 to 90 minutes, were conducted. Although the interviews were partially structured, they were designed to allow the interviewee respondents the freedom to explore their attitudes to trustee exemption clauses and the socio- economic effect of such clauses.

The prevalence of trustee exemption clauses in practice

Sources of trustee exemption clauses

3.19      Trustee exemption clauses are an integral part of the modern trust and respondents indicated that as such they are to be found in many standard trust precedents. Those precedent books referred to included: Butterworth's Encyclopaedia of Forms and Precedents (5th ed 1998); Sweet & Maxwell's Practical Trust Precedents (issued annually); J Kessler, Drafting Trusts and Will Trusts A Modern Approach (5th ed 2000); and Kelly's Draftsman (18th ed 2002). A large proportion of regional solicitors indicated that they used the Society of Trust and Estate Practitioners [STEP] Standard Provisions.

The frequency of trustee exemption clauses

3.20      Respondents of both questionnaires and interviewees thought that trustee exemption clauses were very frequently included in trust instruments. Many respondents suggested that this is because so many of the standard trust precedents include trustee exemption clauses.^[7]
3.21      Although trustee respondents indicated that less than half of their trusts contained a trustee exemption clause, there was a significant difference in frequency as between the various types of trustee. Trustee exemption clauses were much more commonly experienced by trustees in groups one and two than by those in groups three and four.
3.22      The legal adviser respondents thought that trustee exemption clauses were in practice very common. A substantial majority of these respondents believed that a majority of trusts contain a trustee exemption clause.

Types of clause

3.23      Trustee exemption clauses which exclude liability are much more common than those which exclude a duty. The former were encountered in three times as many trusts as the latter.
3.24      In response to the quantitative survey, nearly half of trustee respondents with clauses excluding liability said that their clause excluded liability for mere negligence; a somewhat smaller proportion said that their clause excluded liability for gross negligence; and, surprisingly, nearly half said that their clause excluded liability for fraud or wilful misconduct. This view was, however, contraverted by the impression gained in interviews with legal advisers who claimed that since Armitage v Nurse^[8] virtually no trust instruments contain clauses excluding liability for fraud. It may be that some trustee respondents misunderstood the question in the questionnaire to mean that their clause did not cover fraud or wilful misconduct.
3.25      Trustee respondents indicated that about half of their trusts had an indemnity clause, and indemnity clauses were most common where trustees in group one were concerned. The frequency of indemnity clauses in trust instruments was closely related to the frequency of trustee exemption clauses. An overwhelming majority of those trusts that included an exemption clause also had an indemnity clause. In contrast, of those trusts without an exemption clause, less than half had an indemnity clause.

Reliance on trustee exemption clauses

3.26      Despite their frequent inclusion in trust instruments, the questionnaire responses highlighted the fact that very few trustees ever rely in practice on exemption or indemnity clauses. The vast majority of trustee respondents with the benefit of an exemption or indemnity clause had never had cause to invoke it. The impression of trustee exemption clauses being very rarely called upon was reinforced by the responses from legal advisers, an overwhelming majority of whom indicated that trustees would never or only occasionally rely on an exemption clause.
3.27      The key reason given by interviewees for trustees' reluctance to take advantage of exemption clauses was the damage it could cause to the trustee- client relationship. Some trustees suggested that it was simply uneconomical always to rely on a trustee exemption clause because it would result in the loss of too much business. However, actions for breach of trust are comparatively rare and it is impossible to assess the deterrent effect of the presence of a trustee exemption clause on those beneficiaries who may have otherwise been contemplating action against the trustees.

