Big changes are proposed to the use of trusts as trading enterprises by the Law Commission as part of its ongoing review into trust law.

Recommendations include:

  • restating basic trust law in statute form and confirming that trust deeds cannot exclude the right of indemnity upon which creditors rely (with carve outs for fraud etc)
  • requiring corporate trustees to disclose when they are acting as trustee, rather than in a regular corporate capacity
  • making directors of corporate trustees liable for the debts of the trustee company and liable to beneficiaries as if they were trustees themselves, and
  • making it clearer that liquidators and receivers can be appointed to trust assets.

Submissions are due by 22 February 2013.

Why the need for reform?

The Law Commission is conducting a wide-ranging review of the law of trusts, due to the popularity of trusts as a vehicle for ownership of assets and undertaking business in New Zealand.  This article considers the Commission’s proposals regarding corporate trustees and insolvency, being one part of its review.

When trading with a trustee, the only recourse a creditor has against the trust assets is through the trustee’s right of indemnity from those assets.  That creates legal and practical risks.  The Law Commission has therefore recommended changes to make it easier for creditors to understand who they are dealing with, access trust assets and make claims against the directors of corporate trustees.

The Commission wants to hear submissions on its proposals.  Submissions can take any form, and can comment on some or all of the proposals.  For a copy of the Issues Paper outlining the Commission’s “Preferred Approach”, click here (see chapter 8).  The paper sets out specific questions the Commission wants comments on, and we have included some of our own in this article.  We encourage you to contact the Commission with any comments you may have, particularly on the practical implications of their proposals.

Liability of trustees and right of indemnity

The Commission recommends that a new Trusts Act should restate the following fundamental principles:

  • a trustee assumes personal liability, but is entitled to limit their liability by contract
  • a trustee has the right to an indemnity out of trust assets (and this extends to former trustees), and
  • the trust deed cannot limit or exclude a trustee’s right to indemnity, except in the case of the trustee’s own dishonest conduct, wilful misconduct, recklessness or negligent breach of a mandatory duty.

The first two points are re-statements of the existing law, although at present that law is not contained in any statute.  The Commission considers that a restatement of these principles would be helpful to trustees and creditors, many of whom may not be aware of some key characteristics of trusts.

The third point is not settled law in New Zealand, but many commentators have argued it is essential if creditors are to be protected.  The prohibition on limiting or excluding the right of indemnity means that a creditor of a trustee will, in most cases, have a clearer right to look to the assets of the trust. It is worth noting that the proposed reform would not help a creditor where the debt was incurred by a trustee acting beyond its powers. The creditor will of course retain a right to sue the trustee, and recover from the trustee’s own (beneficially owned) assets, including any claim the trustee may have against its own directors (where it is a company). 

Are there situations where a trustee legitimately ought to be able to limit its right to be indemnified from the trust assets?

Disclosure of trustee status

The Commission wants to amend the Companies Act 1993, so that a company, when acting as a trustee, must describe its status in all communications and contracts in the form:

X Ltd acting as trustee for Y trust”. 

Disclosure of trustee status is not presently required.  This amendment would mean that creditors are at least made aware that their debtor may not have a beneficial interest in the assets it is dealing with.  Accordingly, creditors would be able to consider whether further protection is needed in the contract or, for example, by way of security.

The onus would remain with the creditor to satisfy itself as to the trustee’s authority to transact and the credit risks associated with trading with a corporate trustee, but the creditor would at least be aware of a trust’s existence. 

This disclosure would not, as the Commission notes, have the effect of limiting the liability of the trustees.  A further contractual clause would be required for that to occur.

The Commission recommends that the consequence for failing to disclose trustee status should be a fine, in the same way that failing to disclose incorporated status currently carries a fine.  The Commission does not favour imposing personal liability on those who sign a document containing no disclosure.

Do you agree that trustees ought to disclose their status? If so, is a fine enough for cases where trustees fail to disclose their status?

Directors’ liability to creditors

The Commission favours adopting section 197 of the Australian Corporations Act into our Companies Act.  That would make directors of corporate trustees personally liable for trust debts where the company:

  • cannot discharge a liability, and
  • there is no entitlement to be “fully indemnified” out of trust assets because of a breach of trust by the trustee, the trustee having acted outside its powers as a trustee, or a clause in the trust deed denying the right to indemnity (mere lack of trust funds would not lead to liability).

A reform of that nature is unlikely to change significantly the risks for directors of trustee companies, or the remedies available to their creditors.  In cases where such a section would apply, the directors would likely have breached ordinary duties not to incur company liabilities where they could not reasonably be met.

The proposed reform does not address the main concern identified by submitters, which the Commission described as “where the directors distribute the trust funds regularly so that the trustee holds few or no assets”, with the result that there is nothing left to pay creditors.  The recent case of Levin v Ikiua1 is an example of this problem.

Should there be wider protections, for example requiring trustees to consider solvency when making distributions?  Or can creditors adequately protect themselves by contract terms?

Directors’ liability to beneficiaries

The Law Commission also recommends that directors have the same obligations to beneficiaries as if they, rather than the company, had been the trustees. 

We consider that imposing such personal liability will discourage prudent people from acting as directors of corporate trustees and will increase the cost of director indemnity insurance.  We are particularly concerned that the imposition of personal liability would be unsuitable for certain large trustee companies.  It is not clear from the Commission’s paper whether directors would be entitled to contract out of such liability.

There are existing routes by which directors are directly liable to beneficiaries, such as where they dishonestly assist in a breach of trust, or where they are knowingly in receipt of trust property where a breach of trust has been committed by the corporate trustee.

These remedies do not provide as direct or obvious a remedy for creditors as personal liability might.  However, we think it is dangerous to begin imposing direct liability on directors in one narrow area of the law.  The business community is accustomed to the idea that directors are not automatically liable for a company’s obligations.  Once creditors are compulsorily made aware of the existence of a corporate trust, we think creditors will be in a proper position to negotiate commercially appropriate credit arrangements, which could include personal obligations being imposed on directors.

The Commission has expressly asked for comments on how this proposal would “operate in practice”, and whether it is “suitable for all corporates”.  Will it create problems?

Appointment of liquidators or receivers to trust property

The Commission wants legislative clarification that the court can appoint a receiver or a liquidator in respect of trust assets, to give creditors more direct access to trust assets than they otherwise have. 

Strictly, those rights exist already.  Liquidators were, for example, recently appointed over trust assets (as opposed to the trustee itself) by the Wellington High Court.

It may be helpful to have these rights expressly stated in any new Act, if the intention is to explain more comprehensively and in one place, how trusts operate.

Would it help your practice if the right to appoint a liquidator over trust assets was more clearly set out in a new statute?

Chapman Tripp’s earlier commentary on the review is available here.