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19 January 2023

When should a retiring trustee seek a contractual indemnity?

In this fortnight’s private wealth briefing, Dispute Resolution¬†Associate Clementine Dowley provides guidance on when a retiring trustee should seek a contractual indemnity.

 

Why might a trustee need protection?

Trustees act in their personal capacities and are therefore, personally liable for liabilities they incur in their capacities as such. These liabilities may arise under contracts which they enter as trustees, or for their negligent acts or omissions in the administration of the trust, or for breach of trust or otherwise.

Retiring trustees continue to be personally liable, even after their retirement, for any liabilities incurred during the period of their trusteeship.

What protections are available to trustees?

Under English trusts law, provided that a trustee has acted within the scope of their powers, in accordance with the trust instrument and without breach of trust, they are entitled to use trust property to meet relevant personal liabilities they have incurred as trustees.

As retiring trustees usually cease to hold trust property when they retire, they are unable to apply it against their liabilities directly, which can cause difficulties for them when seeking to rely on this protection in the event that unforeseen liabilities arise (whether as a result of third party claims or their dealings with beneficiaries or successor trustees).

The issue extends to the legal costs associated with responding to any allegations of breach of trust following retirement. A successor trustee may be reluctant part with trust assets to allow a retired trustee to respond to a breach of trust claim, even if the claim is without merit.

What can retiring trustees do to protect themselves?

  • Equitable lien

Under English law, former trustees have an equitable interest, known as an equitable lien, in trust property. This entitles them to ask the current trustees to meet their proper liabilities arising as trustee using trust assets, or, if the trust property has been distributed, seek recovery from the relevant beneficiaries.Equitable liens have some limitations, however. For example, it is possible that the new trustees are (or may in future become) resident in a jurisdiction which does not recognise the concept of an equitable lien, making enforcement problematic. In addition, recovering distributed funds from beneficiaries is often difficult, not least because those funds may well have been dissipated.

  • Retention of trust assets

Another potential option for retiring trustees is to retain trust assets to meet their anticipated liabilities. However, whilst this approach can provide adequate protection in certain cases, it may not always be appropriate. For example, a retiring trustee may find it difficult to ascertain, at the point of their retirement, what their future liabilities are likely to be and, therefore, what value of assets to retain. Retaining trust property could also have tax implications for them.  Further, where a trustee is being replaced by a successor trustee who would generally be thought to take an appropriate approach to any lien or indemnity, the court may well (on an application by the successor trustee) not allow a retired trustee to retain trust assets. The general rule is that trust assets need to be in the control of the current trustee.

  • Contractual indemnity

In light of the limitations outlined above, and as a supplemental measure, a retiring trustee may choose to seek a contractual indemnity from the new trustees. This provides with the retiring trustee with a contractual claim against the new trustees in respect of any proper liabilities which arise to be met out of the trust assets.

Do the new trustees have authority to grant a contractual indemnity?

New trustees can only agree to use trust assets to meet their liabilities under an indemnity if they have authority to do so. This will usually be given in the trust instrument, but if not, trustees may be able to rely on their power to compromise claims under the Trustee Act 1925. It is generally accepted that new trustees can provide contractual indemnities which mirror the scope of the protection available to trustees under trusts law.

What key provisions should a contractual indemnity contain?

The terms of an indemnity will need to be considered on a case by case basis, and tailored to the specific situation in hand. Legal advice should be sought to ensure that the provisions of a contractual indemnity reflect the requirements of the parties and are appropriately comprehensive. The following terms of a contractual indemnity will usually be key:

  • Scope

The indemnity should generally not protect a retiring trustee beyond the extent that they would be protected if they were to remain a trustee. This means that new trustees are unlikely to have authority to grant indemnities which cover breaches of trust. If a retiring trustee has knowingly committed a breach of trust at the request of beneficiaries, they may be able to obtain a separate indemnity from the beneficiaries concerned. In any event, it is fairly common for trustees to seek broader indemnities than the industry standard on retirement.

  • Duration

The appropriate term of the indemnity will depend on a variety of factors, including the applicable limitation periods for possible claims against the retiring trustee. Where a trustee has outstanding liabilities under a deed, for example, an indemnity with a 12 year term may be appropriate. Indemnities which are not limited in time can cause practical problems for successor trustees, and new trustees will generally seek to avoid providing them.

  • Value

New trustees will seek to ensure that their liability under the indemnity is limited to the value of the trust fund from time to time. This means that if a retiring trustee’s future liabilities exceed the value of the trust fund, they may be required to meet the balance personally (as they would if they remained a trustee). The problem can be mitigated to an extent by providing for chain indemnities to be given by beneficiaries receiving distributions.

How should contractual indemnities be negotiated?

In light of their duties to safeguard trust assets for the beneficiaries, successor trustees will generally look to limit an indemnity’s scope as far as they can. Retiring trustees, on the other hand, will be looking for maximum protection for themselves and will therefore request a wide indemnity.

This can give rise to conflict, and careful thought should be given as to whether it is appropriate to appoint separate firms of lawyers to act for the negotiating parties. On occasion, the enforcement of an indemnity by retiring trustees against new trustees can become contentious, in which case it is advisable to seek specialist legal advice.

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Clementine Dowley
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Richard Manyon
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