What’s mine is yours? Trustee vulnerability to proprietary claims : Bajul Shah and Harry Samuels
In this paper Bajul Shah and Harry Samuels explore (i) the Equity Trust decision; (ii) recent jurisprudence on Guardian Trust liability across jurisdictions; (iii) the potential difficulties arising for trustees; and (iv) possible safeguards trustees should be aware of.
The Privy Council in Equity Trust (Jersey) Ltd v Halabi [2023] 2 WLR 133 decided that a trustee’s right of indemnity creates an enduring proprietary interest over trust assets, such proprietary interest ranking pari passu with the equivalent interests of successor trustees in the case of an ‘insolvent’ trust. Absent statutory provisions, such a right of indemnity is for a net sum determined by reference to the trust liabilities after deduction of any amounts for which the trustee is accountable to the trust. However, this landmark decision brings certain ramifications for the administration of trusts, as well as giving rise to possible Guardian Trust liability for trustees taking over insolvent or borderline insolvent trusts or illiquid trusts.
INTRODUCTION
The decision of the Privy Council in Equity Trust (Jersey) Ltd v Halabi [2023] 2 WLR 133 (“Equity Trust”) finally put to rest significant unresolved issues in respect of a trustee’s right of indemnity out of the trust assets. A seven-judge panel unanimously held that a trustee’s right of indemnity gives the trustee a proprietary interest over the trust assets, and endures even after the trustee leaves office and after the trust assets are transferred to a successor trustee. On its face, the decision is likely to be of some comfort to trustees: a proprietary interest confers a significant level of protection for trustees who incur liabilities in the exercise of their duties, and will only be defeasible in the most exceptional of circumstances. Beyond the surface, however, lurk further potential headaches.
In this paper, we will suggest that the decision in Equity Trust has the potential to affect how trusts are administered, in particular in relation to the appointment and retirement of trustees. The decision in Equity Trust may also collide with the long-standing principle in Guardian Trust and Executors Company of New Zealand Ltd v Public Trustee of New Zealand [1942] AC 115 (“Guardian Trust”) and expose trustees who succeed to illiquid or ‘insolvent’ trusts to significant risks or restrictions. In particular cases, trustees may be faced with an unenviable conflict between their fiduciary duties to beneficiaries and a duty to hold the trust assets on the footing that the fund is beneficially owned (in whole or in part) by their predecessor trustees. In exploring these difficulties, we will first set out the decision in Equity Trust, then look at the Guardian Trust principle and recent cross-jurisdictional cases on the same, and then set out both the problem for trustees and the potential safeguards against it.
EQUITY TRUST
The facts of Equity Trust are straightforward. In both cases, trustees of trusts administered in Jersey and Guernsey[1] incurred liabilities which, in the ITG case crystallised shortly before they were removed as trustees, and in the Equity Trust case only crystallised after they had left office. They sought through various claims to have their indemnities upheld in circumstances where those trusts were no longer solvent.
A trust, of course, is not a free-standing legal person or an institution, and so talk of an insolvent trust is technically a misnomer. Subject to statutory provisions, a trustee personally owns the assets of the trust, subject to fiduciary and other obligations, and personally enters into transactions in respect of those assets. When a trust is said to be ‘insolvent’, then, all it means is that the assets held on trust are insufficient to cover the liabilities the trustee has incurred in respect of those assets.
Likewise, when creditors of the trust come knocking, they have no right to enforce claims against the assets of the trust directly. Their recourse is against the person who has actually transacted with them: the trustee. The trustee’s protection from personal liability of this sort is through its right of indemnity out of the assets it holds on trust.[2]
Three issues relating to the trustee’s right of indemnity in respect of insolvent trusts were determined unanimously by the Privy Council, with the reasons set out in the lead judgment of Lord Richards JSC and Sir Nicholas Patten:
- The trustee’s right of indemnity confers a proprietary interest over the trust assets;
- The proprietary interest endures even after the trustee leaves office;
- The trustee’s indemnity extends to the costs of proving its claim in the case of an ‘insolvent trust’.
