Priority
of claims to the assets of an “insolvent” trust[1]
Michael Birt
The
Jersey Court of Appeal recently reversed a decision of the Royal Court in Re Z II
Trust in relation to the priority of
claims to the assets of an insolvent trust. This article analyses the reasoning
of the Court of Appeal and asks some questions as to the practical and legal
consequences of the decision for trustees.
1 In In
re Z II Trust[2]
the question raised was whether, in the case of a trust the assets of which are
not sufficient to meet its liabilities, the creditors claiming through a former
trustee took priority over creditors claiming through a successor trustee. Clyde-Smith,
Commr held that they did not, and that all creditors
ranked pari passu. In a
judgment given on 28 June 2019, the Court of Appeal reversed that decision of
the Commissioner.[3]
2 Their decision was expressly given on
the basis that Jersey law on this issue is the same as English law and the case
may therefore be of interest to English lawyers as well as to lawyers in
offshore jurisdictions such as Jersey.
3 The make-up of the Court of Appeal was
of some interest. It consisted of John Martin QC, one of the leading English
chancery practitioners, who was therefore well placed to consider the position
under English law, Roy Logan Martin QC, a leading Scottish silk (who very sadly
died unexpectedly not long after the judgment was delivered),[4]
and Sir William Bailhache who was Bailiff of Jersey until October 2019.
4 The Z II Trust was a discretionary
trust governed by Jersey law. The former trustee, Equity Trust Ltd
(“Equity Trust”), had retired in favour of Volaw
Trustees Ltd (“Volaw”) in October 2008. Volaw had in turn retired in favour of the current trustee,
Rawlinson & Hunter Trustees SA (“Rawlinson & Hunter”). The trust
was found to be insolvent, in the sense that its liabilities exceeded its
assets, in October 2015. In December 2015—and therefore long after its
retirement—Equity Trust became liable for and paid out of its own
resources a total of £18m in settlement of a claim. It was assumed for
the purposes of the hearing that this was a properly incurred liability for
which Equity Trust could seek reimbursement out of the trust assets. However,
whether this was in fact so remains for determination when the matter comes to
trial.
5 Equity Trust sought reimbursement of
the £18m from Rawlinson & Hunter as trustee of the Z II Trust, and
the matter which came before the Royal Court was a preliminary issue of law as
to the priority between different creditors. Equity Trust argued that its claim
took priority over the claims of the other creditors (who, it would seem, were
all claiming through one or other of the successor trustees) and that it should
therefore recover all of the assets of the trust, which were some £6m. Conversely,
one of the other creditors (the estate of the settlor) argued that all the
debts should rank pari passu, with
the result that Equity Trust would only recover some £330,000. The court’s
decision was therefore of some significance.
6 The case was argued in the Royal Court
on the basis that, as established by the Privy Council in the recent case of Investec (Guernsey) Ltd v Glenalla Properties Ltd,[5]
Jersey law was in this respect the same as English law, in that a creditor has
no direct access to trust assets to enforce his claim. His action lies against
the trustee and his only recourse, in the event of the trustee not satisfying
the claim, is by way of subrogation to the trustee’s right of indemnity. The
case was also argued on the basis that the former trustee has an equitable lien
to secure his right of indemnity as set out by Lord Hodge in Investec in the following terms:
“(v)
A trustee is entitled to procure debts properly incurred as trustee to be paid
out of the trust estate or, if he pays it in the first instance from his own
pocket, to be indemnified out of the trust estate: In re Blundell
. . . (40 Ch. D. at 376). To secure his right of
indemnity, the trustee has an equitable lien on the trust assets: Lewin on Trusts, 19th ed., para.
21–043, at 854 (2017). Because an equitable lien does not depend on
possession, it normally survives after he has ceased to be a trustee: In re Johnson . . .
(15 Ch. D. at 552).”
7 Equity Trust relied upon the general
principle of equity that competing equitable interests rank according to the
date of their creation i.e. the first
in time takes priority. The creditor, on the other hand, submitted that the
principle did not apply, and that all the claims should rank pari passu.
8 Clyde-Smith, Commr
held that the trustee’s lien was intended to give a trustee’s claim
priority over the beneficiaries but it had nothing to do with the equities as
between trustees. Furthermore, fairness together with some of the practical
implications which would result from application of the first in time
principle, suggested to him that it would be preferable for all the claims to
rank pari passu. In the
absence of any authority to the contrary from any jurisdiction, he took the
view that the pari passu
approach should be applied.
