Trustee Protection

Simon Taube – 10 Old Square, Lincoln’s Inn
(taken from Isssue No 12 –  July 2000)

 

This is the text of the address given to the joint STEP(London Central and City branches) and TACT meeting held on 18th April 2000 at The Insurance Institute of London, Aldermanbury.

Introduction

The title of this lecture is `Trustee Protection`. Being a trustee seems a dangerous and thankless task to most sane people. Members of STEP and TACT should be truly grateful that out there in the real world, and even among our own members, there are heroic figures who are willing to put their heads above the parapet and let themselves be shot out as trustees. Our job is to protect them. Trustees need protection from potential attacks from all quarters: from their settlors and beneficiaries; from creditors; from those to whom they owe obligations under statutes or in tort; from the Inland Revenue; and perhaps from themselves.

In this lecture I want to focus on four topics which are relevant to trustees in relation to their own protection:-

  • a trustee’s right of indemnity out of the trust fund and his ancillary lien;
  • a trustee’s right to be personally indemnified by his beneficiaries;
  • the covenants which trustees routinely seek when they retire from a trust; and
  • the role of the court when asked to approve a transaction into which a trustee is proposing to enter.

The first three topics concern the protection of trustees from claims by strangers to the trust, such as creditors and the Inland Revenue, rather than claims by the beneficiaries. Trustees’ covenants are the subject of a recent consultation paper published by a working party of the Trust Law Committee. I hope that at the end of my lecture there will be time for a debate about the issues raised by the Trust Law Committee’s paper, and this may inspire some of you to respond to that paper by writing to the Committee.

My reason for looking briefly at the role of the court, if time permits, is that in a recent unreported case the court has clarified how it approaches applications for directions.

  1. Indemnity out of the trust fund and lien

To most trust practitioners the general outline of the law in this area will be familiar. Under English law a trustee is not generally permitted to receive remuneration for acting as a trustee. But he is entitled to be reimbursed and indemnified out of the trust fund in respect of all expenses and liabilities properly incurred by him as trustee.

  • Re Exhall Coal Co. (1866) 35 Beav. 449 (a trustee who is entitled to reimbursement for expenses or liabilities incurred in the administration of the trust has a first charge on the fund; and he cannot be compelled to surrender the trust property to the beneficiaries until his claims on the fund have been satisfied).
  • In re Blundell (1888) 40 Ch. D. 370, 376 (a trustee’s right of exoneration out of the trust fund exists as soon as the trustee is liable and before actual payment by him).
  • Re Pumfrey (1882) 22 CILD. 255 (a trustee who borrowed money from the plaintiff bank to purchase trust land was entitled to a lien on the trust property and an order for sale of the land, and the bank could stand in the trustee’s shoes).
  • Darke v. Williamson (1858) 25 Beav. 622 (a trustee lent money to trustees to enable a chapel to be rebuilt; after the trustee’s death his personal representatives were held to be entitled to a lien or charge in equity upon the trust property for the amount of the advance – although not an immediate order for sale, because that would defeat the purpose of the trust – and custody of the title deeds pending any sale)

The latter case incidentally indicates that a trustee’s lien is not merely possessory (contrary to the obiter dicta of Walton J. in Stephenson v. Barclays Bank [197511 MR 882). The trustee’s right of indemnity confers on the trustee a proprietary interest in the trust fund which has priority over the interests of the beneficiaries. The right of indemnity survives the trustee’s loss of office. This was confirmed in two recent Australian cases: see Commrs. of Stamp Duties v. Buckle (1998) 72 MAR 242 and Mansfield, J. in Rothmore Farm Pty Ltd. v. Belgravia Pty Ltd (1999) 4 June 1999. The fact that the trustee has a proprietary interest in the trust fund has important implications both for retiring trustees and for beneficiaries who receive distributions. (1 will discuss this further in the context of covenants for retiring trustees.)

In X. v. A and others [20001 1 All ER 490 Arden J. held that the trustee’s right of indemnity extended to possible future liabilities. The beneficiaries, even though they were absolutely entitled to the capital in equity, could not compel the trustee to distribute the trust fund to them so long as there remained the possibility that the trustee would need to satisfy its right of indemnity out of the fund.

