The Jersey Court of Appeal recently handed down its long-awaited judgment in the Z Trusts case. The decision considers important questions regarding the equitable rights of former trustees and whether those rights have priority over the rights of other claimants to the assets of a trust (including successor trustees) whose liabilities exceed its assets.
A settlor, C, established eight trusts, of which the Z II Trust and the Z III Trust were the focus of this case. Equity Trust (Jersey) Limited was appointed as the original trustee of the trusts, but at the beneficiary's request it retired in 2006 and was replaced by new trustees. On retiring, Equity was provided with an indemnity by deeds of appointment and resignation of trustees.
On 31 July 2012 one of the companies within the Z II Trust structure, Angelmist Properties Limited (in liquidation), instituted a claim in the High Court of England and Wales against two of its former directors and Equity (the Angelmist proceedings). The claim alleged a breach of duty against the two directors who were Equity employees and claimed against Equity for vicarious liability and on the basis that it had acted as a de facto or shadow director of Angelmist. Equity notified the then-current trustee of the Z II Trust of its intention to rely on its indemnity.
On 22 December 2015 Entity settled the Angelmist proceedings. As a result of those proceedings, Equity incurred liabilities in excess of £18 million comprising both a payment to Angelmist and Equity's own costs. Equity claimed reimbursement of that sum out of the assets of the Z II Trust, arguing that its claim took priority over the other creditors of the Z II Trust.
The Z II Trust's liabilities exceeded its assets (and in that sense it is described in the judgment as insolvent): the only asset of the Z II Trust was a £186 million loan due by the Z III Trust, but the current value of this loan was approximately £6 million. As such, if Equity's claim for priority succeeded, it would recover all of the Z II Trust's assets. If not, it would rank pari passu with other creditors of the Z II Trust and recover only approximately £330,000.
The current appeal considered three judgments of the Royal Court, two of which are material for present purposes. These were the priority judgment and the recoverable costs judgment.
Priority judgment In the priority judgment, the court recognised that a trustee has an equitable lien (akin to an equitable charge) over the trust assets for its liabilities properly incurred. The court addressed two key issues in relation to that lien – namely, whether:
- a trustee's right of lien takes priority over the claims of creditors making claims to the trust assets; and
- the right of lien of a former trustee takes priority over the right of lien of a successor trustee.
On the first issue, the court noted that the question of competition between a trustee and creditor arises only as a result of Article 32(1)(a) of the Trusts (Jersey) Law 1984, which in effect precludes creditors from claiming against a trustee personally where the latter knows that the former is acting as trustee – thus limiting the trustee's liability to the value of the trust assets. The court held that Article 32 does not go so far as to give a trustee's claim priority over trust assets, reasoning that if a trustee's claim was given priority over the claims of its Article 32(1)(a) creditors, this would lead to the trustee 'scooping the pot', which would go beyond what Article 32 intended.
On the second issue, the court considered that the purpose of the equitable lien is to give a trustee priority over the interests of beneficiaries, who it noted no longer have an interest in the assets once the trust is insolvent. As the lien arises out of the relationship between trustees and beneficiaries (and not between trustees), the court considered that the usual rule that equitable interests rank according to the order of their creation does not apply. In holding that successive trustees' rights under their equitable liens rank pari passu, the court was clearly influenced by concerns of fairness and ensuring the good administration of trusts (ie, avoiding the risk a new trustee would otherwise face of a prior trustee scooping the pot).
Recoverable costs judgment In the recoverable costs judgment, the court found that Equity was not entitled to claim the costs which it had incurred in seeking to prove its claim against the assets of the Z III Trust. The court considered that as trustees are the only persons who can assume liabilities, assuming a pari passu regime, each creditor should assume the costs of proving its claim subject to the court's discretion in any particular case. The court considered that this should not discourage people from becoming trustees, whereas the risk of a prior trustee scooping the pot might do so.
The Court of Appeal overturned both the priority judgment and the recoverable costs judgment.
The court's starting point was the Privy Council's judgment in Investec Trust (Guernsey) Ltd v Glenella Properties Ltd.(1) This judgment recognised that, as a matter of Jersey trust law, trustees have an equitable lien on the trust assets to secure their right of indemnity for liabilities properly incurred as trustees.
The Court of Appeal also noted the acknowledgment in Investec that "the law of trusts in Jersey is a comparatively recent import from England" and the fact that it looked to the trust law of England save where inconsistent with Jersey's customary law and legislation. Therefore, the Court of Appeal considered that, to identify the appropriate priority of the rights of indemnification and lien possessed by trustees in Jersey, it was appropriate to consider the English law on that issue (as well as authorities in other common law jurisdictions that drew on that law). Having done so, it reached the following conclusions:
- A trustee's priority over the trust assets arises by virtue of its office and ranks ahead of beneficiaries and those deriving title there from. Therefore, each trustee possesses its own equitable interest and right of lien enforceable as a first charge against the trust assets.
- The general rule that equitable interests rank according to the order of their creation applies between trustees, such that the right of lien of a former trustee ranks ahead of the right of lien of a successor trustee.
- The trustee's equitable lien has priority over the claims of its Article 32(1)(a) creditors.
- The ranking in priority exists while the trust remains solvent and if it becomes insolvent.
- Each trustee's rights of indemnity and lien are continuing rights that do not depend on there being any actual liability at a given time. Their ranking depends solely on the date on which each trustee took up appointment as trustee.
Applying this reasoning, Equity was entitled to assert its equitable lien in priority to the rights of successor trustees (in this case, there were no trust creditors). Equity's liability resulting from the Angelmist proceedings was not a new liability arising after its retirement, but rather a contingent liability existing when it retired.
The Court of Appeal also overturned the recoverable costs judgment, finding no reason in principle why a trustee could not recover from the trust assets its costs in proving a claim that it had incurred as trustee. The court noted that the recoverable amount would be a matter for taxation, considering all of the relevant circumstances.
The Court of Appeal's judgment is welcome insofar as it confirms the trustee's equitable lien for costs properly incurred. However, trustees should consider the practical implications of this judgment and whether and how they should be mitigated.
Successor trustees clearly face the risk that a predecessor will unexpectedly scoop the pot in connection with a past liability that has since crystallised – potentially in circumstances where the existence or extent of that liability was unknown to the successor trustee. The Court of Appeal considered that this was not a material risk: it noted that it is a successor trustee's choice whether to assume the role, and that before it does so it can "exercise such due diligence as it wishes on the state of the trust and the potential liabilities to which it might find itself subject in due course" and also consider the potential for the trust to become insolvent. Potential successor trustees may question the extent to which they can realistically mitigate this risk through due diligence, especially given that one of the judges in this case recognised that "no reasonable investigation would have revealed the possibility of the Angelmist claim".
Trustees should also consider how to respond if some creditors seek greater protections from them before agreeing to enter into contractual arrangements. Trustees may also wish to consider how to ensure that third parties know that they are dealing with a trustee, so as to attract the protection in Article 32(1)(a) of the Trusts Law.
The bailiff (sitting as part of the Court of Appeal in this case) recognised that the court's decision followed logically from Investec. However, he queried whether the Privy Council in that case had received sufficient submissions on Jersey's customary law and suggested that customary law might not actually recognise the equitable charge afforded by way of the trustee's lien. However, this point of principle is ultimately settled unless it is reconsidered by the Privy Council. As such, trustees should consider the steps that they should take to address the issues raised by the Court of Appeal.
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