9 He added—
“I see no unfairness in this to a former trustee.
One assumes that a trustee will be aware from its administration what
liabilities it may have incurred which could give rise to a claim being made
against it, and it has the right under art. 34(2) of the Trusts Law to require
‘reasonable security’ for those liabilities before surrendering the
trust property.”[7]
10 As stated above, the Court of Appeal
reversed the Commissioner’s decision and held that the claim of Equity
Trust had priority over any claim through the successor trustees. The leading
judgment was given by Logan Martin, JA, with whom Martin, JA agreed. In a
closely reasoned judgment Logan Martin, JA concluded that—
(i) A trustee has an equitable lien in order to secure his
right of indemnity.
(ii)
That lien comes into existence upon the trustee’s appointment and continues
after his retirement.
(iii)
It is a single lien which is enforceable in respect of all the individual
liabilities incurred by the trustee. It is in the nature of a floating charge;
its value expands and contracts with the liabilities incurred by the trustee on
behalf of the trust. The court therefore specifically rejected the view of the
Commissioner that there were in fact a number of different liens which arose
and then ceased as the trustee incurred and then discharged individual
liabilities in the course of administering the trust.
(iv)
The lien of a former trustee is intended to give it some form of security for
its right of indemnity. The effect of ordering pari passu payment of all liabilities in an
insolvency is the practical extinguishment of the lien when its continued
existence would be most critical, namely when there are insufficient assets of
the trust to meet all the liabilities.
(v)
The first in time principle applies generally to equitable interests. The
equitable liens of both a former trustee and a current trustee are equitable
interests in the trust property and therefore, on the face of it, should be
subject to the principle.
(vi)
The court was not aware of any authority which would justify disapplying the principle in the case of a trustee’s
equitable lien.
(vii)
On the contrary, Logan Martin, JA considered that there was one case which,
although not directly in point, lent support to the view he was taking. That
was Lemery Holdings v Reliance Financial Servs in the Supreme Court of New South Wales.[8]
He referred to the fact that in that case, Brereton J had set out nine
principles concerning a trustee’s right of indemnity against trust assets
and had articulated the eighth of those principles as follows at para 21—
“Eighthly,
if the trust property is transferred to a new trustee, the lien survives and
the new trustee takes subject to the lien
of the old trustee—except perhaps in the exceptional case of a bona
fide purchaser for value without notice . . .” [Emphasis
added.]
Clyde-Smith, Commr had
held that the emphasised wording meant no more than that the former
trustee’s right of lien continued to exist. But the Court of Appeal
considered that it went further and meant that a successor trustee takes the
trust assets subject to a former trustee’s right of lien and this must
mean that the former trustee’s right of lien continues to exist and can
be enforced against the trust assets in priority to the lien of the successor
trustee.
11 The court went on to hold that, as it
had reached its conclusion that a former trustee’s lien took priority
over that of a successor trustee as a matter of legal principle, issues of
fairness and administrative convenience did not arise because they could not
outweigh legal principle. The court did address very briefly a couple of the
arguments on fairness but concluded that, as a matter of general impression,
the fairness issue did not fall strongly one way or the other and the question
of novation, which I shall mention in a moment, would have to be assessed once
the trust industry had taken account of the court’s decision.
12 It is interesting to contrast the
different approaches of the two courts. Both were agreed that there was no
authority directly in point in Jersey, England or anywhere else. Given this
background, Clyde-Smith, Commr, approached the
question of whether the first in time principle should apply by considering
whether it was appropriate to apply it to a trustee’s lien in view of the
issues of fairness and administrative difficulty which he thought would follow
from application of the principle. These considerations led him to conclude
that the principle should not be applied. The Court of Appeal, on the other
hand, started from the point that the first in time principle is one of general
application to all equitable interests. As a trustee’s lien was an
equitable interest, the principle should apply unless there was authority to
the contrary, which there was not. As can be seen therefore, the different
starting point of each court partially explains why they came to different
conclusions.
