What to do when a trustee loses capacity

Discretionary family trusts are a popular form of asset protection in New Zealand. Based on Ministry of Justice data, there are somewhere between 300,000 and 500,000 family trusts in the country. Over time, many of these trusts have had to address what to do when a trustee loses, or appears to lose, the capacity to perform his or her functions as a trustee. The issue is amplified by New Zealand’s ageing population and corresponding increase in related diseases such as dementia.

Determining a loss of capacity itself is a difficult issue. Capacity may diminish over time and the legal tests for assessing capacity vary slightly depending on the legal function being performed. For example, an individual may have the capacity to appoint an attorney to manage his or her personal care and welfare, but may not have the testamentary capacity to change their will.

The new Trusts Act (which came into force at the start of this year) has introduced mechanisms for dealing with trustees who lose capacity. Prior to its enactment, a trustee who lost capacity could only be removed if there was a power of removal in the trust deed. Otherwise, a court order was necessary.

But the real problem arose if the trustees of the trust held real property assets (generally New Zealand family trusts would at least hold the record of title for the family home). Even if the trust deed did contain a power of removal, it would still be necessary to apply to the High Court for a vesting order to comply with the requirements of the Land Transfer Act. Such a process was costly and time-consuming. A frustrating example of where two pieces of law do not work together well.

Even under urgency, a court order could take 6 to 8 weeks to process and could cost between $8,000 and $12,000. Due to delays, trustees (through no fault of their own) could find themselves facing difficulties, particularly if a property had been earmarked for sale and penalty interest was accruing.

Under the new Trusts Act, a trustee who loses capacity can easily be removed, even when the trust deed does not contain a power of removal. Removal can be effected by the remaining trustees or the person holding power of attorney for the incapacitated trustee. Importantly, the document removing the trustee serves as the vesting order under the relevant sections of the Trusts Act. “Vesting by statute” removes the need for a court order to comply with the Land Transfer Act.

Trusts have been used quite uniquely in New Zealand to protect private wealth over the last 30 or so years.

In other countries, trusts are typically utilised by the very wealthy, or for the benefit of the vulnerable. In those countries, it is generally considered undesirable for family members to be the trustees or to have effective control over the trust. Instead, independent, professional and licensed trustees undertake the governance of those trusts.

Many of the perceived benefits for having a trust in New Zealand (availability of rest home subsidies, protection of assets in the event of relationship breakdowns, tax advantages) no longer exist. A lack of independent governance and proper administration may result in many New Zealand trusts being unable to withstand scrutiny should a court be required to examine their operation. Courts have displayed a willingness to invalidate trusts on the basis they were illusory or effectively an alter ego of the settlor.

The new Trusts Act is designed to bring greater administrative rigour to discretionary family trusts in New Zealand. The associated compliance costs may have many trustees pondering the value of continuing with their trusts.

Andrew Penn is a principal at Treadwell Gordon, and specialises in trusts, commercial and financial markets law