3 investment rules estate trustees must know

Estate trustees are fiduciaries. As such, they owe numerous duties to both the estate and to its beneficiaries.

One of those duties is the duty to invest the trust property with care. To do so, the trustee must follow three legal rules when investing. We’ll examine each of them.

1. A trustee must obey the trust deed

Often, a trust deed will contain a specific term that limits the trustee’s investment authority – whether intentionally or not. A recent British Columbia court case showed settlors and testators why they need to carefully consider the words in a trust deed. In Dunn v. TD Canada Trust (2016), a trust created upon the death of the testator in 1957 contained a clause directing the trustee to “retain in the form in which they are at the time of my death all my investment in bonds and stocks, and to sell, call in and convert into money all the rest and remainder of my estate.”

Despite that directive, between 1957 and 1973, the trustee sold most of the original investments, including the stocks and bonds. Most of the cash realized from these sales was distributed to the beneficiaries. What remained in the trust was invested in blue-chip stocks and various bonds.

However, despite the fact the beneficiaries had received most of the cash and the remaining investments were prudent, the court found the trustee had breached its duty to obey the trust deed by selling the “bonds and stocks.” Clearly, a trustee and a trust’s investment advisor must carefully read and adhere to the words used in the deed.

Naturally, a testator may include as narrow or as broad language as they wish in the trust deed. Often, the investment clause is written broadly, allowing investment not only in accordance with the prudent investor standard set out in most provincial legislation but also containing a direction exonerating the trustee for any loss, so long as it is made in good faith.

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2. A trustee must invest as would a prudent investor

In order to ensure the investments of a trust are prudent, a trustee is required to consider the following:

• general economic conditions;
• the possible effect of inflation or deflation;
• the expected tax implications of investment decisions or the overall investment strategy;
• the role each investment plays in the trust’s portfolio;
• the expected total return from income and appreciated capital;
• the need for liquidity, any required income payments and the preservation or appreciation of capital; and
• an asset’s special value to the beneficiaries, such as family business shares.

In addition, case law clearly shows that a trustee must diversify the trust’s portfolio to the extent appropriate, even in provinces where the legislation does not require diversification.

In most instances, a trustee must establish and follow an investment plan that assesses the risks and return associated with the investment portfolio. Trustees should ensure they obtain advice from an advisor and review this plan on an annual basis and/or when circumstances change. Failure to establish and follow a plan may result in personal liability for the trustee.

In all provinces, a trustee is permitted to delegate investment authority to an investment advisor — so long as the choice of advisor is prudent. The prudency of the choice would depend on factors such as experience investing within the trust setting and industry qualifications. Over time, investment advisors and/or the companies for which they work may change. Therefore, a trustee should review the choice on a regular basis to satisfy himself that it remains prudent.

Given those challenges, it’s becoming more common to include a clause in a trust deed or will that directs the trustee to retain a specific advisor, so long as that choice is prudent when retained. This ensures some continuity, as the advisor named is often the person who served the testator or the settlor before the trust was created. Where the trustee delegates authority to an advisor, a written agreement between the trustee and the advisor in addition to the investment plan is required.

Read: What to know about investing within a trust

Given the requirement for diversification, mutual funds are ideal trust investments; provincial legislation also specifically authorizes a trustee to use mutual funds when investing in a trust. However, there is some question as to whether an investment advisor retained by the trustee may do so. In the 1994 Ontario case of Haslam v. Haslam, the court held that although delegation by a trustee to an investment advisor was authorized, this did not authorize the investment advisor to sub-delegate to anyone else, including a mutual fund management company. For total clarity, a well-drafted trust deed should specifically authorize a retained investment advisor to use mutual funds and/or ETFs when investing.

Stocks and bonds are also appropriate, particularly in larger estates. However, in smaller trusts, they may not be approriate if there is not enough diversification. Similarly, in larger trusts, a mutual fund or ETF may have to be used in conjunction with bonds and stocks in order to diversify within a sector.

It is also important that a settlor or testator ensure the deed’s terms are broad enough to allow the trustee to deploy investments he or she feels are most beneficial. For instance, if the settlor or trustee finds that a mutual fund with a return of capital component is most suitable, the deed needs to allow the income beneficiary some ability to encroach upon capital — otherwise additional steps will be required in the trust accounting.

3. A trustee must maintain an even hand between the beneficiaries

Often, a trust will have two different classes of beneficiaries, each with competing interests.: income beneficiaries and capital beneficiaries. An income beneficiary is a person who has the right to access the income produced by the trust. Often, the income beneficiary may draw some capital in certain circumstances. A capital beneficiary, on the other hand, is a person who will inherit the capital of the trust when the trust is terminated.

Read: When the executor is also a beneficiary

In some trusts, the settlor or testator has included a specific clause directing the trustee to favour or even ignore one class of beneficiary in order to free the trustee from the even-hand rule. However, in the absence of such a clause, a trustee must consider the interests of all beneficiaries when investing. Excluding certain beneficiaries from communications or investing in a beneficiary’s own business could be examples of violating the even-hand rule.

Conclusion

These three legal rules are paramount when creating and when administering a trust. Failure to consider the rules when drafting a trust will inhibit the trust’s investment advisor. Worse, ignoring them during the trust’s administration will likely lead to liability for the trustee.

Keith Masterman

Tax & Estate

Keith Masterman, LLB, TEP, is vice-president, Tax, Retirement and Estate Planning at CI Global Asset Management. He can be reached at kmasterm@ci.com.