Bust Trusts – Court of Appeal Declares Principles of Trustee Liability

Guernsey’s Court of Appeal has declared, for the first time, the meaning and effect of the key provision in Jersey’s law concerning the liabilities of trustees to third parties to the trust in Investec Trust (Guernsey) Limited & Ors V Glenalla Properties Ltd & Ors. 41/2014

Background Facts

The proceedings concerned the administration of the Tchenguiz Discretionary Trust (the TDT).  The Investec were the previous trustees of the TDT who had been succeeded by Bayeux (the current trustees).

The TDT was a jersey law trust constituted in March 2007. While in office the previous trustees entered into deeds of novation, assuming the liability for sums owed to four BVI companies owned by the trust. The loans were unsecured, repayable on demand and interest free. Importantly to the outcome of the case, they were also undocumented in any kind of formal written agreement. The four BVI companies were put into liquidation and the liquidator called in the loans under the deeds of novation.

At first instance the Guernsey Royal Court found that the former trustees were liable under the loans but were not permitted to rely on Art 32 of the Trust (jersey) Law 1984 so as to limit their liability to the extent of the trust assets.  (See earlier blog post).

The previous trustee’s appealed.  The Court of Appeal gave judgment on 27 June 2012 reversing the finding at first instance; the trustees could rely upon Art 32 as a matter of private international law.  The second half of the appeal concerned the meaning and effect of Art 32 and its relationship to Art 26(2) in order that its consequences can be applied to such sums as were found to be due by the former trustees to the BVI companies

Art 32              Trustees’ Liabilities to Third Parties

(1) Where a trustee is a party to any transaction or matter affecting the trust –

(a) If the other party knows that the trustee is acting as trustee, any claim by the other party shall be against the trustee as trustee and shall extend only to the trust property;

(b) If the other parties does not know that the trustee is acting as trustee, any claim by the other party may be made against the trustee personally (though, without prejudice to his or her personal liability, the trustee shall have a right of recourse to the trust property by way of indemnity).

(2) Paragraph (1) shall not affect any liability the trustee may have for breach of trust”.

Art 26(2) is a statutory expression of the common law position that a trustee is entitled to a full indemnity for all costs and expenses reasonable incurred in its administration of the trust.

Art 26(2)        A trustee may reimburse himself or herself out of the trust for or pay out of the trust all expenses and liabilities reasonably incurred in connection with the trust.

What does Art 32 Mean?

Before going on to discuss the Court of Appeal’s findings, it is worth familiarising ourselves with the trust orthodoxy in England and Wales:

  • A trust is not a legal personality from the trustee. A trustee contracts as principal and not as agent on behalf of the beneficiaries.
  • As a matter of English law a trustee is personally liable on his contracts with third parties.
  • A trustee is entitled to indemnification out of the trust assets to satisfy his personal liability to a third party.
  • A third party who obtains judgment against a trustee is entitled to be subrogated to the trustee’s right of indemnity against the trust assets.
  • A trustee is not entitled to be indemnified from the trust fund if he is breach of duty of duty unless he makes good his default.

All parties accepted that the factual matrix in the appeal fell within Art 32(1)a in that the BVI companies knew that they loaned money to the previous trustee as trustee.  It is sufficient for Art 32 to be engage that the third party knows the trustee is acting as trustee – by whatever means.  It is unclear for these purposes whether ‘knows’ for these purposes includes notice or constructive notice.  It is not a requirement that the third party must be satisfied or have made inquiry that the trustee has authority to contract with it (i.e. to establish whether the trustee is putting itself in default so as to deprive itself of its right of indemnity (on the basis of the orthodox position)).

Although it wasn’t necessary to determine the appeal, the Court held that Art 32(1)b applies in a situation where the trustee does not know that the trustee is contracting as trustee, again this is a question of fact.  It is unclear whether Art 32(1)b can be relied upon where the surrounding circumstances suggest a party can be taken or deemed to know a trustee is contracting qua trustee.  It seems arguable that Art 32(1)b could apply to a situation in which the third party knows he is transacting with a trustee who does not have power to contract as such.

The effect of Art 32(1)a is that while a trustee contracts as principal, the liability owed to a third party cannot be satisfied from the personal assets of the trustee and is capped at the extent of the trust assets.  The personal liability of the trustee to satisfy the from its own assets claim is excluded.  The mechanism by which the trustee has recourse to the trust assets to satisfy the third party claim is via his indemnity under Art 26(2).  Strictly one cannot be indemnified by the trust fund if one has incurred no personal liability to be indemnified for.  The term indemnity is used in English law because the trustee always remains personally liable.  The continued use of the word ‘indemnity’ in Jersey, if this decision is to be followed, may need to be reviewed

What Art 32(1)a amounts to is a statutory equivalent to an express statutory restriction in the contract between the third party and the trustee.

