Saturday, July 19, 2014

Trustees' Duty to Diversify Investments

The British Columbia Court of Appeal removed a trustee for lending all of the trust funds in one trust to a related trust, finding that the investment was an improvident one. In reaching its decision in Miles v.Vince, 2014 BCCA 289, the Court of Appeal found that it is implicit in a trustee’s duty to exercise the care, skill, diligence and judgement of a prudent investor that the trustee diversify investments held in a trust.

William Vince settled two trusts, one of which he named the William Vince Family Trust, and the other, the Vince Insurance Trust. He settled the family trust in 2006 while he was healthy, and he transferred the shares of three companies, each of which owned real estate on Main Street in Vancouver. He settled the insurance trust after he was diagnosed with cancer, and that trust received the proceeds of his life insurance policy of over $2 million following his death in June 2008.

The terms of the family trust gave the trustee the discretion to make income and capital payments to Mr. Vince’s three children. The terms of the insurance trusts also gave the trustee discretion to make income and capital payments, but both his widow, Cynthia Miles, and his three children were the beneficiaries of the insurance trust. Both trusts provided that on a division date, 80 years after the creation of the trust or such earlier date as the trustee decides, the capital would be divided among the three children.

Mr. Vince’s sister, Marilynn Vince, became the trustee of both trusts.

 Ms. Vince as trustee of the family trust endeavoured to carry out her brother’s vision to develop the Main Street properties. She commissioned a report to determine the best way to maximize the best use of the properties, incorporated a non-profit housing society, and arranged financing from B.C. Housing of $5,550,000 to purchase another property and develop the Main Street properties.

She also lent funds from the insurance trust to the family trust to help finance the development. The initial loan was for $1,170,000, but there were further loans, and with accrued interest, the amount owing from the family trust to the insurance trust was $2,135,485 as at December 31, 2012.

The main security for the loan from the insurance trust consisted of second mortgages in the Main Street properties. But under the terms of the mortgages, the insurance trust could only enforce them if B.C. Housing, which held first mortgages consented, or if B.C. Housing commenced foreclosure. Furthermore, the Provincial Rental Housing Authority had an option to purchase the properties, and if it exercised the option, the Insurance Trust would have to deliver a discharge of its mortgage without requiring payment.

From 2008 to 2012, the trustee made payments to Ms. Miles and paid expenses for her and the children from the Insurance Trust, but then stopped.

Ms. Miles applied to the Supreme Court of British Columbia to remove Ms. Vince as trustee of the insurance trust, but her application was dismissed.

She appealed to the Court of Appeal.

Madam Justice Levine for the Court of Appeal wrote the reasons for judgment removing Ms. Vince. In doing so, she considered the different purposes of the two trusts. When he settled the family trust, Mr. Vince intended to create social housing and develop the Main Street properties. But he settled the insurance trust at a time when he was ill with cancer, and he intended the insurance trust to provide for his widow and children following his death.

She held that by putting all of insurance trust assets into an illiquid real estate development, she endangered the insurance trust assets, and Ms. Vince did not meet the standard of a prudent investor.

Although the Trustee Act does not expressly require a trustee to diversify the trust assets, Madam Justice Levine adopted Professor Donovan Waters’ analysis of the prudent investor standard set out in the Trustee Act in Waters’ Law of Trusts in Canada, 4th ed., as follows:

[61]         Professor Waters notes (at 1008) that in 1997 the Uniform Law Conference of Canada promulgated the Uniform Trustee Investment Act, 1997, which imposed an obligation for trustees to diversify investments and provided a list of factors which a trustee may consider in making investment decisions.
 [62]         He describes the “prudent investor” standard as used in the B.C. Trustee Act, (at 1018):

The reference to the “prudent investor” is intended to bring into the picture the requirements of modern portfolio theory, which teaches that one must first decide what is the level of appropriate level of risk, and then seek to maximize the return within that constraint.
 [63]         He points out that diversification is implicit in the prudent investor standard, based on modern portfolio theory (at 1019-1020):

It is true that in some jurisdictions, particularly those retaining the prudent man standard, there is room for argument as to whether the trustee has the duty to diversify. The new prudent investor standard, based on modern portfolio theory, leaves less room for argument; diversity is inherent in modern portfolio theory. Even so, the circumstances of a trust might be inconsistent with diversification. For example, if a trustee expected to hold property only for a few weeks, it might not be prudent to expose the assets to the volatility which inheres in equity investments.
 [64]         Unlike other jurisdictions in Canada, B.C.’s Trustee Act does not expressly impose a duty on trustees to diversify investments in accordance with modern portfolio theory (see The Trustee Act, 2009. S.S. 2009, c. T-23.01 s. 26; Trustee Act, R.S.O. 1990, c. T. 23 s. 27(6); Trustee Act, R.S.N.S. 1989, c. 479 s. 3B; Trustee Act, R.S.P.E.I. 1988, c. T-8 s. 3.1).
[65]         As Professor Waters suggests, however, the “prudent investor” standard implicitly brings modern portfolio theory into play, and thus requires the trustee to assess the level of appropriate risk and whether diversification is required.

Madam Justice Levine also found that in making the loan, Ms. Vince put herself as in a conflict of interest as trustee for both trusts. The loan was now in default, but if Ms. Vince as trustee of the insurance trust demanded payment of the loan, it would put the development in jeopardy.

Furthermore, Ms. Vince as trustee had a duty to maintain an even hand between income and capital beneficiaries. The real estate development had potential for significant profit for the capital beneficiaries, but was not generating income for the income beneficiaries.

The Court has both an inherit jurisdiction and power under section 31 of the Trustee Act to remove and replace a trustee. Madam Justice Levine considered previous decisions in which the courts have exercised their discretion to do so if the trustee has failed to protect the beneficiaries’ interests or jeopardized the trust assets.

Madam Justice Levine summarized her reasons for removing Ms. Vince as follows:

[87]         In this case, the respondent, in her capacity as the trustee of the Insurance Trust, failed to protect the interests of all of the beneficiaries of that trust. By investing all of the trust property in the Loan, she put the trust property at risk, put herself in a conflict of interest, and failed to act with an even hand among the beneficiaries. Her continuation as trustee jeopardizes the proper and efficient administration of the trust. 

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