STEP Hong Kong | Protection from Protectors

STEP Hong Kong | Protection from Protectors

STEP Hong Kong | Protection from Protectors 1200 801 Hugill & Ip
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Discretionary trusts are commonly used as vehicles in private wealth management due to its versatility in application – it can, among other things, help settlors and its intended beneficiaries reap tax benefits and protect assets from being claimed in legal proceedings. However, in order for a discretionary trust to perform its intended function effectively, settlors must sufficiently divest themselves from trust assets. Accordingly, trustees of such trusts are often given wide powers, including but not limited to the appointment and removal of beneficiaries and complete discretion over the distribution of trust assets to the same. Thus, settlors must be extremely selective when choosing discretionary trustees, as any negligence or misconduct on their part can be highly detrimental to intended beneficiaries and require arduous litigious efforts to resolve. You can check our previous STEP article “Removal of Trustees” on the remedies available to beneficiaries who are displeased with the conduct of their trustees.

To prevent trustees from abusing their powers, a mechanism for checks and balances can be introduced into a discretionary trust in the form of a protector. In practice, protectors of trusts go by many different titles, such as appointors, guardians, nominators or otherwise. However, what they are called is inconsequential – it is the powers conferred upon them in the trust deed which defines a protector. Below is a non-exhaustive list of common powers that can be conferred on a protector:

  1. Power to appoint/remove trustees;
  2. Power to appoint new or name successor protectors;
  3. Power to require notice from trustees before they exercise certain powers; etc.

While powers of a protector will vary from trust to trust, the commonality between all protectors is that the powers they have allow them to serve as a safeguard against any potential wrongdoing by a trustee.

Who to appoint as Protector?

Settlors should be minded to carefully select who to appoint as a protector given their crucial role in any trust. There can be different benefits and drawbacks for a settlor to consider depending on who they wish to appoint.

The Settlor

It is possible for a settlor to appoint themselves as protector. This way, a settlor can retain significantly more control over their trust assets than they would be able to otherwise. However, while this may seem an attractive option, settlors should be minded not to confer too much power on themselves. This is because it is possible that, should contentious issues arise, courts may come to the view that the settlor has not sufficiently divested themselves from their trust assets – thus frustrating the asset-protection aspect of trusts. In the case of Kan Lai Kwan v Poon To Otto & Another (2014) 17 HKCFAR 414, for example, it was held that trust assets formed a part of the settlor’s financial resources available to the matrimonial pot. This was because, among other things, the settlor was also the protector and reserved to himself important powers such that it was obvious that he intended for his views in relation to the administration of the trust to be given great weight.

A friend or family member

The settlor can also elect to keep trustees in check through a trusted friend or family member acting as protector. This can reduce (but not eliminate) the risk that a court will find that the settlor has not divested himself from the trust while simultaneously ensuring that someone who genuinely looks out for the beneficiaries’ best interests is in place to keep trustees in line. That being said, there is always the obvious possibility that the friend or family member would turn out to be not as trustworthy as initially thought.

Even in the event that a protector has good intentions and maintains their integrity throughout the duration of the trust, there is a risk (especially where the protector is a layman and/or unfamiliar with trust law) that they may unintentionally attract liability onto the trust and/or themselves. While a protector is not automatically assumed to be a fiduciary, a protector that is given too much power can be found to owe fiduciary or fiduciary-like duties to beneficiaries. Furthermore, in situations where the protector takes on more than a merely supervisory role in their exercise of powers, it is even possible that they will be viewed as a de facto trustee. In the Guernsey case of In the Matter of the K Trust (Royal Court of Guernsey, 14 July 2015, Judgment 31/2015), the protector was described as “almost becoming a de facto trustee” due to her relentless scrutiny over the trustee’s every decision.

Professional Protector

Just as there are professional trustees, with the rise in popularity of trust protectors, there are also many institutions and professional individuals who are willing to act as protector of a trust. Given that they receive remuneration for their services, it is much more likely that a professional protector will owe a fiduciary duty to beneficiaries and must therefore act in their best interests. Furthermore, courts are far less likely to view the appointment of a professional as an attempt by the settlor to maintain significant control over the trust.

That being said, professional fees can diminish trust assets. Additionally, where a protector acts as a fiduciary, they are under an obligation to carefully supervise the action of trustees, which can significantly slow down a trustee’s decision-making process to the detriment of beneficiaries. For example, there could be a deadlock situation where a protector and a trustee have both carefully considered an investment option or a distribution to a beneficiary and arrived at different conclusions. If a trust deed does not specifically provide for a resolution mechanism in such a situation, this can lead to a problem where both the trustee and the protector are under fiduciary obligations to take what they believe is the best course of action for the beneficiaries of a trust. Accordingly, it may be necessary to apply to court for directions to resolve the deadlock. This is, of course, not ideal, as not only is it time consuming but it also diminishes trust assets.

Lastly, potential complications can arise trusts where a natural person (which can be the settlor, a friend/family member, or a professional) is the protector. In the event that they pass away during the trust period and no successor protector has been appointed, it can lead to a situation where the trust is left unprotected for the remainder of the trust.

The situation in Hong Kong

While the office of a protector is well known in many jurisdictions and are often included in Hong Kong trust deeds, the exact nature of protectors remains equivocal in the Hong Kong legal framework. There is no statutory definition for a protector; neither are there any powers, obligations, or liabilities defined in statute for this increasingly commonly utilized role. As such, there is lacuna in the current Hong Kong trust regime – but this has not gone unnoticed. On 11 February 2022, the Law Society of Hong Kong has made proposals to the HKSAR Government to, among other things, amend the Trustee Ordinance to provide for the role, powers, and liabilities of the office of a protector.

In doing so, the Law Society has cited certain provisions in BVI and Guernsey law that it has considered. Among other things, this includes statutory recognition in the BVI to the role of a protector by express provisions in law permitting trust deeds to contain provisions to the effect that a trustee’s exercise of powers shall be subject to the previous consent of a protector and, if so provided in the trust deed, trustees shall not be liable for any loss caused by their actions if such previous consent was given. Importantly, BVI law also provides that protectors shall not be deemed to be trustees nor will they be liable to beneficiaries by virtue of their exercise of such powers. Such statutory protection will provide both trustees and protectors with more certainty in the exercise of their powers and eliminate many of the potential issues outlined above.

Final thoughts

While the Law Society has not specified the exact changes it would like to see made to the Trustee Ordinance, it is still most certainly a step towards the improvement of the Hong Kong trust regime. It remains to be seen whether the HKSAR will heed such recommendation. As it stands right now, however, the only way to prevent such problems from arising is through careful selection of protectors based on the needs of a trust and through prudent drafting of the trust deed.

This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances.

Originally published on STEP Hong Kong – July 2022 Newsletter

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