The attitude of trustees and settlors to the existing law

Trustees

3.28      Legal adviser respondents indicated that the extent to which their trustee clients would know about trustee exemption clauses before seeking legal advice varied widely. About three quarters of legal advisers stated that they advised their trustee clients always to use an exemption clause,^[9] and more than half indicated that, following such advice, most trustees would wish to have an exemption clause included in the trust instrument. However, the likelihood of a trustee requesting the insertion of a trustee exemption clause was not uniform as between the different types of trustee. In particular, lay trustees (that is, trustees in group four) were considerably less likely to request the protection of a trustee exemption clause.
3.29      In the opinion of the legal adviser respondents, the main reasons why a trustee would insist upon the inclusion of an exemption clause in the trust were that these clauses were accepted as part of the modern trust and that trustees were often advised to use such a clause or had used a similar clause before.
3.30      Professional trustees were somewhat polarised in their attitudes to the necessity and propriety of trustee exemption clauses. Most professional trustees were either in favour of or opposed to such clauses, with very few equivocating or failing to form a view. Notwithstanding this polarisation of attitudes, it may be noted that virtually all the professional trustees were agreed on two points: first, that knowledge, awareness and acceptance on the part of the settlor, coupled with clarity and transparency in the trust instrument, constitute an appropriate basis for the insertion of an exemption clause in the trust; secondly that the scope of trustee exemption clauses cannot be entirely unrestricted, for there should be no exclusion of liability in the case of fraud or wilful default.
3.31      Generally trustee exemption clauses were considered necessary by a much higher proportion of professional trustees than lay trustees. A similar trend was identified by legal adviser respondents who, when asked about the general attitude of their trustee clients towards trustee exemption clauses, indicated that around two thirds of professional trustees (that is, trustees in groups one to three) viewed exemption clauses as necessary or very necessary. In contrast only about one half of lay trustees were regarded by legal adviser respondents as viewing trustee exemption clauses as necessary or very necessary.
3.32      Those professional trustees who opposed the use of trustee exemption clauses gave several reasons in support of their view. Many emphasised the professional nature of the services they were providing and the fact that a fee was being charged. It was argued that the use of trustee exemption clauses resulted in inadequate protection for beneficiaries and allowed trustees' conduct to fall beneath the standard of accountable care that beneficiaries should be entitled to assume. Finally many trustees opposed to the use of trustee exemption clauses noted that for commercial reasons it was appropriate to stand by the trustee obligations that were expected by the beneficiary at the outset, and that frequent reliance on trustee exemption clauses would result in a loss of business.
3.33      Those professional trustees in favour of the use of trustee exemption clauses took the view that, in allocating risk, a balance must be struck between all the parties, particularly in the commercial circumstances in which trusts operate. They contended that protection was needed from circumstances which are beyond the trustees' control. Two examples were often cited:

(1) Where a trustee becomes fixed with liability for the acts of other trustees;^[10] and

(2) Where so- called "operational constraints" give rise to trustees' liability. The trustee respondents gave this term a wide definition so as to include unforeseen circumstances or new regulation,^[11] as well as the conduct of external actors, which can often cause problems for trustees.^[12]

3.34      Additionally, many trustee respondents argued that the presence of a trustee exemption clause provides comfort to trustees, especially from the threat of litigation. Most trustee respondents seemed acutely aware of this threat, a majority agreeing that beneficiaries are becoming more litigious. Professional trustees considered themselves a particular target for litigation because their status induced higher expectations and they were seen as having deep pockets.
3.35      Finally, some trustee respondents noted that trustee exemption clauses afford protection to trustees in circumstances where they are put in a position of potential conflict.

Settlors

3.36      The research sought to take account of settlors' views by reference to their legal advisers. Three broad themes concerning settlors' attitudes to trustee exemption clauses were identified.
3.37      First, the legal adviser respondents felt that generally settlors are not well informed about trustee exemption clauses, less than half knowing about trustee exemption clauses before seeking advice on establishing a trust. Several of these respondents also noted the difficulties of explaining the trust concept to their clients.
3.38      Secondly, the respondents took the view that the vast majority of settlors are not particularly interested in the issue of trustee exemption clauses. Settlors are primarily concerned with achieving a specific goal, not the means by which that goal is achieved, and so their concern with trustee exemption clauses is only incidental.
3.39      Thirdly, the majority of respondents suggested that settlors tend to accept trustee exemption clauses as part of the package of the modern day trust, especially if they have received advice to this effect. Moreover it was felt that many settlors regard the choice of trustee as more important than the presence of a trustee exemption clause; about a third of legal adviser respondents thought that settlors include a trustee exemption clause in trusts either in order to attract professional trustees or because the clause was requested by the trustee.
3.40      Very few respondents were able to identify any reasons why a settlor would not include a trustee exemption clause in their trust. Virtually all the respondents emphasised that in practice the issue of non-inclusion of trustee exemption clauses rarely arises. The main explanation for a settlor's failure to include a trustee exemption clause was that the settlor would be unaware of the availability of such clauses.
3.41      This seems to indicate that there is considerable indifference- but also little opposition- by settlors to the use of trustee exemption clauses.

