Breakdown of Trust in Family Trusts
“From shirtsleeve to shirtsleeve in three generations” describes the infamous inheritance issues faced by countless families today.
To solve this problem, many affluent and high net worth families have turned to the trust structure as a centrepiece of their estate planning with the objective to consolidate and preserve wealth for the future generations. A well-constructed trust structure is cost efficient, legally effective, flexible for asset distribution and can fulfil multiple purposes include investment and tax planning.
All’s well and good, until some forget that a trust is called a trust simply because it is fundamentally a type of relationship. ‘Trust’ is an emotive word. One cannot build trust and professionalism with a contract or legal structure. The strength of a family trust is only as strong as the weakest relationship between the people bound to it – which can be fragile when money is brought into the picture.
Even the “world’s happiest” family – the Walt Disney’s Family Trust – is revealing its cracks when news broke out in 2020 that Disney’s third generation beneficiaries started to sue the trustees.
A survey conducted by Herbert Smith Freehills LLP (“HSF”), one of the largest international law practices in Southeast Asia, reveals the most common reasons for trust disputes.
Fig 1: HSF Notes on “Beneficiary Disputes in Focus”
The survey was done across four general kinds of corporate trustees:
- Bank-owned trustees;
- Independent trustees;
- Professional services-owned trustees; and
- Private equity-backed trustees.
Across the categories, almost two out of three disputes are caused by disharmony amongst the beneficiary groups. In fact, in the professional services-owned and private equity-backed trustee categories, the percentage was higher at 85%!
Conventional wisdom tells us that the break down in trust and succession planning is likelier from the third generation onwards than the second. When the second generation retires as the trustee or protector, and the third generation steps up, we move from sibling co-operation to cousin collaboration. In a vast majority of case, there is a negative shift in terms of family dynamics, closeness of kinship, shared values and experiences between cousins. It takes a lot more work for everyone to build harmony and trust in the face of widening diversity.
The percentage of beneficiary disputes is likely to be higher if we examine the next most common reason behind breakdown in trust and succession planning – breakdown in the relationship between trustee and beneficiaries (12%). One may wonder why beneficiaries may sue the trustee, the hand that feeds them. Sure, there are incidents whereby trustees fail to discharge their duties properly. However, the HSF research also suggests that in many instances, trustees simply land up caught in between family disharmony, sometimes between rival factions. For a disgruntled family member, it is probably easier to sue a third-party trustee than another family member. Hence, it is likely that a significant proportion of trustee-beneficiary dispute arose first from a breakdown of the beneficiary group’s relationship, after which the trustee was dragged in. That was what happened in Walt Disney’s case.
The third most common reason for trust dispute is due to the failure of the settlor to communicate the purpose and intent of the trust. The trust is just a ‘WHAT’. Not communicating the ‘WHY’ – the motivation and principles undergirding it – is a recipe for family misunderstanding and confusion.
Most trust setups lack a credible family letter, rule book or family constitution to communicate the ‘WHY’ and ‘HOW’. It’s not hard to understand why. While almost all bona-fide lawyers and corporate trustees can help to craft out a trust deed, only a small fraction of advisors have the experience to guide the family through the laborious and often emotionally charged process when it comes to family relationships. Drafting a trust deed can be easily done in a week whereas producing a family letter often takes 3-18 months. This makes very little business sense for advisors to handhold their clients. In many cases, the settlor may decide to abort the family letter project out of frustration.
Relationship Building is Key
How a family communicates determines how the family business or the family trust operates. A US-based consultancy group plotted out the stages of family business breakdown. Starting from resentment, the cumulative effect of avoidance of difficult conversations eventually leads to divorce, estrangement, lawsuit and loss of business and wealth. Keeping the lines of communication open between trustee, beneficiaries and advisors is going to be an important feature to avoid costly trust disputes.
Fig 2: The Cost of Undiscussables
The HSF survey shows those in the family succession business just how important relationship building is, during and beyond one’s lifetime. Having a trust structure alone is not enough. Opportunities for frequent and open communication, a solid conflict-resolution framework and family bonding mechanisms have to be deliberately built into the family constitution or letter.
The choice of the trustee – both lay and corporate – is also very important. The qualities of a suitable trustee includes one who is able to put himself into a neutral position from the start, having the power and willingness to delegate roles to other professionals such as financial planning and conflict mediation, and keeping in regular touch with the beneficiaries. In this regard, the appointment of a suitable trust protector is highly encouraged to bridge the trustee-beneficiary communication gap.
heritance is designed to narrow the communication gap in families. Check out our Tribe function to engage your beneficiaries and personal representatives. Our SmartWill and Memory Time Capsule also allows you to digitally pass down your family values through the generations. Sign up for our Beta here.
- Beneficiary Disputes in focus. (2020, May 5). Retrieved from hsfnotes.com: https://hsfnotes.com/pwtd/2020/05/05/beneficiary-disputes-in-focus/
- FBCG. (2021, October 31). Communication is the difference between conflict and consensus. Retrieved from thefbcg.com: https://www.thefbcg.com/what-we-do/communication-conflict-resolution/