Bust Trusts: A matter for Priorities

A Privy Council ruling could have wide implications for trustees and creditors of an insolvent trust, says Clara Hamon

Two points of law relating to how to deal with the liabilities of insolvent trusts and the status of a trustee’s lien are to be considered by the Judicial Committee of the Privy Council (JCPC). The case should provide further clarity on these issues; and new points of law to note in England and Wales as well as UK overseas territories and Crown dependencies. In June 2019, the Jersey Court of Appeal ruled in favour of the claimant (Equity) in Equity Trust (Jersey) Limited v E (in his capacity as Executor of the Estate of C) [2019] JCA 188 and overturned a decision of the Royal Court, holding that a former trustee’s equitable lien over trust assets takes priority to successor trustees’ equitable liens. Leave to appeal to the JCPC was granted in September. An equitable lien is different from a common law lien. It is a form of equitable charge upon property until certain claims are satisfied. Equitable liens are similar to mortgages in the sense that they provide security without possession, but they arise by operation of law. The existence of an equitable lien securing the satisfaction of a trustee’s right of indemnity has long been recognised under English law and in other common law jurisdictions. The outcome of the appeal to the JCPC will be of interest to those in the trusts industry, including private client solicitors and those in the wider commercial sector.

Z TRUSTS

There were eight interconnected family trusts based in Jersey (the Z Trusts) of which Equity was the original trustee of the Z II and Z III Trusts. It is common in Jersey to see family wealth structured in the form of related trusts, perhaps with one or two main trusts, with individual trusts primarily for the benefit of children of the family. Equity retired in 2006 and a new trustee was appointed. In 2012, proceedings were brought against Equity in the High Court of England and Wales by the liquidators of Angelmist Properties Ltd (Angelmist), a company in the Z II structure. Equity made a payment to Angelmist and then sought to rely on its indemnity from the successor trustee – and to be indemnified from the assets of the Z II Trust. By this point, the Z II Trust was insolvent and its only asset was a loan from another Z Trust which was worth less than its liabilities. While it is acknowledged that it is not technically accurate to describe a trust as insolvent as it is not a legal entity, the term has been used throughout the successive judgments for convenience to refer to a situation where the assets held on trust by the trustee are insufficient to meet the claims to those assets.

In 2018, Jersey’s Royal Court ruled that Equity’s claim did not take priority and would rank pari passu with the liens of successive trustees and the claims of creditors of the Z II Trust. This would have meant Equity could not ‘scoop the pot’ of the trust assets and could only recover around £330,000. The court proceeded on the basis that Equity was entitled to be indemnified from the trust assets by reason of its equitable lien. Equity successfully appealed. The Jersey Court of Appeal held that a trustee’s equitable lien has priority over the claims of creditors, and also over the right of lien of a successor trustee – even when a trust is insolvent. The court considered it appropriate to look to English law on the priority of rights. Its decision was based on the reasoning that a trustee’s priority arises by virtue of its office, and ranks ahead of beneficiaries and those deriving title from them. Each trustee therefore possesses its own equitable interest and right of lien, enforceable as a first charge against the trust asset. The court also held that the general rule that equitable interests rank according to the order of their creation applies between trustees. In relation to creditors, it should be noted that this only applies in relation to creditors who knew they were dealing with a trustee in its capacity as trustee. A creditor who did not know this is able to claim against the trustee personally and is not limited to a claim against the trust assets (Article 32(1)(a) of the Trusts (Jersey) Law 1984). In the court’s view, a trustee is thereby given an advantage over its trust creditors, and a creditor who is aware it is dealing with a trustee can strengthen its position by taking such security as it chooses.

THE PRIVY COUNCIL

The Jersey Court of Appeal recognised that in normal circumstances it would be left to the JCPC to decide whether or not leave should be given. However, there is no authority in any jurisdiction dealing with the issues in question and the court found it was of general importance – in Jersey and more widely – for the following points to be considered by the JCPC: The correct method of dealing with the liabilities of a trust whose assets are insufficient to meet the claims on it; and i The status of a trustee’s lien in Jersey law. ii The court felt it important that the proper way of dealing with trusts where there is a deficiency of assets should be established sooner rather than later, so that present and future creditors can know where they stand – and make decisions on dealing with trustees.

WATCH THIS SPACE

It will be many months before an appeal is heard by the JCPC, but the eventual decision will be widely anticipated given the potential ramifications. Anyone seeking to obtain assets which are ultimately held in a Jersey trust will want to know how the status and ranking of existing liabilities and liens will have an impact on any available assets. Potential successor trustees and any third parties contracting with trustees will need to exercise caution and may wish to protect themselves by requiring additional security. Thorough due diligence is essential to assess any potential liabilities, but even such precautions may not be sufficient to provide the safeguards sought (one of the Court of Appeal judges noted that the liability in the Angelmist proceedings would not have been foreseeable by reasonable investigation). Trustees should also take advice on how to ensure third parties know they are contracting with a trustee – usually a matter of careful drafting – to obtain the maximum protection possible. Any sense of comfort on the part of former trustees after the 2019 appeal will be dispelled if the appeal judgment is reversed and their equitable rights no longer have priority. Meanwhile, it would be wise for prospective and current trustees and creditors to seek advice on how to reduce financial exposure. A trustee who fears a trust is heading towards becoming insolvent should consider seeking directions from the court on how to administer the trust. This is the most sensible course of action and should also provide protection for fees.