There are a number of reasons why it might be necessary, or at least highly desirable, to partition a trust fund into shares so as to separate the interests of different classes of beneficiaries. The imperative to do so is often seen within US tax, in particular the accumulation distribution rules, which may result in the elimination of a beneficiary’s entire interest in a foreign trust. Alternatively, friction between classes of beneficiaries or with the trustee may also best be resolved by creating a new settlement or a sub-trust which can be administered separately.
If the trustee has a suitable power in the existing trust to partition or to create new sub-funds or separate trusts, no difficulty arises. But many older trusts and a number of trusts encountered outside the UK, particularly those which came from the hand of a US draftsman do not contain such a power. Those trusts tend to contain fixed trusts of income down through the generations before capital is directed to be divided at the end of the trust period. The beneficiary has a share of the income of the whole fund. Contrast a trust in which the capital is divided into shares at the outset or as a result of partitioning: the beneficiary has an interest in the whole income of an individual share of the capital. Moving from the former to the latter changes the beneficiary’s interest in some way – an issue with which the courts in Cayman and London have recently had to grapple, with Cayman leading the way.
If the trustees have no suitable power to partition the fund they may need the assistance of the court. One possibility is an application under the English Variation of Trusts Act 1958 (or its equivalents in other jurisdictions, including section 72 of the Trusts Law (2009 Revision) in Cayman) but those forms of application require all the adult beneficiaries to give their consent and the court to be satisfied that the new arrangements are for the benefit of minor and unborn beneficiaries, conditions which it may not always be possible to satisfy.
The alternative is an application under the English section 57 of the Trustee Act 1925 and its international equivalents, including section 63 of the Trusts Law in Cayman. They are designed to equip trustees with extra administrative powers. The consent of all beneficiaries is not required nor does the court have to be satisfied about benefit for other classes of beneficiaries: the question is one of administrative expediency. Over the past couple of years this jurisdiction has come under the judicial microscope in both London and Cayman resulting, after a trip to the English Court of Appeal, in the vindication of the approach first adopted in Cayman.
Re Z Trust, MEP v Rothschild Trust Cayman Ltd[i]
The first of the recent cases in which section 57 or its equivalent has been considered was heard by the Chief Justice of the Cayman Islands. The trusts were of the type in which each beneficiary has an interest in part of the income of the whole fund - sometimes called ‘Freeston trusts’. For various reasons, including the completion of a family agreement under which the interests were to be separated, the trustees wanted to divide the fund into three separate funds without otherwise altering the terms of the trusts: the result would be that each would have the whole income of an individual share but economically their interests would be the same. Did that involve an alteration to the beneficial interests and if so is that permissible under section 63? The issue arose largely as a result of remarks of Goff LJ in Re Freeston’s Charity[ii] to the effect that:
“It is manifest that an interest in half the income of an undivided fund is quite different from the whole income of a divided half of that fund”.
He rejected an argument that a power to partition could be conferred under section 57. However, the Chief Justice found the answer to that in a further decision of the Court of Appeal in Re Downshire[iii] in which Lord Evershed MR pointed out that section 57 made no mention from start to finish of beneficial interests:
“or give the slightest indication that it was intending to give power to vary or interfere with such interests or intermeddle with them in any way – except to the extent that they might incidentally be affected by the exercise of the powers which the section does in terms confer” [emphasis supplied].
The Chief Justice emphasised that no alteration of beneficial interests was contemplated but that what was proposed was intended only for the “more efficacious management and administration of the trust …” His conclusion was that the proposed partition was administrative in nature and that any variation of the beneficial interests was merely incidental and accordingly permissible.
Sutton v England
Very shortly after the successful outcome in Cayman, an effectively identical application under section 57 came before the English High Court. The application in Sutton v England[iv] caused more difficulty than had been encountered in Cayman. US beneficiaries were badly affected by the existing trusts, for the US tax reasons briefly described in the introduction, and the proposed solution was to create a sub-fund for their benefit with new US trustees.
Mann J declined to make the order on jurisdictional grounds, holding that he had no power under section 57, even though it was clearly expedient to do so. He accepted that a power to appropriate or to partition can be conferred under section 57 where the prime purpose is administrative and managerial and any effect on the beneficial interests is incidental, citing Re Downshire and Re Thomas, but in arriving at the opposite conclusion from that reached on the same facts as the Cayman case, the judge rejected the application on the basis that the effect on the beneficial interests would be to render them “conceptually different”. He drew a distinction between conceptual difference (which he considered would not permit use of s57) and a change in “how the interests are in fact enjoyed” (which would allow s57 to be used). While agreeing with the Chief Justice’s analysis, he differed from him in result. He considered that the way to achieve the desired partition was by way of an application under the VTA and not under section 57.
Southgate v Sutton: The Appeal
Mummery LJ delivered the unanimous judgment of the court allowing the appeal. He approved Mann J’s “cautious” approach to the section 57 jurisdiction but held that there was no binding authority which required the judge to reach the decision he did. He distinguished Re Freeston:
“It is not authority for an unqualified proposition that the partition of a trust fund is always a variation or re-arrangement of the beneficial interests in it, or always has more than an incidental impact on the beneficial interests in it. Freeston was a case of altering the nature of the beneficial interests by the division of the fund, but in circumstances where there were no difficulties ‘in the management or administration of the trust property’. Nor was there any suggestion of expediency which would have justified the conferral by the court of a power to partition the trust property. There was no difficulty of the kind present here of the Trustee having to act even-handedly and having to reconcile the different interests of the different beneficiaries under the settlement.”
Accordingly the Court held that:
“The court had jurisdiction to grant the application as one relating to the administration of the trust property; that the impact of the proposal on the beneficial interests was incidental only; that there was no legal precedent or other obstacle to granting the application and making the order asked; and that the proposed transaction for appropriation and partition was one that was clearly expedient in the interests of the trust as a whole and was the only way in which the benefits of the separation of the interests of the [US] Beneficiaries could be achieved.”
The court paid respect to the non-binding decision of the Chief Justice in MEP v Rothschild and in its reasoning endorsed the approach taken in that case.
As a result of the Court of Appeal’s decision the position is now the same in England as in Cayman. The approach endorsed by the Court of Appeal is straightforward: first ask whether there is a problem of management and administration which it would be expedient to resolve. If the beneficial interests are left untouched, albeit to be enjoyed in partitioned property rather than the whole fund, then the move from an undivided fund to a partitioned fund may be sanctioned under section 57. The jurisdiction pioneered in Cayman is now expected to be available in all jurisdictions with equivalents of section 57.
[i]  W.T.L.R. 735
[ii]  1 WLR 741
[iii]  Ch 218
[iv]  WTLR 335
Shan Warnock-Smith QC is a barrister who provides advisory and litigation services to professional clients in the wealth structuring field. From her bases in London and Cayman, Shan has an international practice, which takes her around the globe to advise and litigate.
Andrew De La Rosa
Andrew De La Rosa has a recognised expertise in cases involving the application of equitable principles and remedies in international disputes, in particular where fiduciary relationships in trust, succession, partnership, corporate governance and investment management spheres are involved. He practices from Cayman and London and has a long-term connection with the Arabian Gulf jurisdictions.