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Trustees have recourse to avoid loan pitfalls

When you look at it, you must wonder sometimes why a layperson would agree to being a trustee. The requirements of the Trustee Act 2000, and previous legislation, can be quite onerous.

The general duty of care, diversification of investments, keeping accounts, submitting self-assessment returns, consulting beneficiaries; all of these aspects are fraught with danger. And it could all result in the trustees ending up in a court dispute with an aggrieved beneficiary.

This is more likely to occur with trusts holding complex and tangible property of course; with a normal run-of-the-mill life insurance trust simply holding an investment bond, there is usually little reason for dispute or onerous trustee activities.

But there is one reason why a trustee might be a little nervous about acting and that is because in one circumstance they have to borrow money that they might not be able to repay – meeting the difference from their own pocket.

That situation arises with a gift and loan trust or loan trust. For example, the client might lend £100,000 to the trustees, who invest that money in an investment bond. Later on, when the lender decides to ask for his loan to be repaid, the stockmarket has crashed and the bond is only worth £75,000. So the trustees have a £25,000 deficit to meet personally.

The initial reaction might be “yes, but they don’t actually have to repay it all do they? The person initially lending the money is usually automatically one of the trustees and he’s not very likely to sue himself is he?”

That statement is true but let me highlight a different scenario that could be a cause for concern.

Mr Good sets up a discretionary gift and loan trust with the intention that the trust fund should be held for his daughter and her children. He has fallen out with his wastrel son and appoints himself, his daughter and her husband as trustees. Mr Good dies a few years later, having never taken any loan repayments from the trustees. The original loan was £300,000 but the investment bond bought by the trustees is now worth only £200,000.

He did make a will but has not updated it since his divorce, so it is now invalid and he is intestate. Under the rules of intestacy, his estate is divided between his son and daughter. And, in order to fully administer the estate, the administrators have asked the trustees for repayment of the outstanding loan.

The son is insistent that he will demand that the administrators obtain a full repayment of the £300,000 loan, so he can get the £150,000 he feels is due to him. Not a situation that any adviser would want to occur with an arrangement that they recommended in the first place.

So how can this situation be prevented? The answer is to make sure that the loan agreement used by the lender and trustees has a limited recourse provision.

This states that the extent of the trustees’ liability to the lender (and, therefore, his legal representatives if applicable) is limited to the value of the underlying trust assets, which will usually be the investment bond claim value.

A typical wording could be: “Notwithstanding anything to the contrary contained in this agreement, the liability of the trustees to the lender for repayment of the principal amount (including the annual repayment sum) shall be limited to the assets of the trust from time to time (other than the gifted property, as defined in the trust) which for this purpose only shall be deemed to include the value of any assets formerly held by the trustees on the terms of the trust which have been distributed to any beneficiary (as defined in the trust, but excluding from the gifted property) with such value being determined at the date the assets ceased to be so held by the trustees.”

If this provision existed in Mr Good’s trust, then his daughter and her husband could with all legal justification refuse the estate administrators demand for full repayment and also keep the wastrel son at bay.

It could be a wise move to check that a loan agreement has a limited recourse provision, if only so that you can make sure that you word your suitability report accordingly.
And when dealing with trusts, you have to remember that they can last 125 years and all sorts of things can happen during that time. So it pays to cover every eventuality in the document.

When it comes to limited recourse provisions in loan agreements, it seems to be a case of why wouldn’t you? It makes sense to have the most far-reaching wording possible.

And on another note, one major headache with loan repayments is that the withdrawal from the bond to fund the loan repayment is usually a chargeable event and can generate a chargeable gain.

This can be negated somewhat by segment surrender, if available, but even that can lead to a substantial chargeable gain and a large tax bill.

This situation can be avoided if the trust asset is one of the new return-of-premium offshore bonds, which can allow up to 99 per cent loan repayment with no chargeable gain. This is because a large withdrawal is facilitated by the surrender of segments for an amount equal to the premiums paid, with no chargeable gain arising.


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