April 2004

Wills & Estates Law Update - Right of Indemnity for Trustees and Out of Office Trustees

Right of Indemnity for Trustees and Out of Office Trustees

The right of indemnity for trustees

A trust is a legal relationship, imposing obligations on a trustee in respect of property. Normally a trustee is personally liable for obligations incurred in administering the trust. That is, even though the obligations are incurred as trustee, the trustee is still personally liable and can be sued and have its own assets applied to meet any judgment.

A trustee may however rely on a right of indemnity against trust assets to meet obligations incurred. The extent and operation of any indemnity is qualified by various factors which we explore in this bulletin.

The legal basis of the trustee's right of indemnity

A trustee manages trust property for the benefit of the beneficiaries and because of this a trustee is permitted to have recourse to the trust property to satisfy the debts incurred on behalf of the trust. This right of indemnity out of the trust fund of the costs, expenses and liabilities properly incurred in the execution of the trusts or powers is recognised by the general law and by statute.1

The trustee's right of indemnity constitutes an equitable proprietary right (namely a charge or a right of lien) over trust assets. As the indemnity confers an equitable proprietary right upon the trustee, it serves effectively to confer on the trustee a beneficial interest in the trust assets according to the quantum of the trustee's unsatisfied indemnity. The right of indemnity has priority over any claims of the beneficiaries of the trust.

No right of indemnity arises as a matter of general law in respect of a trustee's remuneration. Any such right must be conferred expressly by the trust instrument.

Can the trustee's right of indemnity be denied or reduced

The trustee's right to indemnity may be denied or reduced in the following circumstances:-

  • A breach of trust relating to the subject matter of the indemnity will bar a trustee from the right of indemnity in relation to it. Therefore, a trustee who commits a breach of trust cannot claim recoupment until the trustee has provided compensation for that breach.
  • The trust instrument may expressly provide that the trustee's right to indemnity may be denied or reduced in specific circumstances or generally.
  • Where trustees overpay some beneficiaries at the expense of others and make good the shortfall to the latter out of their own pocket, they are not, in the absence of mistake entitled to recoup from the trust estate. A trustee, may however, be entitled to an indemnity in this situation if the trustee was induced by a beneficiary to prematurely hand over that beneficiary's entitlement under the trust.

Can an out of office trustee rely on the right of indemnity to recover out of the trust fund?

An out of office trustee can rely on the right of indemnity given to it by the general law and by statute to recover out of the trust fund. There is well established authority that the right of indemnity, though being proprietary in nature, is not dependent upon the retention of possession of property, and so survives the trustee's loss of office by retirement.2 Therefore, a trustee's right of indemnity does not cease upon retirement.

Can a trustee be liable for acts of a prior trustee?

A new trustee does not inherit or assume liability for the breaches of a predecessor. However, it would be prudent for the new trustee to seek an indemnity from an outgoing trustee to protect the new trustee from the effect of breach of trust by that outgoing trustee during that trustee's period of administration of the trust.

There is statutory legal protection for the new trustee for breach of trust by an outgoing trustee (see sections 59(2) and 59(4) of the NSW Trustee Act 1925). There is also general law protection.

Acting in good faith - but still committing a breach of trust

Section 85 of the NSW Trustee Act 1925 also allows a trustee to apply to the Supreme Court for relief from personal liability where the trustee has acted with all good faith and in a reasonable manner and yet committed some breach of trust for which it would be liable if the law were applied strictly. A professional trustee who is receiving remuneration has a particularly heavy task to make out an entitlement to relief under section 85.

The statutory and general law protection may not however, always be enough. For example, the beneficiaries of the trust may sue a new trustee for breach of trust because the new trustee failed to fully investigate the accounts of the outgoing trustee or to recover or sue for trust property that should have been paid or transferred to the new trustee by the outgoing trustee.

In our experience it is generally very difficult to establish that loss can be soley attributable to the default of the outgoing trustee, or conversely solely attributable to the default of the incoming trustee.

Summary

There are benefits to be gained from a new trustee seeking an indemnity from an outgoing trustee for added protection. However, in many cases benefits will be marginal as the general law position is reasonably satisfactory.

Equally, trustees should avoid giving indemnities which can only extend the trustee's general law obligations and in most cases (except possibly for professional trustees) will be uninsurable risks.

Experience suggests to us that negotiating indemnities in this area may consume significant legal resources and commercial goodwill as the issues are complex.

Position of outgoing trustees of Guernsey trusts

The Guernsey Court of Appeal decision in Virani-v-Guernsey International Trustees Limited is a useful decision that looks at the position of outgoing trustees.

The case considers the position of outgoing trustees of Guernsey proper law trusts who have been removed by a protector with specific power under the trust to do so. It looks at the effective date of removal (held to be the date of the letter of the protector exercising the power of removal), the rights and responsibilities of the trustee after removal (they cannot charge fees but are subject to continued fiduciary obligations), and the extent of the indemnity to which the trustee is entitled (the Court did not look favourably upon indemnity or exoneration provisions which go further than those to which the trustee would have been entitled under the trust deed or Trusts (Guernsey) Law, 1989).

It is considered that Australian law will eventually follow the overseas lead and look to limit indemnity or exoneration provisions in favour of professional trustees.

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1 Octavo Investments Pty Ltd-v-Knight (1979) 144 CLR 360 and section 59(4) of the NSW Trustee Act 1925.
2 Dimos-v-Dikeakos Nominees Pty Ltd (1996) 149 ALR 113 which followed the decision in Kemtron Industries Pty Ltd-v-Commissioner of Stamp Duties [1984] 1 Qd R 576.