The Privy Council has handed down a landmark decision which will have a significant impact, not just on insolvent trusts in Jersey, but also more broadly in the common law world. This serves the purpose of clarifying the nature and ranking of a former trustee’s equitable lien in insolvent trusts.
Jersey trusts are often favoured by wealthy individuals as they have a significant advantage for preserving wealth and protecting assets. Therefore, the decision made by the Privy Council in this case has a significant impact outside of the confines of the island of Jersey.
Background
Firstly, what are insolvent trusts? Unlike people or companies, trusts are not a legal entity, and therefore cannot technically be solvent or insolvent. The Royal Court described the term in the case Re Z Trusts [2015] JRC 196C as a useful shorthand. Nevertheless, in practise, these are trustees who have incurred liabilities which exceed the amount or value of the trust fund.
The proceedings for this case were initiated by a former trustee seeking to recover an alleged debt. The matter subsequently proceeded based on an agreed assumption that was the debt was owing and that there were no secured or preferred debts.
The Privy Council considered four principal issues:
- whether a trustee’s right of indemnity confers a proprietary interest in the trust assets
- if that right of indemnity survives the transfer of the trust assets to a successor trustee
- whether a former trustee’s claim ranks in priority to a successor trustee’s equivalent claim, and
- if the costs incurred by a trustee in proving its claim are included in the sum capable of recovery by the trustee
Judgement
The first, second and fourth issues were decided unanimously by the Privy Council, while the third question was a 4:3 split decision in favour of the appellant. It also gave rise to three separate judgements by the Privy Council. Let’s go through each of the issues in succession.
On the first issue, the question was: does the right of indemnity confer on the trustee a proprietary interest in the trust assets? This refers to the right to an on-demand payment without the need to prove a breach of contract. The Board were unanimous that their answer to this question was “yes”.
The second issue was directly linked to the first issue. Given that the Board decided that the trustee had a proprietary interest in the trust assets, the question was: does the proprietary interest of a trustee survive the transfer of a trust assets to a successor trustee? The unanimous answer to this question was also yes.
Given that the answer to this question is yes, the third issue is: does a former trustee’s proprietary interest in the trust assets take priority over the equivalent interests of successor trustees? On this issue, the Board split 4:3. The split was between whether the Board should prefer ‘first in time’ or ‘pari passu’. The latter view, pari passu, was the one which the majority view deemed most appropriate.
Pari passu refers to “equal right in payment”, defined by Thomson Reuters Practical Law as meaning that “all unsecured creditors in insolvency processes, such as administration, liquidation and bankruptcy must share equally any available assets of the company or individual, or any proceeds from the sale of any of those assets, in proportion to the debts due to each creditor”.
One of the arguments against first-in-time was that this would subject creditors to settlement of their claims on the basis of the date of the date of appointment of the trustee with whom they contracted. This would not be an equitable arrangement given that the information is both unavailable to creditors and likely to be no more than happenstance in a commercial transaction.
Given the majority decision, the Privy Council favoured pari passu as the method of how claims on ‘insolvent trusts’ as a matter of Jersey law shall be resolved in future.
Finally, the fourth issue focused on the costs of the matter. As part of any claim against the assets of the insolvent trust, should the trustee include its costs of proving that claim? The Privy Council found that a trustee is entitled to recover the costs of its claim as part of its recovery from the trust assets. The reasoning behind this is that the trustee is proving the extent of its existing proprietary interest in those trust assets, rather than ‘proving a claim’.
Our thoughts
This is a hugely significant case in the private client area of law. Prior to this case, there was a lack of clarity regarding the position of current and former trustees of so-called ‘insolvent trusts’. As well as insolvent trusts, it will also have significance in the application of trusts more generally.
This case confirms the position of creditors involved in these cases, who may have claims against current and former trustees. The Privy Council also found that trusts have proprietary interest in the trust asset and that unlike liquidators and directors, trustees can add their costs of claim to their total claim over the trust assets.
Despite this, the decision made by the Privy Council does appear to slightly contradict the notion that trustees have proprietary interest in trust assets. For example, if a former trustee has proprietary interest in a trust asset to indemnify him/her any liability (say totalling 90% of the value of the trust asset), the successor trustee will take on the trust asset subject to such proprietary interest.
Therefore, this will mean that the new trustee at most will have only proprietary interest in the trust asset worth 10% of its value, which will make any pari passu distribution unfair to any former trustees (hence their creditors).
Anyone who would like advice regarding the management of trusts and private client services can contact us directly – our legal experts will be on hand to advise you and assist you with your needs.
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