Insolvent trusts: the Z Trust cases
04 June 2019
The Royal Court of Jersey has given further guidance on the issues facing trustees of trusts who find that they are unable to pay trust liabilities out of trust assets as they fall due, or where the trust liabilities exceed the trust assets. Whilst the Court recognised that it is not technically accurate to describe a trust as insolvent, because a trust is not a legal entity and its property is held by a trustee who is personally responsible (to a greater or lesser extent) for meeting trust liabilities, the concept is helpful for determining the duties of trustees - and indeed may affect the recovery of their fees.
The Z Trust cases
There are five judgments of the Court relating to the ongoing administration of a group of eight inter-connected family trusts (referenced in the relevant anonymised Jersey judgments as the Z Trusts), of which the ZII Trust and the ZIII Trust are insolvent. The Z Trust judgments raise some interesting and important issues about the impact of insolvency on trust structures, particularly in relation to:
- the duties of trustees in insolvent situations;
- what sort of insolvency regime, if any, should apply;
- the exercise of fiduciary powers in insolvent situations;
- the nature of a former trustee's equitable lien over trust assets; and
- the ranking of different liabilities incurred by former and successor trustees.
Summary of the facts
The ZII Trust is insolvent. Equity Trust ("Equity"), as former trustee of the ZII Trust, has a personal claim to be indemnified in respect of the liabilities it personally incurred and discharged of £18m, representing damages and legal costs in respect of compromised English litigation. Other unsecured creditor claims included loans made to the Z II Trust by family members (in the sum of £211m) and claims by Volaw for its professional fees incurred as successor trustee. As to assets, the ZII Trust had the benefit of a loan repayable by the connected (but also insolvent) ZIII Trust of significant book value (£186m) but uncertain actual value (estimated at £6m).
At the time of earlier hearings, so far as the cash flow position was concerned: (i) the family loans were not being called in and the bulk of the liability of Equity in respect of the English litigation was not yet due and was uncertain; and (ii) the Volaw claim was due. Since the latter could not be paid from available assets, this rendered the ZII Trust cash flow insolvent. By the later hearing the cash flow position has worsened as the English proceedings had been compromised, leading to enforcement of Equity's indemnity. On a balance sheet basis, whilst the precise financial position of the ZII Trust was uncertain, its insolvency was never disputed.
As a result of the cash flow and balance sheet insolvency position of the ZII Trust, Volaw, the successor trustee, obtained directions and protection of the Royal Court on 29 April 2015. Volaw was subsequently replaced as trustee by Rawlinson & Hunter Trustees S.A. following a hearing on 20 October 2015. The matter came back to the Royal Court in March 2018 on the issue of the priorities of competing creditor claims.
A further hearing took place in 2019, at which the position of the ZIII Trust was re-considered, following a renewed demand for repayment of the £186m loan by the trustee of the ZII Trust.
Duties of trustees in insolvent situations
In the judgment dated 20 October 2015 the Court held that when a trustee realises that the trust has become insolvent, or is probably insolvent, it must take action. Insolvency in this context should be determined on a cash-flow basis (as distinct from the balance sheet basis which applies when a deceased's estate is concerned).
As the beneficiaries are effectively "out of the money", the trustee must shift its attention to the interests of creditors and must obtain approval from either the creditors or (as in this case) the Court for how it proposes to conduct the future administration of the trust. This shift towards the interests of creditors is analogous to company law and the administration of estates. The duties are owed to all creditors as a class and not to individual creditors or to a majority of creditors.
The Court also noted, following previous authority in the context of insolvent estates, that the trustee's ability to charge remuneration based on the trust instrument is conditional on solvency. Upon insolvency, the trustee must get creditor agreement or Court protection for the charging of ongoing fees. Failure to do so may mean that fees incurred beyond the point of insolvency might rank equal to, or perhaps even behind, the claims of other creditors.
What sort of insolvency regime should apply?
The Court was presented with three options:
- The trustee assuming the role of "liquidating trustee" under the supervision of the Court.
- The trustee appointing an insolvency practitioner to assist the trustee with the liquidation of the trust assets. He or she would, in particular, handle the creditor claims adjudication process as a result of the perceived conflict of a trustee conducting that task, since creditor claims are generally brought against the trustee personally.
- The Court appointing an independent insolvency practitioner in respect of each trust, reducing the trustee to a bare trustee, similar to the Court's ability (rarely used) to appoint a receiver of a trust.
The Court ultimately decided to follow the first option, to leave the trustees to conduct the winding up of the trusts under the supervision of the Court, rather than appointing insolvency practitioners, principally in the interest of costs. Volaw was directed to administer the assets of the ZII Trust under the protection of the Court on behalf of all creditors. However the Court also stated that the alleged conflict relevant to the second and third options was generally more perceived than real as a result of limited recourse provisions (statutory or contractual) which made the trustee in essence a cypher through whom claims are made.
