The rules of apportionment
11.As a general principle, trustees must not favour one beneficiary or class of beneficiaries over another in exercising their powers and fulfilling their duties. They have a duty to keep a fair balance between beneficiaries who are entitled to capital, and those who are entitled to income.
12.In the past, that general duty has been considered to require certain returns and outgoings of a trust to be shared in a particular way between capital and income, and in some cases as imposing a duty to sell certain investments, in specific circumstances. These have become known as rules of apportionment. One derives from statute, and the others from case law (and are often known as the “equitable rules of apportionment”). The four rules affected by the Act can be summarised as follows.
Section 2 of the Apportionment Act 1870 is the statutory rule of time apportionment. The effect of the section is that income beneficiaries are entitled only to the proportion of income that is deemed to have accrued during their period of entitlement. The trustees must work out how much income is attributable to each beneficiary, on the assumption that the income accrued at a constant rate over the period.
For example, shares are held by the trustees of the AB Trust (see paragraph 7 above); a dividend is declared on 1st February on shares that last yielded a dividend on 1st December. A died on 1st January. Under section 2 of the Apportionment Act 1870, half the dividend is payable to B and half accrues to A’s estate.
The rule known as the rule in Howe v Earl of Dartmouth is divided into two parts.
The first part of the rule creates an implied trust for sale, putting the trustees under an obligation to sell particular investments and reinvest the proceeds (known as a “duty to convert”). Broadly speaking, it applies to trusts for interests in succession created by will or codicil over the testator’s residuary estate – that is, so much of the estate as remains after payment of debts, liabilities, legacies and other charges. The rule applies where the trust fund includes personalty (assets other than land) constituting investments which fulfil the following criteria. First, they must be unauthorised investments: the trustees would have no power to invest in them, either under the general law (by which, following the Trustee Act 2000, only a few investments are unauthorised) or by express restrictions in the trust instrument (for example, establishing ethical investment criteria). Secondly, they must be “of a wasting or hazardous nature”; that is, having the potential to prejudice the capital beneficiary over time through a dramatic diminution in value, and to produce an augmented level of return for the income beneficiary.
The second part of the rule applies to trusts for interests in succession where a trust for sale applies (this could be implied under the first part of the rule, or express). It applies more widely than the first part of the rule, as it is not limited to trusts created over residuary estates of testators, and applies to unauthorised investments of a wasting or hazardous nature in leasehold (though not freehold) interests, as well as in personalty (see above). Until the investments are actually sold in accordance with the trustees’ obligation under the trust for sale, the life tenant receives a sum calculated by applying a specified rate of interest (traditionally 4 per cent) to the estimated value of the property. This operates to compensate the capital beneficiary for loss pending conversion of trust investments.
The rule known as the rule in Re Earl of Chesterfield’s Trusts applies where there is a trust for interests in succession and compensates the income beneficiary for loss of present income from future property held by the trust, where trustees have exercised a power to defer sale. For example, the trust fund of the AB Trust includes property held in reversion, where X is entitled to the income for life. Until X dies, the property will not produce any income for the AB Trust, but the trustees decide to hold onto it until that time. This rule requires that, when the property eventually comes into the trustees’ hands, it is treated as though it represents partly arrears of income due to A; therefore, it is apportioned between capital and income.
The rule known as the rule in Allhusen v Whittell applies where a testator’s residuary estate is left on trust for interests in succession. It apportions debts, liabilities, legacies and other charges payable out of the residuary estate between capital and income beneficiaries so that broadly the beneficiaries are put in the same position as if payments had been made at the time of death. This requires the trustees to calculate the net average income of the estate from the date of death to the date of the relevant payment and from this to work out how much of each debt paid is attributable to capital and how much to income. The income beneficiary is then charged with interest at the rate of the net average income on the amount of the payment so that the payment is regarded as being made partly from income and partly from capital.
13.The rules apply to private trusts for interests in succession; the extent to which they apply to charitable trusts is unclear. Professionally drafted trust instruments generally exclude them. In most trusts where they have not been excluded they are either ignored or cause considerable inconvenience by requiring complex calculations generally in relation to very small sums of money.
14.The Act abolishes the rules for trusts coming into existence after commencement. But settlors and testators who wish any or all of the rules to apply to the trust can make express provision to that effect in the trust instrument.
