We act as professional trustee of a client’s trust. What are the issues the trustees should consider when we are asked to provide a guarantee?
When we act as independent trustee of our client trusts and/or when we are acting as solicitor for a trust we often have to deal with guarantees which the trustees have been asked to provide in respect of obligations of beneficiaries, companies in which the trust holds shares, or companies in which beneficiaries of the trust hold shares.
There are many issues that need to be considered when deciding whether the trustees should provide the guarantee that they have been requested to provide.
Do the trustees have power to provide the guarantee?
The first issue to be considered by the trustees is whether the trust deed gives the trustees power to provide guarantees and, if so, whether there are any restrictions placed on that power in the trust deed. If there is no power to provide guarantees in the trust deed then the trustees cannot provide a guarantee.
The power may be contained in a clause which refers specifically to guarantees or may be contained in a more general clause which gives the trustees “the powers of a natural person”.
Is it appropriate to provide the guarantee?
If the trust deed permits the trustees to provide a guarantee the next issue that the trustees need to consider is whether it is appropriate for them to exercise that power and provide the guarantee that they have been requested to provide.
The overarching consideration in deciding whether a guarantee should be provided, assuming the trust deed gives the trustees power to provide guarantees, is whether it is in the interests of one or more of the beneficiaries of the trust for the trustees to provide the guarantee in question. If it is not in the interests of the beneficiaries of the trust to provide the guarantee because for example there is no benefit to any one or more of the beneficiaries in providing the guarantee then the trustees should not provide the guarantee.
If a trustee is being asked to guarantee borrowing by a settlor and/or beneficiary that is to be used to make an interest free advance to the trust to enable it to acquire assets that will provide a benefit to the trust and its beneficiaries then the trustees do have power to provide the guarantee.
If the trust is being asked to provide a guarantee of obligations of a company in which it holds shares and the trustees are confident that the company has cashflow which will enable it to meet its obligations under the commitments it has entered into and that its assets exceed its liabilities then, once again, the trustees would have power to provide the guarantee requested.
Even if the trust is not a shareholder in the company, it may be appropriate for the trustees to guarantee the obligations of the company if the company has as its shareholders beneficiaries of the trust, the beneficiaries would benefit from the provision of the guarantee and, the other considerations outlined in the preceding paragraph have been met.
It would not be appropriate for trustees of a trust to guarantee the obligations of a non-beneficiary when there is no corresponding benefit to any of the beneficiaries of the trust.
Does a trustee personally benefit from the guarantee?
If the trustees are satisfied that they have power to provide a guarantee and, that providing it is of benefit to one or more of the beneficiaries of the trust they must also consider whether one or more of the trustees will benefit personally from the provision of the guarantee. If there is a possible conflict between the trustee’s personal interests and the trustee’s fiduciary duty to the beneficiaries of the trust the guarantee should not be provided unless the benefit to the trustee and the conflict of interest is authorised by the trust deed. If a settlor has appointed a trustee who is also a beneficiary of the trust the ability to benefit and the conflict of interest may be impliedly authorised but it is always more comfortable for a trustee if the ability to benefit and to act despite a conflict is expressly authorised by the trust deed.
How to mitigate risk when providing guarantees
If, after considering all of the above issues the trustees decide it is appropriate to proceed with providing the guarantee there are other matters that need to be considered to avoid exposing the trust and the trustee to unnecessary risk and to ensure that the trustees are meeting their obligations to the beneficiaries of the trust.
An independent trustee needs to make sure that their liability under the guarantee is limited to the assets of the trust available to that trustee at the time that the guarantee is called upon (rather than at the time that the guarantee is entered into) to minimise the risk to the trustee personally if the guarantee is called upon.
Commonly banks will send out instructions to solicitors for unlimited guarantees to be provided by the trustees of a trust of obligations of a beneficiary or other party. Assuming it is appropriate for the trustees to provide the guarantee, it is important that the trustees negotiate with the bank to have the guarantee limited to the amount being advanced or, in the case of a revolving credit facility, the amount of the facility that is being provided. An unlimited guarantee exposes the trust fund to the risk of the guarantee being relied on for further borrowing by the person or entity whose obligations are being guaranteed by the trust without the trustees being aware that additional contingent liabilities are being incurred.
The trustees need to be satisfied that the purpose of the borrowing is appropriate, that the debtor can meet all payments as they fall due and that there is a benefit to one or more of the beneficiaries of the trust in the trust guaranteeing the additional obligations.
While banks and other parties seeking guarantees from trustees will almost always prefer an unlimited guarantee because it is more convenient for them and enables them to easily provide additional advances to the borrower, a trustee has an obligation to manage the contingent liabilities entered into by the trust and to manage the risk to the trust of entering into those contingent liabilities.
It is worth noting that the trustees’ certificate that Westpac New Zealand Limited requires trustees to provide to the bank when a trust enters into obligations to the bank requires that the trustees certify (among other things) that:
- “the entry into and performance of the Documents and the Transactions is in the best interest of, and for the benefit of, the Trust or of any beneficiary under the Trust”; and
- “the Documents do not contravene the provisions of the trust deed dated ........ constituting the Trust.”
For the trustees to be in a position to certify as to the matters outlined above, they need to be satisfied that provision of the guarantee is for the benefit of the trust or any beneficiary of the trust and that the risk of entering into the contingent liability represented by the guarantee is outweighed by the benefit being obtained by the trust or any of the beneficiaries of the trust. For that to be the case, the guarantee being provided should be limited to the amount being advanced or the amount of the facility being provided. The trustees must also be satisfied that they are meeting the other pre-conditions to providing the guarantee outlined above.