Landmark Privy Council ruling establishes scope and ranking of ex-trustees' interest in an insolvent trust

Jersey law ruling will have far reaching ramifications for trust administration in common law jurisdictions

The Judicial Committee of the Privy Council (the Privy Council) in Equity Trust (Jersey) Ltd (Respondent) v Halabi (in his capacity as Executor of the Estate of the late Madam Intisar Nouri) (Appellant) (Jersey) ITG Ltd and others (Respondents) v Fort Trustees Ltd and another (Appellants) (Guernsey) [2022] UKPC 36 has considered appeals from the Jersey and Guernsey Courts of Appeal on four issues of Jersey law (which it confirmed was the same in all relevant aspects as English law) as follows:

1. Whether the right of a trustee indemnity confers a proprietary interest in trust assets on the trustee.
2. If such an interest is conferred does this survive the transfer of the trust assets to a successor trustee.
3. Does a former trustee's proprietary interest in the trust assets take priority over the equivalent interests of successor trustees or do these rank equally.
4. Does a trustee's indemnity/lien extend to the costs of proving its claim against the trust even if the trust is "insolvent" such that the trustees' claim to indemnity exceeds the value of the trust fund.

The key part of the decision focused on for the purposes of this article is issue 3, ie, whether a former trustee's proprietary interest in the trust assets deriving from the right to indemnity takes priority over the equivalent interests of successor trustees.

The Court held on a 4:3 majority that a former trustee's proprietary interest does not take priority over the interest of a new trustee and this ranks pari passu (meaning equally) with the new trustee where the trust's assets are insufficient to meet all indemnity claims. Trustee's liens were not intended to be in competition with each other where trust assets were inadequate and they should be recovered pari passu because the trustees had suffered a shared misfortune.

Hussein Mithani, an associate in our disputes and private wealth team, and Philip Lis, a senior associate in our insolvency disputes team, consider the decision in further detail below.

Background

The Jersey Court case concerns a Jersey discretionary trust called the Ironzar II Trust (the Jersey Trust). The Jersey Trust was settled by Madam Intisar Nouri (the Jersey Settlor) and is "insolvent" on the basis that its liabilities far exceeded its assets in or around October 2015.

Equity Trust (Jersey) Ltd (the Jersey Respondent) was a former trustee of the Jersey Trust and had retired from its role in the Trust in 2008. In 2012, the Jersey Respondent was sued by a company in the Jersey Trust structure and, in December 2015, the Jersey Respondent paid a settlement totalling some £18 million. The Jersey Respondent subsequently sought reimbursement out of the Jersey Trust's assets from its new trustee.

The Jersey Respondent argued that its debt was first in time and consequently took priority over the claims of the other creditors of the Jersey Trust and that it should recover all its assets (totalling some £6 million). Simon Halabi (the Jersey Appellant), the executor of the Jersey Settlor's estate and the new trustee of the Jersey Trust, argued in opposition that all the debts should rank pari passu and not based on whose debt was first in time. This approach would have reduced the Jersey Respondent's recovery from £6 million to approximately £330,000. The matter was heard by the Royal Court of Jersey and then on appeal to the Jersey Court of Appeal.

In brief, the Royal Court of Jersey held that the Jersey Appellant was correct and that the liens between former and current trustees ranked equally. It held that a trustee's right of indemnity and lien arises on a liability-to-liability basis and that a creditor of an "insolvent" trust could not claim its costs of proving its claim from the insolvent trust fund. This was notwithstanding the fact that the creditor was a former trustee claiming under their right of indemnity.

The Court of Appeal of Jersey reversed that ruling and held that the Jersey Respondent's lien was first in time and took priority over the other creditors. In particular, the Jersey Court of Appeal held that a trustee has an equitable lien in order to secure its right of indemnity, this lien comes into existence upon the trustee's appointment and continues after the trustee's retirement. The Court of Appeal further rejected the notion that the indemnity and lien arise on a liability-to-liability basis and noted that the lien formed is enforceable in respect of all the individual liabilities incurred by the trustee.

The Guernsey Court case concerns the Tchenguiz Discretionary Trust (the Guernsey Trust) which was governed by Jersey law. Investec Trust (Guernsey) Ltd (the Guernsey Respondent) was the original trustee and assumed liabilities under a loan agreement totalling approximately £100 million and further loans due to two BVI companies totalling €78.825 million and £80.541 million, respectively.

In October 2018, the two BVI companies commenced proceedings to identify and resolve the various claims against the assets of the Guernsey Trust. As part of a settlement, the then trustees of the Guernsey Trust took an assignment of the (now) judgment debts due to the two BVI companies and submitted proofs of debt in respect of the judgment debts. However, the Guernsey Trust did not have sufficient assets to satisfy the claims against it.

