Contents

Chapter 8
Corporate trustees and insolvent trusts

Issues for beneficiaries

Proposal
P36 It is proposed that legislation should require that directors (or equivalent) of a corporate acting as a trustee have the same obligations to the beneficiaries of the trust as they would have had if they and not the company had been the trustees.
Please give us your views on this proposal.

Current law

8.73The position of a beneficiary of a corporate trustee is the same as it is in any other trustee-beneficiary relationship. In the event of a breach of trust, the beneficiaries may have a claim against the company, assuming liability has not been excluded by the trust deed.205  However, if the company has insufficient assets of its own with which to compensate the beneficiaries, pursuing remedies against the company will be pointless.206  The beneficiaries may therefore need to try to claim against the individuals responsible for causing the company to breach the trust, generally the directors of the company.
8.74Claiming against the directors can be more difficult than bringing a claim against the corporate trustee, because there is no direct fiduciary relationship between the directors of corporate trustees and the beneficiaries of the trust for which the company is a corporate trustee.207  Trustees owe a direct fiduciary duty to beneficiaries, and directors owe a duty to the company. But directors are not automatically liable to beneficiaries for the actions of a corporate trustee, including breaches of trust committed by the company.208
8.75However, directors may be liable to beneficiaries based on other claims.209  Where the corporate trustee has committed a breach of trust, a director may be liable for providing dishonest assistance in that breach of trust. Beneficiaries may have other possible claims in knowing receipt; as a trustee de son tort; or a “dog-leg” claim attributing liability to directors indirectly through their duty of care to the company. However, most of these heads of liability are relatively uncertain, being untested in New Zealand, and unlikely to succeed except in limited circumstances.

Issues

8.76A potential problem in respect of beneficiaries of a corporate trustee is that if the business fails, the beneficiaries’ only recourse is against a trustee who may be assetless. Therefore in an action against a corporate trustee, for example if it commits a breach of trust, the beneficiaries will be unable to recover funds (in the absence of insurance cover). Beneficiaries do not have any special protection in these circumstances, and may be vulnerable. However the key question in this area is whether the law adequately protects beneficiaries already through the existing heads of liability referred to above.

8.77The NZLS and Chapman Tripp did not consider there were any problems or disadvantages relating to beneficiaries that were sufficiently serious to warrant intervention. They considered that the cases in which a beneficiary suffers loss are likely to be rare and that there are already sufficient legal remedies available. Taylor Grant Tesiram noted that beneficiaries are unlikely to have the same prospects of a recovery against the trustee as beneficiaries of a trust with individual trustees, which is arguably unfair, but beneficiaries are generally volunteers, and settlor choice is important. The remaining submitters who commented on this perceived that lack of protection for beneficiaries was a problem that needed to be addressed.

Options for reform

8.78The options are:
(a)a “direct look-through” extending the liability of directors of a trust company, to impose on the directors the same obligations to beneficiaries to which they would have been subject if they personally had been the trustees (also proposed by the Commission in its 2002 review);210
(b)a requirement for a professional trustee to disclose to the client settlor the implications of the choice of a corporate trustee and to advise on what trustee insurance the trustee has in place (as proposed by Taylor Grant Tesiram);
(c)a provision similar to section 27 of the Unit Trusts Act 1960, under which the directors of a trustee of a trust can be found liable as delinquent directors on the application to the court by the trustee, a liquidator of the trustee or a unit holder (as proposed by KPMG);
(d)to retain the status quo, with no reforms targeted at beneficiaries.

Discussion

8.79Many but not all submitters favoured reform in this area to protect beneficiaries. Some submitters argued that the position of beneficiaries of a trading trust is even less secure than that of creditors; the beneficiaries’ right to sue for breach of trust is not useful if the trustee is a company that can easily be liquidated, as occurred for example in the case of CIR v Chester Trustee Services.211  The TCA noted that trustees will usually be exempted from liability to the beneficiaries except for dishonesty or wilful breach of trust, so beneficiaries’ possible claims are likely to be limited.

8.80In terms of reform options, several submitters supported making directors personally liable if the corporate trustee cannot pay. The NZLS considered the proposal to be sensible, but of a lower priority than other trust reforms. KPMG favoured a provision based on section 27 of the Unit Trusts Act, and Taylor Grant Tesiram favoured requiring disclosure to the settlor client by the professional trustee about the implications of appointing such a trustee, as set out in [8.78] above.

8.81KPMG raised a further question as to the ranking of the beneficiaries’ claim against a corporate trustee for breach of duty: it was considered unclear whether the claim should be in priority to other unsecured creditors, rank pari pasu, or be deferred to other creditors (with the latter being KPMG’s preferred option).