In respect of one further, but important issue, their Lordships decided 4-3 that the proprietary interest created by the trustee’s right of indemnity ranks pari passu with the equivalent interests of successor trustees where the trust assets are insufficient to cover all liabilities. The lead judgment in respect of this further issue was given by Lord Briggs JSC (Lord Reed PSC and Lady Rose JSC concurring; Lady Arden JSC concurring in part).
Trustees now have the comfort that they retain a proprietary interest in the trust assets. Creditors in turn have a right to be subrogated to that proprietary interest. This will create much more certainty for trustees and trust creditors.
But the pari passu ranking of these interests in the insolvency context is likely to mean that trustees and trust creditors are much more circumspect about the terms on which they engage. Creditors will inevitably seek security over trust assets in priority to trustee rights of indemnity before lending. Incoming trustees will likely apply much stricter due diligence to trust accounts, will seek that third party liabilities are paid off in advance, and will be anxious to negotiate for their own indemnity to take priority over their predecessors.[3] And retiring trustees will also want to protect their own position, either by ringfencing sums[4] or by contending for their own indemnities to take priority.
The decision in Equity Trust may make the retirement (or removal) and appointment of trustees more involved than before. This position is made more complicated still by the looming difficulties of Guardian Trust, to which we now turn.
GUARDIAN TRUST
The principle alighted upon by Lord Romer in Guardian Trust was given without authority, but is now considered to be an integral part of English law.[5] He held as follows at p. 127 of the report:
“[…] if a trustee or other person in a fiduciary capacity has received notice that a fund in his possession is, or may be, claimed by A, he will be liable to A if he deals with the fund in disregard of that notice should the claim subsequently prove to be well founded.”
In short, a trustee will be held personally liable if it distributes assets when on notice of third-party proprietary claims. The importance of this to the present paper is clear. Armed with their unquestionably proprietary claims over the assets of their former trusts, a retired trustee may seek to pursue their successor trustees personally if such assets are distributed inconsistently with their claims.[6]
This is important not just in England and Wales, but across most of the key common law jurisdictions. By way of non-exhaustive example, the Guardian Trust principle has been upheld in Jersey,[7] Guernsey,[8] Canada,[9] and, recently, was upheld and discussed in some detail in the Cayman Islands.[10] There is no reason to believe it will be resiled from in any common law jurisdictions not mentioned here. Indeed, even in jurisdictions such as Jersey and Guernsey where trustees enjoy favourable statutes which appear generally to exonerate them from personal liability,[11] it has been acknowledged –– in Equity Trust no less –– that personal liability may still arise where the successor trustee “threatens to distribute or otherwise diminish the trust fund in a way which would impact upon its effectiveness”.[12] This is identical to the Guardian Trust liability, suggesting it may still bite even on these jurisdictions with additional statutory protection for trustees.
The strictures of the Guardian Trust principle when combined with the recent decision in Equity Trust will, we suggest, have real consequences with which the courts will need to grapple in the future.
For example, in particularly illiquid or embattled trusts, a new trustee may immediately need to cease distributions and hold the assets of the trust on the footing that they are entirely subject to proprietary claims from former trustees. Or where the liabilities are indeterminate but potentially enormous[13]. This is likely to be of real controversy and to put a new trustee in a very difficult position as regards its beneficiaries. Indeed, one can easily envisage a situation where the problem compounds itself: disgruntled beneficiaries may seek the replacement of the trustee, but (i) the trustee may arguably fall under a duty not to allow the Guardian Trust principle to be circumvented by transferring assets to a more unscrupulous successor; and (ii) in any event, the retiring trustee will then seek to recover its own indemnity.
Furthermore, trustees will be considerably more wary of administering trusts when such a situation occurs (or even is likely to occur). They are likely to have to take into account the proprietary interests of the former trustees when administering the trust. Keen to avoid personal liability, we consider it likely that cautious trustees may have to resort to the courts for directions and approvals before acting. Indeed, this course of action was positively suggested in Equity Trust.[14]
POSSIBLE SAFEGUARDS FOR TRUSTEES
We have set out above the potential difficulties faced by trustees in the post-Equity Trust world, particularly when coupled with strict principles like the Guardian Trust principle. Trustees will need to be considerably more circumspect when retiring or being appointed, and we are of the opinion that trust administration will become more onerous as a result of the Privy Council’s decision.
