Trust and Probate Litigation associate Judith-Swinhoe-Standen examines what capacity means in a trust context, the problems that can arise when it is lost and the steps that can reduce the risk of disruption.

A loss of capacity by a trustee or protector can create uncertainty for the trust structure. It can force the administration of the trust to be put on hold or even temporarily lead to a complete halt in decision-making for the trust.

However, with the right foresight, settlors and trustees can put measures into place to address capacity issues before they arise.

What is a trustee?

A trustee is in charge of managing a trust. This involves managing the trust assets by choosing appropriate investments, making distributions to the beneficiaries of the trust and keeping on top of the administrative aspects of running a trust, such as producing annual trust accounts.

Being a trustee comes with various fiduciary responsibility, such as the duty to act honestly and prudently, the duty to exercise discretion in decision-making for the trust and the duty to act in the best interests of the beneficiaries as a whole.

A trustee can be a corporate entity or an individual.

What is a protector?

A protector is not a trustee but is an independent person appointed to oversee trustee decisions. Like trustees, a protector can be a corporate entity, but it is much more common for them to be an individual known to and trusted by the settlor.

What is mental capacity?

Mental capacity is specific to the decision in question and the time at which the decision is made. In broad terms, a person who lacks mental capacity is unable to understand and weigh up factors relevant to that decision to reach a conclusion.

A person is assumed to have mental capacity unless they are shown to lack it. Capacity can also fluctuate, so there may be times when a person has the requisite capacity to make a decision but lacks it at other times.

The legal test applied when determining whether somebody has capacity depends on what the decision is. Generally speaking, the more complicated the decision, the higher the level of capacity required to make it.

What could go wrong when a trustee or protector loses capacity?

Capacity issues can vary depending on the person’s role in the trust. From the outset, questions might emerge about the settlor’s ability to validly settle assets onto trust, meaning the validity of any distributions subsequently made from the trust are cast into doubt.

If the trust has been validly created, issues can still arise later if the trustee or protector loses capacity during the lifetime of the trust. They may be unable to approve certain transactions or make trust administration decisions, meaning aspects of the trust administration cannot progress.

As well as legal and practical issues, tensions can rise if beneficiaries disagree about whether the settlor, trustee or protector has capacity.

How is mental capacity assessed in a trust context?

Capacity is assessed according to the decision at hand. Broadly, the more complex or high-value the decision, the higher the level of capacity required. Capacity is also time-specific, so fluctuating capacity adds a further layer of uncertainty as to whether the powerholder has the capacity to make a particular decision at a given time.

The tests for and definitions of capacity vary across different jurisdictions. In England and Wales, the relevant test is in the Mental Capacity Act 2005 (“MCA 2005”): a powerholder will lack capacity if, at the material time, they are unable to make the decision in question because of a permanent or temporary impairment of, or a disturbance in the functioning of, the mind or brain (section 2 of the MCA 2005).

More specifically, a powerholder will be unable to make decisions if they cannot understand, retain, use and weigh the information relevant to that decision or cannot communicate their decision (section 3 of the MCA 2005). The degree of understanding required will vary and depend on the nature of the power and the complexity of the decision.

Different jurisdictions have slightly different tests. For example, in the Cayman Islands, Re O Trust [2018] confirmed that the Banks v Goodfellow test applies when assessing capacity to exercise trust powers, whereas in England and Wales that test applies when assessing capacity to make a will.

The applicable test usually depends on the trust’s governing law rather than the powerholder’s domicile or nationality.

How to resolve capacity issues affecting trustees or protectors

If a trustee has already lost capacity, it is best for them to step down. Assuming they lack capacity under sections 2 and 3 MCA 2005 to make the decision to do so, a remaining capacitous trustee can arrange their replacement under section 36(1) of the Trustee Act 1925.

It is more difficult if a sole trustee has lost capacity. In this situation, one option is for the trustee’s attorneys under a lasting power of attorney (if they have created one) to take over the trustee’s duties. However, the attorneys are unlikely to be equipped for this, so their best course of action would be to arrange for the incapacitated trustee to retire and appoint a suitable replacement.

Where it is “expedient to appoint a new trustee or new trustees, and it is found inexpedient, difficult or impracticable so to do without the assistance of the court” (section 41 of the Trustee Act 1925), the parties can rely on the court’s inherent jurisdiction to add or replace a trustee.

There is less statutory guidance where the protector’s capacity is in issue. Unless the trust instrument provides a solution, the court will likely need to be involved in removing or suspending the protector’s powers and/or approving their replacement. Meanwhile, any decisions for the trust that require the protector’s approval will be unable to proceed.

Mitigating risks before they arise

Sometimes capacity issues are unavoidable, for example, where capacity loss is sudden or unexpected. However, measures can usually be implemented to prevent these issues before they arise.

At the outset, if the settlor wishes to appoint individuals as their trustees, they can select at least two and specify the mechanics for their retirement and replacement. Alternatively, the settlor could appoint a trust company rather than individual trustees; a trust company will never lose capacity or die.

The settlor will also want to choose their protector carefully if they wish to appoint one. It is not uncommon for a protector to be a long-standing, trusted friend of the settlor. However, if there is no specific plan for the protector’s replacement, this increases the risk of age-related capacity issues as time goes on. To combat this, the settlor (and/or the trustees) may need to have a difficult conversation with the protector to encourage them to step down if and when necessary.

Alternatively, the settlor could consider including an ‘ageing-out’ clause for the protector in the trust instrument, similar to those in partnership agreements in place at many professional firms. This would help alleviate age-related uncertainties about the protector’s continuing capacity to carry out their duties, although having a ‘hard stop’ at a certain age may bring its own issues.

Key points for managing capacity issues in trusts

Ultimately, it is impossible to plan for every eventuality. It is all very well putting plans in place to mitigate health-related capacity risks, but this could all be scuppered if an unexpected event suddenly throws a powerholder’s capacity into question.

Nonetheless, there is nothing to lose by the settlor and their advisers considering foreseeable risks and putting appropriate backup plans in place. This planning might feel arduous or bureaucratic at the time, but it will benefit future beneficiaries, as the trust from which they benefit will be able to continue to run smoothly, irrespective of capacity issues affecting those in charge.

If you are concerned about capacity issues affecting a trustee or protector, our Trust and Probate Litigation team can advise on the options available.