In X v. A the testator died in the 1970s. He left his estate by will to X as trustee. Under the trust his widow was entitled to the income during her life. After her death in 1994 the capital belonged to their three children A, B and C absolutely. During the lives of the testator and his widow the testator’s land had been used first as a sandpit and later as a rubbish tip filled under the statutory supervision of the local authority. By the time of the widows death it was apparent that the rubbish tip might cause serious environmental hazards. The trustee had taken steps to mitigate the problems caused by the rubbish. But those steps required preventive action to continue for a decade or more. Additionally, there was a risk that in future the trustee might be liable to carry out further remediation works to the land under Part IIA Environmental Protection Act 1990. At the date of the hearing Part IIA was not yet in force. So it was uncertain whether the trustee would be liable to the statutory body responsible for enforcing Part IIA or to neighbouring landowners.

The beneficiaries claimed that X’s refusal to distribute the capital to them after the widow’s death was a breach of trust. Relying on Re Pauling’s Settlement. (No. 2) [1963]l All ER 857, Arden J. held that the trustee was entitled to exercise its lien over the trust funds and to retain the funds while the potential liabilities remained a threat.

The interesting feature of the case is that Arden J. also made important directions about the future administration of the trust funds by the trustee while it continued to exercise its lien. She held that the administrative powers of the trustee contained in the testator’s will continued to apply. Those powers included the trustee’s power of investment and its power to charge remuneration for acting as trustee. The trustee’s lien arose by operation of law. It was as if the trustee’s right to retain the funds was written into the trust instrument. So the trustee’s administrative powers applied during the period of the lien’s operation too.

Moreover, Arden J. held that the trustee was entitled to take into account its own interests, as well as the beneficiaries, in deciding how to invest the trust funds during the operation of the lien. The trustee would naturally wish the funds to be invested so as to ensure that there were liquid funds to discharge their liabilities. Provided the trustee acted fairly in reaching its investment decisions, it was not bound to comply with the wishes of the beneficiaries about investments.

Where trustees act in the administration of trust land or a trust business they may be exposed to long-lasting and expensive environmental liabilities. Common examples are mines or landfill sites. It is now difficult to obtain insurance against longtail liabilities. Even if the beneficiaries offer the trustees personal covenants of indemnity, in order to encourage the trustees to distribute the trust funds, there may be doubts about the solvency of the proposed covenantor when the liability matures many years in the future. So in many cases nowadays the trustees may have no alternative but to retain the trust funds in exercise of their lien.

  1. Trustee’s right to personal indemnity from the beneficiaries.

So far I have concentrated on the trustee’s right of indemnity out of the trust fund. But what if the trust fund proves inadequate to reimburse the trustee for the liabilities properly incurred by him? For example, imagine that the trustee has incurred environmental liabilities in managing the trust land and it is now worthless because of those liabilities. Alternatively, take a case where the trustee has already distributed the trust fund to the beneficiaries; at the time of distribution the trustee was ignorant of a potential liability hanging over him; then that liability crystallizes. Has the trustee a right to be indemnified by the beneficiaries personally?

The leading English case is Hardoon v. Belilios [1901] AC 118. A was the registered proprietor of shares in a company. The shares were not wholly paid up. A held the shares on a bare trust for R. This was not the result of any personal dealings between A and R. R was not a settlor or A’s principal. But the situation was akin to a nominee arrangement. When the company went into liquidation A was liable to answer a call for payment on the shares. The Privy Council held that R was bound to indemnify A personally.

`The plainest principles of justice require that the cestui que trustwho gets all the benefit of the property should bear all its burden unless he can show some good reason why the trustee should bear them himself … Even where trust property is settled on tenants for life and children, the rights of their trustee to be indemnified out of the whole trust estate against any liabilities arising out of any part of it is clear…where the only cestui que trust is a person sui juris, the right of the trustee to indemnity by him against liabilities incurred by the trustee by his retention of the trust property has never been limited to the trust property; it extends further, and imposes upon the cestui que trust a personal obligation enforceable to indemnify his trustee. This is no new principle, but is as old as trusts themselves.`

The Privy Council added (at p. 127)

`It is quite unnecessary to consider in this case the difficulties which would arise if these shares were held by [A] on trust for tenants for life, or for infants, or upon special trusts limiting the right of indemnity. In those cases there is no beneficiary who can be justly expected or required personally to indemnify the trustee against the whole of the burdens incident to his legal ownership; and the trustee accepts the trust knowing that under such circumstances and in the absence of special contract his right of indemnity can not extend beyond the trust estate, i.e. beyond the respective interests of hiscestuis que trustent.`

In Hardoon v. Belilios the Privy Council held that in a case where a trustee seeks indemnity from his beneficiary against liabilities arising from the mere fact of ownership it was irrelevant that the beneficiary had not requested the trustee to incur the liability. It was enough that R had never disclaimed the ownership of the shares. At any time R could have called for a transfer of the shares.

