rachel_price_phTomorrow (Tuesday 12 March), a Supreme Court consisting of Lords Neuberger, Walker, Mance, Clarke, Carnwath and Lady Hale will begin hearing the case of Futter & Anor v Commissioners for Her Majesty’s Revenue and Customs.  An appeal against the unanimous decision of the Court of Appeal (Mummery, Longmore and Lloyd LJJ), the issues before the Supreme Court are:

  1. The circumstances in which the Court can interfere with the exercise by trustees of their powers and discretion, specifically, whether the Court can declare void or voidable decisions of trustees on the grounds of failure to take into account a relevant matter in circumstances where the trustees have acted on the basis of professional advice (the “Rule in Hastings-Bass”); and
  2. Whether mistakes in relation to adverse tax consequences are the kind of mistakes which will invoke the court’s equitable jurisdiction to set aside a voluntary disposition for mistake.

It is important to recognise that, whilst the Rule in Hastings-Bass and the doctrine of mistake have increasingly been invoked by trustees to unwind discretionary transactions with unintended and unpalatable tax consequences, the legal bases behind the principles (and their respective consequences) are entirely different.

The Facts

Pitt v Holt [2010] EWHC 45 (Ch) involved the creation of a special needs trust which had been set up pursuant to advice received from financial advisers in a manner which attracted a large charge to inheritance tax, despite the fact that this could have been easily avoided by the insertion of a single provision into the settlement by which the trust was created.

In Futter v Futter [2010] EWHC 449 (Ch) the trustees of two non-UK resident trusts, following incorrect advice from a leading legal practice, had adopted a scheme devised to minimise beneficiaries’ exposure to capital gains tax.  Unfortunately, the intended tax advantages of the distributions were illusory because under the TCGA 1992 it was not possible for the beneficiaries to offset the trust gains generated against allowable losses.

The representatives/trustees in both cases applied to Court on the basis that the transactions were void or voidable and, despite the Revenue’s opposition, the Court held at first instance that the Rule in Hastings-Bass was engaged.  The Revenue appealed, contending that on a correct formulation the Rule in Hastings-Bass did not justify a conclusion that the dispositions in question were either void or voidable.  On 9 March 2011 the Court of Appeal handed down its judgment, reversing the first instance decisions and allowing the Revenue’s appeal.

The Issues

The correct formulation of the Rule in Hastings-Bass

The name of the principle comes from the case of Re Hastings-Bass deceased [1975] Ch 25, in which the Court of Appeal determined the circumstances in which the Court should interfere where a trustee has exercised a discretion in good faith but his action does not have the effect intended.  The principle was developed from the case of Mettoy Pension Trustees [1991] 2 All ER 513 onwards and Lloyd LJ set out what he perceived to be the most workable formulation of the Rule in Hastings-Bass in the context of the first instance decisions in Sieff v Fox [2005]:

Where trustees act under a discretion given to them by the terms of the trust, in circumstances in which they are free to decide whether or not to exercise that discretion, but the effect of the exercise is different from that which they intended, the court will interfere with their action if it is clear that they would not have acted as they did had they not failed to take into account considerations which they ought to have taken into account, or taken into account considerations which they ought not to have taken into account.”

Prior to the Court of Appeal judgment in 2011, there was an increasing reliance on the Rule in Hastings-Bass in instances where voluntary dispositions by trustees bore unforeseen fiscal liabilities.  For many years the Revenue declined invitations to be joined as a party in such cases; however in June 2006 the Revenue announced its intention to give active consideration to participating in cases where large amounts of tax were at stake or where it was felt that it could usefully contribute to the elucidation and development of the principle.  The Revenue expressed the view that “the principle in its [then] present form [had] little or nothing to do with the type of situation which was considered by the Court of Appeal in Hastings-Bass itself, and that it [owed] its origins to the logically flawed positive reformulation of the principle in Mettoy.”  In Futter [2010] EWHC 449, the Revenue submitted that the Rule in Hastings-Bass had been carried to “almost absurd lengths” and stressed the importance of keeping the principle within reasonable bounds.

The Revenue’s submissions were upheld in the leading judgment of the Court of Appeal [2011] EWCA Civ 197, in which Lloyd LJ concluded that, on a re-examination of Hastings-Bass, the case did not bear out or support the rule as formulated.  Lloyd LJ proceeded to identify the correct principle as follows:

  1. The purported exercise of a discretionary power on the part of trustees will be void if what is done is not within the scope of the power;
  2. If an exercise by trustees of a discretionary power is within the terms of the power, but the trustees have in some way breached their duties in respect of that exercise, then the trustees’ act is not void but it may be voidable;
  3. Although it is not possible to lay down any clear rule as to the matters which trustees ought to take into account when considering the exercise of a power of advancement or some other dispositive discretionary power, it is likely that these will involve fiscal considerations; and
  4. Where tax matters are relevant, it is likely to be duty of the trustees, under their duty of skill and care, to take proper advice as to those matters.

