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A remarkable phenomenon is occurring around the world these days. Trust-like arrangements are appearing or are under active consideration in civil law ...


The Dilution of the Trust Gregory S. Alexander Cornell Law School Myron Taylor Hall Ithaca, NY 14853-4901 Cornell Law School research paper No. 11-41

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THE DILUTION OF THE TRUST Gregory S. Alexander∗    

A remarkable phenomenon is occurring around the world these days. Trust-like arrangements are appearing or are under active consideration in civil law jurisdictions at an increasing rate. Two or three decades ago, such a development would have been unthinkable. The trust was the sole possession of the common-law world, Equity’s greatest triumph. All that is now changing. As Alexandra Braun’s paper tells us, two efforts are underway at producing on the European Continent a substantive law that would for the first time give the EU a single trust-like arrangement. As she further tells us, though, such an arrangement would not be the first of its kind to appear on the Continent. Several years ago, Austria enacted legislation that recognizes a device, the Privatrechtsstiftung, that resembles the trust in many ways.1 More strikingly, in 2005, San Marino passed a law recognizing trusts,2 and as Braun points out, Italy may soon be added to the list. Europe is not the sole locus of all the trust action. A number of years ago, Japan enacted a trust code recognizing trusts for both business and personal purposes.3 More recently, China jumped in, enacting in 2001 a Trust Law that recognizes a trust-like arrangement for certain purposes.4 Other civil-law jurisdictions also have passed legislation recognizing trust-like devices.5 Clearly, something is afoot. Notice that I have been careful to refer to “trust-like” arrangements rather than to refer to these new statutory creations as trusts. Few, if any, of the new devices that I have mentioned are true trusts, that is, trusts as the common lawyer would recognize them. Let me be clear about what I mean by the term “true trust.” As defined in the American Restatement (Third) of Trusts,6 the trust is “a fiduciary relationship with respect to property, arising as a result of a manifestation of an intention to create that relationship and subjecting the person who holds title to the property to duties to deal                                                              ∗

 A. Robert Noll Professor of Law, Cornell University. This paper was prepared as a comment on Alexandra Braun, “The Framing of a European Law of Trusts,” which was delivered at the conference on The World of the Trust, which was held at and sponsored by the McGill University Faculty of Law. I wish to thank the conference organizer and my host, Lionel Smith, for inviting me and for his superb job in arranging such a wonderful conference. All errors and infelicities in this essay are, of course, mine.  1  Privatrechtsstiftunggesetz (PSG) 1993. 2  Republic of San Marino L. Nos. 37, 38 (2005). 3  Trust Act of Japan, Act No. 108 of 2006. 4  Trust Law of the People’s Republic of China, Law No. 50, 2001. 5  Taiwan, for example, enacted a trust law in 1996. See Taiwan Trust Act 1996. 6  Restatement (Third) of Trusts §2.

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with it for the benefit of charity or for one or more persons . . . .” Several characteristics mentioned in this definition mark features that I take to be essential to the existence of a true trust, in view of the common law. First, a trust must involve a fiduciary relationship. The fiduciary concept, of course, is not unknown to the civil law and is not unique to the trust. As you know, however, the nature of the trust has been the subject of some controversy over the past several years. Drawing on the agency-relations theory in corporate law which subsumes the many and diverse fiduciary relationships into contracts, John Langbein has argued that the trust itself is a contract.7 Other scholars have disagreed with him, but the contract theory of the tract has been very prominent in recent years. Second, the Restatement’s definition holds that the trust is a property-based relationship. It is common to say that there is no trust without an existing and identifiable res.8 The fiduciary duties must pertain to some specific asset or separate fund. Third, and most important, the definition holds that legal title in the trust property, or res, must be held by a person or persons, who has duties to deal with that property for the benefit of others. Here is the core of the common law trust -- the separation of legal title from equitable ownership. The trustee may also be a beneficiary, of course, but there must be some additional beneficiary other than the trustee to whom the trustee owes fiduciary duties and against whom the beneficiary has rights that are enforceable in equity. It is this fragmentation of ownership that seems so strange, indeed well nigh impossible, to the civilian, but so essential to the common lawyer. So, we must pursue this matter more if we are to get the heart of trust’s dilution. The definition also provides that the trustee must “deal with [the trust res] for the benefit of charity or for one or more persons . . . .” This part of the definition signals two important points. First, a trust requires that there be, at least for what common lawyers call a private express trust, one or more definite and validly ascertainable beneficiaries. Such beneficiaries, it is thought,9 are necessary to enforce the trust. The second point signaled is that in dealing with the trust property, the trustee must act in the beneficiaries’ interest. This is the principle that the Uniform Trust Code, picking up John Langbein’s pithy expression,10 calls the “benefit the beneficiaries” principle.11 It is an integral aspect of the idea that the trustee is acting in a fiduciary capacity and owing fiduciary duties. This, then, is the core of the common law idea of the trust institution. How, then, is it diluting? To begin with, consider the two efforts at harmonization underway in Europe. The first, the DCFR Trust involves the least amount of dilution. Alexandra Braun notes as one point of departure from English trust law that the DCFR provides no durational limit. This I do not                                                              7

