Correcting trust mistakes

He does not need access to the funds but would like to have some control over their future use. The sum in question is £500,000. He is quite keen on settling the funds into a discretionary trust for the benefit of his children and grandchildren. However, his adviser points out that gifts to discretionary trusts are "chargeable lifetime transfers" (CLTs) for IHT so, if he were to gift the entire sum to a discretionary trust, anything in excess of the nil rate band for IHT (£325,000) would be subject to an immediate tax charge at 20%. Having reconsidered, he decides that he would be happy to settle the sum of £175,000 on an absolute trust for his three grandchildren, currently all under the age of 5. A gift to an absolute trust is not a CLT but a PET (potentially exempt transfer). The agreed investment for these funds is an investment bond and to speed the matters up, it is agreed that the trusts will be set up using a “trust request” route (possible as the investment bonds are technically whole of life insurance policies) and that additional trustees would be appointed subsequently by separate deeds.

The draft trust requests provided by the insurance company are pre-populated by the adviser’s admin assistant and sent electronically to Mr Z. The process is made easier using an e-signing platform, Mr Z duly adds his signature on the last pages and sends the documents back. The bonds are issued to him as trustee. It is only a few weeks later, when Mr Z is about to appoint additional trustees to his trusts that he and his adviser realise that both the executed trust documents are identical, both are discretionary trusts. The resultant CLT rather than the intended PET means an immediate IHT charge of £35,000. What can be done now to sort this out? Clearly this is not what was intended.

It’s been a few years since we looked at this topic and, especially given that we have recently had a few interesting court decisions concerning trust mistakes, it seems a perfect time to look at this topic again.

First the fundamentals...

Remedies to correct trust/trustee errors

It is a well-known fact that once a trust deed has been executed it cannot simply be amended/changed later on. Certainly, changes will not be allowed simply because the settlor changes their mind. However, where it is clear that a mistake has been made and there is evidence to support this, there are two possible remedies: a remedy of rectification; and a remedy of rescission (setting aside). Both need an application to the Court and, being “equitable remedies”, are at the Court's discretion, which depends to a large extent on the conduct of the applicant.

A trust deed can be rectified by order of the Court if it can be demonstrated, by reference to evidence, that the trust deed fails to express the true intention of the settlor, for example, if there is a clear mistake in its drafting. An order for rectification will be retrospective in effect.

Rescission (again, by a Court order) means that the trust is set aside and treated as if it had never been made, i.e. the assets would revert to the settlor and they could start again. 

Clearly, whichever method may be appropriate will depend on the circumstances of the case.

If the case affects a tax liability, where a taxpayer is considering seeking a trust law remedy in a Court of equity, they will normally contact HMRC before issuing Court proceedings so that HMRC may join in the case if it so wishes.

Typical possible scenarios where rectification or rescission may be sought are: 1) A deed may contain an error or omission that means it doesn’t properly reflect the parties’ intentions; and 2) Individuals or trustees may claim that they have made a voluntary disposition under a mistake or acted in error, with the result that they incur more tax than anticipated.

The legal principles

The principles on when a trust transaction may be set aside on the grounds of mistake were set out in the Supreme Court case of Pitt v Holt [2013] UKSC 26. Briefly, these are as follows:

•  There must be an actual mistake (not mere ignorance or inadvertence);
• The mistake must be either as to the legal character or nature of a transaction, or as to some matter of fact or law which is essential to the transaction; and
• In relation to a voluntary disposition, the mistake must be sufficiently serious as to render it unjust on the part of the donee to retain the property given to them.

The Court also clarified in its judgment that “it does not matter if the mistake in question is due to carelessness by the person making the voluntary disposition, unless the circumstances are such as to show that he deliberately ran the risk, or must be taken to have run the risk, of being wrong”. Finally, and importantly, the judge in this case dismissed arguments, made by HMRC, that a mistake that relates exclusively to tax cannot be relieved in any circumstances.

So, given the above guidelines, there is considerable scope of being able to rectify a mistake in a trust transaction, provided of course that the stated conditions can be met.

You could say that the aforementioned Mr Z was rather careless when he executed his trust documents without apparently checking the entire documents before signing. And equally, given that the idea behind the two trusts was to avoid an IHT liability on a CLT, clearly, had he been aware what he was signing, he would not have executed the second discretionary trust. So, what next for Mr Z?

Recent case law

There are three recent cases where trust transactions were set aside on the grounds of mistake which are of interest.

In Payne and another v Tyler and another [2019] EWHC 2347 (Ch) the Court agreed to set aside a deed of appointment creating a life interest out of a discretionary trust on the ground of mistake. The trustees were incorrectly advised, by a tax specialist, that the appointment would not affect the IHT treatment of the trust, whereas the opposite was the case.

