Discretionary Distribution and Conflict of Interest
You are the sole trustee of the Henderson Family Trust, a discretionary trust with assets of $2.5 million. The settlor, Margaret Henderson, is deceased. The beneficiaries are her three adult children: Alice, Ben, and Claire. The trust deed gives the trustee absolute discretion to distribute income and capital among the beneficiaries. Ben has requested a distribution of $200,000 to fund a business venture. Alice has requested $50,000 for a house deposit. Claire has not made any request. The trust has accumulated income of $150,000 this year. You are also a beneficiary of the trust, entitled to 10% of income at the trustee's discretion. The trust deed includes a clause allowing the trustee to lend money to beneficiaries at commercial rates. Ben has offered to repay the $200,000 with interest at 5% per annum over 5 years. The current market rate for unsecured loans is 7%. You are considering Ben's request.
1. Identify the conflict of interest in this situation and explain how you should manage it as trustee.
Read the worked answer
There is a conflict of interest because you are both trustee and a beneficiary. As trustee, you must act in the best interests of all beneficiaries and exercise discretion impartially. As a beneficiary, you have a personal interest in receiving distributions. This conflict is particularly acute when deciding on distributions to other beneficiaries, as any distribution reduces the trust fund available for your own discretionary share. To manage this conflict, you should: (1) disclose your interest to all beneficiaries; (2) consider whether the trust deed permits you to act despite the conflict (many deeds include an exclusion clause, but you must check); (3) if not, you may need to appoint an independent trustee or seek court approval for the distribution; (4) document your reasoning and ensure the decision is made in good faith and for the benefit of the beneficiaries as a whole, not just yourself. You should also consider whether the loan to Ben is commercially sound and whether the below-market interest rate (5% vs 7%) constitutes a breach of duty to the other beneficiaries. If you proceed, you should obtain independent advice and ensure the loan is documented with proper security.
2. Evaluate Ben's loan request against the trustee's duties. What factors should you consider before deciding?
Read the worked answer
The trustee must consider the duties of prudence, impartiality, and acting in the best interests of all beneficiaries. The loan to Ben at 5% is below market rate (7%), which may be seen as favoring Ben over other beneficiaries. The trustee should assess: (1) Ben's creditworthiness and ability to repay; (2) whether the loan is secured; (3) the opportunity cost of tying up $200,000 of trust capital for 5 years; (4) the impact on the trust's liquidity and ability to make distributions to Alice and Claire; (5) whether the trust deed permits loans to beneficiaries and on what terms; (6) whether the loan is a proper investment under the trust's investment strategy. The trustee should also consider the prudent person standard and diversification. If the loan is made, it should be at commercial rates, properly documented, and secured if possible. The trustee should also consider whether the loan is in the best interests of all beneficiaries, not just Ben. If the trustee decides to proceed, they must document the reasons and ensure the decision is not tainted by the conflict of interest.