The Guernsey Court was asked to determine whether the claims of a former trustee and its trust creditors had priority over those of successor trustees. The Royal Court of Guernsey held that the claims of a former trustee and its trust creditors had priority over those of successor trustees and that trustee claims had priority over creditors claiming through them as subrogated to their lien. This was upheld by the Guernsey Court of Appeal.

Judgment

Issues 1, 2, and 4

On issues 1, 2, and 4 the Privy Council made unanimous decisions.

In respect of issue 1, as to whether the right of a trustee indemnity confers a proprietary interest in trust assets on the trustee, the Privy Council held that it does. The Privy Council noted that this is an equitable lien which arises by operation of law.

In respect of issue 2, as to whether such a proprietary interest survives the transfer of the trust assets to a successor trustee, the Privy Council held that it does. The rationale for this is that the indemnity creates a proprietary interest in the trust assets and it would be contrary to equity for such an indemnity to cease when the trustee parted with legal title or possession of the trust property.

In respect of issue 4, as to whether a trustee's indemnity/lien extends to the costs of proving its claim against the trust even if the trust is "insolvent" such that the trustees' claim to indemnity exceeds the value of the trust fund, the Privy Council held that it does. In coming to this conclusion, the JCPC noted that there was no analogy with the rule applicable to the costs of creditors in proving their debts which arises out of insolvency law.

Issue 3

However, the Court was split 4-to-3 in respect of issue 3. Issue 3 concerned whether a former trustee's proprietary interest in the trust assets takes priority over the equivalent interests of successor trustees or whether they rank equally.

The majority held that the current and former trustees' liens rank pari passu. In doing so, Lord Briggs noted there was a lack of authority on this point and highlighted "the essentially pragmatic and flexible approach which equity takes to the resolution of problems of this kind". In particular, Lord Briggs noted that the trustee's lien, not being like other kinds of equitable interest, is not amenable to the application of some existing priority rule by analogy and requires a carefully worked-out rule of its own. Trustee's liens were not intended to be in competition with each other where trust assets were inadequate and they should be recovered pari passu because the trustees had suffered a shared misfortune.

Lord Briggs held that the "first in time" approach would seem even more "inequitable and unbusinesslike" from the perspective of trust creditors. He added that, even without the "first in time" approach, the position for trust creditors is, "…bad enough… [as they] are exposed to the unknowable state of account between the trustee with whom they deal and the trust". Lord Briggs further noted that trust creditors generally do not see the trust accounts and if the "first in time" rule applied then these trust creditors would be subject to "the further uncertainty (from their perspective) of the different times of appointment of the trustees, as a basis for allocating priority as between them". Further, the trust creditors' natural expectation, as unsecured creditors, would be that they would share in the trust fund pari passu.

The Privy Council also considered other scenarios where competing claims are made on insufficient assets.  This included directors in a company insolvency (who are ranked pari passu) and liquidators and administrators (who are ranked above other classes of creditor but do not have priority as between them).  The comparison was also made to solicitors who enjoy a lien over the proceeds of litigation for unpaid fees, in which case later solicitors enjoy priority. Lord Briggs considered these examples indicated there was no history of applying a "first in time" rule to equitable liens.

Lord Briggs' judgment was supported by Lady Arden who held that, if the former trustee took priority, then this would be inconsistent with equitable principles and lack a logical basis. She added that the "first in time" approach may cause issues with the administration of the trust more generally.

The dissenting three judges (Lord Richards and Sir Nicholas Patten, with whom Lord Stephens agreed) held that the general principle that the first in time has priority applies to successive trustees. This was on the basis that the right of indemnity is not security for payment of a debt but was to protect the personal position of the trustees who retain personal liability. The dissenting judges also focused on the fact that the right of indemnity does not seek to protect trust creditors and if a former trustee ranked equally to the current trustee the former trustee would demand greater security on retirement.

Comment

The Privy Council's decision provides much-needed clarity regarding the position of current and former trustees of insolvent trusts and for creditors who may have claims against current or former trustees.

Importantly, from a practical perspective, the decision will have considerable, long-term ramifications for the administration of trusts and how trustees will act.

This decision may prompt retiring trustees to act more cautiously when handing over a trust with large liabilities to a new trustee. For example, they may pay particular and closer attention to obtaining indemnities from the new trustee, seek future restrictions on the dealings with the trust fund or try to find other ways to put a cap on their own liability. Other ways which already exist to protect trustees include the trustee itself being an SPV (eg, a PTC) or using SPVs to hold certain trust assets to limit liability (to the extent they can under the relevant law).

However, it may be that those who are most likely to be concerned by this decision are third parties who contract with the former trustees. Given that trustees generally seek to limit their liability to their ability to recover from the trust fund (and jurisdictions like Jersey have put this on a statutory footing), such third parties may take comfort in the size of the trust fund when contracting with trustees. However, later down the line, these third parties may get a nasty surprise when they discover they are at the mercy of future unknown trustees who rank equally with the original trustee.