Two Birds, One Stone: Addressing COO and DAC6 Risks in Tandem
UK Criminal Finances Act 2017 (CFA) and the EU Directive on Administrative Cooperation (DAC6) compliance matters are likely to come under increased scrutiny from the UK tax authority (HMRC). What’s more, HMRC may view a corporate criminal offences (CCO) investigation as an opportunity to spot instances of DAC6 non-compliance, even though DAC6 and the CFA target completely different activities, and non-compliance with DAC6 obligations is not a criminal offence under UK law. However, HMRC might consider mitigating DAC6 penalties if intermediaries or relevant taxpayers take account of DAC6 risks in their “reasonable prevention procedures” defence to the CCOs. This creates the perfect opportunity for UK intermediaries and/or relevant taxpayers to kill two birds with one stone by addressing DAC6 risks and CCO risks in tandem.
Intermediaries typically include corporate services providers, family offices, investment banks, trust companies, accountancy firms and fund managers with a presence or professional registration in the United Kingdom. Intermediaries have an obligation to disclose reportable cross-border arrangements (RCBAs) to HMRC within 30 days of the RCBA being made available for implementation (or in the case of RCBAs implemented between 25 June 2018 and 1 July 2020, by no later than 28 February 2021). The relative urgency of the DAC6 reporting deadlines, coupled with the need to mitigate any penalties under the UK regime, should encourage intermediaries to address another necessary ongoing compliance requirement that is easily overlooked—namely, the need to establish a “reasonable prevention procedures” defence to the CCOs.
You can build DAC6 risk mitigation into your “reasonable prevention procedures” defence by taking the following steps:
- Conduct a risk assessment of your organisation’s activities as a whole and identify any EU-connected cross-border activities. This can be done as part of your CCO risk assessment.
- Consider whether any of the DAC6 prescribed “hallmarks” could apply to those EU-connected cross-border activities. This could be achieved by means of a decision tree or flow chart, or by obtaining bespoke advice on a particular transaction or activity, or a combination of any of the foregoing.
- Document your DAC6 internal review and reporting procedures for inclusion within your wider “reasonable prevention procedures” defence.
See No Evil? Hear No Evil? Do Nothing. A Recent Appellate Judgement is Hailed as a “Return to Business as Usual” and Relieves the Trustee from any Obligation to Inquire into the Holding Company’s Investments because of the Anti-Bartlett Clause; Will Other Courts Follow?
The law is clear: trustees have an obligation to oversee and, where prudent, interfere in investments made through a company in which they hold a substantial interest: Bartlett v Barclays Bank Trust Co. Ltd. (No.1 and No.2)  Ch D 139;  1 Ch 515. The law is also clear that this obligation may be limited to some extent through express trust language: Appleby Corporate Services (BVI) Limited v Citco Trustees (BVI) Limited  17 ITELR 413.
A recent decision of the Hong Kong Court of Final Appeal in Zhang Hong Li and others v DBS Bank (Hong Kong) Limited and others  HKCFA 45 explored a clause in a Jersey law trust that went well beyond the normal language which limits the trustee’s duty to interfere in the investments of the underlying company to situations where it has actual notice that something is awry. The Court held that the trustee was effectively excused from any “high level supervisory duty” of the investments of the trust based on the anti-Bartlett clause of the trust deed. Will other courts follow?
The trust was settled by a married couple for the benefit of themselves and their two minor children, and one of the settlors was appointed as the investment advisor of the holding company. The company made some large bets on the Australian dollar, which resulted in enormous losses. The trust deed contained an unusually comprehensive anti-Bartlett clause relieving the trustee (DBS) of any duty to interfere in the management of the holding company unless DBS had actual knowledge of dishonesty in the company’s conduct. It provided that the trustee “shall assume at all times that the administration, management, and conduct of the business and affairs of such company are being carried on competently, honestly, diligently, and in the best interests of the Trustees in their capacity as shareholders…until such time as they have actual knowledge to the contrary.” The trustee was also relieved under the trust deed of any duty “at any time to take any steps at all to ascertain whether or not [the assumptions that the company’s business was being administered competently, etc.] are correct.”
The lower courts found that DBS had a “residual obligation” to monitor the investments of the trust despite the robust anti-Bartlett clause of the trust deed, and ordered DBS to refund to the beneficiaries the amount of the loss. The Court of Final Appeal reversed, finding that the anti-Bartlett clause effectively precluded DBS from responsibility to monitor or intervene with respect to the trust assets absent actual knowledge of dishonesty, and furthermore, even if DBS did have some residual obligation, it had not been breached.