On the basis of his reformulation of the Rule in Hastings-Bass, Lloyd LJ concluded:

… in a case where the trustees’ act is within their powers, but is said to be vitiated by a breach of trust so as to be voidable, if the breach of trust asserted is that the trustees failed to have regard to a relevant matter, and if the reason that they did not have regard to it is that they obtained and acted on advice from apparently competent advisers, which turned out to be incorrect, then the charge of breach of trust cannot be made out.

In such instances, trustees’ actions will not be vitiated by error and will not therefore be voidable.

The test for mistake

It also falls to be determined by the Supreme Court whether the Court of Appeal [2011] EWCA Civ 197 was correct to hold that:

  1. For the equitable jurisdiction to set aside a voluntary disposition for mistake to be invoked there must be a mistake on the part of the donor at the time of the disposition as to: (a) the legal effect of the disposition; or (b) an existing fact which is basic to the transaction;
  2. The mistake must be of sufficient gravity, i.e. “of so serious a character as to render it unjust on the part of the donee to retain the property given to him“; and
  3. The fact that a transaction gives rise to unforeseen fiscal liabilities is a consequence, not an effect, for the purposes of the test, and is insufficient to invoke the jurisdiction of equity to set aside a voluntary disposition for mistake.

What can we expect from the Supreme Court?

At Court of Appeal level, Longmore LJ identified the appeals as “examples of that comparatively rare instance of the law taking a seriously wrong turn, of that wrong turn being not infrequently acted on over a twenty year period but [the Court of Appeal] being able to reverse that error and put the law back on the right course“.  Whether the Supreme Court will deem the reformulation of the Rule in Hastings-Bass as an example of the Court putting the law “back on the right course” remains to be seen, however if extra-judicial statements are anything to go by, it seems likely that the unanimous decision of the Court of Appeal will attract considerable support from at least two of their Lordships.

In ‘Aspects of the Law of Mistake: Re Hastings-Bass’ (2009) Lord Neuberger observed:

“… it would seem that, unnoticed by the equity judges and academics over the centuries, actions subsequently regretted by trustees have a quality of reversibility.  It appears that Doctor Equity can administer a magical morning after pill to trustees suffering from post-transaction remorse, but not to anyone else.”

In his speech to the Chancery Bar Association in London in January 2009, Lord Neuberger stated that there was:

“… much to be said for the view that the Hastings-Bass principle infringes the most fundamental requirements of any legal principle.  First, it is inconsistent with established law.  Secondly, the circumstances in which it applies are unclear.  Thirdly, the results of its application are unclear. In other words, the Hastings-Bass principle is unsatisfactory both in theory and in practice.”

Lord Walker too has publicly expressed judicial disquiet in respect of the current formulation and application of the principle, opining in ‘The Limits of the Principle in Re Hastings-Bass’ [2002] that:

One’s instinctive reaction (not necessarily a satisfactory substitute for legal analysis) is to ask why the Chancery division, rather than the party’s professional indemnity insurers, should have to pick up the pieces.

The unrestrained extension of the Hastings-Bass principle could lead to trustees being treated as new class of incapacitated persons, like children or feeble-minded adults.  No-one could ever be sure that they had taken proper advice […] or that they meant what they said.  Huge uncertainty would arise ...”

Potential Ramifications

If the appeal is not upheld, there will be fewer instances in which reliance can be placed on the Rule in Hastings-Bass and the fact that a transaction gives rise to unforeseen fiscal liabilities will be insufficient to invoke the jurisdiction of equity to set aside a voluntary disposition for mistake.

Going forward, unless the Court of Appeal judgment is overturned, the remedy for beneficiaries suffering the unpalatable fiscal consequences of incorrect professional advice will lie “not in the realms of equity but by way of a claim for damages for professional negligence“.  Consequently, we may experience a significant increase in the number of cases of beneficiaries suing trustees and professionals who have failed to correctly advise on the consequences of their trustee clients’ transactions.

The judgment of Lloyd LJ emphasised that another practical implication is that it will rarely be appropriate for trustees to initiate proceedings where it is desired to challenge an exercise by trustees of a discretionary power.  Instead, “it will be necessary for one or more beneficiaries to grasp the nettle of alleging and proving a breach of fiduciary duty on the part of the trustees“.