The Effectiveness of Trustee Exemption Clauses

Ian Hammond
(taken from Isssue No 4 – December 1997)

 

The extent to which trustees may limit their liability for negligence, dishonesty or fraud is an issue which has been the subject of much recent debate.

1 Midland Bank Trustees (Jersey) Limited -v- Federated Pensions Services Limited[1996] Pensions Law Reports 179

(a)    Background

Federated was the sole trustee of a pension scheme for nursing staff in Jersey, the rules of which contained the following exclusion:

`The trustee shall be indemnified against all liabilities incurred by it in the execution of the trusts hereof and the management and administration of the scheme and shall have a lien on the fund for such indemnity and shall not be liable for anything other than a breach of trust knowingly and wilfully committed`.

The scheme fund had been invested for 20 years in group pension policies issued by the Jersey agency of the Royal National Pension Fund for Nurses. In June 1988, Federated, with the assent of the states of Jersey, decided to terminate the investment and gave notice accordingly.

A few months later, Federated decided to appoint Hambros as the new investment manager. However, when the time came to transfer the fund to Hambros, Federated declined to do so, on the basis that it required a signed customer agreement for the purposes of FSA compliance. Subsequently, when advised that it had no legal entitlement to delay the transfer of funds on this basis, Federated made the transfer. Hambros began to manage the investment of the funds in February 1989.

Federated resigned as trustee in 1990, subject to the proviso that it should retain the benefit of the exclusion clause.

Proceedings were issued, alleging that Federated had acted negligently and in breach of its duties as trustee, as a result of funds having remained uninvested while the stock market had risen sharply.

For the purposes of the Jersey Court of Appeal hearing, Federated accepted that they had acted negligently and in breach of trust in failing to transfer the fund on 31 December 1988. Accordingly, the only question was whether or not Federated could rely on the exclusion clause.

(b)    Analysis of the Law

The starting point was the Scottish case of Seton -v- Dawson & Others [1841] 4 D 310, in which the exclusion clause provided that the trustees `should not be liable for omissions, or negligence of diligence of any kind…`.

There, the majority expressed the view that:-

`The general principle of our law is that neither the clause which occurs in this particular deed, nor any of the usual clauses framed for the same object, can be held to liberate trustees from the consequences of [gross negligence].

In Seton, the trustees were found to have been grossly negligent, and hence were liable. The basis of the decision in Seton was considered by the House of lords in Knox -v- Mackinnon [1888] 13 App Cas 753. There, Lord Watson held:-

`…it is settled in the law of Scotland that… a clause [of this nature] is ineffectual to protect a trustee against the consequences of gross negligence on his part, or of any conduct which is inconsistent with bona fides. I think it is equally clear that the clause will afford no protection to trustees who…act in plain violation of the duty which they owe to the [beneficiaries]. I agree with the opinion expressed in Seton to the effect that `clauses of this kind do not protect against a positive breach of duty`.

In Clarke -v- Clarke’s Trustees [1895] SC 693, the Court of Session went so far as to say:-

`It is difficult to imagine that any clause of indemnity in a trust settlement could be capable of being construed to mean that the trustees might with impunity neglect to execute their duty as trustees, in other words, that they were licensed to perform their duty carelessly`.

On the face of it, these authorities suggest that attempts to exclude liability for gross negligence or breach of trust will always fail. However, the Jersey Court of Appeal were at pains to emphasise that, in their judgement, these decisions `cannot be taken to be expressing the view that no trustee could ever be permitted to exclude liability for negligence or gross negligence`. Rather it took the message of these cases to be that, `if trustees are not to be liable for the consequences of their negligence, then the exclusion of such liability must be clearly and unequivocally set out.`.

Other more recent authorities were all explained as having turned on the construction of the particular clause or (insofar as they relied on a rule of law against such clauses) to be wrong.

Finally, reference was made to the Law Commission’s 1992 consultation paper on Fiduciary Duties and Regulatory Rules. There, the Commission concluded that, under English Law, a trustee cannot exclude liability for fraud, bad faith or wilful default, and that this `probably` involved a prohibition on excluding liability for gross negligence. Again, however, the Jersey Court dealt with this by saying that it `doubted` that there was any rule of law to that effect and that, in its view, each case would turn on its facts.

I return to the issue of `wilful default`, as applied by the English Courts, below.

(c)    The Decision

The decision in the Midland Bank case turned to a large extent on the interpretation of the 1989 Jersey Trusts Law, which stated that:-

`Nothing in the terms of a trust shall relieve a trustee from liability for breach of trust arising from his own fraud, wilful misconduct or gross negligence`.

This provision came into force in July 1989, long after the relevant trust was established and after Federated had acted in alleged breach of that trust.