The attitude of trustees and settlors to regulation

Necessity of trustee exemption clauses

3.42      It is clear that many trustees, in particular those operating in highly specialised markets,^[13] regard trustee exemption clauses as a pre- requisite to acting as a trustee. Indeed, the majority of trustee respondents either agreed or strongly agreed that in the current economic climate trustee exemption clauses are a necessity for trustees. Support for this attitude came from a substantial majority of legal adviser respondents, who considered that professional trustees see trustee exemption clauses as a pre- requisite to their assumption of trusteeship. Reaction to any potential regulation of trustee exemption clauses was not, however, consistent across the various kinds of trustees. Whereas more than half of respondent trustees in groups one and two stated that they would not have taken up their appointment if the trust instrument did not include an exemption clause, among trustees in groups four, a considerably less intransigent attitude was displayed. Indeed only one fifth of lay trustee respondents considered a trustee exemption clause to be a pre- requisite to acceptance of appointment.
3.43      Interviews indicated, somewhat unsurprisingly, that for the majority of professional trustees, their decision to act as a trustee is a purely commercial one which balances the rewards for acting against the risks incurred- the higher the risk, the lower the return and the greater the likelihood that the trustee will refuse to act.

Willingness to act following regulation

3.44      Concern was expressed by interviewees that regulation of trustee exemption clauses would increase the risk on trustees, thereby altering the risk:reward ratio so that fewer trustees would be prepared to act. Nearly two thirds of trustee respondents predicted that prohibition of trustee exemption clauses would cause the number of people choosing to accept trusteeship to decrease. Very few forecast no decline in the numbers of willing trustees.
3.45      That said, the majority of trustees expressed the view that the decision to become a trustee was not based solely on the substantive clauses contained in the trust instrument, but on an assessment of the overall risk which was being undertaken in all the circumstances.^[14] Moreover, the majority response to potential prohibition of trustee exemption clauses was to seek better protection by means of indemnity insurance. Only a third of those trustees interviewed intimated that they would respond by resigning their trusteeship.
3.46      Most legal adviser respondents agreed or strongly agreed with the proposition that regulation of trustee exemption clauses would cause the number of professional trustees to decrease. Some trustees surmised that when predicting the effect of regulation on professional trustees a distinction can be drawn between the different types of trustee. In their opinion it is the professional trustee in private practice who is likely to regard regulation as a barrier to trusteeship, whilst professional trustees in trust corporations and companies would continue to work in the market, perhaps selecting their work more carefully. There was some support for this thesis among legal adviser respondents.

The attitude of settlors

3.47      Interviewees and questionnaire respondents were agreed that in general settlors do not consider trustee exemption clauses a pre- requisite to appointment of a trustee, but regard them merely as part of the package. However, it was noted that settlors may increasingly consider trustee exemption clauses essential to the appointment of a trustee in order to ensure that they are able to appoint the trustee of their choice.

The perceived consequences of regulation

Movement of operations to less restrictive jurisdictions

What factors influence the location of the activity of trustees

3.48      The overwhelming majority of trustee respondents were trustees of a trust located in England and Wales. Likewise, an overwhelming majority of legal adviser respondents advised trusts that were based in England and Wales.
3.49      Two key factors were highlighted as influencing the location of trustee operations.^[15] First, most respondents considered that the settlor's home or base was the primary influence upon the location of a trust, for it is with that jurisdiction that the settlor will have most commercial familiarity. Particularly in respect of smaller private trusts, it was thought that both settlors and beneficiaries felt more comfortable with trustees based in their own jurisdiction for reasons of convenience and accessibility. Moreover it was noted that many settlors tended to be highly suspicious of off- shore jurisdictions.
3.50      Secondly, the majority of legal adviser respondents considered that financial or taxation reasons influenced the location of a trust. For example, a number of trusts are established in England and Wales for certain Inland Revenue taxation authorisations or approvals. Such trusts include UK pension trusts, employee benefit trusts, unit trusts, small self- administered schemes and charitable trusts. In contrast, very few trustee respondents thought that the location of trusts was influenced by financial or taxation considerations.
3.51      Finally, it was noted by some respondents that the location of a trust may be influenced by regulatory factors.
3.52      However, very few respondents regarded the availability of a trustee exemption clause as a reason for the location of a trust; indeed the majority of legal advisers opined that no trusts were in fact located in a particular jurisdiction because of the efficacy (or otherwise) of trustee exemption clauses in that jurisdiction.
3.53      For professional trustees working in the global securities market, very different factors influence the location of their trustee operations. Interviewees working in this specialised field identified two main reasons for the location of such trusts in England and Wales. First, the flexibility of the English trust renders it much more attractive than other trust concepts^[16] which more narrowly define the role of the trustee. Secondly, as a result of its security and stability, the City of London is regarded as a world- wide capital market in which investors have confidence.