Consequences
13 The decision of the Court of Appeal
is closely reasoned and helpful to the position of a former trustee. But what
are the practical consequences of its decision? Practitioners with an
obligation to advise trustees on a regular basis about issues which may arise
on a change of trustee have much material on which to reflect. But at least
three matters seem worthy of consideration.
(i) Novation
14 On a change of trustee, it is common
for the obligations of the former trustee to be novated to the successor
trustee. Thus, by a deed of novation, the creditor will accept the new trustee
as debtor in place of the former trustee and will discharge the former trustee
from the obligation. That makes sense. After all, it will be the successor
trustee who has possession of the trust property, whereas the former trustee
will no longer hold any trust assets, and will be reliant entirely upon its
right of indemnity to meet any obligation to the creditor. Agreeing to a deed
of novation does not prejudice the creditor in any way and simply recognises
the reality of the situation following the change in trustee.
15 But will creditors be as willing in
future to agree to novation? As was made clear by the Privy Council in Investec, a creditor can only have
access to the trust property via the
trustee’s right of indemnity. If the current trustee’s right of
indemnity ranks behind that of a former trustee, a creditor who has agreed to
novation may suffer prejudice in the event of there being insufficient trust
assets to pay all creditors. He will now claim through the successor trustee
and will therefore rank behind any creditors claiming through the former
trustee whereas, if he had refused to agree to novation, he would have
continued to be able to claim through the former trustee’s right of
indemnity and would therefore have had priority over all creditors claiming
through the successor trustee. Whilst, of course, all this will only matter in
the event of an insolvency arising, one can foresee the possibility of a
cautious creditor (or his cautious advisers) wishing to stay with the former
trustee rather than agree to novation to the successor trustee. If this were to
become widespread, it would seem to be rather unsatisfactory.
(ii) Future
security
16 If the successor trustee purports to
grant security over the movable trust property, whether by means of a security
interest under the Security Interests (Jersey) Law 2012 or under foreign law,
what is the effect in relation to the former trustee’s lien? After all,
the successor trustee will be purporting to grant security over property in
which, to the knowledge of the successor trustee, the former trustee has an
equitable interest which ranks in priority to the successor trustee’s own
lien. Will the security created by the successor trustee trump the former
trustee’s lien or will such security rank behind the lien? One might
instinctively think that the new security would be effective because the former
trustee’s lien is in the nature of a floating charge, which presumably
only takes effect when it crystallises. But, as stated by Sir William
Bailhache, Bailiff, in his judgment,[9] the
Court of Appeal’s decision raises a question over who has priority and one
can see the potential for argument.
(iii) Uncertainty
17 As Clyde-Smith, Commr
pointed out at paras 128—129 of his judgment, quite apart from any question
mark over future security, a successor trustee will face considerable
uncertainty in administering the trust assets. He will know that any claim
through the former trustee will take priority over creditors claiming through
him. The successor trustee will not necessarily be aware of the full extent of
the creditors claiming through the former trustee when he, the successor
trustee, takes office. So, as in the case of the Z II Trust, claims may arise
subsequently out of transactions entered into by the former trustee prior to
the handover. The successor trustee will therefore have to administer the trust
assets in the knowledge that even liabilities which he has incurred properly in
the administration of the trust may end up being irrecoverable because one or
more creditors claiming through the former trustee have, by virtue of their
priority, “scooped the pot” and exhausted all the assets of the
trust in the event of its becoming insolvent.
18 However, in fairness, it is not all
in one direction. Given that a trustee’s lien is in the form of a
floating charge, if claims were settled pari passu, a former trustee or creditors claiming through a
former trustee could find that the value of the former trustee’s lien has
been radically reduced by liabilities taken on by the successor trustee. Whilst
the value of the former trustee’s lien is always vulnerable to actions
undertaken by the successor trustee (whether by incurring liabilities or poorly
managing the trust investments) the effect would be much greater if claims were
paid pari passu than if
the former trustee’s lien retained its priority.
Customary
law point
19 I have dealt so far with those parts
of the court’s judgment which describe the position under English law
just as much as under Jersey law. However, there is a specific point of Jersey
customary law which was raised by Sir William Bailhache, Bailiff, in his
judgment.
