Mind the gap!

Executive summary

Trustees routinely instruct professional advisers such as lawyers, accountants and financial consultants in connection with legal, tax, accounting and financial issues arising from the administration of the trust and exercise of their powers. Those engagements are typically entered into on the adviser’s standard terms, sometimes with little or no negotiation. However, in a trust context, that approach presents a substantial risk where standard terms significantly restrict recovery in the event that advice proves to be negligent and loss is suffered.

Where standard terms fall short

In a contract for professional advice, the contract will typically set out:

• the scope of work to be performed;
• the fees payable for that work; and
• the allocation of risk as between the contracting parties.

Outside of a trust context, that model usually works satisfactorily because the contracting parties are generally those that bear the economic consequences of the arrangement.

However, where a trust is involved, such contracts require closer attention. This is because trustees act in a fiduciary capacity and contract with the professional adviser on behalf of the beneficiaries of the trust or some of them. When a trustee instructs an adviser, they must therefore be alive to the possibility that the consequence of defective advice may be suffered by the beneficiaries as well as or instead of the trustee and potentially in far greater proportion. Therein lies a potential problem for trustees which some may be unaware of.

If standard terms are adopted without adjustment, particular provisions commonly found in them may create serious difficulties if things go wrong. Some of these problematic provisions include:

• Narrow scope definitions: the scope of work is framed too tightly which may not reflect the broader purpose for which the advice is in fact being used.
• Exclusion of liability to third parties: provisions excluding liability to third parties may intentionally or inadvertently exclude all liability to beneficiaries.
• Caps on liability: limits which are sometimes set by reference to fees or a fixed monetary amount may bear little relationship to the significance of the work being undertaken or the potential loss that might be suffered if something goes wrong.
• Shortened contractual limitation periods: time bars which materially reduce the period within which claims may be brought.

These provisions are not unusual but, in a trust context if they are not thought about and addressed appropriately, they may give rise to a real and substantial risk that losses suffered as a result of defective advice are not recoverable, or only to a much smaller scope than expected.

An example

Consider a trustee who instructs a tax adviser to advise on restructuring a trust. The adviser’s engagement is on standard terms which:

• limit the duty of care to the trustee alone;
• exclude all liability to third parties; and
• cap the adviser’s liability at a particularly ungenerous level.

The trustee implements the advice and makes distributions to beneficiaries. However, some years later, it transpires that the advice was wrong. As a result, the beneficiaries incur significant tax liabilities, interest and penalties. The trustee, on the other hand, has suffered no loss.

The beneficiaries, who are not parties to the contract and therefore fall within the definition of “third party”, have no direct recourse against the adviser. They are the parties who have suffered the loss but on the face of it they have no way of making any recovery from the negligent adviser.

The beneficiaries may contemplate a claim against the trustee, but that claim is by no means straightforward as it faces a number of hurdles. The first is that the trustee contracted with the adviser on what it understood were standard terms of business and that the adviser may not have been prepared to extend liability to the beneficiaries. The second is that we expect a trustee would say that there is nothing unusual about this approach and that it is neither negligent (grossly or otherwise) nor an obvious breach of trust. The third is where the trust instrument contains wide exoneration or indemnity wording, as most do, a claim against the trustee may be counterproductive.

The upshot is that the beneficiaries potentially find themselves in the position where they are unable to bring any claim to recover their losses and that part or all of the reason for that position is the way their trustees contracted with the adviser who has caused the loss. That is a position that no trustee will wish to find itself in. Accordingly, trustees should be particularly attentive to the basis on which they contract with third parties whether they be tax advisers, lawyers, banks, investment consultants, investment managers or other service providers.

What should trustees do differently?

Trustees should approach adviser engagement terms as a substantive risk issue, not an administrative step. We set out below some key practical takeaways:

1. Pause and consider how exclusions of liability to third parties will apply in practice. Third party contractual terms tend to be standardised to apply to all assignments across multiple industries. Accordingly, they tend not to be worded in the language of trusts and rarely do they expressly exclude liability to beneficiaries. Instead, they have that effect by excluding liability to all “third parties”. In circumstances where beneficiaries are rarely a party to such contracts they will, without more, fall within the definition of “third party” and therefore liability to them will be excluded. In these circumstances, trustees should push for wording which carves beneficiaries out of the definition of “third party” if there is one, or which expressly acknowledges that liability is owed to beneficiaries.
2. Scrutinise wording on indirect losses. Adviser contracts often exclude any and all liability for loss suffered indirectly. There is a risk that such wording could capture losses suffered by beneficiaries as opposed to trustees and therefore clarity around this position should be sought.
3. Scrutinise monetary liability caps. Any agreed limitations should be assessed by reference to the nature, scale and risks of the transaction, rather than accepted as standard, particularly where the consequences of defective advice may be substantial and may only emerge over time.
4. Consider whether shortened limitation periods are reasonable. Some advisers, particularly accountants, insert contract limitation time periods into their contracts. These can curtail limitation periods from the statutory 6 and 15 years to periods as short as 2 or 4 years. If these are unreasonably short insist on their removal.
5. Take legal advice on terms where the stakes justify it. Adviser engagement terms can be highly technical and their risk allocation effects are often not obvious, particularly in a complex, high-value or investment context.

Conclusion

Standard terms of engagement, designed for bilateral commercial relationships, may be ill-suited to the fiduciary context in which trustees obtain professional advice. Where adopted, such terms may leave the beneficiaries exposed to loss without effective recourse. Trustees should therefore approach advisers’ terms with care, ensuring that they reflect the purpose for which advice is sought and the realities of trust administration.

In a future article, we will explore how some of these contractual difficulties may be overcome where advisers’ standard terms have not been addressed appropriately.

If you have any questions regarding this article, please contact Justin Briggs or the author, Simon Lellouche.