But why should the trustee not be able to claim a personal indemnity from the beneficiaries where the settlor has created successive interests in favour of X for life with remainder to Y? If X and Y are jointly absolutely entitled to the trust property as against the trustee and they have enjoyed the income and capital of the trust property, the underlying rationale of Hardoon v. Belilios appears to apply equally to X and Y. Of course, it may be right to limit the trustee’s right of indemnity against a life tenant, so it is commensurate with the extent of the life tenant’s interest under the trust.

In this context it is important to analyse why a trustee is entitled to a personal right of indemnity in various different categories of cases. There are a variety of potential explanations.

  • In some cases the personal obligation of the beneficiary to indemnify the trustee against a liability flows from a request by the beneficiary to the trustee to incur a liability. In Jervis v. Wolferstan (1874) LR 18 Eq. 18, 24Jessel M.R. said: `1 take it to be a general rule that where persons accept a trust at the request of another, and that other is a cestui que trust, he is personally liable to indemnify the trustees for any loss accruing in the execution of the trust`. (A similar principle applies where the trustee commits a breach of trust at the request of his beneficiary, and the trustee has a right to impound the interest of the beneficiary.)
  • But a more fundamental explanation of the beneficiary’s personal liability is that offered in Hardoon v. BeIilios : the beneficiary who enjoys all the benefits of the trust property ought to bear the burdens too.

Neither of these explanations of the beneficiary’s personal. liability to indemnify the trustee will help the trustee if the beneficiaries include minors, unborns or others who have not been in a position to decide whether or not to accept or disclaim the benefits of the trust (see p. 127 in Hardoon v. Belilios). But where the beneficiaries have not rejected the benefits of the trust, the dicta in Hardoon v. Belilios (cited above) ought to be capable of extension to cases where not all the beneficiaries are absolutely entitled as against the trustees.

In modern Australian cases the courts have recognised that the personal right of indemnity of the trustee against his beneficiaries is based on principles of unjust enrichment and this may enable the right to be extended.

In J.W. Broomhead (Vic) Pty Ltd v. J.W. Broomhead Pty Ltd [19851 VR 891 there was a trading unit trust. The defendants formed a company to trade as trustee and to pay the net income to the defendants in accordance with the number of units they owned under the trust. It was held that each of the defendants must personally indemnify the trustee, even though some had declared sub-trusts of their interests. Each defendants liability was limited to his proportionate interest in income. McGarvie J, echoing the words of Lord Lindley in Hardoon v. Belilios,said:

`The basis of the principle is that the beneficiary who gets the benefit of the trust should bear its burdens unless he can show some good reasons why the trustee should bear the burdens himself’.`

In Balkin v. Peck (1998) 43 NSWLR 706 the Court of Appeal linked the underlying principle to the equitable doctrine of contribution and to principles of unjust enrichment. [Well-known applications of the doctrine of contribution are found in the law relating to joint contractors and to joint sureties. For example (a) a surety has an equitable right to reimbursement from the principal debtor if the surety has to pay the debt due to the creditor which the surety has guaranteed; and (b) if the principal debt is guaranteed by two sureties and one surety pays more than his proportionate share of the guaranteed liability may recover contribution from his co-surety. These principles apply even if each of the two sureties guarantee the principal debt in ignorance of the other.]

In Balkin v. Peck (1998) a settlor settled a house in London on trustees. The trustees held the house on trust for the settlor’s sister for life, with remainder to the settlor’s three children absolutely. The sister died in 1986. The trustees distributed the funds to the three children, but they overlooked the fact that there was a charge to CTT when the sister died. Later the CTO demanded CTT from the trustees. Two of the three children refused to provide funds to the trustees to pay the CTT, so the trustees had to pay two thirds of it themselves. They then sought to recover the CTT paid by them from the two children.

The trustees did not base their claim upon the principles relating to money paid under a mistake. Instead, they argued that since their payment of CTT had been properly made in response to a lawful demand and since it related to the trust, the trustees had a right of personal indemnity from the appellants.

The NSW Court of Appeal decided that the trustees had a personal right of indemnity against the beneficiaries. They relied on Hardoon v. Belilios. But they left open the question whether the position might have been different if there were beneficiaries who were not adult or who only had a limited interest in the trust property. The Court of Appeal said it was no answer to the trustees’ claim that they could, or even should, have recouped the liability for CTT out of the trust property while it was still in their hands. The circumstances raised no equity against the trustees, such as change of position.

I do not think the courts have yet explored fully the extent of a trustee’s personal right to be indemnified by his beneficiaries. This may be an interesting growth area in the future.