Broadly, the Jersey Court of Appeal concluded that:-

  • Subject to the 1989 Law, trustees could (on the basis of the reasoning outlined above) exclude liability for all their actions other than those involving fraud.
  • The 1989 Law was intended to operate retrospectively, save in circumstances where it would be `unfair` to those concerned.
  • There was. In the Court’s view, nothing `unfair` about preventing a trustee from taking advantage of immunity from liability for his gross negligence.
  • There was, on the facts of this case, gross negligence. The Court said that it was not mere negligence consisting of a departure from the normal standard of conduct of a paid professional trustee, but a serious, unusual and marked departure from the standard which, on the correct interpretation of the words, amounted to `gross negligence`.
  • Given the retrospective nature of the 1989 Law, the trustees could not place reliance on the exclusion.

The commentator in the Pensions Law Reports speculated as to whether or not the trustee would have been liable, on the same facts, if it had consented to the transfer to Hambros without a customer agreement being in place and the market had then fallen. Doubtless it would have been argued against them that, out of prudence, they should have demanded that this customer agreement be signed. Such is the professional liability lawyer’s gift of 20:20 hindsight.

2 The `Wilful Default` Debate

The 1989 Law does not, of course, apply in this country. The issue of trustee exclusion clauses has nonetheless been the subject of much recent attention.

Armitage -v- Nurse [1997] (unreported) was a case in which the exemption clause stated that trustees would not be liable for loss or damage to the trust fund or its income `unless such loss or damage shall be caused by the trustees’ own actual fraud`. Fraud, in this sense, effectively means dishonesty, ie either knowing something to have been wrong, or showing a reckless disregard as to whether it was wrong or right – Derry -v- Peek [1889] 14 AC 337.

The beneficiaries argued that the clause was contrary to public policy and therefore void. The Court’s view, however, was that, as matters stand, there is no restriction on trustees excluding liability for any conduct short of actual dishonesty. The clause therefore excluded liability for conduct causing loss or damage to the trust property, no matter how imprudent, lacking in diligence or negligent, provided that the trustees had the honest belief that they were acting in the interests of the beneficiaries.

Giving judgment in Armitage, Millett LJ commented:-

`…in the context of a trustee exclusion clause…[wilful default] means a deliberate breach of trust: Re Vickery [1931] 1 Ch 572. The decision has been criticized, but is in line with earlier authorities. Nothing less than conscious and wilful misconduct is sufficient`.

In other words, gross negligence (as was found in the Jersey Midland Bank case) would still be covered by the exclusion under English Law.

Subsequent to the decision in Armitage, the Law Commission has produced a further consultation paper on Trustees’ Powers and Duties, in which the standard of care required of trustees in choosing and supervising their agents was considered in great detail and various proposals were put forward for reform.

The Commission’s view was that, in order to cut through a lot of the confusion which has accumulated over the years concerning trustees’ duties of care in (a) the appointment and (b) the supervision of agents, the terms on which they are employed, and their supervision. They considered five possible standards of care and were broadly supportive of two:-

  • Conduct of an ordinary prudent man of business carrying out his own affairs.
  • Due care and skill, having regard to the nature, composition and purposes of the trust and the skills which the trustee possesses or ought, by reason of his business, to possess.

The Commission did not express a preference between these two options. The first is the traditional test for trustees’ duties of care and whilst on the face of it a fairly rigid test, has been modified by the Courts into something very close to the second test, ie a mixture of subjective and objective requirements. The best-known example of this Court-imposed flexibility s the decision in Bartlett -v- Barclays Bank Trust Co [1980] All ER 139 that:-

`…a higher duty of care is plainly due from someone like a trust corporation which carries on a specialist business of trust management. A trust corporation holds itself out as being above ordinary mortals. With a specialist staff of trained…managers…ready access to financial information and professional advice…the trust corporation holds itself out, quite rightly, as capable of providing an expertise which it would be unrealistic to expect from the ordinary prudent man who accepts…the burdens of trusteeship…`.

More importantly for the present purposes, the Commission accepted (contrary to the view which had been adopted in 1992) that `wilful default` under English Law had its Re Vickery meaning, ie that of conscious and wilful misconduct.

C Conclusions

But for the effect of the 1989 Jersey Law, the attempt by the trustees in the Midland Bank case to exclude liability for gross negligence would have been successful. As that legislation does not have any application in this country, such an attempt would still be successful here. Moreover, exclusions of liability for wilful default will continue to protect trustees from any categories of negligence, gross or otherwise.

It is therefore important to note that trustee exclusion clauses using the same wording may have different effects under Jersey and English law. In either event, the message from all these recent authorities is that exclusion clauses must be drafted with great care and kept under constant review to ensure their continued effectiveness. However, it should be of some reassurance to know that there are no policy reasons why such clauses should not, if properly worded, be upheld.

Where trustees stray beyond the boundaries of gross negligence and into actual dishonesty of fraud, then they can hardly expect to receive protection from the Courts and must face all the consequences of their actions.

For individual directors of trust companies whilst the HR and Others v JAPT and Others case will have sounded warning bells, numerous obstacles would have to be overcome in order to establish claims against them and my feeling is that, save in the most extreme cases, the floodgates against such claims are likely to remain largely closed for some time yet.

© Ian Hammond
Simmons & Simmons
November 1997