The availability of alternative jurisdictions

3.54      Many legal adviser respondents already advise trustees administering trusts located in other jurisdictions. Most commonly the trust is located in a low tax jurisdiction.^[17] Very few other jurisdictions were mentioned by legal adviser respondents: those worthy of note are Eire, Scotland and New Zealand.

Whether trustees would in fact operate in another jurisdiction

3.55      The vast majority of trustee respondents expressed reserve about moving their operations to another jurisdiction, even if trustee exemption clauses were to become regulated. Overall less than one fifth of trustee respondents thought that regulation of trustee exemption clauses would affect their decision to operate in England and Wales.^[18] However, nearly one third of trustees in groups one and two indicated that their choice of jurisdiction would be affected by regulation of trustee exemption clauses.
3.56      The trustee respondents indicated that the reason for their unwillingness to relocate trust operations in another jurisdiction upon regulation of trustee exemption clauses was because the potential consequences of regulation failed to outweigh the two primary reasons for the location of trusts in England and Wales: specifically the status of the trust in respect of taxation privileges and the familiarity of settlors with the English trust.^[19]
3.57      A third reason for the view that settlors would not move their trusts to another jurisdiction is that for many trusts (and certainly for small family settlements) the cost would be prohibitive.
3.58      Although generally trustees would be reluctant to relocate, those trustees operating in the field of global securities constitute a significant exception to this trend. The majority of trustees working in these markets have the ability and infrastructure to move their operations abroad. New York was identified as a particularly attractive jurisdiction as the main actors in the global securities trust field are US banks and so already have a presence in the US.

Impact of regulation on charges made for the work of trustees

3.59      Two thirds of legal adviser respondents considered that the regulation of trustee exemption clauses would affect the general level of charges being made for the work of the trustees. The majority identified the need for insurance as the greatest reason for an increase in charges, though some also mentioned increased costs attendant upon the need for greater supervision of trustees.^[20]
3.60      The extent to which, in the opinions of the trustee respondents, regulation would affect the charges made to a trust can be looked at from three perspectives.

Operational costs of trustees

3.61      Most trustee respondents stated that in their role as trustee they incurred general operational costs.^[21] However, less than one third of trustees thought that in the event of a prohibition of trustee exemption clauses these costs would rise.
3.62      A distinction was made by professional trustees between trustee exemption clauses that exclude duties and those that exclude liabilities. In general it was thought that the former could reduce the operational costs of trustees as time and resources would be saved in not having to fulfil the excluded duty. Most professional trustees considered that the latter had no effect upon their operational costs at present. However, a minority took the view that the presence of a clause excluding liability does not reduce operational costs but the absence of the clause would increase operational costs. In particular, the need for more extensive insurance cover would lead to an increase in premiums; indeed nearly one half of trustee respondents identified a rise in insurance premiums as the single most important factor in the increase in operational costs.

Administration fees charged by trustees

3.63      Less than one third of all the trustee respondents received a fee or remuneration for their work as a trustee. The overwhelming majority of trustees in groups one and two charged a fee or remuneration for their work as a trustee, whereas less than one third of trustees in group three, and a very small proportion of trustees in group four charged a fee or received remuneration.
3.64      The administration fees charged by the trustee respondents ranged from less than £10,000 to more than £100,000. The reason for the differences in the administration fees was not readily apparent. In general the quantum of the administration fees could be broadly categorised neither by type of trust nor by type of trustee. Most surprisingly the size of the administration fee charged to a trust seemed independent of whether the trust instrument contained a trustee exemption clause.
3.65      Notwithstanding this, of those trustee respondents that charged a fee or received remuneration, more than half predicted that the fee charged would rise if trustee exemption clauses were regulated.^[22] There were different views as to the level of any increase in fees though most trustees thought it would be less than 25 per cent. The reasons given for the anticipated increase in fees were the increased cost of insurance premiums and the costs of additional audit trails.

