Retirement, Replacement & Removal Of Trustees: Guidance Note

 

This Guidance Note will cover a host of practical issues for trustees seeking to step down from office and the practical implications of some recent court decisions on applications to remove a trustee. It will also cover legal issues for both outgoing and incoming trustees and their beneficiaries; such as knowing when a trustee should jump before being pushed if it is experiencing friction with beneficiaries, practical points to consider when facing a court application for removal – parallel claims for breach of trust, conflicts of interest, costs, and the importance of tying up loose ends – and also trickier points in negotiating and structuring appropriate indemnities.

 

Retirement & Replacement

Retirement usually takes two forms: either accompanying a final distribution of trust assets to beneficiaries, or retirement in favour of a new incoming trustee (a replacement). The transition between the outgoing and incoming trustee is usually a consensual process. However, a sole outgoing trustee cannot retire (and leave the trust without a trustee) without either making a final distribution to beneficiaries (so as to end the trust) or appointing an incoming trustee to replace them (Art. 19 Trusts (Jersey) Law (“TJL”) 1984). On the termination of a trust the trustee is entitled to seek reasonable security for its liabilities incurred as trustee and may also seek (but is not entitled to) a release from liability or breach of trust.

A warning from recent history about the risks of an oversight if the power to appoint trustees is vested in someone other than the outgoing trustee was BB A & C [2011] JRC 148.  This case involved an employee benefit trust. A succession of trustees were appointed in 1992, 1997 and 1998. The power to appoint new trustees was vested in the employer company, which had been dissolved in 1996; no one appeared to have noticed this until 1999.  This made the appointments of the trustees in 1997 and 1998 invalid.

The solution from the Royal Court was to bless the first trustee’s application under Article 45; i) relieving it from any fault in having retired in favour of the improperly appointed trustee in 1997 and ii) validating all the acts of trustees 2 and 3 in the intervening years. This case, however, is not a precedent to be comforted by or relied upon. The first and subsequent trustees were fortunate that all parties supported the application.  It may have been more complicated had  the parties been more hostile. The first trustee would still have been the actual trustee with a duty to recover trust assets and consider the reasonableness of the second and third trustee’s entitlement to their professional fees, their conduct while trustees de son tort and decide whether to pay. Trustee 1 would be under a duty to recover the losses caused by any breaches of trust by Trustees 2 and 3. There would have been issues as to whether the second and third trustees’ exercise of powers were valid.

Trustee’s Liabilities

A trustee is liable to third parties to the trust as principal rather than the agent of the beneficiaries.  Liability may arise by virtue of entering into contracts, leases, guarantees, indemnities, to which the trustee is a party, tortious claims for which the trustee can be fixed with liability and of course fiscal liabilities. While in office, a trustee is entitled to reimburse itself from the trust assets for costs it reasonably incurs in the trust’s administration (Article 26 TJL 1984). The trustee may retain and realize assets sufficient in order to ensure it is not left out of pocket.

A trustee who transfers trust assets to a new trustee (and thereby deprives itself of the right to reimburse itself from assets under its control) puts itself at personal risk if it is sued by a third party. However, under Jersey law, the trustee’s liability to a third party who transacts with the trustee knowing him to be a trustee, will be capped to the value of the trust fund. (Article 32(1) TJL 1984).

An outgoing trustee is entitled to the statutory release in Article 34(3) TJL 1984 upon resignation, retirement or removal if it surrenders the trust assets to an incoming trustee.    Article 34 TJL 1984 also entitles an outgoing trustee to require “reasonable security for liabilities whether existing, future, contingent or otherwise.”

This “reasonable security” covers liability to third parties, the costs of transition to a new trustee and any unpaid fees but does not extend to liability for breach of trust or claims to recover trust property.

Whether reasonable security is required at all and the form of security that may reasonably be sought will depend upon the nature of the liabilities, the nature of the trust assets and their location.  The usual form of reasonable security is by way of a contractual indemnity from the incoming trustee (or from the beneficiaries if there is a final appointment).  Other forms of security may include a charge over specific trust assets, placing trust funds in escrow or the retention of some or all of the trust fund by the outgoing trustee.

The core principles of a transfer of trusteeship are as follows:

  • The outgoing trustee is under a duty to be proactive and reasonable in the transfer of assets (Ogier Trustee (Jersey) Ltd v CI Law Trustees Ltd [2006] JRC 158).
  • The trustees’ private interests must not eclipse the interests of the beneficiaries.
  • Outgoing trustees should make reasonable enquiries as to the nature and amount of their contingent and future liabilities (and communicate these to the incoming trustee).
  • Unknown liabilities should be calculated on reasonable and not fanciful assumptions.

When calculating future liabilities, the likelihood of a liability materialising must be considered. It is necessary for the trustee to review sources of potential liability incurred by itself during the tenure as trustee, as well as  sources of potential liability arising before tenure as trustee (e.g. it may have given the previous trustee an indemnity).  The outgoing trustee should seek professional advice as to the nature of claims and limitation periods and consult with the incoming trustee on the extent and the cost of doing so.

