Contents

Chapter 8
Corporate trustees and insolvent trusts

Liability of trustees and right of indemnity

Proposal
P32 New legislation should restate the following principles:
(a)A trustee assumes personal liability unless there is an express limitation to the contrary in the contract.
(b)A trustee has the right to indemnity out of trust assets (in a modernised form of section 38).
(c)A trustee’s indemnity cannot be limited or excluded by the trust deed.
(d)A trustee’s right to indemnity is available to a former trustee in respect of actions taken by them as trustee.
Please give us your views on this proposal.

Current law

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.

8.14The primary claim for creditors is against the trustee personally. Creditors may recover from the trustee directly if the trustee has sufficient assets that are not held on trust. If, however, the trustee has few or no assets of its own, then the creditor must look to the trust property through subrogation, the process by which one person, in this case a creditor, is put in the place of another, here the trustee, so that the trustee’s right of indemnity from trust assets is used to satisfy the creditor’s debt. Since the creditor’s subrogation is entirely derivative, if the trustee’s right of indemnity is impaired, then the creditor’s subrogation is likewise impaired. This can occur through a range of circumstances, for instance:
(a)the trustee may not have properly incurred the liability in the first place, for example because it was beyond the powers of the trust deed or was in breach of duty;
(b)there may be cross-claims by beneficiaries; or
(c)the indemnity may have been excluded or limited in the trust deed itself.

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.

Issues

8.16There is a lack of clarity about the extent to which the trustee’s right to indemnity can be limited or excluded entirely by the terms of the trust. One view is that the indemnity can be limited or even excluded entirely.187  The alternative view is that it may not be excluded because “the right of indemnity from the assets is an incident of the office of trustee and inseparable from it”.188  The position has not been conclusively determined by a court in New Zealand and nor is it clear from the statute.
8.17In 2002 the Law Commission considered that the right of indemnity probably could not be excluded or limited.189  There is still no authority in New Zealand stating the position with certainty, but overall, as discussed in the Fifth Issues Paper,190  the balance of commentary appears to say that it cannot be totally excluded. The question that arises is whether this position (or another) should be clarified in legislation.

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.

Options for reform

8.19In the Fifth Issues Paper, we asked whether submitters thought it would be beneficial to restate in legislation the essential principles of any of the following areas of the case law (as they apply generally, not only to trading trusts):
(a)that a trustee assumes personal liability unless there is an express contract to the contrary;
(b)a trustee’s right to indemnity out of trust assets;
(c)how and subject to what, if any, conditions can a trustee’s rights to indemnity be exercised;
(d)the circumstances in which creditors can be subrogated to a trustee’s right of indemnity; and
(e)exclusion of the right of indemnity.

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.

Discussion

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.

8.23We concur with the majority of submitters that the right of indemnity cannot be limited or excluded by trust deed. We also agree that it would be beneficial to clarify the position in legislation to resolve any uncertainty. This would also provide some protection for creditors who do not necessarily know the terms of the trust. We consider that this is a reform that should apply to all trusts, as section 38 does, rather than trusts with corporate trustees only. A new provision could be based on the wording of Australian legislation.191  It would need to provide that the trustee’s indemnity applied regardless of any contrary intention expressed in the trust deed. Section 38 would be retained in new legislation in a modernised form, so this provision could be added as a subsection in that provision.

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.

187RWG Management Ltd v Commissioner of Corporate Affairs [1985] VR 385 (it should be noted that this case was decided in the context of the Trustee Act 1958 (Vic) which allows for the exclusion of indemnities); Re German Mining Co (1854) 43 ER 415 per Turner J; HAJ Ford and IJ Hardingham “Trading Trusts: Rights and Liabilities of Beneficiaries” in PD Finn (ed) Equity and Commercial Relationships (Law Book Company, Sydney, 1987) at 48.
188BH McPherson “The Insolvent Trading Trust” in PD Finn (ed) Essays in Equity (Law Book Company, Sydney, 1985) at 142. See also Kemtron Industries Pty Ltd v Commissioner of Stamp Duties (QLD) (1984) 15 ATR 627 (QC) at 634.
189Some Problems in the Law of Trusts, above n 186, at [27].
190Fifth Issues Paper, above n 182, at [7.27]−[7.36].
191For example Trusts Act 1973 (Qld), s 65.