The Royal Court of Jersey has recently held that the claims of both former and new trustees of an insolvent Jersey trust, arising under their respective indemnities and equitable liens, rank pari passu.
In Re Z Trusts  JRC 119, the latest instalment in the ongoing Z Trust litigation, the Royal Court was asked to determine the nature of the equitable rights of a former trustee and whether those rights take priority over the other claimants to the assets of an insolvent trust.
The questions before the Court arose as a result of the original trustee (the Original Trustee) having sought to rely on the contractual indemnities afforded to it upon its retirement - several years after having signed the Deed of Retirement and Appointment, the Original Trustee sought to claim reimbursement of £18million that it had incurred as a result of having settled proceedings that had been brought in England as against the former directors of a company within the trust structure. The former directors were employees of the Original Trustee and had thus been supplied by them. An allegation of vicarious liability was also made against the Original Trustee, in addition to a claim that it acted as a de facto and / or shadow director of the underlying company during the relevant period.
As the trust was insolvent (that is to say, that the assets held on trust by the trustee were insufficient to meet the claims to those assets), the issue of priority was of great importance to the Original Trustee - had it been the priority creditor, it would have recovered all of the Trust's assets (assessed as being in the region of £6million), a far less significant shortfall than the £330,000 that it would recover were it required to share the assets of the trust pari passu with the other creditors.
Article 32 of the Trusts (Jersey) Law 1984 (as amended) (the Trusts Law) enshrines in statute a trustee's liability to third parties and, importantly, makes a distinction between those parties who know that they are dealing with a trustee in its capacity as trustee and those who do not. Article 32(1)(a) of the Trusts Law protects a trustee from personal liability where a party knows that they are dealing with a trustee in its capacity as trustee - in such circumstances, any claim that a creditor may have will only extend to the trust property. Conversely, pursuant to Article 32(1)(b) of the Trusts Law, if the other party does not know that the trustee is acting as trustee, any claim may be made against the trustee personally (albeit that the trustee will still have a right of recourse to the trust property by way of an indemnity).
That a trustee is entitled to be indemnified from the trust fund in respect of liabilities (whether existing, future, contingent or otherwise), costs and expenses reasonably incurred by it in connection with its trusteeship was not in dispute. It was accepted by all parties that this right to indemnification gives rise to an equitable lien in favour of the trustee, which takes priority over the interests of the beneficiaries of the trust; however, the Court held that such an equitable lien did not arise out of the relationship between a former trustee and its successors and as such, the Original Trustee had no greater claim to the trust assets than its successors. The Court acknowledged that it would be difficult for any successor trustee to accept that, in the event of the insolvency of the trust at some stage in the future, all and any liabilities that it had properly incurred in connection with the administration of the trust would rank behind those of the former trustee(s), essentially allowing its predecessors to "scoop the pot" - both were involved in the due administration of the trust and one has no better right to be indemnified than the other.
In determining the nature and extent of the a trustee's right of indemnity and associated equitable lien, the Royal Court considered what the position would have been prior to the introduction of the Trusts Law, specifically, Article 32, and noted that previously, creditors would have sued a trustee personally. In circumstances where the trustee was insolvent, trust creditors would have had the right to apply to be subrogated for the trustee, and stand in its place and enforce their claims against the trust assets to the extent that the trustee would be so entitled. If the trust assets were insufficient, the Court noted that it seemed that the claims of creditors would have ranked pari passu.
The Court held that there are good reasons for the claims of trust creditors to rank pari passu, not least because creating a temporal rule of priority between trust creditors would not be conducive to the good administration of trusts - it would be unfair for some creditors to be paid in full and for others not to be paid at all. The Court described Article 32 of the Trusts Law as an "innovation" to the pre-existing legislative regime, which introduced a legal distinction as between a trustee acting personally and a trustee acting as a fiduciary - provided that a party to any transaction or matter knows that the trustee is acting as a trustee, the trustee is afforded protection from personal liability. Article 32 does not operate so as prejudice Article 32(1)(a) creditors and afford a trustee priority over the trust assets for its personal liability to an Article 32(1)(b) creditor.
The Court's decision in this case seeks to establish a fair and practical solution for all those dealing with insolvent trusts.
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