Z Trust litigation

We acted for Equity Trust (Jersey) Limited (ETJL) in this precedent setting case from the Royal Court of Jersey. We provide an overview of the judgment below and explain why the judgment could have very damaging practical consequences for the trust industry.

Factual background

ETJL was the original trustee of the Z Trust, a Jersey discretionary trust. ETJL retired as trustee in 2006 and entered into a Jersey law Deed of Retirement and Appointment with the new trustee pursuant to which it was granted an indemnity from the assets of the trust for any indemnities incurred in its capacity as trustee.

In 2012 a third party issued a legal claim against ETJL in relation to actions taken when it was trustee. The litigation was ultimately settled by ETJL but at a total cost to it of approximately £18 million.

In 2015, the Royal Court of Jersey declared that the Z Trust was insolvent and it was to be administered under supervision of the Royal Court. The Royal Court permitted a new trustee (Rawlinson & Hunter) to take over the trusteeship and administer the trust in accordance with the directions of the court on the basis that its' fees were to be funded by a third party.

Matter before the Royal Court

ETJL issued a Summons seeking a declaration from the Royal Court that ETJL's equitable lien and all other equitable, statutory or contractual rights of indemnity which it held as a former trustee be enforced over the assets of the Z Trust in priority to the current trustee of the trust's indemnity and all creditors' claims which were subrogated to the current Trustee's indemnity.

The current trustee opposed this application and argued that a pari passu approach should be applied with the effect being that their respective rights ranked equally.

The question of whether the current and former trustees' indemnities and equitable liens were to be applied on a first in time basis or pari passu basis had an important financial implication for ETJL. On the last financial summary of the assets of the Z Trust, the assets of the trust were estimated to be approximately £6 million. Consequently if ETJL was granted priority it could at least recover £6 million in relation to the claim against it but if ETJL's claim ranked pari passu with the current trustee then it would only receive approximately £333,000 against a liability of £18 million.

The matter was heard by Commissioner Clyde-Smith in the Royal Court of Jersey on 15 and 16 March 2018.

The decision

The Royal Court handed down its judgment on 3 July 2018 and held that a former trustee's claim under their right of indemnity would rank pari passu with that of the current trustee.

Commissioner Clyde-Smith did not consider there was sufficient persuasive authority as regards the 'first in time' approach and he felt the pari passu approach was the fairest in all the circumstances.

He commented that if one took the alternative 'first in time' approach this would cause issues as regards as to exactly when each trustee's claim arose. Commissioner Clyde-Smith considered that this would be an "unfair outcome" as such a rule would give rise to some creditors being paid in full and others not at all. Commissioner Clyde-Smith further stated that "creating such a regime between trust creditors would not be conducive to the good administration of the trusts".

Analysis

This judgment is a significant one for the trust industry as it is the first time any court in any jurisdiction has considered and addressed the question of how current and former trustees' respective rights of indemnity and equitable liens should rank in the circumstances of an insolvent trust.

The decision has significant adverse implications for former trustees who wish to recover assets from an insolvent trust to meet the costs of a third party claim against them. As a result it brings the value of a former trustee's indemnity and equitable lien into question.

In this case, as explained above, the former trustee had an £18 million liability in the form of a legal claim by a third party which it incurred after it transferred the trust’s assets. However rather than being able to rely on its indemnity and claim all the remaining trust assets (which have an estimated value of £6 million) to partially meet this liability, the Royal Court determined that former trustee's claim to the assets ranks pari passu with the current trustee (and any unsecured creditors who claim through the current trustee). Consequently the former trustee is only likely to recover £333,000 from the trust assets. This is despite the fact that the current trustee is protected from personal liability to any creditors who may try and claim through it by operation of its right of exoneration under Article 32(1)(a) of the Trusts Law.

This judgment means that former trustees face the prospect of their indemnities and equitable liens being worthless should the assets of the trust be diminished to the point of insolvency. Given that a third party could bring a claim against a former trustee up to ten years after the event under Jersey law, this leaves former trustees vulnerable in personal liability for third party claims for a significant amount of time, and with no control over the administration of the trust in the meantime.

However this is not the last you will hear on this case as ETJL is appealing the decision and we expect the appeal to take place during the Court of Appeal's January sitting in Jersey.

We will keep you updated.

Read the judgment here.