Many herald this as a victory for the trust industry. However, it is far from clear how such an extraordinary restriction on trustee oversight can be reconciled with the trustee’s obligations to prevent bribery, tax evasion and money laundering. You may see no evil and hear no evil, but if you think trust deed language will really excuse you from looking for evil, you should expect an unpleasant shock: most trustees have much bigger worries these days than breach of trust claims.
Trust Insolvency – Priority of Rights
In its latest decision in the long-running saga of the Z Trusts litigation in Jersey, the Jersey Court of Appeal provided further clarity and guidance to trustees concerning prioritisation of their claims in the context of “insolvent” trusts (i.e., where the liabilities of a trust exceed the assets held by the trust).
As former trustee, Equity sought reimbursement of £18 million in costs and liabilities from the Z II Trust, which held assets of £6 million. The question of priority was therefore critical to Equity and the other trust creditors, which included the successor trustee R&H. Priority meant Equity would recover £6 million as opposed to approximately £330,000 if it ranked equally with the creditors.
At first instance, the Royal Court of Jersey found that Equity’s claims did not have priority over the ordinary trust creditors (whose claims against the trust assets were by way of subrogation to Equity’s indemnity under Article 32(1)(a) of Trust (Jersey) Law 1984), nor over R&H’s claims as successor trustee. The rationale for these decisions was to promote good trust administration and avoid an unfair situation where a former trustee could “scoop the pot” ahead of other creditors.
However, the Jersey Court of Appeal overturned these decisions in 2019. The Court recognised that trustees have a right of indemnity against the trust assets for liabilities properly incurred in their capacity as trustee, which is secured by way of an equitable lien over the trust assets. Drawing on English law principles and the decision of the Privy Council in Investec Trust (Guernsey) Ltd v Glenalla Properties Ltd  UKPC 7, the Court considered the general rule that equitable interests rank according to the order of their creation (i.e., the “first in time” rule) and ruled that a trustee’s right of equitable lien is enforceable as a first charge over the trust assets and takes priority over the claims of its Article 32(1)(a) creditors and the lien of each successor trustee. Finally, the Court also found that the claims of the creditors arising during a former trustee’s appointment had priority over both the successor trustee and creditors arising during the tenure of the successor trustee.
Whilst the decision provides clarity, it naturally raises cause for concern for creditors and successor trustees following a change of trusteeship, particularly as the liability that Equity sought to recoup was contingent at the time it retired and could not have been discovered by R&H prior to its appointment. However, the case is now headed to the Privy Council, and its definitive ruling on the priority of claims in an “insolvent” trust is eagerly awaited.
Removal of Trustees
When relationships between trustees and beneficiaries break down, beneficiaries often wish to consider removing and replacing the trustee. If the trust instrument empowers someone—usually a protector, but sometimes the majority of the beneficiaries—to remove and replace the trustee, this may be the solution. But if no such power exists, or if the person empowered to remove the trustee does not wish to exercise the power, the beneficiary may have to apply to the court to order the removal and replacement of the trustee.
This problem is not new. The leading case on trustee removal is the 19th century case of Letterstedt v Broers, in which the court found it has inherent jurisdiction to remove trustees: “…if satisfied that the continuance of the trustee would prevent the trusts being properly executed, the trustee might be removed. It must always be borne in mind that trustees exist for the benefit of those to whom the creator of the trust has given the trust estate”. However, rather confusingly, the court also stated that “friction or hostility between trustees and the immediate possessor of the trust estate is not of itself a reason for the removal of the trustees.”
The position has been somewhat clarified in more recent cases. In the 2007 case of Thomas and Agnes Carvell Foundation v Carvell, which concerned the removal of personal representatives, the court held that “the overriding consideration is…whether the trusts are being properly executed” and that “the main guide must be ‘the welfare of the beneficiaries’”.
This ruling was applied three years later, in the 2010 cases of Augus v Emmott, where a dispute between estate executors was hampering the administration of the estate, and Kershaw v Micklethwaite and others, in which a beneficiary had applied for the removal of executors. In that case, the court held that friction or hostility between an executor and a beneficiary would not, in and of itself, suffice to remove an executor. On the other hand, “a breakdown in relations between an executor and a beneficiary will be a factor to be taken into account, in the exercise of the court’s discretion, if it is obstructing the administration of the estate, or even sometimes if it is capable of doing so”.
What is clear from all of these cases is that where the breakdown in relations between trustee and beneficiary is well founded and involves misconduct by the trustee, the court would (and should) be very vigilant of the welfare of the trust and its beneficiaries. Misconduct can range from deliberate breach of trust to failure to consider the beneficiaries’ interests, taking a partisan approach or taking a laissez faire approach to the affairs of the trust. But as always, prevention is the best cure, and careful thought to a removal and replacement mechanism at the drafting stage may avoid litigation when things go wrong.