General number of trustees

General 1366. A landmark decision in South African trust law
January 2006 – Issue 77

The decision in Land and Agricultural Bank of South Africa v Parker (2005 (2) SA 77 SCA) handed down by the Supreme Court of Appeal in September 2004, is one of the most important in the South African law of trusts.

As Honoré’s South African Law of Trusts observes (5th Edition page 2), the rules of South African trust law are a mixture of English, Roman-Dutch and distinctively South African rules, with the latter continually growing in importance. It is, moreover, a dynamic area of law, in a continuing state of development. The Trust Property Control Act No. 57 of 1988 is not a code, in other words, it is not an encyclopaedic statement of the law, and it is for the courts to develop and refine the law within the framework of the Act.

The decision in Parker exposes a consequence, not laid down in the Trust Property Control Act, not hitherto articulated by the courts, and not suspected by most practitioners, of the situation where there are fewer trustees holding office than the minimum number laid down in the trust deed. Indeed, the principle on which the case was decided is so novel that it was not even advanced in argument by counsel.

The nub of the decision in Parker is that, during any period in which there are fewer than the minimum number of trustees laid down in the trust deed, the trust lacks legal capacity. From this it follows that, during the period of such incapacity, the trust is unable to enter into any juristic acts, such as a contract. Since the trust lacks capacity, the trustees necessarily lack authority, and are unable to enter into contracts on behalf of the trust. If they purport to do so, the contract is a nullity.

The distinction between capacity and authority
The distinction between capacity and authority is well established in company law. The term capacity connotes the capability to acquire legal rights and incur legal obligations. Authority connotes the power of an agent to represent and bind his principal. Clearly, the authority of an agent cannot be greater than the capacity of his principal. Thus, if the principal lacks capacity to enter into a particular transaction, an agent cannot have authority to enter into that transaction on his behalf.

A company is a legal person in its own right. At common law, the capacity of a company was defined by the objects clause in its memorandum of association. Any act outside the company’s express or implied objects was said to be ultra vires (beyond its powers) and consequently void, even if all the members of the company consented to it. If the company itself had no capacity to enter into a particular contract because it was ultra vires, it followed that none of its directors could have authority to bind it to the contract.

The law relating to a company’s capacity, and the consequences of its acting outside the scope of its objects clause, were radically changed by the enactment of section 36 of the Companies Act, 1973 which was introduced to protect outsiders who contracted with the company.

By contrast, a trust is not a legal person, except for purposes of the Income Tax Act No. 58 of 1962, and this was affirmed in the Parker judgment which could have (but did not) take the step of declaring that a trust is a legal person. The precise legal status of a trust is controversial, and a trust is recognised for many purposes as a legal entity (see Honoré’s South African Law of Trusts, 5th ed pp 67 – 73). The Parker judgment is the first time a South African court has declared an act of a trust to be invalid on the grounds that the trust lacked capacity.

The far-reaching implications of the Parker judgment
The principle, laid down in the Parker judgment, that the provisions of a trust deed which specify the minimum number of trustees who must hold office at any given time are a "capacity-defining condition" has far-reaching implications.

If it turns out that, at the time the contract was entered into, there were fewer trustees holding office than the minimum laid down in the trust deed, the result will be that the contract will be void. There is no provision in the Trust Property Control Act analogous to section 36 of the Companies Act which protects the outside contracting party in this situation. The result is that no contractual rights and obligations will arise from the transaction. Since the contract is void, the outside contracting party will have no contractual right to compel the trust to carry out its side of the bargain, for example, to pay a purchase price or to transfer property.

Caution when entering into a contract with a trust
The Parker judgment is yet another warning to be careful when entering into contracts with a trust. The decision highlights that it is imperative to inspect the trust deed to ascertain how many trustees ought to hold office at any given time, and to determine that at least the minimum number are in fact holding office at the time of the contract.

In company law, the rule in Royal British Bank v Turquand ((1856) 119 ER 886) entitles a third party to assume that all acts of internal management have been carried out, and this is an important protection to persons who contract with companies, for they usually have no way of knowing whether there has been some internal irregularity that would invalidate the contract, such as the lack of a quorum at the directors’ meeting which approved the contract. It is not clear whether the Turquand rule applies to trusts, and the court in Parker did not find it necessary to decide this issue.

In the aftermath of the Parker judgment, it will be vital that a person who enters into a contract with a trust should insist that the trustees bind themselves as co-principal debtors for the obligations undertaken by the trust. It would also be advisable to insist that the trustees give personal warranties that the required number of trustees are in office and have been validly appointed.

The potential abuses of trusts
The Supreme Court of Appeal judgment points out the abuses to which trusts – particularly family trusts – lend themselves. In particular, the lack of formality in creating and operating a trust can allow the functional separation between control (i.e. the powers of management vested in the trustees) and enjoyment (receiving distributions of trust income and capital) to be undermined by having the same persons as trustees and beneficiaries. This, said the court, has the result that "the core idea of the trust is debased in such cases because the trust form is employed not to separate beneficial interest from control, but to permit everything to remain as before". In other words, persons who, in their capacity as beneficiaries, enjoy the income and capital of the trust, are in control of the trust in their capacity as trustees.

The court suggested that the Master of the High Court should ensure that there is adequate separation of enjoyment and control in every trust by insisting on the appointment of an independent outsider as trustee to every trust in which the trustees are all beneficiaries and the beneficiaries are all related to one another. The court said that the independent trustee does not have to be a professional person, such as an attorney or accountant.

It would appear that the various Masters of the High Court are implementing this recommendation, and are now refusing to register trusts in which the beneficiaries are also the only trustees, and where there is no independent trustee.

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