Other administrative costs

3.66      Most trustee respondents stated that their trust incurred other administrative costs beyond the operational costs or the fees of the trustee.^[23] About one third of trustee respondents predicted that these other administrative costs would rise if trustee exemption clauses were prohibited.

Impact of regulation on investment of wealth in England and Wales

3.67      In the short term the regulation of trustee exemption clauses was not seen by trustees or their legal advisers as having a direct effect on the use of the trust unless other equally effective vehicles could be used to achieve the settlors' objectives of financial planning and asset protection. Furthermore, the trust was also seen to endure in other areas, such as pensions, as a result of legislative requirements.
3.68      However, a significant proportion of trustee and legal adviser respondents had definite concerns over the longer term use of the trust in England and Wales based on the broader economic consequences of regulating trustee exemption clauses.
3.69      First, respondents predicted that there would be an increase in the cost of administering trusts if trustee exemption clauses were subject to regulation.^[24] This would reduce the economic viability of many trusts.
3.70      Secondly, many respondents emphasised that regulation of trustee exemption clauses would lead to an increase in over- cautious or defensive trusteeship. It was contended that this defensive trusteeship would lead to excessive use of lawyers, accountants and other professionals- thereby rendering decision making slower and more expensive- as well as encouraging investment in low risk entities- thereby leading to reduced investment in new industries.
3.71      Overall, when asked whether the current availability of trustee exemption clauses encouraged the investment of wealth in England and Wales and whether the prohibition of trustee exemption clauses would discourage the investment of wealth in England and Wales, the overwhelming majority of trustee respondents were unsure.
3.72      However, professional trustees were much less reluctant to form an opinion. Many, albeit not the majority, considered that the current availability of recourse to trustee exemption clauses encouraged the investment of wealth by the creation of trusts, and that the prohibition of trustee exemption clauses would discourage the investment of wealth in England and Wales. A similar view was taken by many legal adviser respondents.
3.73      Generally respondents noted that in three particular areas the regulation of trustee exemption clauses and the resulting discouragement of investment could have particularly serious ramifications.
3.74      First, trustee respondents in the pensions sector highlighted the current onerous nature of trusteeship, with the complexity of legislation and the burden of compliance costs. These respondents expressed concern that further regulation would severely impede the running of pension schemes.
3.75      A contraction in pension provision would, for at least two reasons, have negative implications. In 20 to 30 years people may be in the situation where they begin retirement without an adequate pension. Moreover, reduced investment in pensions could also affect the stability of the market, and may even lead to its stagnation.
3.76      Secondly, some trustee respondents in the charity sector felt that regulation of trustee exemption clauses would have a negative effect on charitable trusts, leading to a contraction in the size of the sector. They predicted this would have an immediate effect upon the investment of wealth regionally in England and Wales.
3.77      Respondents foresaw that the main difficulty with which charities would have to contend was the recruitment of trustees. Charity trustees have an increasing awareness of the risks attendant upon their responsibilities and so, especially those with a professional background, would be unwilling to act without the benefit of an exemption clause.
3.78      Thirdly, some trustee respondents operating in the global securities market expressed the view that investors were attracted by the flexibility of the English law trust and that any change endangering this flexibility may have a serious impact on the utility of the trust in these markets and the willingness of these trustees to operate in this jurisdiction. It should, however, be noted that the other jurisdiction with which such investors are already most familiar- New York- itself controls trustee exemption clauses and that this particular form of regulation may not therefore be seen as being a serious incursion into trustee autonomy.

Wider financial implications

3.79      Many trustee respondents believed that regulation of trustee exemption clauses would not only lead to a reduction of investment of wealth through the creation of settlements in England and Wales, but would also affect the market as a whole. It was pointed out that the administration of trusts generates an income for a number of service industries. This led trustees to argue that prohibition of trustee exemption clauses would have a negative effect on the commercial and financial climate of England and Wales.
3.80      Overall, the legal adviser respondents were more optimistic in their predictions. Only one fifth of those respondents agreed or strongly agreed that regulation of trustee exemption clauses would detrimentally affect other sectors of commerce in England and Wales. A slightly larger proportion disagreed or strongly disagreed that regulation would have any effect on other sectors of commerce.

