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What Is a Letter of Wishes: How Settlors Guide a Discretionary Trustee in Hong Kong

What a letter of wishes is, and where it sits

A letter of wishes is a document addressed by a settlor to the trustee of a trust, setting out how that settlor would like the trust administered. It is not a prerequisite for establishing a trust, but in a discretionary trust it is the mechanism through which a settlor can guide the trustee on intentions and on the exercise of discretion, and can retain flexibility by updating it during his lifetime without having to amend the trust deed. In the modern international trust context, the letter of wishes is a near-ubiquitous companion to the trust instrument.

Its position is therefore alongside the trust deed, not inside it. The trust deed creates the trust, defines the trustee's powers and sets the terms on which the trustee holds the assets. The letter of wishes speaks to how those powers might be used. It is common practice, when a trust is established, for the economic settlor to provide such a letter, addressed to the trustees, setting out their wishes with respect to the administration of the trust.

Not binding, and yet not irrelevant

This is the point that is most often stated wrongly. A letter of wishes does not bind the trustee, and it is not a substitute for the deed. As a matter of trust law, it is the trust deed which determines the trustee's powers and not the letter of wishes; the trustee must take into account all relevant considerations when exercising their discretion. Most letters of wishes expressly say they are not intended to bind the trustees and acknowledge the trustees' right to exercise their discretion over the trust assets.

Non-binding does not mean the trustee may put the document aside. A trustee exercising any power in relation to a trust must take into account all relevant considerations and disregard irrelevant ones, and a settlor's wishes are a relevant consideration for that purpose. Lord Walker put the point directly: "The settlor's wishes are always a material consideration in the exercise of fiduciary discretions." The duty is one of proper consideration. In [2013] UKSC 26, Lord Walker described the rule as being "concerned with trustees who make decisions without having given proper consideration to relevant matters which they ought to have taken into consideration."

The two halves stand together. A trustee is bound to consider the settlor's wishes, whether expressed in a letter of wishes or otherwise, but that does not mean it is bound to follow them. On the contrary, the trustee is obliged to make its own decision; it cannot fetter its discretion by blindly following the settlor's wishes. A trustee that treats a letter of wishes as a command has not exercised the discretion the deed confers on it at all.

One well-respected practitioner text has attempted to categorise letters of wishes into three: those that are "legally binding", those that are "legally significant" — which must be taken into account but need not be followed — and those that are "morally binding", where it is for the trustee whether to take them into account. That is one text's categorisation, not a statutory classification. On that analysis the first category is not really a letter of wishes properly so called, but a trust document delineating the trustee's powers and obligations, and it is the second category that reflects letters of wishes as generally understood in the authorities.

What a settlor can properly put in it

The useful content of a letter of wishes is guidance about judgment, not instruction about outcome. A settlor's letter may address the investment approach to be taken in respect of trust assets; the factors to be taken into account when making distributions to beneficiaries; and the person whose wishes the trustee should ascertain following the settlor's death, often the settlor's widow. It may also include relevant background about the family, including the beneficiaries and their respective circumstances, and may ask the trustee to consult the settlor during his lifetime before making distributions.

Style varies, and both ends of the range are legitimate. Some settlors take the opportunity to set out prescriptive "rules" about how the trust is to be managed, identifying assets that should remain in the family, setting out particular investment guidelines, and outlining when and to whom income and capital should be distributed. Others take a more "hands off", principle-based approach and leave the detail to the trustee, both as to investment and as to distribution. Where minor children are concerned, a settlor may also include instructions for executors to pass on to those appointed as guardians, covering matters such as upbringing, where the children might live, and religious beliefs.

The settlor's own family knowledge is often the most valuable part. Circumstances of beneficiaries, family history and the reasons behind a particular pattern of provision are things a corporate trustee cannot know unaided, and a letter of wishes is the ordinary vehicle for conveying them.

The limits, and the discipline that keeps a letter inside them

A letter of wishes cannot confer powers, override the deed, or convert a discretionary trust into something else. Because the deed determines the trustee's powers, anything in the letter that purports to direct the trustee is, at best, guidance, and at worst an attempt to fetter a discretion the trustee must keep. The same applies in reverse: a letter cannot cure a defect in the deed or substitute for a power the deed does not grant.

Two drafting and maintenance disciplines follow from this. First, provenance. Letters of wishes do not have formal validity requirements, as a will does, so a settlor can write one at home or ask others to assist. Trustees should therefore review it and discuss it with the settlor, to assess as far as possible that the settlor is making the decision freely and is not being pressured by others.

Second, currency and consistency. The most obvious discipline is keeping the letter up to date and considering it together with any other estate planning documents the settlor may have. If all letters of wishes and wills are considered together, issues such as assets being in the "wrong place" are likely to be identified and, if necessary, remedied. A common problem is that letters are not kept current: what was an appropriate letter at the inception of the trust may no longer be suitable ten or more years later.

The R Trust case illustrates both the risk and the result. There, a will and a letter of wishes were said to be in conflict. The judgment approved the trustees' decisions for two reasons: the decision accorded with the wishes of the settlor, in the sense that the will and the letter of wishes were not in conflict; and the distribution of the property, or company shares, was in the best interests of the trust as a whole.

When a trustee may decline to follow it, and disclosure to beneficiaries

Trustees should bear in mind that a letter of wishes is just that: wishes. They should independently exercise their own judgment based on the circumstances facing them at the relevant time and take into account all relevant factors. If necessary they should take advice and, as in the R Trust case, seek the approval of the courts. As a practical matter, trustees often do follow the guidance set out in letters of wishes, although this is not always the case. Departure is properly justified by the trustee's own assessment at the time — a change in a beneficiary's circumstances, a conflict between the letter and the interests of the trust as a whole, or a change in the family or assets since the letter was written.

Disclosure is a separate exercise and is not governed by the settlor's labelling of the document. No beneficiary has any automatic entitlement to disclosure of documents relating to a trust, but trustees do have duties to provide a certain level of information to beneficiaries. Trustees are not normally required to disclose information about how they reached a particular decision, which means letters of wishes are not within the category of documents that should be provided as a matter of course. However, the courts have held that even where a letter of wishes is marked confidential it may be disclosed to a beneficiary at the trustees' discretion, and trustees should not refuse disclosure simply because the letter is stated to be confidential. They must carry out a balancing exercise, considering the specific reasons for the request and what is in the best interests of all the beneficiaries together, taking into account all the circumstances at the time.

Key takeaways