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It is a fundamental principle of trust law that trustees are entitled to be indemnified from trust property for expenses that they properly incur in discharging their duties and in conducting trust business. In New Zealand, that principle is reflected in the Trusts Act 2019, case law and invariably in trust instruments. It is also well-established that a trustee’s right of indemnification survives their replacement as trustee. 

But what happens if, as between two or more trustees, there are not sufficient assets to go around? Who gets priority and on what basis? These issues were considered by the Privy Council in an opinion released last week: Equity Trust (Jersey) Ltd v Halabi [2022] UKPC 36. The Board’s decision is broken down into four related issues, each of which is summarised below.

The first issue: does the right of indemnity confer on the trustee a proprietary interest in the trust assets?

On this issue the Board was unanimous: the right of indemnity confers on the trustee a proprietary interest in the trust’s assets. This means that until the trustee is repaid, their interests rank above the beneficiaries’ interests. The Board dismissed the appellants’ arguments that the trustee’s interest was possessory in nature, meaning that if the trustee (or former trustee) no longer had access to the trust property, their right of indemnification was lost. In confirming the proprietary nature of the interest, the Board followed longstanding Australian authority to the same effect.

As a matter of practice, the proprietary nature of the interest means that in New Zealand, a trustee would be entitled to lodge a caveat against any real property owned by the trust (as was recognised in Camray Farms Ltd (in liq) v BL (Nature Sunshine) Trustee Ltd [2019] NZHC 2536).

One matter of interest is that the Board confirmed that the right of a ‘trust creditor’ – a creditor of the trustee in respect of a debt incurred in relation to the trust – is a right against the trustee personally. For the purposes of enforcement, access to trust assets is facilitated by a right of subrogation. In other words the trust creditor steps into the trustee’s shoes and enforces against the trust assets in reliance on the trustee’s indemnity. As a consequence, if the trustee does not have a right against trust assets, the trust creditor is out of luck. That may occur because the trustee owes the trust more than the trust owes the trustee, or because the trustee has acted dishonestly.

In New Zealand, the Trusts Act 2019 has modified that position somewhat. Section 86 provides that if “for any reason [the trustee] is not entitled to be indemnified or fully indemnified from the trust property (for example, because the trustee incurred the liability in breach of trust)”, but the creditor has acted in good faith and given value, the creditor has a right against the trustee which may be met from trust property.

The second issue: does the proprietary interest of a trustee survive the transfer of the trust assets to a successor trustee?

The Board was also unanimous on this issue: the proprietary interest survives the transfer of trust assets to a successor trustee. Again, this was a conventional answer to the question in light of the substantial Australian authority considering this issue.

The third issue: does a former trustee’s proprietary interest in the trust assets take priority over the equivalent interests of successor trustees?

This issue was at the heart of the appeal and resulted in a difference of views between the judges. Three judges (Lord Richards, Sir Nicholas Patten and Lord Stephens) favoured the prioritisation of trustees’ claims according to the chronological order in which they were appointed. That view accords with the traditional ‘first in time’ approach which the courts of equity use to resolve competing claims.

Four judges (Lord Briggs, Lady Rose, Lord Reed, and Lady Arden albeit for slightly different reasons) instead favoured the pari passu ranking of trustees’ claims. The essence of this approach was that notions of “justice, equity, fairness and common sense” compelled a pari passu rule. The judgment of Lord Briggs emphasises that the priority of trustees should not turn on whether one trustee signed the deed of appointment one day before their co-trustee:

In short, why should fiduciaries who have worked as such together in a common enterprise, for the benefit of others rather than themselves, not be paid pari passu from a deficient fund? Their respective dates of appointment would be mere happenstance, having no connection of any kind with equity or justice.

The fourth issue: does a trustee’s indemnity extend to the costs of proving its claim against the trust if the trust is “insolvent”, in the sense that trustees’ claims to indemnity exceed the value of the trust fund?

On this issue the Board was again unanimous: the trustee’s indemnity extends to the costs of proving their claim. This is a logical extension of the well-established proposition that “a trustee’s right of indemnity extends to costs incurred in proceedings brought by or against a trustee in its capacity as trustee, provided only that there is no misconduct on the part of the trustee”.

The upshot for New Zealand?

Much of the Board’s analysis is a conventional application of principles that are well-established in Australia and New Zealand. Nevertheless, the decision provides a helpful restatement of the applicable principles in an area where competing interests (as between trustees, beneficiaries and creditors) and overlapping legal principles (rules of law and equity, particularly as it relates to trusts and insolvency) very often cause confusion. On the issue of priority as between trustees, it remains to be seen what approach the New Zealand courts will take. Given that this issue appears to have been raised for the first time in the Equity Trust (Jersey) Ltd v Halabi case, it may be that it is some time before the New Zealand courts are called upon to consider this issue.