At a Guernsey Finance seminar in London a couple of years ago, in a memorable presentation, Joe Truelove (now a Director at Carey Group) gave the analogy of a unit trust being akin to an ugli fruit, at least with respect to the ability to list units on a stock exchange. Perhaps for that reason, unit trusts seem to have fallen out of favour as a fund vehicle in Guernsey, with limited partnerships and companies (particularly protected cell companies) being more commonly used.
Nonetheless, ugli fruit or not, there remain a significant number of unit trusts established as funds in Guernsey and elsewhere, and it is thus perhaps surprising that there have not been more court cases considering the fundamental nature of a unit trust. In Barclays Wealth Trustees (Jersey) Limited and Barclays Wealth Fund Managers (Jersey) Limited v Equity Trust (Jersey) Limited and Equity Trust Services Limited  JRC102D, the Royal Court of Jersey made a number of important observations about unit trusts, which will be of interest to trustees and managers of unit trusts, and to professional advisers who deal with them.
The case concerned three unit trusts (the “Trusts”), established in materially the same form, between Equity Trust (Jersey) Limited (the “Former Trustee”) and Equity Trust Services Limited (the “Former Manager”). Each Trust invested into property of various kinds in Bulgaria, Croatia and Montenegro respectively.
In August 2007 the Jersey Financial Services Commission started regulatory proceedings against each of the Trusts, seeking the removal of the Former Trustee and the Former Manager, and the winding-up of the Trusts. In December 2007 Barclays Wealth Trustees (Jersey) Limited (the “New Trustee”) and Barclays Wealth Fund Managers (Jersey) Limited (the “New Manager”) were appointed by consent as trustee and manager respectively.
The New Trustee and the New Manager issued proceedings against the Former Trustee and the Former Manager, claiming that the latter were liable to make compensation to the Trusts in respect of alleged breaches of duty committed in the course of their trusteeship and management of the Trusts. The claims were expressed to be in terms of alleged breaches of trust, fiduciary duty and contract.
Why is the case of interest?
The judgment considers, amongst other things:
- From a legal point of view, what is a unit trust?
- What duties does the manager owe to unitholders?
- Where a former manager is replaced by a new manager, is the new manager empowered to bring claims against the old manager in relation to alleged breaches of duty?
- Where a former trustee is replaced by a new trustee, and the new trustee seeks to bring a claim against the former trustee for breach of trust, is the new trustee limited to bringing claims for breaches of the duty of loyalty, or can it bring claims for other breaches, including negligence or breaches of a duty of care to unitholders?
It should be noted at the outset that the case is unusual. It concerns an application to strike out a number of aspects of the claims by the New Trustee and New Manager against the Former Trustee and Former Manager. As such, the Court’s primary analysis is whether the defendant had shown that the plaintiff’s claims were bound to fail, being a steep hurdle for the defendant to overcome. The Court therefore did not need to definitively decide a number of the points made in the case, and thus much of the commentary should be treated as obiter dicta. Nonetheless, the judgment is still instructive on a number of points and would remain highly persuasive in Guernsey should a similar application be made here.
The fundamental nature of a unit trust
The case confirms that a unit trust can be expected to establish a triangular relationship between the manager, the trustee and unitholders. A unit trust is essentially contractual, but with a trust relationship created by the contractual nexus. This combined contractual/trust relationship is highlighted by the judge’s findings that the trustee and the manager owed trustee-like or fiduciary obligations to unitholders, whilst also owing contractual obligations to each other.
It is therefore important for trustees, managers and unitholders to remember what might seem obvious: a unit trust is still a trust, and unitholders are the beneficiaries of fiduciary obligations having effect under that trust (subject to specific derogations effectively provided in the trust instruments). Unitholders are beneficiaries of the unit trust, and have a beneficial interest (perhaps of a limited kind) in the trust property. This makes unit trusts significantly different from (for example) a collective investment scheme established as a company, where the manager and the custodian owe their duties to the company, and shareholders have no beneficial interest in the property owned by the company.
What duties does the manager of a typical fund that is established as a unit trust owe to unitholders?
The case confirms that the manager (at least) owed fiduciary obligations to the unitholders in regard to its duties and responsibilities as manager, and that breach of those duties and responsibilities would give rise to enforceable claims either to replace assets which had been paid away without authority or to make reparation.