 John H. Langbein, The Contractarian Basis of the Law of Trusts, 105 YALE. L.J. 625 (1996).  E.g., Brainerd v. Comm’r, 91 F.2d 880 (7th Cir. 1937). 9  See, e.g., Clark v. Campbell, 133 A. 166 (N.H. 1926). 10  See John H. Langbein, Mandatory Rules in the Law of Trusts, 98 NW. U. L. REV. 1105, 1107 (2004). 11  See UTC §105(b)(3). 8

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find especially important for my purposes, as the same is true of trusts for family property settlements in several U.S. jurisdictions these days, owing to the abolition of the Rule Against Perpetuities as it applies to trusts in these states. And it really does not go to the heart of the trust form. As to that form, the DCFR Trust appears to be quite consistent on the whole with what I have called the “true trust.” It requires a separate and identified trust res, so that it is a propertyfocused arrangement. It requires a trustee who owes duties of a fiduciary nature to beneficiaries who have enforceable rights against the trustee. All in all, the picture that emerges is remarkably like the common law trust. The other European project leaves us with a quite different impression. The proposed Directive on “protected fund” creates an institution that is a considerable distance from the common law trust. Its very title suggests that this is not a true trust but rather a “ring-fenced” fund, created solely for commercial purposes. Now, the mere fact that its sole function is commercial does not itself rule out the possibility that it might be a true trust. As John Langbein has reminded us in a splendid article,12 the common law trust form is used today for a variety of important commercial purposes in the U.K., the U.S., and throughout the Commonwealth. The problem stems from the fact that the arrangement does not appear to involve a separation of legal title from equitable, or beneficial, ownership, which, as I have indicated, is the core of the common law trust form. Indeed, the authors of the proposed Directive themselves contemplate that the “protected fund” device is not a true trust but only “trust-like.” Perhaps they might call it “trust-lite.” Is the separation of legal title and equitable ownership indispensable for the creation of a true trust, such that any arrangement that does not strictly involve the separation of legal title and equitable ownership is a trust-lite? Not really. Professor du Toit’s fascinating paper13 tells us why. As we learn from his paper, the South African trust does not involve a strict separation between legal and equitable ownership as there is in the common law trust. As du Toit points out,14 however, the South African trust is based on a functional substitute for the common law’s approach of dual ownership, namely, a duality of estates. This arrangement appears to overcome the civilian’s conceptual problem with divided ownership, yet it does virtually the same functional work, in terms of the beneficiaries’ rights and remedies, that the common law idea does. Moreover, like the common law trust, South African trust law conceptualizes the trust beneficiaries’ rights as stemming from the trustee’s fiduciary duties rather than from contractual obligations, or at least not from contractual obligation alone. Tony Honorè has argued on more than one occasion15 that the essential mechanism of the true trust’s operation is not the separation                                                              12

  See John H. Langbein, The Secret Life of the Trust: The Trust as an Instrument of Commerce, 107 YALE L.J. 165 (1997).  13   Francois du Toit, Jurisprudential Milestones in the Recognition and Development of the Trust in South Africa’s Mixed Legal System 14  Id. at [TAN 14]. 15  See, e.g., Honorè, On Fitting Trusts into Civil Law Jurisdictions, supra at 6; Tony Honorè, Trust, in SOUTHERN CROSS: CIVIL LAW AND COMMON LAW IN SOUTH AFRICA, Reinhard Zimmermann & Daniel Visser eds. 849 (Oxford


