NOTES ON TRUST ACCOUNTS-PART 2

PART 2- PART 3 COMING SOON

Investments by Trustees Generally

At common law, trustees were viewed as stewards of trust property. In those days the primary asset entrusted to trustees was land. The threshold of care was that the trustee would take care of trust property as if it was his own. The industrial revolution brought on new forms of property e.g. factories and shares. There was a new requirement in equity that trustees invest trust funds for the benefit of beneficiaries. Are there any rules that govern a trustee vis a vis his position as an investor?

Under the common law, the trustee is only under a duty to govern the trust funds as received. His duty was mainly as defined by a will. In intestate succession his duty was defined by the common law. The trustee was primarily involved in administration of land and the standard of care required of him was that he should administer the land as he would his own. However, with the advent of the industrial revolution towards the end of the 18^th century, the role of the trustee widened with the advent of new forms of property e.g. capital.  The trustee’s role went beyond mere stewardship to include application of the trust fund to enhance the benefit of the beneficiaries, both the tenants for life and the remainderman.

The trustee’s duty however remained fiduciary in nature but was required to act in good faith and exercise prudence and care in his role as investor so as to result in maximum benefit to the person beneficiaries of the trust. He had the additional duty to ensure that the beneficiaries would get a reasonable and comparable benefit from the investment as a trustee. The trustee was also duty bound to seek advice on the best investment but to retain ultimate judgment in his decisions.

By the mid 19^th century there had been development of the rules requiring the trustee to invest only in authorized investments. However, even where an investment was authorized by the law, it was still incumbent upon the trustee to exercise due care and prudence in his investments.

The current position

Section 4 of The Trustee Act (Cap 167) provides for the authorized investments in which the trustee may invest trust fund. It may be categorized into two broad classes:

(a)             Fixed interest investments; and

(b)             Wider range investments

Section 2 of the Act defines a fixed interest investment as:

(a)             a security which under its term of issue bears a fixed rate of interest; or

(b)             a mortgage of immovable property; or

(c)              a deposit whether fixed term or otherwise with a bank or financial institution, building society or the Kenya Post Office Savings Bank.

Wider range investment is defined in the schedule to the Act as an investment other than a fixed interest security.

S 4 shows the list of authorized fixed interest investments:

(a) any securities in which trustees in England are in the time being authorized by English Law to invest trust funds;

(b) any securities on which is for the time being guaranteed by the UK Government or the Kenyan Government or any public debentures issued under the authorization of or guaranteed by any Act;

(c)  any security given by a city or municipal council established under the provision of the Local Government Act which the Minister has by Notice in the gazette declared to be a trustee security for the purposes of the Act;

(d)any security issued by Kenya Railways;

(e)  any security or any loan to the Industrial Development Bank Limited; and

(f)   the purchase of any immovable property in Kenya held for an estate in fee simple or for a term of years of which not less than 40 years is unexpired, and which is not subject to a rent exceeding 4% of the unimproved value thereof.

Authorised Wider Range Investments

(i)               Any security the price of which is quoted on a recognized stock exchange in Kenya subject to the following qualifications:

(a) must be of a company registered under The Company Act.

(b) Its total issued and paid up capital must not be less than Kshs 10 million.

(c)  The company must have paid dividends for all its shares that rank for dividends for each of the 5 years immediately preceding the year in which the investment is made.

(ii)             Any units or other shares of the investments subject to the trusts, of a unit trust within the meaning of The Unit Trusts Act (Cap 521) and registered under section 7 of that Act.

(iii)          Any shares of a building society.

Operations of Investments

When a trustee decided to invest trust funds, he must divide the investment into two. Rule 3 of the Schedule to The Trust Act provides that,

A trustee may not make or retain any wider range security unless the trust fund has been divided into 2 parts referred to as the fixed interest part and the wider range part with the parts being equal in value at the time of division.

Where such a division has been made, no subsequent division of the trust funds shall be made and no property shall be transferred from one part of the trust fund to the other unless either:

(a)     The transfer is authorized or required by the provisions of the schedule; or

(b)     A compensating transfer is made at the same time.

These requirements are intended to ensure that firstly the investments made by the trustee are safe and that they afford a reasonable and fair benefit to both the tenant for life and the remainderman.

Fixed interest securities are primarily attractive to the remainderman because of the guarantee given their value. They are also attractive to the tenant for life because of the return which, though conservative, is guaranteed.

Wider range securities will primarily be attractive to the tenant for life because of the high interest returns but they are also acceptable to the remainderman because of their long term appreciation.

[Must consult Rules 3,4,5,6 and 7 in the Schedule].