Availability and effectiveness of alternative protections from liability

3.81      Many respondents, both trustees and legal advisers, stated that if trustee exemption clauses were prohibited, they could envisage alternative methods by which a trustee could be protected from liability. While we now proceed to examine the role of insurance and the utility of indemnity clauses we should note that there was little consensus as to the effectiveness of such alternatives. Indeed, the majority of respondents were of the view that trustee exemption clauses were the only truly effective method of protecting trustees.

Insurance

3.82      Both trustee and legal adviser respondents suggested liability insurance as the main alternative to trustee exemption clauses. Nearly one half of all trustee respondents indicated that they already had the benefit of personal indemnity insurance, though the proportion of trustees with insurance varied as between the different types of trustee. Insurance was more common among trustees in groups one and two. Less than one half of lay trustees had insurance.
3.83      Of those trustee respondents without insurance, the majority indicated that, in certain circumstances, they would consider taking out insurance in the future, and a small number said unconditionally that they would take out insurance. Over one third said that they would take out insurance if the premiums were paid for directly by the trust fund; others said that they would take out insurance if they could incorporate the premiums into the fee charged to the trust.
3.84      One fifth of trustee respondents thought that the need for insurance would have deterred them from accepting their trusteeship, but over one half would not have been deterred from acting by the need for insurance alone.
3.85      Overall, about one half of trustee respondents believed that personal indemnity insurance was a viable alternative to trustee exemption clauses: less than one fifth regarded it as unworkable. The legal adviser respondents were divided on this issue, being split between those who agreed or strongly agreed that personal indemnity insurance would be a viable alternative to trustee exemption clauses, and those who disagreed or strongly disagreed.
3.86      Nonetheless, many trustee respondents, including some of those who had recommended it, had serious concerns as to the effectiveness of insurance as a solution to the regulation of trustee exemption clauses. These respondents highlighted four main drawbacks to the widespread use of insurance.
3.87      First, many respondents thought that the cost of insurance would not just be an extra burden to bear, but that it would be prohibitive to the running of many trusts, especially small family and small charitable trusts.
3.88      Secondly, it was noted that insurance is not available for all types of trust or for all types of trustee. Respondents highlighted lay trustees and trustees of small family trusts as frequently encountering difficulties in obtaining individual insurance because of the problems involved in assessing their risk and the lack of any previous claims history.
3.89      Thirdly, many trustee respondents opined that insurance was insufficiently secure or consistent to offer adequate protection. It is not uncommon for insurers to include exceptions in their policies, and so in this way even an insured trustee may be exposed to liability. Furthermore, typically insurance policies cover only current claims and yet a trustee may still incur liability after retirement. Thus a trustee would require insurance indefinitely, and many respondents doubted whether sufficient and effective policies would be available upon the retirement of trustees.
3.90      Fourthly, doubts were raised by the trustee respondents about the capacity of the insurance market to cover the trust industry, particularly in the global securities market where the insurable risks would be extremely high.

Indemnity clauses

3.91      Many trustee respondents expressed no concern with a prohibition of trustee exemption clauses because they advocated an increased use of indemnity clauses in the trust instrument. The source of the indemnity would depend upon the nature of the trust.
3.92      Other respondents, however, were more reluctant to accept the viability of indemnity clauses. It was noted that any indemnity was only as strong as the person or entity contracted to provide it. Although some trustees, in response to this point, proposed that indemnity clauses should be backed by a bank guarantee, concerns were raised as to the prohibitive cost to some settlors of establishing such an indemnity. It was argued that further difficulties would be encountered in arranging for indemnity when a trustee retires.

