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Understanding the Risks of Trusts Standing Surety for Underlying Company Debts, inter alia

by | Jun 28, 2024 | Advisory Services | 0 comments

In the complex landscape of financial instruments and legal entities, trusts play a significant role in managing assets and liabilities. One such role, often overlooked, is their potential involvement as sureties for debts incurred by underlying companies. This practice, while common, carries inherent risks that trustees and beneficiaries should carefully consider.

Trust Suretyship Explained

A trust, in legal terms, is a relationship where a trustee holds assets for the benefit of others, known as beneficiaries. In some cases, trusts are asked to stand as sureties for debts owed by companies in which the trust has a vested interest. This arrangement means the trust guarantees to pay off the debt if the company defaults.

The Risks Involved:

  • Financial Exposure: By standing surety, the trust exposes its assets to potential liability. If the underlying company defaults on its debt obligations and the surety is called upon, the trust’s assets could be at risk. This can jeopardize the financial security of the trust and impact the interests of its beneficiaries.
  • Legal Complexity: Suretyship agreements involve complex legal obligations. Trustees must fully understand the terms and implications of standing surety, as well as any legal recourse available if the company defaults. Failure to comply with these obligations could lead to legal disputes and potential liability for the trustees personally.
  • Trustee Liability: Trustees have a fiduciary duty to act in the best interests of the trust and its beneficiaries. If trustees agree to stand surety without due diligence or proper consideration of the risks involved, they could be held personally liable for any losses incurred by the trust. This includes potential breaches of trust or negligence in managing trust assets.
  • Impact on Beneficiaries: Standing surety can affect the beneficiaries of the trust. If trust assets are depleted due to a suretyship obligation, beneficiaries may see a reduction in their expected benefits or even face financial hardship. Trust deeds should clearly outline the scope of trustee powers and any limitations regarding suretyships to protect beneficiaries’ interests.

Mitigating the Risks

To mitigate these risks, trustees should:

  • Seek Professional Advice: Consult legal and other relevant advisors who specialize in trust law and suretyship agreements to fully understand the implications.
  • Conduct Due Diligence: Assess the financial stability of the company requesting surety and evaluate the likelihood of default.
  • Limit Exposure: Consider alternatives to standing surety, such as providing other forms of financial support or negotiating terms that minimize risk.
  • Review Trust Deeds: Ensure trust deeds are comprehensive and align with current regulations regarding suretyship agreements.

Standing surety versus signing as grantor or guarantor

  • Liability: When a trust stands surety for a company’s debts, it directly exposes its assets to potential creditor claims if the company fails to pay. In contrast, signing as a grantor or guarantor typically involves securing specific obligations without the same direct exposure to debts incurred by another entity. An example being where a trust may sign as a guarantor for a lease agreement, ensuring that rent payments will be made by the lessee (beneficiary).
  • Legal Relationships: In both cases, the trust’s role involves assuming legal responsibilities, but the scope and nature of those responsibilities vary significantly.

Providing security as may be required by the Master of the High Court

The Master of the High Court may require trustees to provide security under certain circumstances, typically to safeguard the interests of beneficiaries and ensure proper administration of the trust. An example of an instance where the Master may require security:

  • For trusts with intricate structures or substantial assets, the Master may request security to ensure that the trustees adhere strictly to the trust’s objectives and distribute assets correctly.

Conclusion

Trusts can engage in different financial roles depending on its legal capacity and the specific circumstances and, while trusts can play a crucial role in supporting business activities through suretyship, trustees must proceed with caution. Understanding the risks involved and taking proactive steps to mitigate them is essential to protect the interests of the trust and its beneficiaries. By carefully evaluating each suretyship request and seeking expert advice, trustees can navigate this complex area of financial management responsibly and effectively.

Sentinel International Advisory Services (PTY) LTD offers specialized Trust services and advice and is well positioned to assist with any complexity regarding Trusts and the effective management thereof.

Werné Strydom BAP(SA), GTP(SA)

Head of Trusts / Trust Executive