If a contractual indemnity is being sought, the trustee should consider whether it’s actually necessary. A contractual indemnity serves to exchange the outgoing trustee’s rights under Article 26 with a single contractual right against the incoming trustee (or beneficiary).  A contractual indemnity that is wider in scope than that to which the outgoing trustee is entitled will not be reasonable Caversham Trustees [2008] JRC 065.

In terms of structuring a contractual indemnity, the two classic models are a chain indemnity and a replacement indemnity.

‘Classic’ Chain Indemnity

Chain Indemnity

Replacement Chain Indemnity

Replacement Indemnity

The replacement indemnity has some distinct advantages over a chain indemnity.  It allow direct recourse to the party with the trust assets so missing links in the ‘chain’ are not a problem for a retired trustee faced with a liability that suddenly materialises. It is therefore more robust than a chain and also provide a clean break for retired trustees. The mechanism provided by the replacement indemnity is, to a large extent, replicated in in Article 34(2A) TJL 1984.  The  conditions that must be satisfied to take advantage of that provision are that a fresh indemnity is provided on subsequent changes of trustees and that the terms of that indemnity must provide the right for the retired trustee to enforce the indemnity or that the indemnity purports to confer a benefit on the retired trustee.

Security of Contractual Indemnities

The utility of the security provided by a contractual indemnity is dependent on the value of the trust fund in the hands of the new trustee. The likelihood of the future diminution of the fund must be considered, with factors such as the location and form of incoming future trustees (which may affect enforcement) and whether the beneficiaries’ interests are vested or discretionary taken into account. It may be difficult to make a distribution to which a beneficiary is entitled conditional upon the beneficiary giving security to the trustee. An incoming trustee should consider whether the outgoing trustee’s entitlement to seek reasonable security will interfere with the smooth administration of the trust in the future.  It may be possible to agree that de minimis distributions from the fund (say 10%) can be made to beneficiaries without triggering a requirement on the incoming trustee to seek an indemnity from the beneficiary.

Thought should also be given to the duration of any contractual indemnity. It’s rare for a trustee to be exposed to an uncapped risk of indefinite duration.  The duration of a contractual indemnity will be largely governed by the limitation period applicable to a particular head of liability. It will be appropriate for the outgoing trustee to seek legal advice on both domestic and foreign limitation periods and on the likely governing law of a given liability if the trustee is unsure of the position.  It may also be possible to cap the quantum of the liability for which an indemnity may be sought.  A trustee should ask for no more than it reasonably needs. A peculiarity of Jersey law is that Article 32 TJL 1984 has the effect of capping the trustee’s right to an indemnity at the value of the trust fund.

A contractual indemnity may in some cases be insufficient as ‘reasonable security’. Where, for example, the assets are illiquid such as land or shares in a private company or where the assets are controlled by the settlor or beneficiaries (who may be hostile to the trustee, particularly if there has been an attempt to remove the trustee). Alternatives to an indemnity include charges over specific assets, although the enforceability of this must be considered. There is also the alternative of retaining assets/cash or a combination of measures.

Retention of assets is the most drastic solution and will not be appropriate where the value of a liability is unknown, or where other forms of security are more appropriate such as partial retention, retention limited by time or contingency, a staged release of assets or an escrow/joint control of assets with a new trustee. It is inappropriate for a trustee to retain the whole fund as a ‘ransom’ for outstanding costs (Carafe Trust [2005] JLR 159). A trustee who unreasonably insists upon a particular form of security runs a risk that it will be made to pay the costs from its personal assets if the matter has to go to court for resolution.

Conclusions on Replacement and Retirement

When negotiating the transition between an outgoing and an incoming trustee, reasonableness is the name of the game. The trustee is entitled to reasonable security for liabilities and the incoming and outgoing trustee should behave reasonably in the transitional arrangements. A court application for directions is always a fallback where agreement cannot be reached and the court will support a reasonable trustee by giving it reasonable security. However, the court will penalise unreasonable behaviour in costs.

Removal

Trustees need to know the legal position if the relationship with the beneficiaries turns sour.  When is it appropriate for a trustee to go, when should it stay, should it jump or wait to be pushed? Trustees also need to know the cost implications in choosing one of these positions.

In all applications for removal, the beneficiaries’ welfare and the competent administration of the trust is paramount (Letterstedt v Broers (1884) 9 AC 371).

There are a number of factual scenarios that may be a pretext for removal; they can include situations when the trustee is conflicted, the trustee appropriates or deals with trust assets for their own advantage, friction with beneficiaries and/or an irretrievable breakdown in the relationship occurs, the trustee is obstructive and has demonstrated a general dereliction of duty as to the rights of beneficiaries to information, accounts, distributions and so on, the trustee refused to act/ is untraceable (In The Matter Of The Jeep Trust 2010 JLR Note 25) or the trustee(s) is/are deadlocked (Trilogy Management v YT [2014] JRC 214).