of legal and equitable ownership but the existence of the trusteeship as an office. Professor du Toit’s paper picks up this point by emphasizing that in South African law, not only does the trustee stand in a fiduciary relationship with the beneficiaries – obviously not a sufficient condition for the existence of a true trust – but also trusteeship is an office.16 So, if the absence of a strict division between legal and equitable ownership is not at the heart of the dilution of the trust, as the South African example appears to show,17 just exactly what features have contributed to the trust’s dilution? Two examples from elsewhere in the world may illustrate the point. Consider first one of the newest trust-like arrangement to appear in the civil-law world, the Chinese trust. The first Trust Law of the People’s Republic of China (PRC) was enacted in 2001.18 It states that it applies to “civil, business, or public interest” activities in the PRC. However, its objective is primarily commercial. Many aspects of the so-called trust under the 2001 Trust Law remain murky. However, it seems rather clear that it is not a true trust but rather a trust-like arrangement created largely for the reasons that underlay the European proposed Directive on “protected funds.” The Chinese Trust Law does not categorize the trustee (whom the law does call a trustee) as “owner” of the trust property. Indeed, the law does not state that the settler must “transfer” property to the trustee. Rather, it deliberately abandons the term “transfer” and substitute for it the term “entrusts”: It provides that the settlor “entrusts the property rights in his property” to a trustee.19 This is quite problematic.20 To the common lawyer, the term “entrusts” signals that the trustee’s relationship with respect to the trust property is materially less than ownership. In Chinese law, the term carries basically the same meaning. It is used to create an agency relationship, in which possession but not ownership is transferred.21 This is simply inconsistent with the core idea of the common law trust. As Tony Honorè states, “The settlor may be the constituent of the trust, but the trust instrument is its constitution.”22 Honorè goes on flatly to declare, “In administering the trust cannot be the mere agent of the settlor or subject to his orders.”23 This is black letter law for common law trusts, but the Chinese Trust Law appears to violate it. In the context of the Chinese Trust Law, the term “entrusts” has proved to be controversial and troublesome. Some have argued that its contextual meaning is the same as                                                                                                                                                                                                  1996); Tony Honorè, Obstacles to the Reception of Trust Law? The Examples of South Africa and Scotland, in AEQUITAS AND EQUITY: EQUITY IN CIVIL LAW AND MIXED JURISDICTIONS, A.M. Rabello (Jerusalem 1997), 792. 16  Du Toit, Jurisprudential Milestones in the Reception and Development of the Trust in South Africa’s Mixed Legal System, supra, at [TAN 17]. 17  See Tony Honorè, On Fitting Trusts into Civil Law Jurisdictions at 1-12 (unpubl. ms. 2008) (footnote omitted). 18  Trust Law, 2001, Order No. 50 of the President of the People’s Republic of China [China Trust Law]. 19  Trust Law of the People’s Republic of China art. 2. 20  For an excellent discussion of the merits and demerits of the entrustment approach, see Lusina Ho, The Reception of Trust in Asia: Emerging Asian Principles of Trust? [2004] SINGAPORE J. OF LEG. STUDIES 287, 294-296. 21  Id. at 294. 22  Honorè, On Fitting Trusts into Civil Law Jurisdictions, supra at 6. 23  Ibid.


“transferred.” They point to the requirements that the trustee “transfer” trust property to those entitled upon termination of the trust24 and that the trustee segregate trust property from the trustee’s non-trust assets.25 But these requirements would not seem to require that “entrust” mean “transfer.” The requirement that the trustee transfer trust property, for example, does not state that the trustee transfers legal title. If, as seems to be the case, “entrust” means “entrust,” then this suggests that under the China Trust Law it is possible to create a trust by entering into a contract with the trustee rather than by transferring legal title to the trustee. 26 From the perspective of the common law trust, this is very problematic conceptually, not to mention practically. The Trust Law goes on to give the trustee powers to “manage[]” and “dispose[] of” trust property. Moreover, the law states that the trustee is to manage the trust property “in his own name,”27 and although an exercise of the power of disposal is supposed to be according to the settlor’s wishes, a disposal against the settlor’s wishes is still valid unless the court revokes it upon the settlor’s petition. The mere entrustment of the trust property in the trustee seriously complicates the trustee’s management power. For if the settlor retains title, then whenever the trustee seeks to invest trust assets, it will be necessary not only to produce the trust instrument but, seemingly, to provide authorization from the settlor. And if the settlor, as the owner, can veto or affirm a proposed trust investment at will, then will the trustee’s fiduciary duty of prudence be effectively undermined? The picture that emerges from even a cursory review of the China Trust Law is that it is indeed not a true trust but rather a “trust-like” arrangement, or, if you will, “trust-lite.”