Investment Account

Fixed interest Securities

No.	Date	Particulars	Amount	Reference
1.	1.1.2006	Fixed deposit in KCB account, 1 year fixed interest	2,000,000	Memorandum Cash
2.	2.3.2006	Rental property o LR  no. xxx	5,000,000	Mem. Sch. of Assets Cash
3.	3.3.2006	Treasury bonds	1,000,000	Xxx

Wider range securities

No.	Date	Particulars	Amount	Reference
1.	xxx	Shares	xxx	Xxx
2.	xxx	Unit trusts	xxx	Xxx
	xxx

Apportionment Account

Apportionment refers to the need to distribute the proceeds between the various beneficiaries of the Estate who have different entitlements under the law.

At common law, the tenant for life was only entitled to interest on money lent out of the estate. Any other income was presumed to be an appreciation on capital and was therefore the property of the remainderman. This situation was obviously unfair to the tenant for life because their were other forms of income which in time were comparable to interest on money lent out. Consequently, statutory attempts were made to remedy this position culminating in The Apportionment Act 1870 which now makes provision as to how apportionment is to be made.

This Act is a statute of general application in Kenya pursuant to The Judicature Act provisions. Section 2 of this Act provides that all rents, dividends and other periodical payments in the nature of income are like interest on money lent out to be considered as accruing from day to day and accordingly to be apportioned in respect of time.

Apportionment may now be analysed under two categories:

Statutory apportionment

Is the allocation of income accruing to the estate to 2 or more beneficiaries on the basis of time. Where there is only 1 beneficiary, the question of apportionment does not arise. Similarly, where there is no dispute as to whether income relates to the period prior to and after the death of the deceased. The trustee must address 2 questions in this regard:

(a)  to what period of time does the income relate? When did it accrue?

(b)  When was the income actually received by the estate?

Once these questions have been answered, the following guidelines apply to apportionment.

(i)               All income received prior to the testator’s death will be treated as capital income irrespective of the period to which it relates e.g. if the deceased had entered into a tenancy agreement in relation to some property forming part of the estate for the period say 1.10.2005 to 30.9.2006, at a monthly rent of Kshs 10,000 payable in full in advance and the money was received on 1.10.2005 and the deceased died on 1.1.2006.

(a)  Moneys accruing to the estate prior to the deceased’s death are treated as capital irrespective of when the cash is actually received.

(b)  In addition, if the income accrues prior to the testator’s death, it will be regarded as capital irrespective of the period to which it relates.

[This example will be question four in the exam].

Onyango enters into a lease agreement covering the period 1.10.2005 to 31.10.2006. He agrees with Rashid, the lessee, that the monthly rent payable shall be Kshs 60,000 p.m. Onyango dies in an accident on 6.1.2006 and he has appointed you the executor of his will. How do you apportion income in the following situations:

(a)             Rashid had paid the 6 months rent in advance on 1.10.2005;

(b)             The lease only provided for payment of one month’s rent in advance;

(c)              1 month’s rent was payable in advance but no rent had been paid at the time of the testator’s death. The entire rent is paid on 31.3.2006;

(d)             The lease agreement is silent as to the time of payment of monthly rent and no payment has been paid to date.

Equitable Apportionment

Courts of equity have stated that where statutory apportionment does not achieve a fair distribution of the proceeds of the estate, equity may intervene to achieve a more just apportionment.

These rules attempt to interpret the best wishes of the deceased that may not have been expressly provided in the instrument appointing the trustee/executor.

Howe v Earl of Dartmouth (1802) 7 Ves 137

Where, on the death of the deceased there is residuary personalty which is to be enjoyed by persons in succession, the trustee is under a duty to convert into money such parts of the residuary personalty that may be of wasting, future or reversionary character or which constitute unauthorized securities. After payment of general and testamentary expenses relating to the estate of the deceased, the trustee should invest the balance in authorized securities.

However, the testator may expressly empower the executor to postpone the need to convert as contemplated in Howe’s case.

Re Fawcett (1940) Ch 447

Where there is a duty to convert in accordance with the rule in Howe’s case, and there is no specific power to postpone conferred on the executor, the issue of apportionment of income for the period between the death of the testator and the actual conversion of the assets will be governed by the rule in Re Fawcett.

Between the death of the testator and the actual conversion, the trustee will provide a notional valuation of the assets and apply a base rate of interest as income accruing to the tenant for life at the end of the period.

Re Beech (1920) 1 Ch

The recommended rate of interest should be 4%.

         

Re Parry (1947) Ch 41

The rule in Re Parry states that where a will gives an executor the power to postpone the conversion and the executor exercises that power, then for purposes of determining the income to be given to the tenant for life, the value of the estate will be presumed to be the value at the testator’s death. Interest will be 4%.

Earl of Chesterfield’s Trust (1883) 24 Ch 643.