Touchstones for Removal

Removal Touchstones

Costs of Removal Applications

Applications to remove a trustee by a beneficiary are classed as hostile litigation, with the usual rule that costs follow the event (i.e. the loser pays). Applications by the trustee and/or beneficiaries for directions as to the trustee’s position are different, as the costs in most cases will come from the fund. In both hostile and non-hostile proceedings, costs can be awarded on the standard or indemnity basis.

It is important for trustees and beneficiaries to remember that the cost risk in a removal application is asymmetric in favour of the trustee. If a beneficiary makes an application seeking the trustee’s removal and the trustee wins, the trustee will be entitled to its costs from the fund.  As the loser, the beneficiary and must pay its own costs, and may be ordered to pay the trustee’s costs if they are not to come from the fund.  However, if the beneficiary wins, it will be entitled to its costs either from the fund or from the trustee personally, but the trustee, even though it has lost, is still entitled to its costs from the fund if it has not acted unreasonably in the proceedings.

Breach of Trust

Deliberate breach(es) of trust are unlikely to withstand an application for the trustee’s removal. A breach of trust does not have to be deliberate to justify removal but not every breach of trust will justify removal when weighed against other factors including the gravity and nature of the breaches and the cost of the transfer of the trusteeship.

Irretrievable Breakdown

While a beneficiary cannot change trustees at will, an irretrievable breakdown in the relationship between the trustee and the beneficiary can, of itself, justify removal. Mere friction or hostility of itself will not usually justify removal, although it does depend on the source of the hostility. This makes for a tricky area, with many shades of grey. Beneficiaries may plead breach of trust with a fallback position that a breach (even a minor one) has led to an irretrievable breakdown/loss of confidence as a pretext to seek the trustee’s removal.

If a trustee can fend off a breach of trust claim, is the court still likely to order removal? The court may order removal – even if the cause of the disharmony is unjustified – if it impacts negatively on the administration of the trust. This is where it’s necessary to know when to jump before being pushed, and note the cost position if it’s unreasonable for the trustee to defend the application for its own removal.

There is an unfortunate perverse incentive for beneficiaries to deliberately prompt a breakdown in the relationship with the trustee in order to achieve the beneficiary’s desired removal of a trustee. The courts are aware of this will look at who has caused (in some cases manufactured) the problem in the relationship when asked to consider removal. It is almost inevitable that friction can make the trust more expensive and slower to manage as the trustee deals with the beneficiary’s concerns and there is greater scrutiny of the trustee’s actions. It’s important for the trustee to remember to engage, be (and be seen to be) reasonable when dealing with the beneficiaries, and to remember that the power to remove trustees protects the welfare of beneficiaries of the trust.

In terms of awkward beneficiaries, the dissatisfied beneficiary’s interest must be considered; is the demand to step down coming from all the beneficiaries? All the adult beneficiaries? Some of the beneficiaries, or only one of the beneficiaries? Is the beneficiary a discretionary object or do they have a vested interest in possession? A trustee should consider canvassing the views of the other beneficiaries. Beneficiaries should be advised that the court’s power to remove and is not a rod with which to beat the trustee into submission to the beneficiaries’ will.

Conflicts of Interest

The court will remove a trustee if it is in conflict with the beneficiaries’ interest or with itself, and may penalise any truesee in costs if the conflict is so obvious that the trustee should have resigned instead of causing an application to be made. See In the Matter of E, L O and R Trusts [2008] JRC 150.

It will be crucial for the trustee to keep the structures under its management under constant review to spot and manage any potential for finding itself in a position of conflict.

Tying Up Loose Ends

As far as the timing of removal is concerned, there may be a good reason for a trustee to stay in office, at least for a while, and then go. The trustee may be part-way through a task at the time of the removal application e.g. litigation, the sale or disposal of significant trust assets, a rights issue or floatation of an underlying company If the task being undertaken will have to be completed by a new trustee but the current trustee is best placed to see it through (factoring any time sensitivity and cost in bringing the new trustee up to speed with the relevant background) then the current trustee will often have a good argument to remain in office, at least until the task is completed.  If a trustee is resolved to go at a certain point, they should say so openly to the beneficiaries.

Summary: Considerations when faced with Removal, consider:

The following is intended to be a helpful checklist for trustees and beneficiaries when considering an application for removal or a complaint that has the potential to lead to argument as to whether the trustee should remain in office.

1)   How does the complaint affect the trust’s administration?

2)   Who is responsible for hostility/friction?

3)   Is the friction objectively justified?

4)   Which beneficiaries are for and against T’s removal?

1)   Any a particular reason to stay (for now)?

2)   What is the likely cost of a new trustee?

3)   Keep the temperature low.

James Sheedy
Associate
jamessheedy@bakerandpartners.com
 
March 2015

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