Trusts and insolvency
Earlier this year, in June, the partners of Carey Olsen, the Channel Island law firm, and barristers from the well-known Chancery set, Wilberforce Chambers, presented a joint seminar in Jersey and Guernsey dealing with trusts and insolvency. The purpose was to discuss problems that arise in practice when trusts or their underlying investments are affected by the current economic conditions, or where the trust or even the trustee becomes insolvent, and to make suggestions as to how those problems might best be resolved in practice. The event also contained some analysis of recent case law in Jersey relevant to the issues being addressed. The topics covered fell into four distinct areas, each with a different emphasis, and the purpose of this article is to summarise the main points that emerged, and to highlight (where significant) any differences between Channel Island and English law in the context of trusts and insolvency.
Investment strategy in a declining market
Clearly a worldwide economic downturn will cause most trustees at least to review their investment strategy. But the issue is wider than one of review, being whether there is any different meaning to be attached to the word ‘prudence’ when the worldwide economy is in recession. The answer is that whatever the conditions, what is or is not prudent will remain essentially the same. So, even in a recession, the familiar Re Whiteley (1886) 33 ChD 347 (CA), 12 App Cas 727 (HL) standard continues to apply, subject to the modern prudent investor rule in the post-Markowitz era. What will change, however, is the approach to determining the balance between risk and return, where issues such as the move from equities to bonds, and concerns about hedge funds, bring asset allocation and diversification to the forefront of a trustee’s mind.
Of course, another result of a downturn is that trustees become fearful of claims for underperformance. But such claims are hard to make out, not least because trustees are not judged by reference to hindsight, and because many claims will fall within the scope of an exoneration or indemnity clause in the trust deed. In comparing English, and Jersey and Guernsey law, however, one point is that potentially, trustees in the Channel Islands are likely to find it more difficult to rely upon exoneration provisions in the trust instrument than if they were dealing with trusts governed by English law. The reason for this is that the terms of Jersey and Guernsey law trusts cannot relieve trustees from liability for gross negligence or worse,1 whereas in England, all liability, other than for actual fraud or dishonesty, is exonerable.2 That said, while professional trustees are assessed by a higher standard than their lay counterparts,3 few trustees are now actively involved in choosing investments, preferring instead to delegate that function to properly selected investment managers, with whom they agree investment principles and over whom they retain a supervisory role. Provided such managers are properly appointed and supervised, in Jersey and Guernsey, statute provides that the trustee will not be liable for their default.4
Any trustee liability is therefore likely to be limited to administrative (or supervisory) failure, so unless a beneficiary can point to a breakdown in the administrative process, or flaw in the investment strategy, and one so serious that the trustee cannot rely on the exoneration clause, the beneficiary is unlikely to succeed.
Issues affecting trusts with underlying companies
Many trusts own holding or trading companies. Where insolvency affects those entities, the issue becomes to what extent is the trustee liable? It is well established that Re Lucking’s Will Trusts  1 WLR 866 (Lucking) and Bartlett require something more than information about an underlying company, but more interesting is whether the rule against ‘reflective loss’ will deny beneficiaries a claim against the trustee where an underlying company loses value.
The recent decision of the Jersey Royal Court in Ansbacher v Freeman  JRC 003 indicated5 that the ‘defence’ of reflective loss was unavailable to trustees in that situation. Reflective loss is a rule of public policy preventing a shareholder from recovering a loss from a defendant, D, that was properly a loss suffered by the company, and where the company would make good its loss if it enforced its rights against D.6 In the context of trusts it can be seen that if a beneficiary sues a trustee for breach of its duty to supervise the underlying company, the argument will arise that if the resulting loss is to the value of the company, only the company can sue to recover that loss. However, it is only in the paradigm case where the trustee is also a director of the underlying company (as in Lucking), that reflective loss is applicable. In that instance, the company may sue the trustee director to recover its loss, so to allow the beneficiary to sue the trustee would be to allow double recovery. By contrast in Bartlett, where no trustees were directors, reflective loss has no application, as there could be no reflective loss barring the claim. Ansbacher v Freeman was a case of the Bartlett type, so because the underlying company had no claim against the trustee at all, there could never have been any question of reflective loss barring the claim. In other words, only in the very limited circumstances where the trading company has a claim against its directors for which the corporate trustee was somehow vicariously liable,7 can any issue of reflective loss arise.
More generally, there is the question of the extent to which the trustee is bound to involve itself in the affairs of an underlying company – Bartlett has been referred to already. But more difficult is whether, as shareholder, a trustee is under any positive duty to place the company into administration or liquidation, if it is approaching insolvency. Whilst no authority suggests the Bartlett duty goes that far, if the only reasonable way to protect or preserve the trust assets is to have an insolvency practitioner appointed, then that is what the trustee should do. But once an underlying company is insolvent, the trustee has the difficult problem that its duties as director will cease, but as trustee will not. So it still needs to protect the trust fund, albeit by working with the insolvency practitioner. Steps that could be taken to ensure that control is not lost would include monitoring the practitioner’s conduct or even securing a place on a creditor committee.