How can we account for the global emergence of these trust-like arrangements? Rather clearly, I think, the reason is not the same as that which account for the remarkable success and popularity of the common law trust. As Tony Honorè noted, in the common law world trusts are used for a wide range of purposes, “almost as a universal fix-it,” as he put it.28 Many of the trustlike arrangements in civil law jurisdictions have limited purposes, usually commercial. That is almost certainly what accounts for their recent development throughout the world. As Alexandra Braun’s paper points out, the proposed EU Directive on “protected funds” was motivated by the perceived need for a device that would enable Continental European financial institutions to compete effectively by protecting lenders and investors against loss in the event of borrower insolvency.29 In Japan, trusts, although permitted for personal and as well business purposes, are                                                              24

 Trust Law art. 41.  Id. at art. 16. 26  See Ho, The Reception of Trust in Asia, supra, at 295. 27  Trust Law art. 14. 28  Tony Honorè, On Fitting Trusts into Civil Law Jurisdictions at 4 (unpubl. ms. 2008). 29  Braun, A “trust” for Europe?, supra, at . 25


primarily used for commercially, notably as a device for creditor-protection but also asset management. Why have these jurisdictions limited the purposes of the trust-like devices? Why not seek to obtain the breadth of purposes that comes with the flexibility of the common law trust? Why not, in short, go for the real thing – the true trust, rather than its ersatz substitute? The answer, I think, is less a matter of fear of Anglo-American legal imperialism than it is the doctrinal problem with the numerus clausus. We have our own numerus clausus,30 of course, but its contours and its conceptual underpinnings are different from those of the civil law, having no difficulty with two dimensional fragmentation of ownership, between legal and equitable ownership and between presently possessory estates and future interests. Along with the fragmentation of ownership, the availability of proprietary remedies to the beneficiaries of the common law trust further exacerbate the difficulty of reception of the fullfledged common law trust in civil law jurisdictions. Equitable tracing to recover trust assets in the hands of a third party and assertion of claims against the asset via a lien of constructive trust run deeply against the grain of civilian legal notions. As others have observed,31 these obstacles can be overcome, and it is quite possible that at least in some jurisdictions they will be overcome. We may eventually come to view the trust-like arrangements as the first steps taken toward true trusts, an initial stage in an institutional development that somewhat resembles the development of the English trust itself. Finally, it is worth asking what implications the emergence and spread of the trust-like arrangements – diluting the trust as it does – has or may have for the common law trust. The short answer, I think, is absolutely nothing, at least nothing bad. I see very little threat that the emergence of the trust in diluted form in the civil law world will dilute the trust in its true form in the common law world. If there is such a threat – and I am not saying that there is – it is an internal threat. The development of new features added to trusts, such as the trust protector device,32 pose a greater risk of dilution rather do any external trust-like arrangement. If anything, trust-like arrangements give those of us in the common law world ideas for trust law reform, making the common law trust even more flexible and adaptable to a wide variety of uses. It might be useful, for example, to explore relaxing the common law requirement that the trustee hold legal title to the trust res. So long as the res is identified and segregated and the trustee has the power to administer it in the interest of the beneficiaries, we might treat the trust in existence even though the trustee does not hold legal title to the res, at least for certain purposes where the settlor has a legitimate reason for not wanting to part with title. There may be other areas as well                                                              30

 See Thomas W. Merrill & Henry E. Smith, Optimal Standardization in the Law of Property: The Numerus Clausus Principle, 110 YALE L.J. 1 (2000). 31  See, e.g., Honorè, 32  On the risks of the trust protector device in American trusts, see Gregory S. Alexander, Trust Protectors: Who Will Watch the Watchmen? 27 CARDOZO L. REV. 2807 (2006); Stewart E. Sterk, Trust Protectors, Agency Costs, and Fiduciary Duties, 27 CARDOZO L. REV. 2761 (2006).


in which we can learn from these civilian innovations, without endangering the core common law idea of the trust. This would truly be a move toward harmonization.