Guiding Trustees: Indemnities on a change of trustees

Chapter 1 – Fundamental principles and changing over trustees

A trustee’s right to indemnity – and particularly that of a former trustee’s right to indemnity vs. a new trustee – hit the legal headlines recently in Equity Trust (Jersey) Ltd v Halabi; ITG Ltd v Fort Trustees Ltd [2022] UKPC 36 (Halabi). The specific facts were in the context of a so-called “insolvent trust” (a developing area of law with particularities stemming from Jersey and Guernsey trust legislation, and a whole topic in its own right). In this series of short pieces on a trustee’s right to indemnity, we go “back to basics” on the fundamentals of a trustee’s right of indemnity.  The first instalment focuses on the basic underlying principles and on the changeover of trustees.

The underlying principles

Trustees in office

A trustee’s ability to recoup costs properly and reasonably incurred in administering a trust is particularly important for professional trustees. Trustees have an equitable interest (see below) in the trust property which gives them priority over others with rights and interests in the trust property – this includes the beneficiaries.  

Under English law, the overarching basis of a trustee’s right to indemnification while in office is enshrined in section 31(1) of the Trustee Act 2000 which confirmed the position long held under general law.

Trustees, in summary, have the right to apply trust assets to pay for trust liabilities, costs and expenses properly incurred (known as the right to exoneration) and to be paid back for any of these expenses paid out of their own pocket (known as the right to reimbursement).

Trustee remuneration, however, is not to be conflated with trust expenses. Under English general law, Trustees did not have any right beyond that explicitly set out in the trust instrument until the Trustee Act 2000 created an implied remuneration clause for professional trustees and trust corporations (but not PTCs).

Crucial in making these rights “worth their salt” are the trustee’s ancillary rights to retention and realisation of the trust property. This allows the trustees to ringfence certain trust assets or sell illiquid trust assets to give effect to their primary rights to reimbursement and exoneration.

Trustees leaving office

It is important that these rights do not just evaporate for the outgoing trustee upon a change of trustee, something we were all reminded of following the Halabi judgment.

A former trustee’s right to exoneration and reimbursement continue beyond office. This is because the trustee’s equitable interest in the trust property (referred to above) is known as “non-possessory” i.e. it does not depend upon the former trustee continuing to possess the trusts assess to retain these rights. This means that a former trustee can hand over the trust property to a successor trustee without giving up their rights to exoneration and reimbursement.  

The position is slightly different with the rights of retention and realisation as the former trustee will no longer be in a position to exercise these rights following the transfer of assets into the name of the new trustee.

Instead, the outgoing trustee has a new right to ensure that the new trustee does not take steps to destroy, diminish or jeopardise the outgoing trustee’s rights of reimbursement and exoneration. That is to say that the new trustee must exercise its own rights of retention and realisation for the benefit of the former trustee.

While the former trustees have the right to reasonable information sufficient to know that the present trustees are taking the relevant steps to honour the indemnity some reciprocity is required – the former trustee should keep the new trustees informed of existing or prospective liabilities. The new trustee might find itself in breach of trust territory if it distributed the entirety of the trust fund to beneficiaries with full knowledge of a former trustee’s liability.

Do we need to document this if the law provides for it already?

Yes. We provide some useful and detailed advice on practical steps on the changeover of trustees here. For now, some salient points:  

• The position explained above is under English law. The default position will differ between jurisdictions and navigating these nuances is an important exercise.
• Whilst relying on the general law is possible, it provides a general framework rather than provisions tailored to the circumstances of a particular structure. It may be better to have it all written down and signed.
• Crucially (in particular for the incoming trustee), the English common law rights to indemnity are not clearly capped at the value of the trust fund from time to time (unlike the position in the legislation of some offshore financial centres). Express provisions are necessary to make it clear that the indemnity does not extend to the trustees’ own pockets.
• An incoming trustee should pay particular attention to the existence and substance of any chains of indemnity where trusteeship has changed hands previously.
• The exercise cannot be completed without reference to the trust deed and parties should be alive to any express provisions governing the level of protection they are entitled to under the deed.
• The exercise should also include an assessment of the actual and potential risk of the indemnity being called upon in the future (which will be specific to the facts of each trust) to ensure the level of protection is aligned with the actual position under the trust. Boilerplate, non-personalised indemnities used for every changeover are unlikely to meet the mark.