Wednesday, January 17, 2007

The Rule Against Accumulations and the Law of Unintended Consequences

Imagine setting aside some money. Then investing it. The income is paid to a couple of relatives. Forever.

You are not supposed to be able to do that under British Columbia law. But, that is what I think happened as a result of some quirks in some relatively obscure laws in a recent decision: The Canada Trust Company v. Shaver, 2007 BCSC 54.

Benjamin John Mott signed his last Will and Testament on March 16, 2004. In his Will he appointed Canada Trust as a trustee to hold funds from his estate in a trust. He directed Canada Trust to payout 60% of the income from the trust funds to three friends and to the “Salvation Army Kelowna Community Church.” Mr. Mott provided that when each of the three fiends died, Canada Trust would to add the friend’s share of the income to the Salvation Army’s share. Eventually, the Salvation Army would receive 60% of the income. He directed Canada Trust to retain the other 40% of the income in the trust. (Actually, Mr. Mott directed Canada Trust to retain at least 40%, and more if the inflation rate is higher.) Mr. Mott did not provide for any distribution of the capital of the trust.

After Mr. Mott died, Canada Trust made an application to the Supreme Court of British Columbia to decide several issues.

The court had to consider whether Mr. Mott could create a trust in which the trustee would hold the capital in trust forever.

The usual rule under British Columbia is that you cannot use a trust to keep property out of circulation indefinitely. This is called the rule against inalienability. I won’t get into all of the technicalities of British Columbia’s rules against inalienability or perpetuities, but British Columbia’s Perpetuity Act, RSBC 1996, c. 358, modifies and relaxes in some respects the traditional rule that you cannot keep property in a trust for longer than the lifetime of a person alive (or conceived) at the beginning of the trust plus twenty-one years.

But there is an exception for charitable gifts. The rule against inalienability does not apply to a gift that is charitable. In this case Madam Justice Homes held that the gift of income in perpetuity to the Salvation Army was charitable, even though part of the income was given to Mr. Mott’s three friends during their lifetimes. Because the trust was charitable, the rule against alienability did not make the trust invalid. In short, Mr. Mott could direct that Canada Trust invest funds from his estate in the trust forever, because income from the trust would be used to benefit a charity.

The court also had to consider whether the provision requiring Canada Trust to accumulate 40% of the income was valid. Under s. 25(1) of the Perpetuity Act, you can provide for the accumulation of income in a trust if the accumulated income is or may be disposed of within the perpetuity period (a life in being plus 21 years, or the alternate period of 80 years.) In other words, you can allow the income of a trust to be added to the capital of the trust for a while, but not forever.

The rule against accumulations beyond the allowable period applies to charitable gifts as well as to gifts that are not charitable. In this case Mr. Mott’s direction to accumulate 40% of the income forever was invalid.

The next question is what happens to the 40% if the direction to accumulate is invalid?

Madam Justice Holmes held that the trustees could allow some income to be added to the capital to the extent that doing so preserved the value of the capital against inflation.

But, after allowing for some income to be used to preserve the value of the capital, the court ordered that the rest of the 40% of the income be paid to Mr. Mott’s intestate heirs, or in other words, to the people who would inherit if Mr. Mott died without a Will.

In arriving at her decision that the 40% of the income will go to the intestate heirs, Madam Justice Holmes rejected Canada Trust’s proposed charitable scheme for the 40% of the income. This is called a cy-pres (as near as possible) scheme, which gives the court the ability to apply gifts to charity if there is an invalid direction to accumulate, and the court finds that the testator of the Will or settlor of the trust had a general charitable intent. In this case Madam Justice Holmes found that Mr. Mott wanted to specifically benefit the Salvation Army, and he did not have a general charitable intent allowing the court to apply the income cy-pres.

What are the implications? If I have understood the result correctly, Mr. Mott’s next of kin, who include two sons of a cousin of Mr. Mott, are entitled to receive 40% of the income (subject to an adjustment to preserve the capital of the trust) forever. After they are gone, their estates will be entitled to the income for thousands of years. I hope they have a very good estate plan.

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