A trust does not have legal personality and therefore cannot
technically be labelled 'insolvent' or as having creditors.
However, the use of 'insolvent' and 'creditors of a
trust' has become more common place in the context of trusts
particularly in instances where liabilities exceed the liquid trust
assets that the trustees have available to meet the immediate
financial liabilities of the trust.
In general terms, trustees utilise trust assets to compensate
trust creditors, as and when the debts arise. Trust assets can
include a wide range of items such as shares, cash, a discretionary
investment portfolio, real estate and highly valued art. When there
are no longer any liquid assets to use to cover the trust's
debts then inevitably the trustees must consider disposing of fixed
assets in order to satisfy the trust's debts so as to avoid
creditors seeking to commence legal action.
In the instance of insolvency, trustees can be faced with
various conflicts and obstacles. As examples:
The trustees may be trust creditors
too, as they are entitled to remuneration for their services;
There will most likely need to be
some balancing of potentially conflicting interests from multiple
parties such as creditors, beneficiaries, protectors and the
In the case of the settlor, he may
have specified in a letter of wishes (or in the trust instrument)
that certain trust assets are not to be sold. Of course, when trust
assets are no longer liquid, and creditors are requesting payment
then trustees may be forced to consider selling such valuable and
cherished assets in order to settle the outstanding debts; and
With regard to the trust instrument,
the trustees should always check the document to ensure that there
are no restrictions and they have the unambiguous powers they
require in order to deal with the trust fund and creditors, as they
Recent case law
A recent case in Jersey involved eight trusts (referred to as
the "Z-Trusts"), which were all settled by one
individual. Two of the Z Trusts were considered insolvent whilst
the remaining trusts were in some financial difficulty. The matter
was made more complex by the settlor and her family being creditors
of certain trusts, complicated inter trust arrangements and four
professional trustee companies being represented either as present
or former trustees. One of the trustees applied to the Royal Court
of Jersey for directions, which established two important
principles when dealing with an insolvent trust. 1
The first principle is the 'cash flow' test, which
should be applied in order to establish whether or not a trust is
insolvent. The question to be answered is - do the trustees have
sufficient liquid assets available in order to cover the immediate
financial liabilities? If they do not, then the trust is considered
to be insolvent.
As you will have understood, this cash-flow test is similar to
the test applied in respect of companies and individuals who are
facing financial difficulties.
The second principle is if the trust fails the cash flow test
then the trustees are no longer required to act for the benefit of
the beneficiaries, but rather must act in the interests of all the
creditors, as a class. This may of course lead to decisions that
the beneficiaries do not agree with, however, the Court has
confirmed that their claims are outweighed by the established
claims of the creditors.
It is crucial that trustees are skilled at navigating the
financial affairs of a trust to ensure that financial obligations
can be satisfied as they fall due.
If a trustee considers that a trust may be 'insolvent',
meaning it fails to satisfy the cash flow test, then the trustee
would be well advised to work with all the creditors, exercising
their powers fairly and with the support of such creditors or
failing which in accordance with directions provided by the
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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