Administering a trust can be expensive. Trustees expect to be able to pay or reimburse themselves for such expenses with trust funds and their right of indemnity against trust funds protects their ability to do so.
But what about former trustees? Do they similarly enjoy a right of indemnity out of trust funds for costs and expenses incurred in relation to the trust, notwithstanding their removal or retirement as trustees? A recent decision of the New Zealand High Court(1) answers this question in the affirmative.
On 17 February 2020, by deed of retirement and appointment, the former trustee, Temple 88 Ltd (in liquidation), retired in favour of the current trustees, Ms Hassine and Mr Pruett. The principal asset of the trust (known as the "Clifton Realty Trust") was an apartment property in Auckland (the property), valued at between NZ$2.5 and NZ$2.8 million. However, the property was not transferred to the current trustees following their appointment and the former trustee remained the registered proprietor.
On 14 July 2020, in proceedings commenced by the body corporate of the property, the Court entered judgment against the former trustee and declared that it was in breach of its obligations under the Unit Titles Act 2010 and an implied term of contract with the body corporate. The Court ordered the former trustee to perform its obligations under the contract to allow the body corporate and its agents access to the property to complete necessary repair and maintenance works. However, the former trustee failed to comply with this judgment and failed to pay a related costs order.
On 28 August 2020, the body corporate successfully applied to place the former trustee into liquidation. Thereafter, the liquidators received creditor claims, including by the body corporate, totalling NZ$477,527.72.(2) In addition, the former trustee owed NZ$774,641.06 to ASB Bank Ltd and this debt was secured by a mortgage over the property.
The former trustee, by its liquidators, claimed a right of indemnity out of the assets of the trust for the liabilities it had incurred as trustee and sought orders for the possession and sale of the property in order to satisfy those liabilities.
The current trustees were served with the claim but did not file statements of defence. Accordingly, the Court dealt with the claim by way of a formal proof hearing.
The proceeding was commenced prior to the Trusts Act 2019 coming into force on 30 January 2021. Nevertheless, the former trustee submitted that, under the Act's transitional provisions,(3) the Act applied in this case.(4)
The Court held that a trustee has a right of indemnity against trust assets for liabilities incurred in the performance of the trustee's duties, whether expressly provided for in the trust deed, implied in equity, or pursuant to the Act.(5) In this case, the former trustee had an express right of indemnity under the trust deed.
The former trustee relied on the Court's decision in Camray Farms Ltd (in liq) v BL (Nature Sunshine) Trustee Ltd(6) for the following further principles:(7)
- The right of indemnity against trust assets existed where a trustee has paid trust expenses from their personal funds and recoupment of such funds was sought (the right of recoupment). It also existed where liabilities were incurred, but unpaid. The trustee in this case could pay the liabilities out of trust assets or, in other words, be exonerated of those liabilities (the right of exoneration).
- The trustee's right of indemnity takes priority over the beneficiaries' interest in the trust property because it is inequitable for a beneficiary to benefit from the property without also bearing the burden associated with the property. However, a trustee can only call on the indemnity if a liability had been properly incurred. It may therefore be lost where a trustee was in breach of trust.
- The trustee's right of indemnity was protected and enforced by way of an equitable lien over the assets of the trust. The equitable lien created a proprietary interest in the trust property in favour of the trustee, capable of supporting the registration of a caveat and enforceable like any other charge over land.
- The lien came into existence when the right of indemnity arose, that is, at the time the liability was incurred. It was not always necessary for the amount of the liability to be determined in order for the trustee's charge or lien to arise.
- The trustee retains the right of indemnity and its equitable lien even after it has resigned as trustee or been replaced. The new trustee takes the trust property subject to the former trustee's equitable proprietary interest arising out of the right of indemnity.
Applying the principles in Camray Farms Ltd (in liq), the High Court held that the former trustee retained its right of indemnity from the trust's assets when it was replaced as trustee in February 2020. The fact that there was a "no indemnity" clause in the retirement deed was irrelevant since the former trustee was not seeking to enforce any personal indemnity against the current trustees. The right of indemnity was not a personal claim against the current trustees, but rather an equitable lien against the trust's asset, being the property.
The former trustee's right of indemnity was prioritised over the current trustees' beneficial interest in the trust's property (as trustees), and their beneficial interest was subject to the former trustee's equitable interest arising out of the right of indemnity.
However, the Court found that, unlike an incumbent trustee, a former trustee may only have recourse to trust assets with the Court's assistance.
Where, as here, the former trustee was in liquidation, the right of indemnity and the equitable lien over the trust assets passed to the liquidator. Accordingly, the liquidator was entitled to have recourse to the trust property in order to pay the costs and expenses of the liquidation incurred in connection with the trust.(8) The Court held that the liabilities were properly incurred.
The Court concluded that the liquidators could have recourse to the trust's property for the purposes of meeting the liabilities incurred by the former trustee and their costs and expenses as liquidators. The Court was satisfied that the liabilities were properly incurred by the former trustees and that all the costs and expenses of the liquidation related to the activities of the trust.
The Court ordered that the property be sold in order to satisfy the former trustee's equitable lien over the property.(9) In addition, the Court ordered that possession be recovered from the current trustees since they were found to have no right to occupy the property and the liquidators required access to the property to arrange repair work for sale.
Firms or individuals looking at taking on the role of trustee of an existing trust should carefully investigate the financial position of the trust to identify whether liabilities are owed to former trustees. Temple 88 Ltd (in liq) illustrates that current trustees who ignore or refuse to satisfy such liabilities do so at their peril.
On the other hand, trustees facing removal or retirement should be aware that following such removal or retirement they may only have recourse to trust assets with the court's assistance. Accordingly, trustees in this position would be well advised to ensure that they are compensated for any costs incurred before removal or retirement. In the event of retirement, the usual course is for an express indemnity from the incoming trustee to be included in an instrument of retirement and appointment to protect the retiring trustee.
That said, the New Zealand High Court held that a trustee can only call on the indemnity against trust assets for their costs and expenses if a liability has been "properly incurred", and that it may be lost if the trustee is in breach of trust.(10) Current trustees who are concerned about the extent of liabilities incurred by their predecessors may therefore be able to challenge whether such liabilities have been properly incurred. That said whether such a challenge will succeed will depend on the facts and the standard imposed by the court may be difficult to surmount in practice.(11)
For further information on this topic please contact Shan Pearson at Wilson Harle by telephone (+64 9 915 5700) or email ([email protected]). The Wilson Harle website can be accessed at www.wilsonharle.com.
(1) Temple 88 Ltd (in liquidation) v Hassine and Pruett  NZHC 2351.
(2) The body corporate also gave notice of likely future claims.
(3) Trusts Act 2019, Schedule 1, clause 2.
(4) The former trustee also referred to the provisions of the old Trustee Act 1956 in any event.
(5) Trusts Act 2019, section 81. See also Trustee Act 1956, section 38(2).
(7) Temple 88 Ltd (in liq) at .
(8) The Court also found at  that a liquidator's right to remuneration was a debt incurred in performing the duties of the trustee.
(9) The Court noted at  that, based on the market appraisal, the anticipated sale price of the property would significantly exceed the amounts due under the right of indemnity and ASB Bank Ltd's mortgage, leaving a surplus for the current trustees.
(10) Camray Farms Ltd (in liq) at , as cited by the Court at .
(11) See, by way of example, the detailed discussion by the Guernsey Royal Court of this issue in ITG Ltd & Anor v Glenalla Properties Ltd & Ors  GRC007. The author was part of the in-house team which advised the current trustees in this proceeding.