Tag: Percentage Trusts
The “even hand rule” is often found at the core of trustee obligations. This is because one of the most fundamental duties of a trustee is to treat different classes of beneficiaries equally and without preference. Often, this entails finding the balance between preserving the capital of a trust for the capital beneficiaries while maximizing income revenue for income beneficiaries. Obviously, this can be a challenge as the interests of capital and income beneficiaries can be inherently opposed to one another. While one class seeks to preserve the trust assets, the other may prefer to engage in riskier investments in order to stimulate higher revenues.
The use of a unitrust (also known as a percentage trust) can be used to mitigate this problem. A unitrust is a trust in which a fixed percentage of the total value of the trust property must be distributed by the trustee in a predetermined period. Although the percentage payment is made from revenue generated by the trust, if there is insufficient revenue to make the payment, the difference is paid from the capital. Any revenue that is generated in excess of the percentage is added to the capital.
In this way, the trustee’s duty is no longer limited to preserving capital while maximizing revenue. The duty under a unitrust is to increase the value of the entire trust for the benefit of both classes of beneficiaries. This is accomplished by providing the trustee with much wider discretion as to making trust investments with the idea being that it will increase the overall value of the trust. It also allows the trustee to distribute funds without being overly concerned about whether the funds are stemming from income or capital. In removing this distinction, and the even hand rule concerns that come with it, the trustee is left free to optimize the value of the trust as a whole.
The concept of the unitrust is not a new one by any means. It was endorsed as far back as 1984 by Ontario’s Law Reform Commission in its Report on the Law of Trusts. Although they are not widely used, these arrangements can be seen in trusts of significant value where the settlor seeks an arrangement in which the trustee’s investments are not hindered by balancing class interests.
The unitrust is not without its own set of challenges. In times of economic downturn or when risky investments fail to yield anticipated results, the trust may not generate sufficient revenue to cover the fixed percentage payable to the income beneficiaries. Under these circumstances, there may be no choice other than to liquidate capital assets in order to meet the requirement. As a result, there is a risk of depleting the value of the trust up to its full amount prior to the right of the capital beneficiaries ever materializing.
Potential solutions to this dilemma have included drafting techniques which account for periodic downturns. For example, in “The Percentage Trust- Uniting the Objectives of the Life Tenant and Remainderperson in Total Return Investing by Trustees”, Anne Werker suggests including a “force majeure” clause. These types of mechanisms provide the trustee with an established process in which he or she can periodically review and revise the percentage payable. Implementing these techniques can be critical in ensuring that unintended consequences do not arise.
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