Trustee accountability, liability and indemnities

As discussed in our second Brief Counsel in this series, the new beneficiary information obligations in the Act will assist beneficiaries greatly in this area.

The Act also contains new provisions that will make it easier for beneficiaries to question trustee decisions in court.

This is likely to result in more trustees being held liable to beneficiaries for their actions (and inactions) and is consistent with the stated aims of the trust reform process – to make the law of trusts more accessible, to strengthen and clarify beneficiaries’ rights and to lift the standard of trusteeship generally.

The Act largely confirms and restates the existing law on trustee liability, including the extent to which trustees may be excused from liability for trustee breach of trust and trustee indemnification for liability from trust assets. However there is one significant change. The Act prohibits trust deeds from limiting liability for, and indemnifying trustees against, a new category of breach of trust, termed ‘gross negligence’, other than in very limited circumstances.  

Trustee accountability

New provisions of the Act enable a beneficiary to apply to court to have a trustee’s act, omission or decision (including a proposed act, omission, or decision) reviewed on the ground that the act, omission or decision was not or is not reasonably open to the trustee in the circumstances.  

The beneficiary must produce evidence that raises a genuine and substantial dispute that this is the case. The burden then passes to the trustee to establish that the act, omission or decision was or is reasonably open to the trustee in the circumstances. The court is to make its decision based on the balance of probabilities. Arguably this process around burden of proof tips the balance of success in favour of the beneficiary.

Where the court finds in favour of the beneficiary the court may:

• set aside the act or decision, or direct the trustee to act in the case of an omission
• restrain the trustee from acting or deciding to act in the case of a proposed act or decision, and direct the trustee to act in the case of a proposed omission, or
• make any other orders that the court considers necessary.

The orders the court can make must not affect:

• a valid distribution of the trust property that was made before the trustee had notice of the application, or
• any right or title acquired by a person in good faith and for value.

Trustee liability and the general right to indemnity

Section 81 of the Act confirms the well-established principle that trustees are personally liable for all and any expenses, losses or other liabilities incurred by the trust fund.

However there are a number of circumstances that permit the trustee to claim reimbursement from trust funds:

• if the expense or liability is incurred reasonably on behalf of the trust, the trustee may be reimbursed from trust property or may pay the expense or discharge the liability directly from trust property
• the trust deed may exclude or limit trustee liability even for losses incurred through actions or omissions that amount to a breach of trust provided the breaches are not caused by the trustee’s dishonesty, wilful misconduct or gross negligence, or
• the trust deed may indemnify the trustee against such costs and losses, again unless they were caused by the trustee’s dishonesty, wilful misconduct or gross negligence.

Gross negligence

Gross negligence is a new concept in trust law introduced by the Act. There is no definition of what would amount to gross negligence in the Act, but some guidance is given by section 44.

This section applies to guide the court when deciding whether a trustee has been ‘grossly negligent’.

A court must consider whether, having regard to the factors listed below, the conduct was so unreasonable that no reasonable trustee in that trustee’s position and in the same circumstances would have considered the conduct to be in accordance with the role and duties of a trustee. The factors are:

• the circumstances, nature and seriousness of the breach of trust
• the trustee’s knowledge and intentions relating to the breach of trust
• the trustee’s skills and knowledge that are relevant to the role of trustee
• the purpose for which the trustee was appointed
• any other circumstances, including whether the trustee has been remunerated for the role, or characteristics of the trustee that are relevant to the role of trustee
• the type of trust, including, without limitation, the degree to which the trust is part of a commercial arrangement, the assets held by the trust, how the assets are used, and how the trust operates
• the purpose of the trust, including, without limitation, what the trust is intended to achieve, and whom the trust is intended to benefit and in what ways, and
• any other factor the court considers relevant.

Until some decisions start coming through the courts we can only speculate where the line will be drawn in applying this test. The intention however is very clearly to impose higher standards of care on trustees and assist beneficiaries in holding the trustees to these standards. One must hope that the line is not drawn so clearly on the side of beneficiaries that trustees become reluctant to take on the significant responsibilities of trusteeship and a new level of personal risk.

Indemnification with agreement of beneficiaries

There is one exception to the new general rule on gross negligence that does allow a trustee who has been found to be grossly negligent to rely on an indemnity clause. This is where the trustee has the agreement of all the beneficiaries of the trust and the specific requirements of section 82 are met.

Section 82 provides that a trustee may be indemnified from the trust property for a breach of trust if all the beneficiaries who together hold all of the beneficial interest in the trust property agree and the following conditions are satisfied:

• every beneficiary consents to the indemnification
• the beneficiaries receive independent legal advice before consenting to the indemnification, and
• if any beneficiary lacks capacity (for example the beneficiary is a child or not yet born), the court has made an order approving the indemnification on behalf of that beneficiary.

Creditor indemnity

So far in this Brief Counsel we have focused on trustees’ personal liability and beneficiaries’ rights to bring claims against trustees and how trustees can claim reimbursement and indemnity from the trust fund to satisfy those claims.

Also relevant in the context of a trustee’s personal liability are claims made against a trustee by a third party creditor. This is a complicated and somewhat uncertain area of trust law, particularly in relation to the interaction between trust law and insolvency law. The Act does not make significant changes to the law in this area. Creditors’ claims generally still lie against the trustees themselves, consistent with the trustees’ personal liability, rather than against the trust fund directly. However one change has been made concerning creditors’ rights in relation to trustee indemnities.

Section 86 provides that if a trustee incurs an expense or liability to a creditor and certain requirements are met, the creditor’s claim may be satisfied by the creditor being indemnified from the trust property as if the creditor were in the position of a trustee with the right of indemnity. The requirements are either:

• that the trustee has the right of indemnity, or
• if the trustee has lost the right to indemnity or full indemnity (for example through a breach of trust), but:
  • the creditor has given value
  • the trust received a benefit from the transaction, and
  • the creditor acted in good faith.

The amount of the claim is limited to the benefit received by the trust fund plus interest and must be paid in priority over any payment to a beneficiary unless a court orders otherwise, but does not alter the priority of creditors who may be entitled to claim from the trust fund.

For specialist advice on any matter raised in this Brief Counsel, please contact a member of the Private Client team.