Where an asset is subject to conversion in accordance with the rule in Earl’s case, but it earns no income and the executor has either exercised the right of conversion or has postponed conversion, then at the time when conversion is actually done, income is to be computed as follows:

the proceeds of the conversion are assumed to have both portions of capital and income and in order to determine the income portion, it is assumed that the capital element was invested at the time of death at its value then and that it has accrued interest in the interim period. That interest is to be calculated on a compounded basis between time of death and conversion.

[Photocopy:

The Advocate’s Accounts Rules

The Advocate’s Deposit Rules

The Advocate’s Accountancy Certificate Rules

All at the back of The Advocates Act

[Look at Rowland’s for examples of calculating the apportionments for different kinds of income. Also look at The Advocates Act since Advocate’s Accounts Rules etc will be in the exam].

Distribution Account

Trustee’s Role

(i)               Secure assets and establish liabilities.

(ii)             Administer trust funds efficiently/lawfully.

(iii)          Distribute the deceased estate to legitimate beneficiaries in accordance with the applicable law.

·        Pay of all liabilities to bona fide creditors;

·        Distribute the balance to rightful beneficiaries

Factors to Consider

1.       Under s 24 of The Trustee’s Act, the trustee is at liberty to exercise the power of advancement of any part of the estate to any of the remaindermen so long as this will be taken into account at the time of distributing the net estate.

         

This is statutory recognition of the doctrine hotchpot. This is an accounting method of distributing property to persons taking into account property that you had disposed off to them earlier.

2.       All the accounts in the Estate Book should be closed and the balances brought to the distribution account.

3.       Establish the authenticity of each of the claims and compute their respective entitlements in accordance with the law.

4.       The trustee will seek to have the beneficiaries reach an agreement on the mode of distribution of the estate e.g. the beneficiaries may agree to share out the estate in specie and any shortfalls or surpluses of any beneficiaries to be offset in cash.

Example 1

Mr Omondi, a widower, dies intestate leaving 3 sons, John Peter and Michael who are all aged over 18 years. Under The Law of Succession Act, the late Omondi’s estate falls to be distributed amongst his 3 sons equally. The net estate comprises the following:

                                                             i.      House LR xx Nairobi            3 million;

                                                          ii.      Motor vehicle                        2 million;

                                                       iii.      Cash in bank                         100, 000

                                                        iv.      Ordinary shares in X ltd                 10,0000     

                                                           v.      Personal effects                     410,000

                                                        vi.      Estate owes Mortgage debts          500,000

                                                     vii.      Legal fees                               10,000

It is decided between all the beneficiaries that John will take the house in specie and Peter the shares in specie. Draw up the distribution account.

In the Estate of Mr Omondi (Deceased)

Distribution Account

No.	Particulars	Ref.	Amount	No.	Particulars	Ref.	Amount
1.	House on LR xxx Nairobi	Sch Mem.	3,000,000	1.	Mortgage debt	Xxx	500,000
2.	Motor Vehicle	xxx	2,000,000	2.	Legal Fees	Xxx	10,000
3.	Cash in Bank	xxx	100,000	3.	John’s Share (House less paid to estate)	Xxx	1,700,000
4.	Shares	xxx	100,000	4.	Peter’s share	Xxx	1700000
5.	Personal effects	xxx	410,000	5.	Michael’s share	Xxx	1700000
			5,610,000				5,610,000

Workings

1.       John’s Share

          House – paid to estate                              3000000

                                                                   1300000

                                                     1700000

2.       Peter’s share                                             

          Shares + estate                                           100000

                                                                   1600000

                                                                   1700000

Example 2

Michael dies leaving a will under which his 3 children, Naomi, Leah and Rachel are given equal shares of the residual estate. Before the estate is wound up, Rachel requires funds to set up a medical practice and is advanced 200,000 from the estate. The Net Estate comprises

1.       House in Nakuru                             2000000

2.       Personal effects                                         100000

3.       Cash in Bank                                            100000

4.       Shares                                                        300000

5.       Mortgage debt                                           500000

6.       Legal fees                                          25000

The beneficiaries have agreed that the mortgage debt will be taken over by Naomi who also takes the house in specie. Leah will take the personal effects and the KCB shares will be transferred to Rachel. Draw up the distribution account.

In the Estate of Michael (Deceased)

Distribution Account

No.	Particulars	Ref.	Amount	No.	Particulars	Ref.	Amount
1.	House on LR xxx Nakuru	Sch Mem.	2,000,000	1.	Mortgage debt	xxx	500,000
2.	Personal effects	xxx	100,000	2.	Legal Fees	xxx	25,000
3.	Cash in Bank	xxx	100,000	3.	Rachel’s Share (House less paid to estate)	xxx	1,250,000
4.	Shares	xxx	300,000	4.	Naomi’s share	xxx	725000
5.	Advancement to Rachel	xxx	200,000	5.	Leah’s share	xxx	725000
			2,700,000				2,700,000

*[Must show workings]