Contents

Chapter 3
Trustees’ duties

Avoiding the consequences of a breach of trust

3.32If legislation is to assist people in clearly understanding the extent of trustees’ obligations, it needs to address potential modifications to the consequences of a breach of trust. By limiting or avoiding liability for a breach of trust or being indemnified against such liability, the importance of the duties can be undermined. Consequently, there are limits to the extent that trust deeds can do this.

Proposal
P8
(1)New legislation should include a provision stating that the terms of a trust must not:
(a)limit or exclude a trustee’s liability for:
(i) breach of a mandatory duty (listed in P6(1)) arising from the trustee’s own dishonesty, wilful misconduct, recklessness or negligence; or
(ii) any other breach of trust arising from the trustee’s own dishonesty, wilful misconduct or recklessness; or
(b)grant the trustee any indemnity against the trust property in respect of liability for:
(i) breach of a mandatory duty (listed in P6(1)) arising from the trustee’s own dishonesty, wilful misconduct, recklessness or negligence; or
(ii) any other breach of trust arising from the trustee’s own dishonesty, wilful misconduct or recklessness.
(2) “Recklessness” should mean when a person knows that there is a risk that an event may result from the conduct or that a circumstance may exist, and he or she takes that risk, even though an honest and reasonable person would not in the circumstances take the risk.
(3) To the extent that any clause of a trust purports to have the effect stated in P8(1)(a) or (1)(b) new legislation should provide that the clause is invalid, provided it is clear that the settlor’s overall intention was to create a trust.
(4) The legislation should imply the following rule into the codes of conduct of professional regulatory bodies relevant to trusts in order to promote settlor awareness of trustee exemption clauses:
Any paid trustee or paid trust adviser or paid drafter of a trust who causes a settlor to include a clause in a trust deed which has the effect of limiting or excluding liability for negligence, or granting an indemnity against the trust property in respect of liability for negligence, must before the creation of the trust take such steps as are reasonable to ensure that the settlor is aware of the meaning and effect of the clause.
(5) New legislation should retain an equivalent of section 73 of the Trustee Act 1956, which gives the court the power to relieve a trustee wholly or in part from personal liability for a breach of trust if the trustee has acted honestly and reasonably, and ought fairly to be excused.
Please give us your views on this proposal.

Current law

3.33Exemption clauses exclude trustee liability for a breach of trust. Breaches of trust may arise when a trustee breaches a duty, or fails to follow the terms of the trust, or fails to perform the trustee’s duties or exercise powers adequately.104  Exemption clauses are not currently regulated by statute in New Zealand. As established by the English Court of Appeal in Armitage v Nurse, the law currently allows exemption clauses to be used to exempt a trustee for liability for a breach of trust as long as the trustee acts in good faith and in the honest belief that he or she is acting in the best interests of beneficiaries. This case has established that a trust deed can exclude trustees’ liability for a breach of trust arising from conduct that is not fraud (in the sense of dishonesty), including any form of negligence.105
3.34The Privy Council considered exemption clauses in the recent case of Spread Trustee v Hutcheson.106  The Privy Council upheld by majority the trustee’s appeal against the Guernsey Appeal Court’s decision that liability for gross negligence was not able to be excluded under an exemption clause prior to the introduction of Guernsey’s statutory prohibition against exemption clauses purporting to exclude liability for gross negligence. The majority of the Privy Council approved the current law on exemption clauses as represented by Armitage v Nurse. However, the two judges in the minority provided strong dissenting judgments that appear to consider that Armitage v Nurse is open to criticism and that trustees ought not to be able to avoid liability for gross negligence.107
3.35An indemnity clause in a trust deed allows the trustee indemnity from the trust fund in respect of any liability arising for breach of trust. Indemnity clauses can have the same practical effect as exemption clauses in relieving the consequences of a breach of trust from a trustee. Indemnity clauses cannot relieve a trustee from liability for his or her own deliberate acts or omission in breach of trust.108

3.36Section 73 of the Trustee Act 1956 gives the court the power to relieve a trustee wholly or in part from personal liability for a breach of trust if the trustee has acted honestly and reasonably, and ought fairly to be excused for the breach of trust and for omitting to obtain the directions of the court in the matter in which the trustee committed the breach.