  1. Retiring Trustees – Trust Law Committee’s Consultation Paper.

Where a trustee retires he will often wish to receive covenants of indemnity from his successors. The purpose of such covenants is usually to indemnify the retiring trustee against obligations and liabilities incurred by him as trustee, e.g. under contract or for tax.

One of the reasons why the retiring trustee (T1) will seek a personal covenant of indemnity from the continuing trustee (T2) is because of the legal uncertainty about the retiring trustee’s rights of indemnity out of the trust assets once he has lost possession of the trust fund. As I have indicated above, Australian authority indicates that the retiring trustee will retain a proprietary interest in the fund, so long as he is entitled to be indemnified out of the fund. But his proprietary lien may turn out to be worthless. The retiring trustee may be unable to enforce the equitable right against the successor trustee in the jurisdiction where the successor resides. Or the successor may have distributed the funds to the beneficiaries. Under the general law, in the absence of any express obligations, can the retired trustee (T1) recover from a beneficiary trust property which the successor trustee (T2) has distributed to him? This appears to be an unresolved question. It highlights the risk confronting the retiring trustee.

The negotiation of covenants of indemnity for retiring trustees often involves considerable complexity. Frequently it is time-consuming and and expensive. In the most common form of covenant the successor trustee (T2) will be obliged to indemnify the retiring trustee (T1), not against all liabilities, but only in respect of liabilities the retiring trustee would have a right to reimburse himself out of the trust fund if he had continued as trustee. The liability of the successor trustee will be limited to the value of the trust fund in his hands when he is notified of the retiring trustee’s claim. But, in order to protect the retiring trustee against the possibility that the continuing trustee will transfer funds out of his hands, the limitation of the liability of the continuing trustee will not operate if he fails to procure that any transferee from him gives the retiring trustee an equivalent covenant of indemnity.

One of the objects of the consultation paper from the Trust Law Committee’s working party was to try to identify whether the costs of this sort of covenanting could be avoided. The consultation paper sought to ascertain what the law was. In some respects it could not be said to be settled. The consultation paper then proposed the following statutory reforms:

(1) The law should declare (or confirm) that a retiring trustee should automatically continue to have an equitable non-possessory lien when he transfers the trust fund to his successor, and this would bind successive trustees.

(2) Where a trustee transfers funds out of the settlement, whether to a beneficiary absolutely or to the trustees of a new settlement, the law would prohibit any equitable lien arising in favour of the transferring trustee.

(3)    To the extent that a retired trustee can not exploit his lien to obtain reimbursement for properly incurred liabilities out of the trust fund from a successor trustee, the retiring trustee should have a new statutory right of indemnity. In such case the retired trustee (T1) would have a statutory right to be indemnified personally by any person (`the distributee`) to whom a distribution of the trust funds has been made. To obtain such a right the retiring trustee would have to serve on the distributee a statutory notice informing him of such potential liability. The distributee could be a beneficiary or a trustee. A distributee would only escape liability in respect of such distribution to the extent that he had distributed the property to a donee to whom the distributee had given a similar statutory notice, and so on.

(4) The law would also seek to promote fairness as between the beneficiaries, distributees and donees in any case where the retired trustee sought to recover from distributees or donees because he could not recover under his lien.. In such a case any beneficiary against whom trustee proceeded could seek contribution from other beneficiaries and donees. The aim would be to ensure that the liability of the trustee was borne by the beneficiaries proportionately to what they had received from the trust fund.

Personally, I find the second proposal unattractive. Is it right for Parliament to take away a trustee’s existing right to rely on his lien as against a distributee? In practice, the new machinerty for statutory notices may not work so very differently from the existing practice, where the retiring trustee takes a covenant from a distributee. Although, it would be helpful to clarify the law, there appears to be a danger that the existing rights of trustees may be reduced.

  1. Trustee’s application to the court

Where a trustee is contemplating taking a step in the execution of the trusts he may, after taking legal advice, be worried that his decision will be attacked by the beneficiaries. It is not always possible to obtain the consent of all the beneficiaries. In such circumstances the trustee may seek to protect himself in a variety of ways.

First, he may seek the advice of counsel. That may be appropriate in a case which depends on a question of law, but not where the question for the trustee depends on commercial or other non-legal factors. Counsel’s advice, moreover, is not always complete protection for the trustee. A trustee who relies on counsel’s advice may still be debarred from recovering out of the trust fund an expense incurred in reliance on that advice (see Re Beddoe [1893] 1 Ch 547) or liable for breach of trust.

