Author: Simon Ekins
The Supreme Court has been busy. Two final appeals in matters of interest to trust practitioners have been heard in the past few weeks. Judgment is awaited on the appeals in Petrodel Resources Limited & others v Prest & others (1) and the conjoined appeals in Pitt v Holt and Futter v Futter (2). The note below should whet the appetite for those judgments.
Petrodel concerns the jurisdiction of English courts (in particular the Family Division of the High Court) to make property transfer orders in matrimonial proceedings relating to assets held by companies, as opposed to assets held either legally or beneficially by the husband (H) or wife (W). Section 24 (1)(a) of the Matrimonial Causes Act 1973 permits the court to make an order that one party to a marriage transfer to the other party any "property to which the first-mentioned party is entitled, either in possession or reversion". This is of interest to trustees who hold (for example) English real estate through offshore SPVs. The extent of the section 24(1)(a) jurisdiction affects the ease with which divorcing spouses may be able to enforce ancillary relief orders against that company-owned real estate.
In a simple case, where H is the legal and beneficial owner of a property in England, he can be ordered pursuant to section 24(1)(a) to transfer it to W. If he fails to do so he risks committal for contempt and the necessary conveyance can in any case be effected pursuant to an order of the court. But what if the property is owned by an off-shore company, which itself is legally owned by third parties, but is seemingly under the close control or influence of H? Such was the case in Petrodel. H conducted a successful oil exploration business through companies incorporated in the Isle of Man, including Petrodel Resources Limited (PRL). PRL owned several English properties. H was neither a shareholder nor director of PRL. However, he had enjoyed free access to its assets to support his and his family’s lifestyle throughout the marriage. That was enough for Moylan J. in the Family Division, who ordered H to transfer several of PRL’s properties to W. He held that the order was necessary to achieve fairness in the allocation of matrimonial assets and that section 24(1)(a) granted the court jurisdiction to make such an order where H enjoyed effective power over the assets of PRL and no third party interests (i.e. shareholders of PRL independent of H) would be prejudiced.
On appeal, Lord Justice Thorpe agreed with Moylan J.’s reasoning, thinking it consistent with authority in both the Family Division and Court of Appeal over the past 20 years. Lord Justices Rimer and Patten, however, were unimpressed (to put it mildly) and held as follows. Section 24(1)(a) bites only on property owned beneficially by one party to a marriage. The assets of a company are beneficially owned by the company itself, and the company’s shareholders have no interest, legal or beneficial, in its assets. Thus creditors of a company cannot enforce against the assets of the shareholders and creditors of the shareholders cannot enforce against the assets of the company. That is the essence of limited liability, which applies even where the company is owned and managed by one person.
The court may only "pierce the corporate veil" and treat a company’s assets as belonging to its shareholder(s) in very limited circumstances. Impropriety linked to the use of the corporate structure to avoid or conceal liability is a necessary condition for veil piercing. In Petrodel, there was no such impropriety. Despite H having taken several leaves out of Iqbal Mubarik’s seminal book Cunning Ruses for the Better Thwarting of English Court Processes (3), PRL was nevertheless a genuine company, properly incorporated under the laws of another jurisdiction, for legitimate trading and tax planning reasons. For those reasons, section 24(1)(a) did not give the court jurisdiction to make a property transfer order against the assets of PRL.
In Petrodel the Family Division’s overriding duty to achieve a fair result on the division of matrimonial assets crashed head on into the concept of limited liability, a fundamental principle of company and property law underpinning corporate economic activity in this country. Lord Justice Thorpe in his dissenting judgment noted that the strict application of company and property law principles would deprive the Family Division of a crucial tool for delivering effective justice between divorcing spouses. By lessening the threat of direct enforcement against trust assets, Petrodel may have enabled trustees to participate in the debate about division of assets more effectively on their own terms. The Supreme Court decision will, therefore, have a major effect on the balance of power in matrimonial disputes over corporate assets.
Pitt v Holt; Futter v Futter
In March 2011 the Court of Appeal rewrote the law relating to the circumstances in which a trustee’s exercise of discretionary dispositive powers can be set aside if an unforeseen, undesirable consequence (usually a tax charge) follows. For 35 years, following the case of Re Hastings Bass (4), trustee dispositions could be set aside if the trustee failed to take into account relevant matters or took into account irrelevant matters in the exercise of the discretion. Failing to take into account the true effect of tax legislation could trigger the jurisdiction, to the relief of remorseful trustees and unhappy beneficiaries. This was an aspect of equity’s capacity to intervene in the administration of trusts to protect the interests of beneficiaries.
However, that 35 years’ jurisprudence was in fact wrong, said Lord Justice Lloyd on appeal in Pitt. Trustee dispositions are only void if outside the trustee’s powers or made for an improper purpose. They are voidable at the instance of the beneficiaries if tainted by breach of fiduciary duty. This was intended to bring the law as it affects trustees into line with the law as it affects everyone else.
Lord Justice Lloyd went on to say that in the context of private discretionary trusts, bound up as they generally are with considerations of tax mitigation, failure to consider the tax implications of a disposition could amount to a breach of fiduciary. That produced a curious result. If the trustee fails to take proper tax advice before effecting a damaging transaction, the beneficiaries may bring a claim alleging breach of fiduciary duty against the trustee. The trustee may defend that claim, particularly if his exoneration clause does not appear to protect him from liability.
If the beneficiaries are successful there would be cost implications for the trustee, but the beneficiaries may elect to set aside the transaction. Beneficiaries and trustee (but not the taxman) are relieved. But if a trustee, as he should, takes specialist tax advice but that advice turns out to be wrong, the trustee will not be in breach of duty, the transaction cannot be unwound, and the only recourse to recover losses for the beneficiaries will be professional negligence litigation with the trustee’s tax advisor. The beneficiaries might prefer their trustees to have been in breach of fiduciary duty (5).
The Supreme Court must now finally determine whether trustees, dealing with assets held on behalf of others, have any greater protection from the unforeseen consequences of their actions than anyone else.
(1)  EWCA Civ 1395
(2)  EWCA Civ 197
(3) See Mubarak v Mubarik  EWHC 220 (Fam)
(4)  Ch. 75
(5) For a more detailed description of the ins and outs of Re Hastings Bass, please click here for the June 2011 newsletter.