As to the actual exercise to be undertaken, the Court did not think a formal process modelled on the insolvent estate case of Re Hickman  JRC 040 (itself modelled on the Bankruptcy (Désastre) Jersey Law 1990 and the Bankruptcy (Désastre) Rules 2006) was always appropriate and called for a flexible approach depending on the nature, number and type of creditor claims.
As Volaw had an ongoing role, it was granted priority for the payment of its fees for administering the assets of the ZII Trust from the date of the hearing onwards. The Court held that should any creditor challenge any of Volaw's proposed steps then Volaw should seek Court directions, and any creditor appearing might have to bear its own costs.
A similar regime was put in place in respect of the ZIII Trust. But in 2019, following a breakdown in the relationship between key parties and a renewed demand for repayment of the £186m loan by the trustee of the ZII Trust, the Court was invited to re-consider who should handle the insolvency of the ZIII Trust and whether a formal procedure should be adopted.
In a judgment dated 26 April 2019, the Royal Court decided that whilst the winding up of the affairs of the ZIII Trust could continue to be conducted by its trustee acting as "liquidating trustee" and without requiring the appointment of an insolvency practitioner, a formal regime, modelled on that used in the Hickman case, should now be adopted "in order to ensure the fair treatment of creditors and to impose a timetable which should bring the matter to a conclusion without undue delay". The Court noted that "there is no shortcut to the winding up being done properly". The precise directions imposed are appended to the Court's judgment of 26 April 2019.
The equitable lien
In the judgment dated 12 February 2015 the Royal Court principally considered the position of Equity, which was concerned to ensure its ability to exercise its equitable lien over the assets held by Volaw as replacement trustee of the ZII Trust. Equity cited the case of Investec Trust (Guernsey) Limited-v-Glenalla Properties Limited [41/2014] (29 October 2014, Guernsey CA) where the Guernsey Court of Appeal held that a trustee who has transacted has a right to be indemnified by out of, and up to the limit of, the trust assets held by a subsequent trustee. This right gives the former trustee a proprietary equitable charge over, or equitable interest in, the trust property held by the successor to the extent necessary to satisfy claims under section 32(1)(a).
The Court made the following findings:
- The Investec case on equitable liens applies in Jersey;
- Equity has an equitable right and is entitled to ensure that the present trustees of the trust concerned do not take steps to ''destroy, diminish or jeopardise'' that right. The right extends to all of the assets of the trusts concerned;
- Equity's equitable right extends to liabilities reasonably incurred in connection with the trusts concerned;
- Equity's equitable right takes priority over the claims of beneficiaries.
Priority of creditor claims
The judgment dated 3 July 2018 contains a detailed analysis of the priorities of various competing claims: (i) the priority between Equity's indemnity claims in respect of liabilities incurred by Equity for its English litigation liabilities and the other unsecured loan liabilities it incurred whilst trustee; (ii) the ranking of those claims alongside liabilities subsequently incurred by Volaw as successor trustee (and subject to Volaw's right to an indemnity).
All such liabilities are secured by equitable liens (secured at different times) in favour of each trustee.
The Royal Court held that all claims (whenever incurred) rank pari passu. The Court held that Equity could not assert a lien in respect of the payments it had made in the English litigation ahead of its other loan creditors and ''scoop the pot''. Further, none of Equity's liabilities could rank ahead of later indemnification claims asserted by Volaw as successor trustee. Instead, Equity must share the estimated £6m equally with all creditors.
Previously there has been precious little judicial guidance as to how trustees should conduct themselves where they become unable to pay the trust debts as they fall due or where the trust liabilities may exceed available assets. These decisions are helpful for current trustees, former trustees with continuing liabilities, and creditors.
Trustees need to be particularly mindful of to whom their duties are owed and will have a personal interest in ensuring that creditor agreement or court direction is obtained in order to ensure their remuneration continues to be recoverable.
Creditors, for their part, can be confident that their interests will take priority over those of beneficiaries, and this should prevent any distributions being made to beneficiaries to the detriment of creditors.
The most interesting and difficult part of these decisions is derived from the 3 July 2018 judgment. Following the Privy Council judgment in Investec Trust (Guernsey) Limited-v-Glenalla Properties Limited  UKPC 7,  2 WLR 1465 a trustee may incur "fiduciary" liabilities for which recourse is limited to the trust assets under Article 32(1)(a) of the Trusts (Jersey) Law 1984 or it may incur "personal liabilities" for which there is no such limited recourse. Moreover it may retire and its successor may incur further liabilities. All three applied in this case. Equity attempted to contain its "personal" losses, by arguing that it should be entitled to reimbursement prior to any other claims by creditors or the successor trustee, but it did not succeed.
Several of these decisions are subject to appeals which were heard in January 2019. Judgment is awaited.
  JRC 031,  JRC 196C,  JRC 214 and  JRC 119