8.82Based on the response from submitters, it appears that this issue is finely balanced in terms of the necessity of reforms in relation to beneficiaries. Submitters were divided about the adequacy of current measures and about the existence and extent of a problem in this area.

8.83Although there are several existing routes by which directors could be held liable to beneficiaries, there have been few such claims in New Zealand. As such these possible avenues are uncertain, and it is difficult to assess whether they are in practice sufficient, but it is likely they would involve high thresholds to succeed. The lack of claims cannot necessarily be taken to indicate that there is no problem in this area.

8.84We have considered the advantages and disadvantages that direct liability on directors would bring. Several submitters argued that imposing a direct relationship between directors of corporate trustees and beneficiaries would provide accountability and an incentive to directors to ensure that trading trusts are run properly. It is effectively the case that the directors of the company are to all intents and purposes the trustees, and so should be treated as such. It would seem sensible for the law to recognise the practical reality of the arrangement, notwithstanding the conventional protection of the corporate veil – and one submitter noted that the corporate veil ought to be for the protection of investors rather than directors.

8.85On the other hand, there are various disadvantages to the proposal. Extending liability of directors in this way could discourage third parties from acting as directors of corporate trustee companies. One submitter commented that a law that imposed a direct relationship could be considered to cut across and complicate fundamental aspects of company and trust law; such an intervention would be difficult to design and could create problems in the interaction between the two areas of law. A submitter commented that the corporate veil should not be pierced and directors should continue to be protected from liability, provided that they have acted in accordance with their duties.

8.86On balance, we have concluded that it is preferable to introduce a direct look-through with directors of companies acting as trustees being directly accountable to beneficiaries. We are concerned about the precarious position of beneficiaries and the difficulties involved in attempting to hold a corporate trustee to account through the indirect mechanisms that are currently available. We consider that there is potential for the corporate trustee structure to be used as a means to avoid liability to beneficiaries, and that direct liability on directors is the most straightforward and effective means of addressing this. We believe there is some merit in KPMG’s suggestion involving section 27 of the Unit Trusts Act and a provision in new trusts legislation could in part draw on this provision. An alternative formulation is found in clauses 130 to 132 of the Financial Markets Conduct Bill, which will repeal the Unit Trusts Act. Clause 130 provides that the manager of a registered scheme established under a trust deed has the same duties and liability in the performance of its functions as manager as it would if it performed those functions as a trustee, within the context of the wider civil liability scheme of the bill.

8.87Since we are elsewhere proposing liability to creditors for directors of corporate trustees, it is also desirable to have consistency in the approach taken. We acknowledge that there may be some issues arising over interaction with the company law scheme. We are interested in submitters’ views about how this proposal would operate in practice. We particularly invite comment on whether the proposal is suitable for all corporates and how it would impact on different types of corporate.

8.88The proposal by Taylor Grant Tesiram may warrant further consideration, as in addition to the preferred approach set out above, or as an alternative. This proposal was to require professional trustees to disclose to the client settlor the implications of the choice of a corporate trustee, and advise as to what trustee insurance is in place. They also suggested minimum requirements as to trustee insurance cover may be appropriate. We discuss a comparable option in relation to informing clients about exemption clauses in chapter 3,212  and similar considerations apply here: administrative and cost burdens on those settling trusts; questions about effectiveness; evidential difficulties in establishing compliance; and an issue about the consequences attaching to a failure to inform the client as required. However, we note that the settlor is usually the director in these cases, and so this proposal does not directly address the problem of the risk to beneficiaries. We prefer that it remain as a possible alternative position if the preferred approach does not proceed.
205For a full discussion of trustee exemption clauses, see Law Commission The Duties, Office and Powers of a Trustee: Review of the Law of Trusts Fourth Issues Paper (NZLC IP26, 2011) at ch 3.
206Ford and Hardingham, above n 187, at 58.
207Jeff Kenny and Jared Ormsby “Trading Trusts” in Andrew S Butler (ed) Equity and Trusts in New Zealand (2nd ed, Thomson Reuters, Wellington, 2009) 415 at 422.
208At 421; Bath v Standard Land Company Ltd [1911] 1 Ch 618.
209See Fifth Issues Paper, above n 182, at [8.1]−[8.9]. For further discussion of the liability of directors, including other heads of liability not covered here, see Chris Kelly and Greg Kelly “So you want to be trustee” (paper presented to New Zealand Law Society Trusts Conference, 2009) at 52–54.
210Law Commission Some Problems in the Law of Trusts, above n 186, at [29].
211Commissioner of Inland Revenue v Chester Trustee Services Ltd [2003] 1 NZLR 395.
212See [3.64]−[3.68].