Essay: The duties of a trustee

Definition of bond- A bond is a means of borrowing money by issuing the lender with a transferable security in return for the loan, as well as undertaking to pay interest on the loan and to repay the loan capital at the end of the loan term.
International issue of bonds originated in the year 1963 with an issue by Autostrade, the motorways operator of Italy. That time they were referred to as “Eurobonds”, but now the term is being used less, because of the markets being more internationalized and the confusion of the term with the euro. In the last 50 years since the first issue the international bond markets have grown enormously. According to one of the leading writers on Capital markets, Richard Roberts, in 1998, London’s share of the primary market was 60% and share in the secondary market was 75%. International bonds are a way of raising funds for the issuer. The issuer in return for receiving the issue price, the issuer issues the bonds to the holders and promises them to pay the sum borrowed on the maturity date, and till then it promises them to pay interests on the specified dates. The bonds are easily transferable and are held in an international clearing system, and are listed on a stock exchange.
In the issues, the issuer appoints a trustee to represent the holders. The trustee when appointed is the representative of the holders, and owes it duties to them. Its primary function is to monitor compliance by the issuer with its accountableness and to take enforcement action on behalf of the holders. It also has the prudence to agree to modifications with the issuer, waive defaults, without reference to the holders.
Bond markets are a source of debt financing for companies. The economic benefits that can flow from well- functioning corporate bond markets include-
i. Diversification of sources of funds for the corporate sector, thereby making it less vulnerable to collapses in bank lending;
ii. Increased choice and flexibility, which enhance the ability of firms to raise finance that is a good match for the timing and currency of their cash flows;
iii. Strengthening of the balance sheets of pension funds and life insurance companies by providing institutional investors with instruments that satisfy demand for fixed income assets with long maturities, higher returns than government bonds, and less risk than equity.
The role of trustee
The three key elements of the trustee’s role are-
i. Monitoring compliance by the issuer with its accountability,
ii. Prudence to agree alteration, to remit defaults and to give other permit,
iii. Taking action for enforcement wherever necessary.
A trustee is used in a bond issue to provide security to the bondholders, i.e. the trustee can act on behalf of the bondholders in the event that the issuer fails to make a payment. Before the Financial Securities and Markets Act, 2000 was enacted, a system of Yellow Book, which stood for securities regulation governing listed companies was in force in UK. The trustee has the power to intercede whenever there is any uncertainty with the payment of coupon by the issuer to the investor. The bonds are held by the trustee on the trust that the issuer will pay them on time and the investors acquire the right of beneficiaries under the trust. All the payments to the investors are made through trustees.
The procedure of bond issue involves two types of fiduciary: – fiscal agents and bond trustees. The fiscal agents act solely as an agent to the issuer and does not owe any fiduciary obligations towards the investors whereas bond trustees owe obligations towards the investors. In case of trustee the issuer will agree to provide all necessary information to the trustee, to observe pari passu and negative pledge clauses, so that the affairs are conducted in an appropriate manner and to make sure that no default under the bond agreement occurs.
The negative pledge clause is a promise by the borrower that it will not grant security to the third party. In this the borrower cannot grant the security given to the bank to the third party for its sale, rent or lease. It is a security for the bank to keep the loan intact in the case the borrower is insolvent then the banks can resort to the security and get then repayment of the loan. In some countries quasi-security devices are also used but under English law it is void. If the borrower breaches the negative pledge then as in the loan agreement the borrower is liable to pay the damages caused by the breach but the cost of litigation and time will be unattractive due to cost and time delays, so the bank can resort to obtaining an injunction to prevent the breach, it can go for specific performance and it can go for automatic security which will give back the security taken by the third party. As stated in De Mattos v. Gibson, LJ Knight Bruce said that, “Reason and justice seem to prescribe that at least as a general rule, where a man, by gift or purchase, acquires property from another, with knowledge of a previous contract, lawfully and for valuable consideration made by him with a third person, in opposition to the contract and inconsistently with it, use and employ the property in a manner not allowable to the giver or seller.”
This pledge has negative effect as the security cannot be used by the borrower to obtain funds from the third parties. The trustee has to see that these clauses are well versed and during the agreement the bond holders are being protected in case the borrower becomes insolvent.
The trustee has another crucial role i.e. to ensure the equal treatment of loans and there redemption. This equal treatment is also referred to as the pari passu principle. This is one of the duties of bond trustee towards the bondholders enhancing its role in the very purpose of the relationship between the two.
The Trust Property-
A trust is a way of managing assets for people. Trust involves-
i. The settlor- the person who puts assets into trust
ii. The trustee- the person who manages trust
iii. The beneficiary- the person who benefits from the trust
Moreover, the trustee should look after the trust property as mentioned in the agreement, but the trustee does not own the property, and owes fiduciary obligations to the beneficiaries. If there is no written deed, then general law will apply.
