Cayman Islands: Risk Management For Trustees: Practical Lessons From Recent Cases About Providing Security For The Outgoing Trustee´s Indemnity And No-Contest Clauses

Last Updated: 3 October 2007
Article by Sara Collins

Most trustees understandably want nothing to do with litigation. The experience of making or defending a hostile claim is usually bad for business and certainly counterproductive to good relations between all of the parties involved in administering a trust, or who have an interest in the assets held on trust. One of the key selling points of the Cayman Islands as the jurisdiction of choice for the settlement of private and commercial trusts has been the consideration by the courts here in recent years of some of the risk management tools which are commonly employed in order to avoid precisely this type of situation.

Judicial guidance has also emerged recently in the form of 2 landmark decisions in complex areas of law which had previously been largely uncharted territory. For this reason, there has been a great deal of healthy interest in the jurisdiction as private client advisers throughout the world deliver the message to their clients that in Cayman they will be in safe hands. The widely held view that Cayman has a proven track record for developing case law with significant practical implications for the use and efficiency of the Cayman Islands trust, is one of reasons the popularity of the jurisdiction and its reputation for leading the field.

This article will focus on two recent decisions of the Chief Justice which provide examples of practical strategies for mitigating or avoiding the identified risks: ATC (Cayman) Limited v Rothschild Trust Cayman Limited [2006] dealing with an incoming trustee’s power to undertake to reserve a portion of the trust fund to indemnify outgoing trustees and AN v Barclays Private Bank and Trust Company Limited [2006] dealing with the validity of no-contest/forfeiture provisions in discretionary trusts.

Securing Indemnities

In ATC V Rothschild, ATC succeeded Rothschild as trustee of two Cayman Islands trusts and sought directions whether it had power to, and could, undertake to retain a certain amount of money in the trust fund for a specified period of time in order to meet any claims on Rothschild’s indemnity (calculated by reference to what ATC believed to be a reasonable pre-estimate of Rothschild’s potential liabilities). The question which arose was whether this would be an impermissible fetter on ATC’s discretionary powers of appointment as ATC essentially bound itself not to appoint or distribute that amount to beneficiaries for the specified period of time.

The principle that a trustee cannot fetter its discretion found earlier expression by way of elucidation in the decision of the Chief Justice in Re T Trust in 2000, which confirmed: "the fundamental principle that it is not given to trustees to seek to fetter in any way the manner in which they or their successors might exercise powers of appointment in the future. Trustees must be free to take all circumstances into account and to act accordingly at the date they actually do exercise that power".

In this case, a specific clause in the trust deed gave the trustee power to enter into an indemnity in favour of any former trustee and, in the exercise of its absolute discretion, to apply the whole or part of the trust fund or the income thereof "by way of mortgage, pledge or otherwise, as security for such indemnity". The Chief Justice held that the rule against a trustee fettering its discretion could be excluded or restricted by an express provision in the trust deed, so that this clause relaxed the principle by conferring on ATC express power to do what it had in mind. He described his view as "one which I think accords with the modern realities of trust administration addressing the kind of eventuality properly anticipated by the draftsman…as likely to arise and to be provided for in the often complex management and administration of valuable trusts".

No Contest Clauses

In practice, the inclusion of "no-contest" provisions in Cayman trusts has been rare, but this may change in the light of AN v Barclays Private Bank and Trust Company Limited , in which the Chief Justice ruled on the validity of such a clause. There were two trusts under consideration, but the relevant clause (clause 23) in each was the same and stated as follows: "Whoever contests the validity of this deed and the Trust created under it, of the provisions of any conveyance of property by any person or persons to the Trustee to form and be held as part of the Trust Fund and of the decisions of the Trustee and/or of the Protection Committee shall cease to be a Beneficiary of any of these Trusts and shall be excluded from any benefits direct or indirect deriving from the Trust Fund"

The beneficiary sought to challenge certain decisions of the Trustee and sought a declaration that the no-contest clauses were invalid in order to allow her to proceed to obtain the orders sought. The Chief Justice was ultimately satisfied that "construed as intended to conform with the decided cases, [the clause] can be validated so as to eliminate any concerns about uncertainty, repugnancy or ouster of the jurisdiction of the Courts".

The Chief Justice took a purposive approach to construction of the clause, concluding that it "must be read by implication as allowing not only such contests which are successful; but also contests which are justifiable, in the sense of being taken bona fide, not frivolously or vexatiously, or with probabilis causa litigandi". The clause was therefore saved by the implied insertion of the word "unjustifiably" before the word "contests", described by the Chief Justice as "the implied term of justification", so that the opening phrase was as follows: Whoever unjustifiably contests….". The effect of this construction was to leave unclear for the time being the operation of the clause in the circumstances of the particular case, as it would have to be subsequently determined whether the particular challenges were "justifiable" or not.

In this case, the validity of the trust was not under attack but the question was whether the beneficiary had "contested" the Trustee's decisions in such a way as to trigger the forfeiture. The central issue was therefore to what extent the scope for such challenges could be proscribed in accordance with the settlor's intentions without cutting away the root of a trust, namely the irreducible core of obligations owed by the Trustee to the beneficiaries as a whole. A situation in which trustees could not be controlled by the court in any way in the exercise of fiduciary powers would clearly be unsatisfactory.

The Chief Justice was persuaded by the argument that: "… Clause 23 does not deprive a beneficiary of the right to sue in court….[It] has no application to a claim by a beneficiary to sue the trustee in respect of the Trustee's fraud or bad faith. Further, if the beneficiary's claim on any other ground is successful (alternatively brought bona fide and with probabilis causa litigandi) clause 23 will not apply". Thus, even if the challenge is ultimately unsuccessful, clauses of this nature would not cut out a beneficiary who had made a claim justifiably, in good faith and with "probable cause". Inclusion of such clauses, in the light of the judgment, should ensure that beneficiaries must be conscious of the threshold of "justification" before embarking on challenges to the trust or decisions of the trustees.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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