Alternatively, the trustee may apply to the court for guidance. Where a trustee applies to the court for guidance there are broadly three different types of application.

(1) The issue in the application may be whether some proposed action is within the trustees’s powers. This is usually a question of legal interpretation decided in open court.

(2) The issue may instead be whether the proposed course of action is a proper exercise of the trustee’s powers. In this type of case it may be clear as a matter of law that an appropriate power exists which authorises the proposed act and the trustee may have decided that it wishes to carry out the proposed act. But the act may be of a kind which is momentous or controversial or opposed by some of the beneficiaries. A good example of such a case might be a decision to sell the trustee’s controlling holding of shares in a family company or a settled estate. As a matter of prudence the trustee applies to the court for its blessing of the proposal, but the trustee does not formally surrender its discretion to the court.

(3) The trustee may surrender its discretion to the court and leave it to the court to decide what to do. The court will only accept the surrender of the court’s discretion for a good reason. Examples of such reasons are if the trustee is disabled by a conflict of interest or the trustees are deadlocked.

Obiter dicta in the opinion of Lord Oliver in the Privy Council in Marley v. Mutual Merchant Bank and Trust Co. Ltd. [1991] 3 All ER 198, 201 have caused some confusion in this area;

`there has always to be borne in mind the position and duties of a trustee who applies to the court for directions. A trustee who is in genuine doubt about the propriety of any contemplated course of action in the exercise of his fiduciary duties and discretions is always entitled to seek proper professional advice and, if so advised, to protect his position by seeking the guidance of the court. If, however, he seeks the approval of the court to an exercise of his discretion and thus surrenders his discretion to the court, he is always to bear in mind that it is of the highest importance that the court should be put into possession of all the material necessary to enable that discretion to be exercised.`

This passage, in particular the underlined words, appears to treat the second and third types of case as identical. In other words, where a trustee applies to the court for approval of a transaction, this is in substance the same as a surrender of the trustee’s discretion to the court.

If this were right it would have important practical implications. Where the trustee surrenders his discretion, the court will need evidence on all the matters which a properly informed trustee would require before he could make a fiduciary decision, and the court will then reach its own conclusions. Were it correct that, where a trustee applies to the court for its approval of a decision already taken by the trustee, the trustee is surrendering its discretion to the court, then the court could only approve the trustee’s decision if the court itself would have reached the same conclusion. On the other hand, until the Marley case it was widely assumed by Chancery practitioners that a trustee, who seeks the court’s approval of his decision., only needs to show that his decision is one which a reasonable trustee could reach.

In the unreported recent case of Public Trustee v. Cooper (1999) 20th DecemberHart J. held that the former assumption of Chancery practitioners was correct. So, if on an application for the court’s blessing of a proposed transaction the trustee is careful not to surrender his discretion to the court the decision will be tested by reference to whether or not it was within the range of what a reasonable trustee might decide.

Finally it is interesting to note the following point in relation to trustee’s applications to the court for guidance. One of the fundamental considerations, which underlies the practice in this area, appears to be based on hopelessly outdated 19th century assumptions. In Sharp v Lush (1879) 10 Ch. D. 468 Jessel MK held that a reference in a will to `executorship expenses` included the costs of an executor in taking legal advice and in legal proceedings for the administration of the estate. At p. 471 he said:

`It is very often cheaper to take the opinion of the court than even the opinion of counsel.`

A similar view is to be found in Re Beddoe [1893] 1 Ch. 547, 558. There Lindley L.J. refers to

`the ease and comparatively small expense with which the trustees can obtain the opinion of a judge of the Chancery Division on the question whether an action should be brought or defended at the expense of the trust estate`.

The assumption that a trustee can obtain the guidance of the court easily and cheaply may have been carried into s.61 Trustee Act 1925. Where a trustee commits a breach of trust s.61, the court may relieve him from liability if he

`has acted honestly and reasonably and ought fairly to be excused for the breach of trust and for omitting to obtain the directions of the court`.

In modern conditions, except in the simplest case, it is no longer true that trustees can obtain guidance from the court inexpensively. Anyone who has been involved in such an application, e.g. under Re Beddoe, will know that the legal costs will usually reach five figures and may end up much more. Trustees frequently come under pressure from their beneficiaries not to `waste` trust money on such applications.

I suggest that, in view of these changes, the courts ought to take a more realistic attitude to the question whether or not it was reasonable for a trustee to have taken a step, which a beneficiary later criticises, without the prior blessing of the court.

SIMON TAUBE Q.C.
10 Old Square, Lincoln’s Inn