8.13A trustee is personally liable for all liabilities incurred in performing the trust, including debts to third parties, unless liability has been contractually limited to the trust assets. The trustee has an indemnity against the trust assets to satisfy debts properly incurred under the trust, both in terms of reimbursement and the ability to pay trust liabilities directly out of the trust assets. Improperly incurred liabilities are not covered by the indemnity. The trustee’s right to indemnity creates an equitable interest in the trust assets.
8.15These principles are found in the common law and are not set out in any trusts legislation at present, aside from certain aspects of the trustee’s right of indemnity which are recognised in section 38(2) of the Trustee Act 1956.
8.18There may also be some uncertainty and lack of understanding about the other legal principles referred to above regarding the trustee’s personal liability, exercise of the indemnity, and circumstances in which creditors can be subrogated. Non-lawyer trustees and settlors in particular may not necessarily comprehend these areas well. There is a further question that requires clarification of whether the indemnity extends to acts of former trustees or whether it applies only to the current trustee’s actions.
8.20The alternative is to retain the status quo and not to state these principles in legislation, beyond what is specified currently in section 38.
8.21Regarding (a) to (d) in the list above, many submitters considered it would not be worthwhile to include these principles in trusts legislation. They considered that the case law in these areas is sufficiently clear and well understood as to their meaning and operation, and as such it would be unnecessary to restate them in legislation. The NZLS observed that addressing the circumstances in which a creditor will be subrogated may require an unduly complex legislative provision. However some other submitters said that these principles are not always well understood and there would be benefits in restating them in legislation. The TCA and Perpetual suggested that creditors’ rights of subrogation be clarified.
8.22On the other hand, most submitters responded that it would be useful for legislation to clarify the position regarding exclusion of the right of indemnity. Most agreed that the right of indemnity cannot be modified or excluded by the trust deed. Chapman Tripp’s view was that the trustee’s right of indemnity is a fundamental part of its role as trustee and incident of the trust relationship; without the right of indemnity the trustee would be unable to deal with the trust assets. KPMG observed that if a corporate trustee’s right to indemnity was reduced the directors would be at risk of being personally liable for trading while insolvent. The NZLS considered that the current lack of an express rule was not causing problems in practice, and noted that any rule introduced would need not to cut across existing rules of indemnification which operate effectively and are well understood.
8.24The provision would need to set out the extent of the indemnity. One submitter observed that section 38(1) currently carves out wilful default but dishonesty could also be added. Our view is that any provision in this area should align with the approach proposed to be taken to exemption clauses, which would carve out dishonesty, wilful misconduct and recklessness, and a negligent breach of a mandatory duty.
8.25It would also be necessary to consider how this provision would impact existing trusts, and whether it would have retrospective effect or only apply to new trusts settled after it came into force.
8.26We also consider that there is value in restating in a revised section 38 some of the other fundamental and well-understood principles in this area, including a trustee’s personal liability. It would be useful for this provision to clarify the application of the indemnity to former trustees, which we consider should extend to such trustees. Section 38, as it stands currently, seems to us to be incomplete and it would be preferable to have a section that covered all key aspects of the indemnity.
8.27Although most submitters said that these principles were certain and well understood, we consider that it would nonetheless be helpful to lay trustees and third parties to have them spelled out simply and concisely in legislation. The provision may have an educative function for some lay trustees and the public at large about the nature of a trust and whether a trust is a separate entity. It may allay any confusion or lack of awareness regarding the personal liability of a trustee in contracts entered into. Restatement of settled common law principles is also in line with the general approach we are taking in this review. We emphasise that there is no intention to undermine or displace existing principles in this process of restatement.
8.28There is a question as to whether it should be permissible for the indemnity to be substituted so that it is not provided by the trust assets but a substitute indemnity is provided through a contractual arrangement with a third party. If this approach is considered to be consistent with the principles underpinning the indemnity, legislation could make clear that such an arrangement is possible.