The judge, however, also considered whether it was arguable that a manager of a unit trust is liable as a trustee, and concluded that in this case the Former Manager was potentially liable as a trustee. In this regard, it was held that the Court is not bound by the titles and descriptions that parties give themselves and will analyse the substance of the situation, and use that analysis to determine the remedies available.
In this case, under the Trust Instruments, the Trustee’s role was reduced largely to that of a custodian, i.e. to take custody of the unit trust’s property and to take instructions from the manager, while the manager was given responsibility in relation to almost all other operational elements of the Trusts, including investment management and administration. The Court held that “virtually all the trustee-like functions are allocated to the manager, virtually none to the trustee. It would be stultifying for the court not to hold the manager responsible for the way in which it executes its duties and exercises its powers”.
Where a former manager is replaced by a new manager, is the new manager empowered to bring claims against the old manager in relation to alleged breaches of duty?
As might be expected given the conclusion that the Former Manager was potentially liable as a trustee, the Court confirmed that the New Manager (alongside the New Trustee) had standing to bring claims against the Former Manager and the Former Trustee.
Where a former trustee is replaced by a new trustee, and the new trustee seeks to bring a claim against the former trustee for breach of trust, is the new trustee limited to bringing claims for breaches of the duty of loyalty, or can it bring claims for other breaches, including negligence or breaches of a duty of care to unitholders?
Another point confirmed by the case is that a new trustee seeking to claims against a former trustee is not limited to claims solely for breach of loyalty. Instead, a new trustee has standing to sue a former trustee for breaches of trust of all kinds, including (as was alleged in this case) for unauthorised payments by companies comprised (indirectly) in the trust funds, and for breaches of a duty of care owed to the beneficiaries of the trust.
In addition to the point above, the case also serves as a reminder that trustees also need to bear in mind their duty to take proceedings to get in the trust estate, which includes rights of action against former trustees for breach of trust, unless those proceedings would be considered futile.
Those interested in the legal basis upon which a successor trustee is empowered to sue a former trustee may also find the discussion contained in paragraphs 82 onwards of the judgment useful.
Notwithstanding the fact that the case considers a striking-out application, we believe that the case will be of considerable use in confirming the exact nature of a unit trust, and confirming that managers (at least) owe fiduciary obligations to unitholders, assuming that the relevant trust instrument divides the responsibilities of the manager and the trustee in relation to the unit trust in materially the same way as in this case – certainly this is the case for a number of the unit trusts that we have had experience working with.
The implications of this are that managers of unit trusts need to carefully consider these obligations and what effect they might have on the manager, particularly if the manager gets into a dispute with unitholders or the trustee.
In our experience, when faced with such a dispute, many managers will look to the terms of the trust instrument to provide them with indemnities to cover any liabilities, or to exclude liability altogether. In our experience, unit trust instruments typically contain wide indemnities out of the trust property to cover the manager’s liabilities, including in relation to legal fees incurred in defending any action.
Given the confirmation that managers owe fiduciary obligations, and may even be considered to be trustees, the inclusion of such clauses in the trust instrument are not the end of the matter, and managers may well find that they are not able to rely on them. Certainly, managers will need to be very careful if they are relying on an indemnity from a unit trust in circumstances where the trustee itself could not seek to be indemnified, and on the flipside, trustees will need to be very careful in paying out money from a unit trust if they receive a claim under an indemnity from a manager to ensure that they too are not committing a breach of trust.
For example, under the Trusts (Guernsey) Law, 2007, a trustee cannot exclude liability for its own fraud, wilful misconduct or gross negligence, and nor may it be indemnified out of the trust property in respect of the liability either. It would seem highly anomalous to allow a manager to exclude liability or to be indemnified out of the trust property given their fiduciary obligations to unitholders. Trustees will need to ensure that they too fully consider the implications of allowing a manager to rely on the indemnities under a trust instrument, and even if the manager can rely on the indemnity in principle, at what time is it appropriate to allow a manager to rely on the indemnities – it may be that (in accordance with the principles applicable to trustees) a manager cannot rely on an indemnity under a trust instrument until it has been proven that they are not at fault.
To turn back to the analogy offered at the start of this article, for managers and custodians of funds looking for certainty about their obligations, the analogy of unit trusts and ugli fruit might well be right – and not just in relation to the listing of interests.