At this year's Legal Week Trust and Estates Litigation Forum, senior lawyers outlined the different approaches to trustee liability adopted by the UK, US, Channel Islands and British Virgin Islands

Nigel Sanders, partner, Ogier 

Imagine a simple scenario. A trustee has incurred liabilities by borrowing some money. It has spent its money on various assets and it is watching those assets diminish in value day by day. Now its creditors are starting to swell, the liabilities are beginning to crystallise and the trustee is wondering whether or not it is going to meet the trust debts and what it should do when it simply can't meet the liabilities that are coming in its direction. To what extent is the trustee personally liable?

Nick Holland, partner, Bircham Dyson Bell 

From the English law perspective, you start off with the premise that the trustee has an unlimited personal liability for the liabilities incurred in the administration of the trust. It has an indemnity against the trust property for those liabilities; it has a lien over the trust property in connection with those liabilities; and there is also a right of subrogation for the creditors to step into the shoes of the trustee and take steps against the trust property to satisfy those liabilities.

Where the English position gets interesting is in connection with the ability of the trustee to contract out of that liability or limit that liability, and also in the English response to statutory limitations or purported statutory limitations on trustee liability in the Channel Islands and the British Virgin Islands (BVI). When it comes to the issue of contracting out of liability, you start from the premise that in the City of Glasgow Bank case the court established that there was nothing to prevent a trustee limiting its liability contractually. But a fairly high bar was set on limiting liability contractually. So in limiting your liability you have to be very careful.

For example, in the Watling v Lewis case, the trustees used this language: "As such trustees but not so as to create any personal liability on them or either of them." You would think that would be exactly what you are looking for – strong language that clearly states there is no personal liability. But, of course, that was a problem because a trust doesn't have any existence as a legal person. 

The court said that construing a liability and then limiting it by removing any personal liability was an anathema of the contract and undermined it. So you have to find the mid-way ground that ensures the contract limits your liability without actually removing it.

Sanders

In the Channel Islands – both in Jersey and in Guernsey – there are statutory provisions, which on the face of it do limit the liability of trustees. Article 42 of the Guernsey Trusts Law and ­Article 32 of the Jersey Trusts Law are very similar in terms of ­concept. They both provide that if a trustee is dealing as a trustee with a third party and that third party knows the counterparty is acting as a trustee – or in the Guernsey case is made aware that the counterparty is a trustee – then the trustee can obtain statutory protection, so it seems, such that the trustee is only liable to the extent of the trust assets. This appears to remove the fundamental position that you are personally liable as trustee for any liabilities that you enter into.

The Jersey provision is before the Guernsey court and we are waiting for a judgment from Lord Justice Chadwick to provide a view on what these provisions actually mean. It is not simply a question of reading the statute and seeing a protection on its face.

Nick [Holland] has made the point about the basic right of indemnity: query how it interplays with the statutory protection, particularly in circumstances where a creditor would ordinarily be subrogated. What if the trustee is in breach of trust? What if the transaction that has given rise to the liability was a breach of trust? Is it right in those circumstances that the trustee can simply say 'look to the assets, don't come to me personally'.

Another issue is whether or not these provisions offer a way for a creditor to claim directly against the trust assets. Both suggest the claim is limited to the extent of the trust assets. Now, that may be taken as an indication that the creditor has a claim to those assets, somehow elevating its position to one of a proprietary nature. 

Again, is that right when one also needs to consider the beneficiaries' position? It seems difficult to justify that. And if it is simply a question of looking at the trust assets, at what point in time do you consider them? Is it when you transacted with the trustee, or is it when you have judgment or possibly when you seek enforcement? 

Now, Bajul [Shah], you have looked at some of the BVI provisions. Perhaps you could give us a Caribbean perspective?

Bajul Shah, barrister, XXIV Old Buildings 

The BVI has an interesting set of provisions in Part X of the Trustee Act that addresses many of the issues Nigel [Sanders] has outlined. 

So, for example, Section 98 stipulates that in cases of contract when the trustee has been acting properly liability is limited to the extent of the trust assets at the time of payment. Then there is an anti-avoidance provision, which extends not just to the trust's assets at the time of payment, but includes assets that have been distributed to beneficiaries as well.

