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Retention of trust assets by outgoing trustees – a cautionary tale for trust draftsmen

08/03/18

In the case of Meritus Trust Co. Ltd v. Butterfield Trust (Bermuda) Ltd [2017] SC (Bda) 82 Civ, the Supreme Court of Bermuda provided welcome guidance as to the rights of an outgoing trustee to protect itself from potential liabilities.

Under Bermudian law, an outgoing trustee has:

(i)  no right to retain trust assets; and

(ii) no right to require a contractual indemnity from the incoming trustee in respect of known or contingent liabilities.

Such rights must be expressly set out in the trust deed in order to apply.

The facts of the case

Butterfield was removed as trustee of two Bermudian trusts in December 2016, with Meritus appointed in its place. Butterfield’s removal occurred, so the Supreme Court said, under the dark cloud of a threatened claim. This meant that the transfer process (i.e. the transfer of assets and documents to the new trustee) was somewhat prickly.

Butterfield estimated the potential liability in respect of the threatened claim at $5million and took steps to protect itself. As an outgoing trustee, one might naturally ask why the outstanding liability mattered to Butterfield. It mattered because trustees incur liabilities personally. Liabilities do not remain with the trust (as they would with a company). They remain with the trustees. Therefore the outgoing trustees were personally liable for the full $5million.

To compensate for this severe rule, the law affords protection to trustees in respect of expenses and liabilities properly incurred, by way of an indemnity. This entitles the trustee to be indemnified out of the assets of the trust.

The issue for Butterfield was that it was being removed as trustee. Once removed, the assets of the trust would be transferred to the new trustee. Butterfield would have no control over the trust’s assets, which might be transferred to a third party, or otherwise used up. Its indemnity, while still in existence, might be worth less than the total potential liability.

Butterfield therefore sought to retain sufficient trust assets against which to enforce its indemnity. Further, it sought a contractual indemnity. The incoming trustee disagreed and litigation ensued.

The judgment of the Supreme Court – the right of retention

Meritus presented the following arguments to the court:

(i) a former trustee’s indemnity in equity took effect as a non-possessory lien. It did not include a right of retention;

(ii) by s. 27 (d) of the Bermudian Trustee Act 1975, all trust assets were vested in the new trustee upon appointment or as soon as possible thereafter; and

(iii) relevant case law supported Meritus’s objections (Lemery Holdings Pty Ltd. v Reliance Financial Services Pty Ltd [2008] NSWSC 1344).

The court agreed with Meritus. Bermudian trust law held that a deed appointing trustees operates so as to automatically vest trust property in the trustees, unless contrary provision is made in the deed. In other words, if a trustee wanted a right to retain trust property following their removal, then that right must have been included in the relevant trust deed. Unfortunately for Butterfield, the relevant trust deed in fact declared expressly that “…the Trust is hereby transferred to the New Trustees…”.

The court followed the ruling in Lemery Holdings. This held that a former trustee does not have a right to retain as against a new trustee the trust assets as security for an accrued right of indemnity. The former trustee was entitled however to ensure that the new trustee did not take steps which would destroy the old trustee’s right of security.

Butterfield argued that trustees had a recognised right to retain trust assets as against a beneficiary (for example, where the trustee successfully sues a beneficiary and is entitled to his costs out of the trust and a lien for their payment). But the argument that this principle extended to incoming trustees was rejected. The court found that Butterfield was protected by its equitable lien. No retention was allowed.

The judgment of the Supreme Court – the right to a contractual indemnity

The court bluntly noted that no authority had been cited to support a right to a contractual indemnity. In fact, there was authority which suggested that the courts of equity had no power to make an order requiring the incoming trustee to enter into a contractual document.

Conclusion

The rule of equity that a trustee incurs liabilities personally is a severe one, but it encourages trustees to behave faithfully and properly in their duties. Those trustees who act properly can expect an indemnity from the trust fund in respect of such expenses; those that do not, should not.

But such an indemnity is of fluctuating value. If the assets out of which the indemnity will be satisfied are no longer in your control, your ability to satisfy the liability with trust funds may be lost or prejudiced.

Trusts are always at risk of a change of trustees. As such, trustees should be wary of the ruling in Butterfield v Meritus. While an express clause in the trust deed can provide the protection that Butterfield sought, that protection relies upon the trustee identifying this potential issue well before the event.  

Accordingly, Butterfield found itself in an unenviable position, and one with no easy or clever solution. In other jurisdictions, such as Jersey, trustees are protected by article 34 of the Trusts (Jersey) Law 1984. There is no such law in Bermuda.

This episode, therefore, is but one more illustration of the caution that should be exercised when considering an appointment as trustee.

Harcus Sinclair LLP specialises in advising trustees and beneficiaries in respect of both on shore and off shore trusts. If you require advice in relation to the above, or any other trust matter, please call us on 020 7242 9700 and you will be put through to the relevant specialist.

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