Issues

3.37The question at the heart of the consideration of exemption clauses is whether or not the current law is fair. It can be argued that the current permissible breadth of exemption clauses is too wide. Some have criticised the law for allowing trustees to avoid liability for a breach of duty that results in conduct for which trustees should be held responsible. For instance, some would consider that trustees should be liable for failing to use reasonable care and skill or for taking action that they know is risky. Beneficiaries are vulnerable to the effects of exemption clauses as their interests in the trust property may not be protected despite trustees owing them obligations. The interests of beneficiaries must be balanced against the freedom of trustees to rely on exemption clauses.109  We are not convinced that the present law adequately balances the interests and needs of trustees, beneficiaries and settlors.

3.38If legislation were to limit the types of trustee conduct for which their liability could be excluded under an exemption clause, there is a question of whether the same limits should apply to non-professional trustees as would apply to professional trustees. The concern that exemption clauses unfairly limit trustee responsibility is perhaps more acute in relation to independent trustees who are employed and paid to carry out this role. However, many trustees in New Zealand are not paid professional trustees. Allowing exemption clauses to apply more broadly to lay trustees than professional trustees may leave open the concern that the duties of trustees are being undermined by the reduced consequences for a breach of trust.

3.39We understand that some settlors of trusts are unaware of the practical effect of the broad exemption and indemnity clauses that are included in many trust deeds. Exemption and indemnity clauses are often included in standard trust deeds and sometimes settlors are not aware of their practical effect. These clauses can be a key part of the arrangement negotiated with paid professional trustees for their services as trustees. This is problematic because settlors may not realise that trustees will not be held liable for breaching the trust and that the benefit that is intended for the beneficiaries may be vulnerable as a result. If one of the reasons for allowing exemption clauses is that settlors should be able to include the terms of trust that they choose as far as is reasonable and as accords with the trust concept, then the problem of settlors not understanding the effect of the clauses needs to be addressed.

3.40The interaction between the mandatory duties and exemption of liability clauses is unclear. It does not seem to be rational for a duty to be considered so central to the trust concept that it is implied into every trust relationship if the trustee is able to avoid having to pay any compensation for loss resulting from a breach of that duty. The law is currently ambiguous with regard to whether liability can be excluded for breach of a mandatory duty. The cases have not analysed exemption clauses as they relate to the positive duties of a trustee. Professor Penner has commented that there is no intellectually coherent stopping point at which trustees must not be relieved of liability for the duties to still apply.110  As a result, any limitation on the ability to limit the liability of trustees needs to be policy-based rather than conceptual.

Options for reform

3.41The options raised in the Fourth Issues Paper were:

(a)retaining the status quo by leaving any limits on exemption clauses to the courts and case law; or
(b)introducing some form of statutory regulation of exemption clauses, including:
  • a requirement for settlors to be informed of the effect of an exemption clause;
  • expanding the types of conduct for which liability cannot be excluded; and
  • placing greater limits on the exemption clauses that may apply to professional trustees than to lay trustees; and
  • altering section 73.

3.42In addition, we have considered addressing indemnity clauses as well as exemption clauses.

Discussion

The case for reform of exemption clauses

3.43It can be argued that settlors are free to do what they like with their property when they own it, so they should have extensive powers to exclude trustee liability in a trust deeds. This provides protection for trustees from litigious beneficiaries, and ensures that trusteeship is still attractive and that insurance is available to trustees. However, beneficiaries are vulnerable to the consequences of exemption clauses, because they will potentially lose out if the value of trust assets is reduced by trustees not conducting themselves in a way that trustees should. Where an exemption clause applies, beneficiaries will probably have no effective means of redress for loss to the trust property. While settlors can be seen as representing the interests of beneficiaries when a trust is settled and the exemption clause agreed to, it seems that many settlors are not actually aware of the effect of the exemption clause and the possibility that beneficiaries might lose out as a result.

3.44We are also concerned that allowing broad exemption clauses may undermine the core trust concept, which requires that a trustee has obligations towards beneficiaries in respect of the trust property. Exemption clauses do not remove the obligations from trustees, but they do remove the most significant consequences of a breach of the obligations and leave beneficiaries without the most effective redress for the breach. The effect of these exemption clauses may be to allow trusts that strain the concept of the trust because beneficiaries do not have an effective means of holding trustees to account. While there are some other possible consequences of a breach of trust, such as the removal of the trustee, it can be argued that the duties of trustees are effectively empty if the trustee is exempted from liability for compensation.

