Your client is a trustee of private shares—now what?

If you advise a family with a private corporation, trustee concerns could arise for family members. That could happen when shares become part of the business founder’s estate after death, or when shares are held in trust as a result of succession planning.

Here are some initial considerations for trustees, as well as considerations when drafting a trust deed, as discussed by an expert panel at STEP Canada’s 20th national conference in Toronto this week.

Top of mind for trustees

The first question for a trustee of private shares to ask is whether to hold or dispose of those shares.

Trustees should first consult the trust document for guidance, said Eric Hoffstein, partner at Minden Gross in Toronto. Guidance includes whether trustees have voting control and whether they’re bound by the prudent investor rule, which deems trustees must act as would a prudent businessperson. If shares don’t meet the standard of a prudent investment for a trust, the trustee would have a fiduciary duty to dispose of them.

Read: 3 investment rules estate trustees must know

For trustees who have justification to retain shares, along with voting control, the question becomes one of how to administer the company, said Hoffstein. In other words, to what extent should the trustee get involved in the company’s business?

Though the associated case law in Ontario isn’t settled, there’s a view that trustees have “an obligation to assert positive supervision of the corporation,” said Hoffstein. That could mean that trustees appoint themselves as directors of the corporation, or, for those without the required expertise, it could arguably mean appointing a nominee with accompanying supervision requirements.

“It’s not enough to simply review an annual report,” said Hoffstein. “You have to, as a trustee, monitor the ongoing business of the corporation.”

If trustees with voting control appoint themselves as directors, they should understand whether they’re exposed to liability in the case of, for example, an environmental claim. “A trustee would want to know: Does the trust provide for insurance or indemnification for me as a director or officer in the case of that personal liability?” said Hoffstein.

Another challenge is whether a trustee-director is required to vote their shares in accordance with fiduciary obligations as a trustee, or in the best interest of the corporation as a director—also not settled law in Ontario.

The general approach is that, when acting as a trustee, trust law principles apply with the attendant fiduciary obligations; when acting as a director, corporate law principles apply, and directors must subsequently act in the corporation’s best interest. Where there’s a conflict between what’s in the best interest of the trust beneficiaries versus the corporation, a director acts in the best interest of the corporation, said Hoffstein.

Where trust property includes private company shares, courts don’t require trustees to act as directors, said Fiona Hunter, partner at Horne Coupar in Victoria, who was on the same STEP panel. Hunter was referring to case law.

But as a trustee, “you can’t just sit on your laurels,” she said. “You have to take some active involvement,” such as regularly meeting with directors to find out what’s going on within the company.

Protections for trustees

Hunter said there are two ways to cover liability for trustees as they administer trusts: relief from breach of fiduciary duty or protection clauses within the trust document.

All common-law provinces except P.E.I. have statutory provisions for relief from breach of fiduciary duty, she said. A common requirement for relief is that the trustee must have “acted honestly and reasonably” and “ought to be fairly excused” for the breach of trust.

Case law generally shows that acting “honestly” requires active involvement in the trust’s administration, and “reasonably” means what an ordinary, prudent businessperson would do. Referring to active involvement, Hunter said trustees should actively supervise shares and not simply review annual financial statements.

So long as the trustee has been active and prudent, “usually the courts will relieve the trustee from errors they have made provided they have been acting honestly and reasonably,” said Hunter.

In cases of breach of trust, courts will consider such things as whether the trustee sought professional advice, as well as the communication between trustees and beneficiaries leading up to the breach. “Even if you’ve got nothing to report, report it, because where you run into trouble with beneficiaries is when they don’t get information about what’s happening,” said Hunter.

Other factors include whether the trustee is a professional and received remuneration. Though family members might act as trustees without compensation, “sometimes, that can backfire on you,” said Hunter.

Exoneration clauses in trust deeds

When drafting a trust deed, Hunter notes the importance of including an exoneration clause for the trustee who’s a family member and requires leeway to run the business. Other drafting considerations include the type of trust and whether trust property is high risk.

She added that there’s little case law for exoneration clauses. Where there are such cases, the court uses strong terms such as “actual fraud” and “willful fraud or dishonesty.” However, an Alberta case reveals that a trustee could be held liable for gross* negligence. Thus, holding shares in a company and being an officer or director should be looked at very carefully in Alberta in particular, suggests Hunter.

Compensation concerns

In Ontario a trustee is entitled to fair and reasonable compensation based on such things as trust size, responsibilities and time requirements, and skill. In addition to administration fees, compensation is based on a care and management fee intended to reflect a trustee’s duty of oversight.

A potential compensation challenge is directors’ fees, which are often considered related to oversight and so should be deducted from the care and management portion of trustee compensation.

The appropriateness of directors’ fees depends on who the trustee is, said Hunter. For example, directors’ fees might not be required for a neutral third party with no involvement in the business. She added that estate planners should have compensation discussions with clients.

Another concern—especially for corporations with passive investment income—is the potential to be accused of double dipping, in a context where trustees, who have appointed themselves as officers or directors, take compensation for both roles.

When the company solely has passive investment income, consider whether a financial advisor receives commission, which would perhaps “detract from the compensation that a director or officer would be entitled to take,” said Hoffstein. He added that such issues are ideally dealt with when the trust document is drafted.

For tax efficiency, said Rosanne Rocchi, partner at Miller Thomson in Toronto, who spoke on the same STEP panel, directors’ fees are deductible from the corporation’s income, so care and management fees are best discharged as directors’ fees when trustees serve as directors.

*A previous version of this story failed to specify “gross” negligence. Return to the corrected sentence.

Also read:

How to deal with an insolvent estate

Prevent problems with bequests

Don’t make estate administration mistakes