Summary

3.93      We have found the research extremely helpful in identifying current trust practice and attitudes to regulation of trustee exemption clauses held by trustees, in particular by professional trustees, and settlors. It has also assisted us in assessing the potential economic impact of any regulatory control.
3.94      It is clear that trustee exemption clauses are now widely used in trust instruments and that professional trustees in particular have come to rely upon them as affording a means of protection from liability for breach of trust. This trend is not by any means universally approved even among professional trustees themselves, many of whom take the view that those who charge for their services should be properly accountable to the beneficiaries of the trust. While settlors are generally indifferent on the subject, not being themselves at risk, it would be reasonable to assume that beneficiaries would support greater regulation.
3.95      It is nevertheless the case that many professional trustees consider trustee exemption clauses to be a necessary component in modern trust practice. They would argue that any regulation would lead to a greater reluctance to act and possibly to the transfer of trusts to jurisdictions which do not restrict reliance on trustee exemption clauses. We are not presently convinced that there is a significant risk of the latter. The most convenient jurisdictions, namely Jersey and Guernsey, have already imposed controls on trustee exemption clauses, and it does not appear that this is an issue which is usually determinative of choice of jurisdiction for a settlor or for that matter a trustee. It may be that there are certain trusts markets where regulation may have a greater impact than others.
3.96      The insurance perspective (which we discuss further below in Part IV) is important. We realise that liability insurance premiums are reduced where the trust contains a trustee exemption clause. In so far as exclusion of liability by such means is regulated, the trustee's degree of risk will increase, and the concomitant rise in premiums will be carried through to the settlor in the fees being charged by the trustee. There may also be higher operational costs which can also be fairly attributed to regulation.
3.97      It is clear that regulation would have some impact on the level of charges being demanded by professional trustees. In so far as regulation affects lay trustees, they may seek to have their own insurance costs paid out of the trust fund. The question, to which we shall now turn in Part IV, is whether in the light of these circumstances there is a strong case for intervening with the freedom of the settlor and the trustee to stipulate the terms of the trust.

Note 1   This categorisation of trustee was found convenient for the purposes of the socio-economic research. It was not intended to provide a definitive classification of professional and lay trustees on which provisional proposals would be based. As will be seen in Part IV, our provisional proposals adopt the categorisation employed in the Trustee Act 2000.    [Back]

Note 2   This group includes solicitors, barristers and accountants not employed by trust corporations.    [Back]

Note 3   This target group comprised professional representative bodies, institutions and banks as well as professional and lay trustees.    [Back]

Note 4   The high number of pension trusts resulted from the fact that many professional trustees in trust corporations tended to specialise in this area of trust law and information about trustees in this area was more readily available.    [Back]

Note 5   For example, a will trust.    [Back]

Note 6   A number of respondents suggested that the response rate was low as a result of the survey coinciding with the busiest time of year for trust solicitors (that is, the end of the tax year and the budget) and following too closely the Law Commission’s own questionnaire, which had already been completed by the majority of the target group.    [Back]

Note 7   See para 3.19 above.    [Back]

Note 8   [1998] Ch 241. See para 2.42 above.    [Back]

Note 9   Furthermore, almost all legal adviser respondents noted that there were no types of trust for which they would advise a trustee not to use an exemption clause.    [Back]

Note 10   Whilst most professional trustees were aware of the right of the innocent trustee to seek contribution or indemnity from those trustees whose actions had caused the breach of trust, this solution was deemed too uncertain and inadequate.    [Back]

Note 11   For example, the liability imposed under environmental legislation (eg Environment Act 1995) for environmental damage clean- up costs.    [Back]

Note 12   For example, in the pension sector, the liability which may result from late payments by the company, or reliance upon the veracity of information from the company.    [Back]

Note 13   For example, the global securities market.    [Back]

Note 14   That assessment may be made, for example, by consideration of the nature and value of the trust assets or the characteristics and experience of the other trustees.    [Back]

Note 15   It must be noted that virtually all respondents stated that only exceptionally would a trustee operate in a jurisdiction other than that in which the trust was located. Thus those factors influencing the location of trusts will also influence the location of trustee operations.    [Back]

Note 16   Such as the US trust under the Trust Indenture Act 1939.    [Back]

Note 17   Such jurisdictions include the Channel Islands, the Cayman Islands, Bermuda and Switzerland.    [Back]

Note 18   It is notable that a slightly larger proportion of those trustee respondents currently with the benefit of a trustee exemption clause than of those without indicated that their decision to set up a trust in England and Wales would be affected.    [Back]

Note 19   Some respondents did suggest that as the practice of using an off-shore jurisdiction becomes less of an unknown quantity, settlors’ use of that jurisdiction would rise and this would encourage more trustees to operate there.    [Back]

Note 20   For example, this would include costs incurred through increased resort to legal advice.    [Back]

Note 21   Such operational costs include travel and basic office costs.    [Back]

Note 22   It is notable that a majority of trustee respondents having the benefit of a trustee exemption clause predicted an increase in their administration fee if such clauses were prohibited. Less than one third of trustee respondents without the benefit of a trustee exemption clause predicted an increase.    [Back]

Note 23   For example, the salary costs of administrative support and the fees of advisers to the trusts.    [Back]

Note 24   See paras 3.63 to 3.66 above.    [Back]