In Hartogs v Sequent (Schweiz) AG and others [2019] EWHC 1915 (Ch), the settlor acting on professional advice set up two offshore trusts believing he was non-UK domiciled (and so under the impression he was creating excluded property trusts) whereas, in fact, he had become deemed domiciled for IHT purposes prior to creating the trusts, something which his advisers had failed to identify. The Court accepted that Mr Hartogs acted under “a false belief or assumption” and that this was sufficient to constitute a “mistake”. The tax arising on the transfers into trusts approached £3m and, clearly, Mr Hartogs would not have made the transfers had he known of the potential tax charges. The Court agreed to set aside the transfers, although it also emphasised that the Pitt v Holt principles “should not be viewed as an available ‘get-out-of-jail-free’ card, which may be invoked wherever a taxpayer finds himself facing a charge to tax which has not been anticipated”, and that relief will only be given where the strict conditions set out in Pitt v Holt are met.

In a 2021 case, Ware v Ware [2021] EWHC 694 (Ch), the Court agreed to rectify flawed trust deeds of appointment which resulted in unexpected tax charges. While the intention was to add some new potential beneficiaries under two pre-2006 interest in possession trusts, the deeds instead terminated the existing interest of the life tenant and created a new one in his favour as well as adding the new potential beneficiaries. This was done on the advice of a solicitor who also drafted the deeds. Not only did this result in a chargeable transfer from the life tenant, it was also a gift with reservation of benefit and brought the trust property into the relevant property regime for IHT purposes. The judge ordered rectification on the basis that the mistake was not merely as to the fiscal consequences but because the deeds had unintended legal effect. (There is also a reminder here to be extremely careful when dealing with pre-2006 interest in possession trusts!)

What is interesting from this last case for our Mr Z are the judge’s references to another “mistake case” namely Allnutt v Wilding [2007] EWCA Civ 412. The judge in that case said:

"… rectification is about putting the record straight. In the case of a voluntary settlement, rectification involves bringing the trust document into line with the true intentions of the settlor as held by him at the date when he executed the document. This can be done by the court when, owing to a mistake in the drafting of the document, it fails to record the settlor's true intentions. The mistake may, for example, consist of leaving out words that were intended to be put into the document, or putting in words that were not intended to be in the document; or through a misunderstanding by those involved about the meanings of the words or expressions that were used in the document. Mistakes of this kind have the effect that the document, as executed, is not a true record of the settlor's intentions."

The Court also clarified the principles to be applied when considering rectification.

"First, the claimant's case should be established by clear evidence of the true intention to which effect has not been given in the instrument. Such proof is on the civil standard of balance of probability. But as the alleged true intention of necessity contradicts the written instrument which is ordinarily regarded as the only manifestation of the party's intent, there must be convincing proof to counteract the evidence of a different intention represented by the document itself".

For our Mr Z this should not present a problem as the adviser will presumably have a written record of the recommendations and the client’s instructions.

Next, "there must be a flaw in the written document such that it does not give effect to the parties'/donor's agreement/intention, as opposed to the parties/donor merely being mistaken as to the consequences of what they have agreed/intended. For example, it is not sufficient merely that the document fails to achieve the desired fiscal objective."

Again, the second discretionary trust clearly does not give effect to Mr Z's intentions.

Thirdly, "the specific intention of the parties/donor must be shown; it is not sufficient to show that the parties did not intend what was recorded; they also have to show what they did intend, with some degree of precision".

Here, again, written evidence of what Mr Z intended should suffice.

Finally, "there must be an issue capable of being contested between the parties notwithstanding that all relevant parties consent to the rectification of the document". To show this it would be advisable to instruct counsel to present the case in the Court, as happened in the Ware case (the claimant (the beneficiary) was the son of the defendant trustee who did not contest the application).

Interestingly, in the Allnutt case, a settlor intended to make a PET by making a settlement for the benefit of his adult children, but the trusts of the settlement were discretionary trusts, and, as such, his transfer into the settlement was a CLT. The trustees sought to rectify its provisions so that it would be an interest in possession settlement (the original trust was made before 22 March 2006). Such rectification was refused because there was no evidence as to the type of trusts which the settlor intended, only evidence that he intended a PET, and a "mistake about the potential fiscal effects of a payment following the execution of the settlement does not … satisfy the necessary conditions for grant of rectification".

In the case of Mr Z there was a clear intention and evidence that the second trust he intended to set up was to be an absolute trust, so this should help obtain a right decision.

Comment

Clearly, each case will depend not only on its own facts but also on the evidence supporting those facts. But even if there is plenty of evidence that there was a mistake, the point is that an application to the Court may be needed and this involves considerable costs (especially if Counsel is instructed), and, of course, the outcome of any Court action is never guaranteed. The moral of the story is, of course, never sign anything without checking that you are signing the right document. And while online execution of documents allows for transactions to be completed more easily and faster, when it comes to trust deeds, a little extra care should be recommended so there will be no need to correct anything.