20 As I have already said, the
foundation of the court’s decision was the assertion of the Privy Council
in Investec that Jersey law was to
the same effect as English law, in that a former trustee has an equitable lien
over the trust property in support of his right of indemnity. However,
Bailhache JA queried whether the Privy Council had been correct in this
assertion. He pointed out that there is a long standing rule of Jersey law
encapsulated in the maxim “meuble n’a point de suite par hypothéque”
i.e. movable property may not be
subject to hypothecation. Thus, historically, it was not possible under Jersey
law to create security over movable property except by way of pledge
accompanied by delivery of possession of the relevant property. This was only
changed following the introduction of the Security Interests (Jersey) Law 1983,
which has in turn been superseded by the Security Interests (Jersey) Law 2012. But
these two laws only apply to security specifically created pursuant to those laws.
21 The existence of this rule of Jersey
customary law does not appear to have been drawn to the attention of the Privy
Council in Investec, and Bailhache JA was of the view that
its decision that a former trustee had an equitable lien over property of which
he no longer had possession (because it was in the possession of the successor
trustee) would appear to be inconsistent with this rule of Jersey customary
law.
22 Of course, if the former trustee does
not have an equitable lien over the trust property in the hands of a successor
trustee, there can be no question of competing equitable interests and
therefore no question of any application of the first in time principle. Although
he does not expressly say so, it appears that, were it not for the decision of
the Privy Council, Bailhache, JA would have concluded that the pari passu
principle was appropriate. However he felt bound by the decision of the Privy
Council notwithstanding that he felt it had been given in ignorance of the rule
of Jersey customary law to which reference has been made.
23 The case is expected to go to the
Privy Council which will have an opportunity of considering all these matters—the
Court of Appeal gave leave to the creditor to appeal to the Judicial Committee
of the Privy Council. The Jersey trust industry and those who advise in
relation to it, as well as English trust practitioners, will no doubt await the
outcome with interest.
Other
points in the decision
24 Two other matters decided by the
Court of Appeal are of some interest—
(i) It is to be recalled that under art 32(i)(a) of the Trusts (Jersey) Law 1984 (“the Trusts
Law”), where a creditor knows that he is dealing with a trustee, his
claim is limited to the trust property and the trustee is not personally liable
for any shortfall. Conversely, under art 32(i)(b), if
a person who does not know that he is dealing with a trustee transacts with a
Jersey trustee, the trustee remains personally liable as under English law. Clyde-Smith,
Commr held that, in the case of insolvency, no
distinction was to be drawn between art 32(i)(a)
creditors and a trustee exercising his right of indemnity in respect of art 32(i)(b) creditors with whom he has settled. They all rank pari passu between
themselves in so far as they have transacted with the same trustee and are
therefore claiming through that trustee’s right of indemnity. The Court
of Appeal disagreed with this finding. They held that, if the intention of art
32 (which was to protect trustees at the expense of creditors) was to be
fulfilled, a trustee seeking an indemnity in respect of an art 32(i)(b) creditor should rank ahead of art 32(i)(a) creditors. The court’s reasoning on this aspect
was fairly brief. On the face of it, this could have consequences which some
might think to be unsatisfactory. A trustee who has neglected to tell a
creditor that he is dealing with a trustee and who pays the creditor in full
(assuming the trustee is solvent) will obtain recompense from the trust
property ahead of those creditors to whom he has disclosed that he is a
trustee. It is not clear why in those circumstances it is thought fair for the
trustee to be reimbursed ahead of the art 32(i)(a)
creditors rather than pari passu with
them.
(ii)
In a second judgment,[10]
Clyde-Smith, Commr held that a creditor claiming
against an insolvent trust may not claim for the costs incurred in connection
with bringing his claim. He reached this conclusion by analogy with the
position where there is a bankruptcy and accordingly refused to allow the
former trustee to recover the costs incurred in connection with the present
litigation. This was overturned by the Court of Appeal which held that the
former trustee was entitled as a matter of principle to recover from the trust
assets its costs in proving its claim as trustee.
Issues relating to the retirement of trustees
(i) Retention of trust
property
25 Given that English trusts have been
in existence for such a long time, it is rather surprising to find that there
appears to be some uncertainty as to whether a retiring trustee can retain any
trust property as against a new trustee in support of his right of indemnity.