Investment
The duty of care applies to a trustee—
(a)when exercising the general power of investment or any other power of investment, however conferred;
(b)when carrying out a duty to which he is subject under section 4 or 5
Acquisition of land
The duty of care applies to a trustee—
(a)when exercising the power under section 8 to acquire land;
(b)when exercising any other power to acquire land, however conferred;
(c)when exercising any power in relation to land acquired under a power mentioned in sub-paragraph (a) or (b).
The trustees have a legal binding under the acts as a duty of care and investment.
Trustees – Powers of Investment-
The Trustees Investment Act 1961, have been removed in UK due to the realization that the beneficiaries or the bondholders were under risk of inflation and that they could be saved from such risk by holding equities. Another reason was to increase the equity portfolio that reduced the risk associated with holding individual shares.
According to the new Trustees Act 200, trustees have regard to standard investment criteria as contained in the act. These are-
i. The suitability to the trust of investment of the same kind as any particular investment proposed to be made or retained and of that particular investment as an investment of that kind; and
ii. The need for diversification of the trust, so far as is appropriate to the circumstances of the trust.
According to the Trustees Act 2000, the delegation powers now should be mentioned in the terms of the policy and the agent should agree to that and then section 1 of the act i.e. ‘duty of care’ should be applied accordingly.
Trust Deed-
‘A deed of conveyance creating and setting out the conditions of trust.’
It is an agreement which states the powers and duties of the trustee but also specifies the measures of his liability for the wrong done. A trustee is required to act in utmost good faith to both issuer and bondholder.
Duties of the Trustee-
A trustee should make sure of the certification document of the bond is correct. Trustee should always act in good faith and according to beneficiary’s interest. The trustee should not make profit from his position and exercising of his powers. In case of conflict in the interest of the trustee and beneficiary, the trustee should make sure that the interest of beneficiary is taken into account. Trustee should ask prior permission from the beneficiary before engaging with any third party. According to the Trustees Act 2000, trustees are required to lay emphasis on-
a) the suitability to the trust of investments of the same kind as any particular investment proposed to be made or retained and of that particular investment as an investment of that kind, and
b) the need for diversification of investments of the trust, in so far as is appropriate to the circumstances of the trust.
In this the term suitability means that the investment managers required to consider the risk with the investment. If the trustee is not making an effective decision by investing then he would be liable for the breach of trust. In the case of Target Holdings V. Redferns the trustee on the breach of trust was held liable for the wrong investment decision and for the intention of committing the fraud and the trustees had to give the compensation.
Breach of Trust-
A. Liability of Trustee-
A trustee would be liable to the beneficiaries for the loss they suffer on the account of breach of trust. In the case Target Holdings v. Redferns Lord Browne-Wilkinson identified three possible remedies-
i. Proprietary remedy in which the the trustee is required to recover the precise property which was earlier the part of the trust fund.
ii. Personal remedy for the breach of trust which requires a payment of money by the trustee which should be equal to the amount of fund the trust fund lost.
iii. To further the beneficiaries for further loss if they have incurred due to breach of trust.
B. Exclusion of Trustee’s Liability-
In Armitage v Nurse the court ordered that it will permit exclusion of liability for gross negligence but not dishonesty. As in the case the trustee acted in good faith but due to negligence the beneficiary suffered a loss. Millett L.J. said that “In my judgment clause 15 exempts the trustee from liability for loss or damage to the trust property no matter how indolent, imprudent, lacking in diligence, negligent or willful he may have been, so long as he has not acted dishonestly.”
i.
Definition of Fiduciary Relationship-
Lord Browne-Wilkinson defined fiduciary relationship as-
“The paradigm of the circumstances in which equity will find a fiduciary relationship in where one party, A, has assumed to act in relation to the property or affairs of another, B”.
In this trustee acts as a fiduciary to the bondholders as it takes care of the security against the loan advanced to the issuer for the bonds issued.
In UK structured finance transaction the role of the trustee is to protect the interests of both the issuer and the bond holders. The legal protection in the case of bond holders is not adequate as if the terms of the deed mention to exclude the trustee from its liability or due to negligence the trustee can exclude his liability for the losses occurred then the bond holders have to bear the losses.
The Law Commission proposed changes to the law according to which-
• All trustees should be given power to make payments out of the trust fund to purchase indemnity insurance to cover their liability for breach of trust.
• Professional trustees should not be able to rely on clauses which exclude their liability.
• Trustees should not be permitted to claim indemnity from the trust fund.
• The court should have the power to dis-apply duty exclusion clauses or extended power clauses to determine that the trustees have been negligent, as reliance on such clauses would be inconsistent with the overall purposes of the trust and trustees should not exempted from liability as it is unreasonable.
In case of breach of trust by the trustee there is personal liability which is mainly through dishonest assistance or by receiving the trust property by breach. In the case of Twinsectra v. Yardley Lord Hutton suggested that the test for dishonesty should be combination of two elements i.e. objectivity and subjectivity. In the case of Royal Brunei Airlines v. Tana solicitor escaped on breaching the trust as he did not consider that act would be considered as a dishonest act though he was under fiduciary duty, bu then also he passed the money to his client.