In the past year, The Bahamas Supreme Court dealt with what is known to be its first case involving an insolvent trust. This is novel area of the law in The Bahamas and other common law jurisdictions where there is no statutory regime to deal with the issue.
The term “insolvent trust” is of course, a misnomer. As a trust is not a separate legal entity and cannot itself be “insolvent”. For present purposes, therefore, the term “insolvent trust” is shorthand for a situation case where the Trustee has insufficient trust assets to meet the liabilities it has assumed in the capacity as Trustee.
The case involved:
- A Settlor who had been married on 3 separate occasions to 3 different women;
- A family trust established [in 1996] by the Settlor for the benefit of his third wife and his children (by all three marriages);
- A Corporate Trustee;
- A foreign divorce proceeding commenced against the Settlor by his second wife, which culminated in a financial provision order exceeding £50 million.
The Settlor died very shortly after that order was made, and the second wife sought to enforce the order against the assets of the Trust.
The trust assets were held by various offshore companies and included real property, art and other luxury items.
And the liabilities primarily consisted of:
- the outgoings related to the real property; and
- an outstanding loan in the amount of approximately £26 million, which was due to an affiliate of the Trustee.
The outstanding loan was secured by a mortgage over one of the real properties subject to the Trust and NOTABLY, was guaranteed by the Trustee to the extent of the assets of the Trust.
Prior to his death, the Settlor personally met the liabilities of the trust. Moreover, the Trustee’s accounts indicated that although the Trust corpus had a book value of $36 million, its liquidity value was a mere $400k.
In all the circumstances, the trust had become “cash-flow” insolvent.
Finding itself in this dilemma and in a position of potential conflict because the largest trust creditor was its own affiliate, the Trustee, on advice, resigned as Trustee and gave notice of its resignation to the adult beneficiaries of the trust in accordance with the terms of the trust instrument.
Higgs & Johnson acted for the Trustee, and upon its resignation, the Trustee sought the advice/directions of the Court.
In giving its directions, the Bahamas Supreme Court provided guidance on the underlying principles relevant to “insolvent” trusts. And in doing so, adopted with approval several of the principles established in the Z-Trusts case[i] by the Royal Court of Jersey.
1. Duty of the Trustee to act in insolvent situations.
The Court agreed that a Trustee must take action when it realises that the trust is insolvent or will become insolvent. The Court also agreed that in this context, insolvency should be determined based on a cash-flow test, rather than a balance sheet test.
The Trustee’s application for directions in light of the cash-flow insolvency of the Trust was therefore regarded as necessary and appropriate in the circumstances.
2. The shift in duty from beneficiaries to creditors.
The Court agreed that where a trust is insolvent, the Trustee must shift its focus from the interests of the beneficiaries to the interests of creditors and should seek to ascertain the wishes of the creditors regarding conduct of the future administration of the trust.
This shift towards the interests of creditors is analogous to that which pertains in company law – where the directors’ duties shift from being owed to the company to being owed to the creditors as a whole.
On this basis, the Trustee was authorised and directed to serve its application on the creditors of the trust, so that the creditors would have an opportunity to be heard.
3. Respecting the breadth of its powers.
The Court was of the view that its inherent supervisory jurisdiction in relation to Bahamian trusts is sufficiently wide in scope to permit a flexible approach. Indeed, the Court acknowledge and agreed that it had power to appoint a receiver or insolvency practitioner to wind up the affairs of the Trust if the circumstances warranted, as was contemplated by the Jersey court in the Z-Trusts case.
However, because of the financial position of the Trust, there were practical challenges with finding a person willing to assume such role.
In the end, arrangements were made between the adult beneficiaries of the Trust and the largest trust creditor, which included the appointment of a successor trustee.
4. On the issue of the Trustee’s costs and payment of the trust assets after insolvency.
The Court considered that it had inherent jurisdiction make orders respecting the priority of payments from the trust assets, based on the circumstances of the case.
And the Court granted leave to the Trustee to realise the assets of the trust for the purposes of settling its costs in priority to the claims of the other trust creditors.