26 The issue fell for decision fairly
recently in the Bermuda case of Meritus Trust Co Ltd v
Butterfield Trust (Bermuda) Ltd[11]
where the case was argued on the basis that Bermuda law was the same as English
law on this point. Both parties accepted that a trustee is entitled to retain
trust property as against a beneficiary when a distribution is made because the
trustee’s equitable lien (which survives retirement) confers an equitable
interest in the trust property which has priority over the interests of the
beneficiaries. However Kawaley, CJ held that there
was no right of retention as against a new trustee. He did so on two main
grounds—
(i) Section 30 of the Trustee Act 1975 of Bermuda (which
appears to be in similar terms to the English Trustee Act) provides that, save
for certain assets such as stocks and shares, a deed of appointment of a new
trustee operates to vest the trust property in the new trustee without the need
for any further document, and s 27 of the same Act imposes a mandatory
requirement upon a retiring trustee to execute any document which is necessary
to transfer trust assets (e.g. shares
in a company). The Chief Justice felt that these provisions were inconsistent
with a right of retention by a retiring trustee.
(ii)
The Chief Justice considered that, whilst there were dicta to the opposite effect, the preponderance of judicial
authority was in favour of the new trustee’s submission that there was no
right of retention. He placed particular reliance upon the Australian case to
which reference has been made, namely Lemery Holdings Pty Ltd
v Reliance Financial Servs Pty Ltd.[12]
That case had held that a former trustee did not have a right to retain, as
against a new trustee, trust assets as security for its right of indemnity. Both
the Australian case and the Bermuda case appeared to accept that there is a
discretionary jurisdiction in the court to order retention of trust property if
it thinks the circumstances justify it, but there is no right in a retiring trustee to retain trust property.
27 The position is different under
Jersey law. First, there is no equivalent provision in the Trusts Law to s 30
of the Bermuda Act to the effect that the deed of appointment itself operates
to transfer title to trust property subject only to certain exceptions, such as
stocks and shares. Secondly, art 43A of the Trusts Law provides that before a
trustee retires and surrenders trust property, he may require to be provided
with reasonable security for liabilities, whether existing, future, contingent
or otherwise. In the event of a dispute as to whether it is reasonable in a
particular case to retain trust property and if so, how much, the matter would
be resolved by the court which would undoubtedly sit promptly to resolve the
matter. There are at least two cases where this has occurred. The first is In re Carafe Trust,[13]
where the court directed payment into an escrow account to cover a claim for
outstanding fees by the retiring trustee. The second is In re Essel Trust,[14]
where the court made it clear that the retiring trustee was not entitled to
retain the whole of the trust fund pending payment of its fees.
(ii) Contractual indemnities
28 In the past, it was comparatively
rare for English trusts to be exported, with the consequence that the new
trustee was subject to the jurisdiction of the English courts, which would of
course apply, and be familiar with English law. Retiring trustees were
therefore often content to rely upon the right of indemnity and equitable lien
which the law gave them.
29 In the offshore world, a new trustee
may often reside in a different jurisdiction and the proper law of the trust
may be changed to the law of that jurisdiction. In those circumstances a
retiring Jersey trustee may well feel nervous about relying solely upon a point
of Jersey law which would, in the event of the retiring trustee needing to
enforce its equitable lien or right of indemnity, have to be proved to the
satisfaction of the foreign court. For that reason, retiring Jersey trustees
usually insist upon contractual indemnities in the deed of retirement, in the
expectation that this will be much easier to establish in a foreign court even
if that court is unfamiliar with the niceties of the Jersey law of trusts. The
indemnity usually includes a personal covenant by the new trustee that, before
distributing any trust property to a beneficiary or passing trust assets over
to a successor trustee, he will in turn obtain an indemnity by the beneficiary
or successor trustee in favour of the former trustee.
30 But of course, whether a retiring
trustee is relying upon his indemnity at law or a contractual indemnity, its
effectiveness will ultimately be dependent not only upon the ease of
enforcement in a foreign court against any defaulting new trustee, but also on
whether the new trustee is an entity of substance which can meet any
obligation. Retirement in favour of Flybynight
Trustees Ltd might well not be the best of ideas!
Sir
Michael Birt was Bailiff of Jersey from 2009 to 2015. He now sits as a
Commissioner, as an Ordinary Judge of the Courts of Appeal of Jersey and
Guernsey, and as a Judge of the Cayman Islands Court of Appeal.