3.45Reforms of exemption clauses have occurred in a number of overseas jurisdictions, although usually in a narrow and cautious form.111  The majority of submitters thought that there was a case for statutory reform although some, including the NZLS and the ADLS, stated that this should be narrowly focused.

Indemnity clauses

3.46Indemnity clauses should be restricted in the same way as exemption clauses. Trustees who are unable to avoid liability for breach of trust under an exemption clause should not be able to achieve the same effect by relying on an indemnity clause to obtain recompense from the trust property for loss due to the same liability. The same arguments that can be made in respect of exemption clauses as to the effects in undermining the trust concept and in weakening the obligations to beneficiaries relate to indemnity clauses.112

The types of conduct for which liability cannot be excluded

3.47We propose that legislation should clarify the types of conduct for which liability cannot be excluded by providing more guidance for those involved in trusts. To do this we need to draw a line between the type of conduct leading to breach of trust for which liability should be able to be excluded and the type of conduct for which it should not. It appears from Armitage v Nurse that currently the line lies at dishonesty, so that only where a trustee has committed a breach of trust due to dishonest conduct will an exemption clause be of no effect.

3.48A number of submitters considered that the law should not favour trustees to the extent that it does currently. These submitters differed in their views about whether exemption clauses that excuse liability for negligence should be prohibited, or only those that excuse gross negligence. More submitters, including law firms and accountancy firms, considered that fraud, misconduct and gross negligence were the types of behaviours for which liability should not be excluded in a trust deed. Government and non-governmental organisations thought that the prohibition should extend even further to cover exemption clauses purporting to exclude liability for negligence. The TCA considered that it is consistent with the nature of the office of a trustee that liability cannot be excluded for gross negligence, fraud or wilful breach of trust. On the other hand, the ADLS considers that trustees can be vulnerable to litigious beneficiaries and that it is going too far to prevent the exclusion of liability for all negligence. They favour the line being drawn at gross negligence. Chapman Tripp and the Society of Trust and Estate Practitioners New Zealand wanted the law to remain as it is in this area, only prohibiting exemption clauses that exclude liability for fraud.

3.49We agree with the majority of submitters that some shift in the balance of the law on exemption clauses is warranted by the nature of the trust obligation. There is conduct outside of dishonesty which is sufficiently blameworthy and of which the trustee is sufficiently conscious that it needs to be firmly excluded from the bounds of what is acceptable for a trustee. As we pointed out in the Fourth Issues Paper, under the current law it is open for a settlor to permit a trustee to be completely incompetent.113  However, we consider that the law cannot go as far as to prevent the use of exemption clauses to exclude liability for any and every failure to use reasonable care and skill (negligence). That would be a significant shift from the current position. Many trustees in New Zealand do not have professional expertise as trustees and are not paid. There is a strong case for allowing protection from liability for these trustees. Yet our view is that the law should prevent the use of exemption clauses to exclude liability for a breach of a mandatory duty due to negligence. If this were not the case then the mandatory duties are not truly mandatory. We consider that the mandatory duties are essential obligations in a trust and trustees who breach them negligently should be liable for compensation.

3.50For all other breaches of trust, however, our preference is to draw the line at a workable standard of conduct between fraud and negligence. This would provide greater protection for beneficiaries as it would reduce the circumstances in which trustees can be exonerated. It would arguably be more in keeping with the nature of trusteeship and the desire not to empty it of much of its meaning by allowing trustees to avoid liability for blameworthy behaviour. The difficulty is finding a sufficiently clear line.

