The Judicial Committee of the Privy Council has handed down its long-awaited judgment in the joined cases of Equity Trust (Jersey) Ltd v Halabi and ITG Ltd and others v Fort Trustees Ltd, each focusing on the nature of a former trustee's right of indemnity against trust assets, and how a former trustee's right of indemnity ranks alongside the equivalent rights of successor trustees in the context of a so-called “insolvent” trust. Both cases (the latter being the most recent of the proceedings concerning the Tchenguiz Discretionary Trust) were consolidated and heard together by the Privy Council in June 2021, having been appealed from the appellate courts of Jersey and Guernsey respectively.
In summary, the Privy Council held that:
(i) a trustee's right of indemnity confers a proprietary interest in the trust property in favour of the trustee;
(ii) this proprietary interest survives the transfer of the trust assets to a successor trustee;
(iii) a former trustee's proprietary interest in the trust assets does not take priority over the equivalent interests of successor trustees – they rank pari passu if the trust fund is insufficient to pay all the sums against which they are entitled to be indemnified; and
(iv) a trustee's indemnity does extend to the costs of proving its claim against the trust where the trust is insolvent.
Trustee's Right of Indemnity
A trustee's right of indemnity for debts it incurs as trustee is well established in English law (and is typically confirmed in specific legislation in other jurisdictions – in the case of Jersey, the Trusts (Jersey) Law 1984). However, the circumstances of the cases required the Privy Council to consider how such an indemnity could be exercised where the trust assets were insufficient to meet the competing claims of successive trustees and the trust is therefore “insolvent”.
An ‘insolvent' trust?
What is an insolvent trust? Self-evidently, it is one where there are insufficient assets to pay creditors. However, a trust is not a legal person or entity in itself, in the way that a company is. Instead, it is a set of rights and responsibilities imposed on the trustee who is the legal person or entity who holds the assets. It is the trustee who is responsible for paying creditors, because it is the trustee which is the person against whom the payment of debts can be enforced. The creditors are therefore the trustee's creditors, rather than the trust's. For this reason, to talk of an “insolvent trust” is a misnomer, albeit convenient shorthand, as the Jersey court observed in earlier judgments connected with the Equity Trust case.
As a matter of English law, the insolvency of a trust matters mainly to the trustee, not the creditor. That is because, although the trustee has a right of indemnity in respect of any payment it makes, the trustee itself remains liable for 100% of the debt to its creditor, even where incurred as trustee, irrespective of whether or not there are sufficient assets in the trust to pay that debt in full. However, Jersey law – as do Guernsey and BVI law – contains statutory provisions to limit a trustee's liability. Essentially, these provisions provide that where the creditor knows it is dealing with a trustee, the trustee's liability to that creditor is limited to the extent of trust assets. In these circumstances, the insolvency of the trust matters less to the trustee but rather more to the creditor, because it is the creditor, not the trustee, which faces the shortfall.
On the question of how the rights of indemnity of successive trustee rank between each other in the context of an “insolvent” trust, the majority (the Board split 4:3 on the issue) held that a distribution of assets on a pari passu basis ought to be the general rule of priority, subject only to the claims of subrogation creditors. Such a determination was said, by Lord Briggs, to be in the interests of “justice, fairness, equity and common sense.”
Lord Briggs, giving the lead judgment for the majority, considered whether applying the first-in-time maxim in an insolvency context would run contrary to the interests of justice and equity as a whole. In deciding this question in the affirmative, he held that while the pari passu rule may not work in every situation, it must be the starting point when considering the indemnification of loyal fiduciaries, since competition between them for unequal shares of an inadequate fund would be incompatible with their joint pursuit of a common cause.
Lady Arden agreed and elaborated on this finding, stating that the well-established first-in-time maxim applicable to equitable interests should not apply to successive trustees where such interests arose out of a right of indemnity pertaining to an identical trust.
Prejudice to Creditors
Lord Briggs was quick to emphasise the importance of creditor expectations in circumstances where a trust has become insolvent. Such uncertainty, he said, would be avoided by having trustees rank pari passu together with all other unsecured creditors. A first-in-time rule would, on the contrary, expose trust creditors to uncertainty and defeat their natural expectation that all trust creditors should share pari passu the consequences of an inadequate fund.
Lady Arden agreed, and emphasised that the application of the first-in-time maxim would unnecessarily prejudice creditors by leading to unnecessary delay in determining claims and distributing assets. The first-in-time maxim, she said, will “disrupt trust administration and diminish the utility of the trust concept. The priority which trustees have for expenses is as against the beneficiaries, and not as against each other.”
Such guidance will no doubt be welcomed by those engaging in commercial arrangements with trustees (in their capacity as trustees of a particular trust) and seeking certainty as to their position should an insolvency event arise.
Practical Considerations for Trustees
The Privy Council decision is clearly one of great significance for Jersey law. However, it is clear that it will also have great significance in other common law jurisdictions, in particular those of the BVI and Guernsey, as well as those such as Bermuda and Cayman where the Privy Council acts as the jurisdiction's final court of appeal.
Indeed, the Privy Council expressly acknowledged that the question of trustee priority was “not covered by any binding or even persuasive authority, anywhere in the common law world, so that (albeit strictly only for the purposes of the law of Jersey) the Board is called upon to decide it for the first time.” It then went on to approach the question on the assumption that Jersey law is the same as English law unless there is a reason to displace that assumption – and none of their Lordships identified any such reason to do so.
Trustees generally, and in particular those of Jersey, Guernsey, Bermuda, BVI and Cayman law trusts will need to be careful to ensure (as far as possible) that the applicable indemnity provisions in the trust instrument and any instrument of retirement and appointment are appropriately drafted, and that they can be properly indemnified from the trust assets if there are competing claims. In Equity Trust, for example, the priority issue before the Privy Council arose because of contingent liabilities which only became apparent after the transfer of trusteeship from the original to the successor trustee. With this in mind, while outgoing trustees already seek indemnity and security for known liabilities, they may wish to increase the indemnity provided or security to allow for such contingencies.
Indeed, Lord Briggs expressly left open the question of whether his general rule of pari passu distribution could be displaced in a particular case, such as by express provision to the contrary in the trust instrument. This is certainly a point for trustees to consider when taking on an appointment, either as first trustee or as a successor trustee.
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.