Insolvency of the trustee
It is not only issues affecting the trust’s administration that bear scrutiny in a downturn, as the trustee itself, whether individual or corporate, could become insolvent. When that happens, the first point is whether the trustee should (or must) vacate office. Strangely, the general8 rule is that insolvency does not automatically mean the trustee must cease to act,9 although in both Jersey and Guernsey, the regulatory capitalisation requirements will probably mean any corporate trustee will be unable to continue, and the terms of the trust may in any event require the trustee to cease acting. In practice, however, even where vacation of office is not the consequence, most insolvent trustees should think very seriously about doing anything other than resigning.
One tricky problem that can arise where a trustee becomes insolvent, is who is left to do the job of trustee, even if only to resign. Usually, to a lesser or greater degree, the powers of the directors of a corporate trustee will pass to the liquidator, and administrators may exercise powers to the extent they might save the company from proceeding into liquidation. But liquidators will rarely think administering a trust is in the interests of the company’s creditors, and administrators will be reluctant to act as trustee or even consent to others doing so on any long-term basis. So inevitable conflicts arise, and in cases (as in administration) where the directors do retain some powers, care must be exercised to minimise potential loss to company creditors, while also acting as a diligent trustee.
Finally, there are difficult rules that apply to determine whether creditors of the trustee can even access trust (as opposed to the trustee’s own) funds to get paid. One might have thought not, as the trustee has a clear duty to separate its own money from the trust fund. But given the right of indemnity in respect of expenses reasonably incurred is a personal asset of the trustee,10 any ‘trust creditor'11 of the trustee, can exercise a right of subrogation to the trustee’s right of indemnity and get paid that way.12 One limitation on that right, however, is that if the trustee has no right of indemnity in respect of the debt, the creditor has no right of subrogation.13 That is often seen as a disadvantage under English law, as is the second limitation, which is that a trustee must first discharge any prior indebtedness of its own to the trust before exercising its right of indemnity.14 What creditors cannot do under English law is to levy execution direct against the trust fund,15 whether by the exercise of a personal or proprietary right.
Proprietary claims against the trust assets
While that may be the English position, the provisions in Guernsey and Jersey,16 which say that third parties dealing with trustees in the knowledge that they are so doing, have a claim that extends only to the trust property, may alter the position, as on one interpretation this appears to be a proprietary claim.17 This may be an improvement on English law, as for some time now, steps have been proposed to clarify the extent of trustees’ liabilities under contracts and encourage third parties to contract with them by giving a right of recourse against the trust property other than by subrogation.18 However, there is still uncertainty in the Channel Islands as to the mechanism by which the third party claim would be enforced, and about other matters, such as the rules’ application to foreign law contracts, and when exactly the trust fund is valued for the purposes of quantifying the assets available to meet the third party’s claim. If one thinks of proprietary claims against trust assets, or even personal claims based upon rights of subrogation, the possibility of an insolvent trust becomes real if the liabilities exceed the assets. There are some difficult issues of priority to work out here, such as whether any ‘unsecured’ trust creditors rank pari passu or first in time,19 and there seems very little law on this. But we can be sure that if creditors are given rights of direct recourse, the strain on trust assets will become greater, especially if they are vulnerable to claims from those traditionally limited to a personal claim against the trustee, as well as to the more familiar assaults such as sham, Quistclose or tracing-type remedies, or transactions defrauding creditors.
- 1. under Article 30(10) of the Trusts (Jersey) Law, 1984 (as amended) (“TJL”) and section 39(8) of the Trusts (Guernsey) Law 2007 (“TGL”).
- 2. Armitage v Nurse  Ch 241.
- 3. Bartlett v Barclays Trust Co Ltd  Ch 515.
- 4. Article 25(3) of TJL and section 33(3) of TGL.
- 5. the case involved a strike out application, so the matter was not full argued.
- 6. Johnson v Gore Wood & Co  2 AC 1 @ 35-6; 61-2.
- 7. e.g. if those directors were employees of the trustee.
- 8. in Jersey, any trustee ‘en désastre’ must resign to avoid the commission of a criminal offence.
- 9. Re Barker’s Trusts (1875) 1 ChD 43.
- 10. Jennings v Mather  1 KB 108.
- 11. not a personal creditor, as the trustee has no right to reimburse personal debts out of trust assets.
- 12. Re Johnson (1880) 15 ChD 548.
- 13. Re Johnson (supra) @ 552-53.
- 14. Smith v Dale (1881) ChD 516 @ 518.
- 15. Re Morgan (1881) 18 ChD 93 @ 100-101.
- 16. Article 32 of TJL and section 42 of TGL.
- 17. section 42(1) of TGL says the trustee incurs no personal liability where the creditor knows it is dealing with a trustee.
- 18. 1997 Paper “Rights of Creditors Against Trustees and Trust Funds”, para 4.4, a proposal not taken up in the following 1999 Report of the Trust Law Committee.
- 19. Re Suco Gold Pty (1983) 33 SASR 99 may suggest the former.
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