Trustees are not without hope, however. In suitable cases, there may be means by which trustees can safeguard themselves against proprietary claims.
First, as we have already suggested, much will come down to the specific provisions of the deeds of appointment and retirement executed by retiring trustees and their successors. There is no reason in principle why inventive solutions cannot be negotiated, such as prioritising one trustee’s indemnity, or ringfencing a particular pot of money. Likewise, successor trustees are advised to scrutinise carefully the accounts of any new trust they propose to be appointed to. But how easy it may be to glean the financial position of the trust and any difficulties likely to arise with respect to former trustees and trust creditors will depend on the quality of the financial records kept.
Second, recourse to the courts is possible. Without seeking to ‘cancel’ the proprietary interests of former trustees, it may nonetheless be possible to flush out claims and allow administration to proceed at least on a temporary or limited basis. For example, as Re X and Y Trusts –– the Cayman case cited supra –– demonstrated, the court has the jurisdiction to permit trustees to distribute notwithstanding potential proprietary claims.[15] In that case, a trustee was permitted to pay its own fees and expenses notwithstanding the possibility of substantial (but as yet unarticulated) proprietary claims to the trust assets. This type of application will be useful where claims have been vaguely intimated or suggested but not formally brought, for example in relation to third party creditors. Likewise, it is suggested that trustees could make use of the jurisdiction to apply for a ‘put up or shut up’ order,[16] although again this is more likely to be useful in respect of creditors of the trust, or former trustees who (perhaps unusually) have dragged their heels on seeking reimbursement under their indemnity.
As can be seen from the above, former trustees pose a particular problem: in view of Equity Trust, it is very unlikely the courts will abrogate or restrict their indemnity in any way, and it has to be assumed that most trustees will avail themselves of their indemnity promptly. In the absence of any specific statutory provisions which could assist, it may be that specifically negotiated provisions in the relevant instruments of appointment or retirement are the only way to provide comfort for a successor trustee.
CONCLUSION
We hope to have illustrated the effects of the Equity Trust case, in that it opens up incoming trustees to a new class of proprietary claim which is often exceptionally difficult to defend against. In so doing, we have drawn attention to the specific problems of the Equity Trust decision when taken alongside the Guardian Trust case. Trustees of illiquid and insolvent trusts may now find themselves exposed to personal liability if they distribute to beneficiaries, but may also be put under pressure from those beneficiaries for the same reason. Careful management is required to prevent complex and costly litigation arising.
[1] But both were governed by Jersey law.
[2] In certain circumstances, a creditor can be subrogated to the trustee’s right of indemnity and the trustee’s proprietary interest over the trust assets, and thus seek to recover in that way.
[3] In jurisdictions where this is possible.
[4] As Equity Trust acknowledged had happened in Jersey
[5] Lewin on Trusts, 20th edn., [24-030]
[6] See also Equity Trust at [262], per Lord Briggs JSC, where it was suggested that this would amount to a breach of trust, albeit without discussing the Guardian Trust case
[7] Sinel Trust v Rothfield Investments [2003] JCA 048; [2003] WTLR 593; Re BNP Paribas [2010] JRC 199
[8] Investec Trust (Guernsey) Ltd v Glenalla Properties Ltd (2014) GLR 371 –– NB this is the very judgment which, on appeal to the Privy Council, became Equity Trust.
[9] Yanke v Fenske [1959] 21 DLR (2d) 419 (Sask CA)
[10] Re X Trust and Y Trust (FSD, unreported, 7 November 2022), building on Re Saad Investments Co. Ltd. [2019 2 CILR 828]
[11] See discussion in J. Harvey-Hills and J. Wessels, “Insolvent trusts: the Privy Council decides” (2023) 2 PCB 81, 93
[12] Equity Trust at [244], per Lord Briggs JSC
[13] X v A [2000] 1 All ER 490 (environmental clean-up costs under the Environmental Protection Act 1990)
[14] Equity Trust at [301], per Lady Arden JSC
[15] Along the principles set out by David Richards J (as he then was) in Re MF Global UK Ltd (No. 3) [2013] 1 WLR 3874
[16] As suggested in J. de Lacey and N. Herrett, “Guardian Trust revisited” (2023) 29(2) T&T 143-157