Gross negligence
3.51In the Fourth Issues Paper we proposed prohibiting exemption clauses that exclude trustee liability for gross negligence. In our view, and the view of the majority of submitters, this sets the standard of conduct for which liability cannot be excluded at the right sort of level. It would be a departure from the current English and New Zealand position based on the English Court of Appeal’s decision in Armitage v Nurse, however. Yet there have been some commentators and judges indicating that a shift away from Armitage v Nurse may be warranted. In their dissenting judgments in Spread v Hutcheson, Lady Hale and Lord Kerr considered that from a public policy perspective denying trustees the opportunity to avoid liability for their gross negligence would not be “eccentric or unusual”114  and would be entirely in keeping with the essential aim of the concept of trusteeship, “the placing of reliance on a responsible person to manage property so as to promote the interests of the beneficiaries of a trust”.115
3.52Several jurisdictions have adopted the standard of gross negligence. A statutory gross negligence standard for exemption clauses has been adopted in Guernsey and Jersey. It is also arguable that the position under Scottish law is that exemption from liability for gross negligence is prohibited.116  Outside of the trusts context, gross negligence is used as a legal test in a number of areas of law. In New Zealand, several statutes have been enacted in the last ten years that refer to gross negligence.117
3.53The strongest argument against gross negligence being included in types of conduct for which liability cannot be excluded is that a statutory provision that relies on a distinction between gross negligence and ordinary negligence would be unlikely to improve the clarity of the law. It is difficult, and some would argue impossible, to delineate between the two. Greg Kelly Law stated that the law should not use gross negligence as it is too vague and subjective a concept. Gross negligence may be too imprecise to be of practical use. This would undermine the intention of improving the clarity of the legislation for trustees and beneficiaries. In the Supreme Court’s decision in Couch v Attorney General, which considered whether exemplary damages could be awarded for negligence, Tipping J described gross negligence as “notoriously difficult to define or apply consistently” and found with the majority that subjective recklessness was the necessary standard of misconduct that may warrant exemplary damages.118
3.54The view of the English courts is that the difference between ordinary negligence and gross negligence is a matter of degree.119  It is conceivable that in the not too distant future the English courts may reconsider Armitage v Nurse and take a different position if the right case arose.120  However at present if New Zealand were to take the approach of prohibiting exemption clauses that remove liability for gross negligence, it would put New Zealand trust law out of step with English law.
Recklessness
3.55For the reason that there does not seem to be sufficient confidence that creating a distinction between negligence, for which exemption clauses would be allowed, and gross negligence, for which they would not, would create a clear and effective dividing line, we prefer an alternative option. We propose to shift away from relying on the language of negligence and instead look to recklessness and knowledge. We propose prohibiting clauses that exonerate a trustee from liability for breach of trust arising from the trustee’s own fraud, wilful misconduct or recklessness.121
3.56We suggest that a standard of recklessness be used, that is, having knowledge that there is risk that by acting or failing to act in a certain way there will be a breach of trust and taking this risk even though an honest and reasonable person would not. A trustee would not be able to avoid liability for a breach of trust resulting from this conduct by relying on an exemption clause. This type of standard means that we can specify the frame of mind that a trustee would need to have, and we can set the line at conduct that is more blameworthy than merely being careless or ignorant. Some guidance can be taken from the equitable principles in the categories of knowledge considered in knowing receipt and accessory liability cases. In this area of law a distinction was drawn between recklessly failing to make inquiries that an honest and reasonable person would and knowing of circumstances which would indicate facts to an honest and reasonable person.122  In criminal cases, the New Zealand courts generally give recklessness a subjective definition. The classic definition for this was provided originally by the United Kingdom Law Commission, and we have used this as a base for the definition of recklessness in our proposal.123

3.57If objective recklessness, that is, acting in a way that a reasonable person would have known created a risk of a breach of trust, were the standard, we consider that exemption clauses would be disallowed more readily than they currently can be. This could be a significant departure from the current law and may mean that, in effect, trustees are unable to rely on exemption clauses where they have been negligent. We consider that it should be possible to protect trustees from the consequences of their own negligence.

3.58Setting the line between conduct for which liability may be excluded and conduct for which it cannot at recklessness may not be that far removed from what Millet LJ had in mind in Armitage v Nurse. He took the view that actual fraud:124

… connotes at the minimum an intention on the part of the trustee to pursue a particular course of action, either knowing that it is contrary to the interest of the beneficiaries or being recklessly indifferent whether it is contrary to their interests or not.

3.59Drawing the line for allowable exemption clauses at recklessness is a more workable and useful test than gross negligence. We accept that there will still be some element of interpretation and resort to court judgment involved. However, it is not possible to find a perfectly clear dividing line, but that the provision we propose is nevertheless worthwhile.

