Guiding Trustees: A Protector’s right to indemnity and a trustee’s right to reimburse settlors
In a previous instalment on a trustee’s right to indemnity, we explored the basic underlying principles and headline points on the changeover of trustees (this article can be found here if you missed it).
This week, we will consider (a) whether another fiduciary – the protector – can enjoy a comparable expectation of an indemnity as the trustee and (b) the trustee’s ability in certain limited circumstances to reimburse the settlor.
Exploring the Protector's Right to Indemnity
The scope and nature of the role of protectors is an emerging area of law, subject to recent and widely reported judicial scrutiny. For this article’s purposes, we will focus purely on the extent to which a protector is entitled to an indemnity from the trust fund.
A “protector” does not hold trust property but is instead granted bespoke powers and obligations under the trust deed. One very common power is to remove and replace the trustee.
It is common for a protector to be granted a right to reimbursement of expenses incurred in carrying out its duties under the terms of a trust deed. Where a protector is a fiduciary, it is likely that the same principals will apply to a protector as to a trustee in that such an indemnity will be restricted to expenses reasonably or properly incurred: this was discussed in the Bahamian Supreme Court decision in Patton v Alvarez (2017/CLE/gen/00777).
What if there is no express provision for the protector to be indemnified?
Although the trust deed in the above case contained express provisions (rather than being silent on the matter so as to put the availability of an implied right to indemnity to the test), the court confirmed that at least in The Bahamas it was ‘settled law that a protector’s legal status in relation to costs and his right of indemnity in trust proceedings are analogous to that of a trustee if the protector has fiduciary functions’. It is likely open to a protector acting in a fiduciary capacity lacking an express indemnity to rely on one being implied under the general law by analogy with a trustee.
Of course, there is one key practical difference between protectors and trustees. Unlike the trustees, the protectors are not in possession of the trust fund and therefore unable to reimburse themselves directly. The result is a two-stage reimbursement: first, the trustee reimburses the protector and then, relying on its own right to be indemnified, the trustee reimburses itself from the trust fund. In practice, this will more than likely be a single payment from the trust assets to the protector. The trustees, as fiduciaries, are likely to have duties to satisfy themselves that an expense claimed by the protector is properly incurred and liable to be reimbursed (under the trust deed or general law), depending on the precise terms of the trust.
Key Takeaway: Establishing Clarity in Protector's Right to Indemnity
Our message for trustees in respect of their indemnity outlined in our previous article was that it is always advisable to have clear, professionally drafted, express provisions within the trust deed – and this applies equally to the scope of a protector’s right to indemnity, given the relative lack of developed law in this area. This minimises the opportunity for disagreement and misunderstanding between the trustee and the protector, maintaining a harmonious working relationship which is better for everyone.
When can a Settlor be reimbursed from the Trust Fund?
The simple answer to this question is “it depends” – principally on in what capacity a settlor might seek to be reimbursed.
The overarching principle of trust law is that when a settlor transfers assets into trust, they are relinquishing control of those assets in favour of the trustee subject to the terms of the trust deed.
The primary concern for the trustee when deciding whether to meet a request for reimbursement of an expense by the settlor (or anyone for that matter) is that it must be clear that doing so is a reasonable and proper expense of the trust such that the trustee can rely on their right to be indemnified from the trust fund. If it is not a trust expense, but simply a liability of the settlor, the trustee would need to be able to benefit the settlor as a beneficiary in that separate capacity.
Sometimes, UK legislation can shift liability for tax relating to the trust from the settlor to the trustee (eg section 201 Inheritance Tax Act 1984). Specific tax advice should be taken in any given circumstance but, by way of example, this can arise when the settlor fails to pay the tax due on the creation of the trust. Where a UK trustee is liable for the tax liability under the domestic law, the situation is relatively straightforward. However, it is not necessarily so in a cross-border trust structure since, under the conflict of revenue laws rule, deriving from the decision in Government of India v Taylor ( AC 491), common law jurisdictions tend not to enforce the revenue laws of the other (absent, for example, a treaty framework). A trustee is therefore only authorised to pay foreign taxes from the trust fund if (i) the liability is enforceable on the trustee in their home jurisdiction or (ii) if authorised by an express provision in the trust deed. In both these examples, the payment of any tax liability would be a “proper expense” and the trustee would be entitled to rely on their right to be indemnified from the trust fund.
Key Takeaways: Navigating Settlors' Reimbursements
- The trustee should always seek professional advice if unsure whether to authorise a reimbursement or payment of a tax liability.
- The trustee could, in particularly complex situations, either seek an indemnity from the beneficiaries or, if this is not possible, directions from the relevant court (where available) as to whether to (i) make the reimbursement or (ii) pay the foreign tax liability. Court-sanctioned action should provide comfort that the amounts spent are covered by the trustee’s right to be indemnified out the trust fund.
Understanding which, and whose, expenses can be met from the trust fund is essential to trust management.
In this article, we explored the protector's right to indemnity and emphasised the importance of clear provisions in the trust deed in avoiding conflicts.
We also examined the settlor's limited potential for reimbursement. Where the settlor is not a beneficiary of the trust, the trustee will need to be satisfied that it is a proper and reasonable expense of the trust. Specialist advice should be taken where a settlor has failed to pay tax due on the creation of the trust – the trustee’s position being made less straightforward in cross border trust structures.