Trustees: insolvent trusts and conflicts of interest

In the Matter of the H Trust [2018]

Trustees faced with a “momentous” decision concerning the affairs of a trust are well advised to seek prior sanction from their supervising court. This will help protect the trustee (and its professional indemnity insurers) from exposure to claims for breach of trust relating to the decision.

In the overwhelming majority of cases, the trustee’s decision receives the desired court sanction. However, this recent decision of the Royal Court of Jersey illustrates circumstances in which a court may refuse sanction and highlights particular issues to be navigated by trustees when the trust is insolvent.

Background

There were three beneficiaries of the trust in question (the Trust), of which the sole asset was a Jersey company that owned a residential property in London.

The Trust found itself to be cash flow insolvent as a result of its inability to pay management fees and other charges in connection with the property. The trustee therefore sought to sell the property with a view to paying creditors, including the trustee itself (who was owed a significant sum for professional fees), and then distributing the balance to the beneficiaries. One of the beneficiaries supported the trustee’s decision whereas the others objected and instead sought to buy out the supporting beneficiary’s interest. However, no agreement on this was reached and the trustee therefore applied to the Royal Court of Jersey to sanction the sale of the property.

The decision

Although the trustee’s application appeared to have at least superficial merit (given the Trust’s insolvency and the apparent lack of alternative options), the court nevertheless refused to give sanction. The court held that it had to satisfy itself that: (i) the trustee’s decision was in good faith; (ii) the decision was one a reasonable trustee properly instructed could have reached; and (iii) the decision had not been impaired by an actual or potential conflict of interest. Based on these matters, the court was unwilling to bless the trustee’s decision, for three key reasons:

  1. The trustee had a clear conflict of interest in light of its position as a creditor of the Trust and its interest in being able to settle its debt from the sale of the property. The court found that it was of fundamental importance for the trustee to address the conflict issue head on and to document why, despite such conflict, it was in the beneficiaries’ interest to sell. The trustee’s application contained no such evidence.
  2. The trustee had not considered the tax implications of the proposed sale due to lack of funds. The court was unwilling to accept this as a reasonable excuse for not taking necessary advice, noting that the trustee would have been able to recover its reasonable costs in due course.
  3. It was not reasonable to insist on a sale of the property when two of the beneficiaries sought to retain it and it was incumbent on the trustee to see if there was any way the interest of the third beneficiary could be bought out.

Comment

Whilst it may be tempting for a trustee of an insolvent trust to proceed with haste and minimum expense to liquidate trust assets, the trustee is not relieved of its duty to act reasonably and in good faith. If necessary, the trustee must incur professional expenses (e.g. for tax advice) even if the trustee is unable to meet such expenses from trust assets. The trustee should also be particularly mindful of the need to take account of its own conflicts of interest, including where the trustee is itself a creditor of the trust, and the trustee must ensure that its deliberations and decisions are properly documented.

Read other items in Professions and Financial Lines Brief - March 2019

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