Interaction between duties and exemption clauses

3.60We intend that the law on trustees’ duties and the law on exemption clauses accord. Our proposals marry the mandatory conduct obligation to act in good faith and honestly with the limitations on exemption clauses. In our view the obligation of good faith and honesty includes the obligation not to act in a way that is subjectively reckless. Under our proposal it is not possible to exclude the obligation of good faith and honesty from a trust and it is not possible for a trustee’s liability for a breach of this obligation to be excluded.

3.61Just as the duty of care cannot be excluded from applying to the mandatory duties (P5(4)), we propose that liability for a negligent breach of a mandatory duty cannot be excluded. These mandatory duties are essential to the existence of the trust. Their effect would be eroded if it were possible for a trustee to avoid paying compensation for their breach through an exemption clause.

3.62Exemption clauses may remove liability for breach of the duty of care in relation to all other exercises of duties, powers or discretions by a trustee.

Greater restrictions on the use of exemption clauses for professional trustees

3.63We considered the option of prohibiting professional trustees from excluding liability for negligence, while for lay trustees liability could be excluded for negligence. However, this approach seemed too complex. Having one standard for the conduct that cannot be excluded is simpler and easier to understand. The higher standard in what is expected of professional trustees will arise through the duty of care and the court’s interpretation of what constitutes fraud or recklessness for professional trustees.

Requirement for settlors to be informed

3.64The option of requiring a trust drafter or adviser to inform a settlor of the meaning and effect of an exemption clause addresses the issue of settlors not understanding the implications of such a clause. Settlors would be given an informed choice about including the clause at the time of settlement. This reform would not affect beneficiaries directly, but if settlors are better informed about exemption clauses they may choose not to include such broad clauses in their deeds or at least have a more accurate understanding of the trust arrangement.

3.65We have considered what the nature of this requirement should be. We prefer the approach of the requirement being implied into practice rules of professional bodies for lawyers, accountants and financial advisors, rather than legislation. A breach of the rule would not have the consequence of invalidating the exemption clause, but would invoke the disciplinary sanctions of the relevant regulatory body. This is the option recommended by the Law Commission for England and Wales and adopted in the United Kingdom.125

3.66The alternative approach, a statutory obligation that if not met would mean that an exemption clause would have no effect, would be unnecessarily burdensome and difficult to enforce. Because of the serious consequences of failing to inform a settlor regarding an exemption clause, trust advisers would be concerned to ensure the requirement was complied with by introducing time-consuming and expensive processes in order to avoid doubt about the advice being given. Whether it is required by the law or not, many may insist that settlors receive independent legal advice. While this would ensure that settlors are well informed, it would significantly increase the overall cost of establishing a trust. Such an approach is likely to be overly onerous. There could also be evidential difficulties in establishing that a settlor was advised about the nature and effect of an indemnity clause, especially when the exemption clause becomes relevant some time after the trust was established. The trustee seeking to rely on an exemption clause may not be the same trustee appointed at the time the trust was created. This difficulty would be more problematic if the consequence of not being able to prove that the advice was given was that an exemption clause would have no effect.

3.67Submitters generally considered requiring a trust drafter or adviser to inform a settlor of the meaning and effect of an exemption clause to be a worthwhile proposal. It seems to have been seen as a cautious step that could be taken to improve the current situation and one that addresses a need. The NZLS considered that beneficiaries are disadvantaged when they do not have full awareness of the existence and meaning of exemption clauses and that this option would be helpful. Submitters that were less in favour of reform to exemption clauses in general, such as Chapman Tripp and Taylor Grant Tesiram, considered that this option had merit.

3.68We accept that it may be appropriate to exclude the application of the rule from some types of trusts. For instance, in superannuation trusts the settlor is the employer who will usually be legally advised and aware of the exemption clause as a matter of course.

Section 73

3.69We consider that section 73 should be retained. It allows the courts to alleviate unfairness created by a rule in the legislation by using their discretion to relieve a trustee of liability. All submitters responding to this question, including the NZLS, thought that section 73 should be retained, because it continues to be useful. The ADLS pointed out that it has been around for many years and there has been no criticism of it. They agreed with its fact specific, objective test. Greg Kelly Law noted that section 73 is useful because not all trustees have comprehensive knowledge of trustee practice.