The critical time at which the obligation on the trustee to expend the trust assets in satisfaction of the third party’s claim arises is – somewhat imprecisely – at the time the claim falls to be satisfied.  That must be taken to mean the date of enforcement and not the earlier time that had been postulated in argument, the date when the liability was assumed.

Where, as in Investec, a former trustee is sued by a third party with whom it had contracted while trustee, after it has relinquished office to a new trustee, the former trustee has a right to be indemnified by a subsequent trustee out of and up to the full extent of the trust assets as they stand at the time of the claim.

The former trustee’s right is characterised as being in the nature of an equitable non-possessory lien –  a proprietary equitable floating charge over the trust property as constituted from time to time.  The existence of such a right was tentatively hinted at by Birt DB in Re Esteem Settlement 2002 JLR 53.  If this is correct, it is a significant innovation.  Historically Jersey has not recognised the concept of a floating charge as a form of security interest – for trustees or any other security holder.  Jersey has recently restated its law of security in Security Interests (Jersey) Law 2012 which expressly states it does not apply to a lien arising by operation of law.  It is presumably this gap in the law into which the trustee’s right slots.

Art 32(1)a does not confer on the third party any direct right of recourse against the trust fund as a body of assets independent of the trustee.  Any claim under 32(1)a must be made against and through the trustee.  This had been argued but did not succeed.  Had it done so it would have meant a fundamental restatement as to the nature of a trust in the Channel Islands, thankfully that precipice has been avoided.

Art  32 creates, what as a matter of English orthodoxy is a heresy: an insolvent trust, shifting the risk concerning the trustee’s indemnity from the trustee to the third party.  As a matter of English orthodoxy the trustee is personally liable for the liabilities of the trust to the full extent of his assets.  If the trustee was in default of duty so as to preclude reliance on the indemnity, the trustee would have to satisfy any third party claim from his own assets.  Art 32(1)a has the effect of capping the trustee’s personal liability to the third party at zero. If the trust’s assets are insufficient to meet the claim the third party creditor has no mechanism to obtain recovery from the trustee for the shortfall.

Art 32(1)b operates in a similar fashion but in the first instance, the ignorance of the third party as to the capacity in which the trustee contracts means that the trustee is personally liable to the full extent of his assets.  A trustee in such a position is still able to rely upon his indemnity from the trust fund provided there are sufficient trust assets.  Where the issue as to the trustee’s liability in default to the beneficiaries is still at large Art 32(1)b significantly alters the orthodox position concerning a trustee’s right to indemnify himself from the trust fund.

The relationship between Arts 32(1)a and (1)b and Art 32(2)

The Court of Appeal found that 32(1) and 32(2) are to be read and applied disjunctively.  A beneficiary with a claim alleging a breach of trust is not in the same position as a third party creditor to the trustee and is not limited in its claim against the trustee to the value of the trust assets.

Where Art 32(1)a and (2) are both engaged, a claim against the trustee by a third party can be satisfied from the trust fund up to the value of the trust assets irrespective of whether the trustee is liable to the beneficiary for breach of trust.

Where Art 32(1)b and (2) are both engaged and the trustee has incurred liability to the third party in breach of duty or is otherwise alleged to be in breach of trust, the trustee is still entitled to have his indemnity satisfied in order to meet the third party’s claim.  In other words, a third party who contracts with a trustee not, knowing him to be a trustee, is entitled to satisfaction of its claim via the trustee’s indemnity so long as there are trust assets, irrespective of whether the trustee, in contracting with the third party, has done so in breach of trust.

Together therefore Art 32(1)a and (1)b represent a significant departure from the orthodox position for both trustees and creditors.  The law of Jersey, so far as the Court of Appeal in Guernsey is concerned no long follows the position as declared by Jessel MR in In Re Johnson [1880] 15 Ch D 370.  If this is correct the principles in the Jersey decision of the Jersey Court of Appeal in Re Bamford [2003] JCA 048 (that a trustee who deals with trust property in disregard of what is prima facie a reasonable claim) has been rendered irrelevant.

It may yet be significant that the trustee’s right to be indemnified irrespective of the position vis a vis the account with the beneficiaries seems to apply only to an alleged rather than proven breach of trust claim.

The Effect of this Judgment

This is the first definitive exploration of the meaning and effect of Art 32.  However, as this is a decision of the Guernsey Court of Appeal it is not binding, only persuasive, in Jersey – who’s trust law – Art 32 forms part.  By agreement, the parties to the appeal agreed to dispense with any formal process of calling expert evidence of foreign law.  Instead the Court was formally asked to construe Art 32 as if it were construing a Guernsey statute. Incidentally Guernsey has a similar provision to Art 32 in its own trust law.

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