There is also a statutory right of subrogation in Section 100 that has a couple of interesting features in it. One is that it specifies the extent of the subrogation, so that, when calculating what the trustee's indemnity would be from the trust fund, any liability that the trustee may have to recompense the trust fund is disregarded. 

The problem under the common law has always been that a creditor who wants to be subrogated to a trustee's right steps into the shoes of the trustee and can only be in the same position as the trustee. 

If the trustee has been in breach of trust or is in some way liable to recompense the trust fund, the creditor can't be in any better position and the creditor's ability to get to those trust assets is similarly limited. The BVI statute gets around this by saying that, for the purposes of the statutory right of subrogation, you disregard any liabilities that the trustee has to recompense the trust fund.

The other interesting feature that the BVI statute has is that it provides that the right of subrogation extends not just to the trust's assets but to what has been distributed to the beneficiaries.

Then there is a third provision that applies only if you specifically incorporate that provision into the trust instrument and if the trust was created on or after 1 March 2004. That section provides that the trustee does not have personal liability for contract. Presumably it has to be possible to sue the trustee in some way; ie in its capacity as a trustee. 

The next part of the statute addresses the consequences of this question. It says that if a claimant sues a trustee as trustee, the claimant is entitled to satisfaction from the trust assets directly rather than by way of subrogation. That is the only statutory provision I have come across that actually allows a creditor explicitly to be able to get at the trust assets directly. So it is a very interesting feature.

Sanders

What about the in the US, Joshua [Rubenstein]? ­Presumably you have the same common law principles that we have and trustees are on the hook?

Joshua Rubenstein, co-managing partner, Katten Muchin Rosenman

Actually, we have the reverse presumption. The presumption is that the trustee is liable only in his, her or its fiduciary capacity and not individually. I suspect what is behind the different presumption is that for us a trust is very much an entity. It is a tax-paying entity. 

You have probably seen this if you have done cross-border work and tried to fill out tax returns where the US authorities are insisting that a trust is an entity, and from your point of view it as an arrangement but not an entity. 

In the US, it is also a juridical entity, although it is unique among juridical entities in that you technically can't sue a trust and a trust technically can't sue. It sues or is sued by its trustee. But apart from that, it is an entity. So the day one presumption is that, because it is an entity, whoever is its representative is representing the trust and not him, her or itself.

Now, the lender can vary that. If the lender is worried that the trust assets are insufficient security it can ask for a personal guarantee, although you are more likely to get that from a beneficiary than a trustee. You can also ask for security in non-trust assets. There are plenty of things the lender can do to protect itself. But to reverse the presumption and find the fiduciary trustee personally liable, the trustee would have to have done something wrong. 

So you have to ask yourself why the trust is not in a position to repay the assets. Why did the trust assets go down? If it is because of investment losses, then not every investment loss is actionable. It has got to be an actionable investment loss and even then it does not necessarily mean the trustee is personally liable for the entire amount of the loan it can't repay. The trustee is only liable for the amount of the loss as to which it was negligent, and different US states calculate loss in different ways.

But first of all, to ascertain whether or not a trustee is liable, you shouldn't simply look at how the investment turned out. It may have turned out to be a Madoff situation. But was it reasonable at the time you made the investment? You don't have to turn out to have been right. Assuming that it wasn't even reasonable at the time you did it, then what is the measure of damages and how much is the creditor going to get towards repayment of the loan?

If you are in a state such as New York, it is the amount you lost from the time you should have known not to make the investment, plus interest. In a state such as Florida, it is lost opportunity. What could you have done with the money and turned it into? So you are more likely to get full repayment in a state that is a lost opportunity state than one that is a damages state.

The other reason a trustee might not be able to repay a loan is that it made distributions to beneficiaries. Then the question would be whether it was reasonable for the trustee to have made those distributions at the time it made them. Did it have any reason to know that making those distributions was rendering the trust insolvent? If it didn't, then it is probably OK. 

If, however, a secure creditor is involved, it absolutely comes first and the trustee will be liable, although it does have the right to fish back the distributions from the beneficiaries assuming they are good for it.

This is an edited transcript of a panel session at the Legal Week Trust and Estates Litigation Forum, which took place in Provence, France, on 14-16 March.