104Andrew S Butler “Breach of Trust” in Butler (ed) Equity and Trusts, above n 90, 255 at 258.
105Armitage v Nurse [1998] Ch 241; Spread Trustee Company Ltd v Hutcheson [2011] UKPC 13 (by majority of 3-2). Spread Trustee Company Ltd v Hutcheson related to Guernsey trusts legislation. In 1991, the Trusts (Guernsey) Law 1989, s 34(7) was amended so that it read “Nothing in the terms of a trust shall relieve a trustee of liability for a breach of trust arising from his own fraud or wilful misconduct or gross negligence”. The first New Zealand case in more than a century to address exemption clauses was Spencer v Spencer HC Wellington CIV-2001-485-857, 19 October 2011. Because the trustees acted dishonestly, the question of whether the exemption clause in the trust deed validly excluded liability for gross negligence was not considered (Andrew Butler “What’s Topical – Challenging Times, Challenging Trustees” (paper presented to STEP New Zealand Trust Conference, Auckland, March 2012)).
106Spread Trustee Company Limited v Hutcheson [2011] UKPC 13.
107See also, Daniel Warents and Owen Curry “Gross negligence after Spread Trustee v Hutcheson: the transition from vituperative epithet to meaningful standard” (December 2011) 26 JIBFL 671 at 671; Anthony Grant “To what extent can trustees limit their liability for loss?” NZLawyer (New Zealand 15 July 2011) at 9.
108Noel C Kelly, Chris Kelly and Greg Kelly Garrow and Kelly Law of Trusts and Trustees (6th ed, LexisNexis, Wellington, 2005) at [27.2.1].
109Law Commission (UK)Trustee Exemption Clauses (LAW COM No 301, 2006) at 27.
110JE Penner “Exemptions” in PBH Birks and A Pretto (eds) Breach of Trust (Hart, Oxford 2002) 241 at 259−260.
111See Fourth Issues Paper, above n 90, at [3.13]−[3.24].
112In ch 8 we make a somewhat related proposal to restate in the new legislation that the trustee’s right of indemnity out of trust assets cannot be limited or excluded by a trust deed (see P32(c)).
113Fourth Issues Paper, above n 90, at [3.6].
114Spread Trustee Company Limited v Hutcheson [2011] UKPC 13 at [137] per Lady Hale.
115At [180] per Lord Kerr.
116Three of the judgments agreed in Spread Trustee Company Limited v Hutcheson [2011] UKPC 13 per Lord Clarke, Lord Kerr and Lady Hale, but Lord Mance disagreed, as did Millet LJ in Armitage v Nurse [1998] Ch 241.
117For instance, Private Security Personnel and Private Investigators Act 2010, ss 73−74 and 80, Corrections Act 2004, s 195, and Retirement Villages Act 2003, s 40.
118Couch v Attorney General [2010] NZSC 27 at [170].
119Curry and Warents, above n 107, at 672; Spread Trustee Company Limited v Hutcheson [2011] UKPC 13; Grill v General Iron Screw Collier Co (1866) LR 1 CP 600.
120Hon Mr Justice Hilyard “Prudence and Vituperative Epithets” (Lecture to the Chancery Bar Association Annual Conference, London, 21 January 2012); Grant, above n 107; Lee Aitken “Limiting the Trustee’s Liability – is “gross negligence” relevant?”(2011) 127 LQR 503 at 505.
121This is a similar approach to that recommended recently in Hong Kong Financial Services and the Treasury Bureau Detailed Legislative Proposals on Trust Law Reform (consultation paper, March 2012) at annex H, 1.
122Baden v Société Générale pour Favoriser le Développement du Commerce et de l'Industrie en France SA [1993] 1 WLR 509 at 575; Tim Clarke “Knowing Receipt and Accessory Liability” in Butler (ed) Equity and Trusts, above n 90, 575 at 579−580.
123Laws of New Zealand Criminal Law (online ed) at [22]; see Law Commission (UK) Codification of the Criminal Law: General Principles: the Mental Element in Crime (Working Paper No 31, 1970) at 50: “an accused is reckless if, knowing that there is a risk that an event may result from the conduct or that a circumstance may exist, he or she takes that risk, and it is unreasonable to do so having regard to the degree and nature of the risk which he or she knows to be present.”
124Armitage v Nurse [1998] Ch 241 at 251.
125Law Commission (UK), above n 109, at 69.