Once upon a time trusts were a tool of the privileged, used primarily for the purpose preserving inter-generational wealth in prominent families. Today, trusts have become commonplace in the business and commercial landscape. Trusts are now used as vehicles for property development, trading entities for businesses and private wealth-distribution vehicles.
Often, trusts are established as a means of limiting commercial liability and minimising tax. Enthusiastic entrepreneurs are attracted to the potential flexibility offered by a trust and unreservedly assume the role of trustee without fully understanding the potential liabilities and obligations a trustee is exposed to.
Recently, the Supreme Court of NSW, in the matter of ALYK (H.K) Limited v Caprock Commodities Trading Pty Ltd and China Construction Bank Corporation , unambiguously confirmed that trustees are personally liable for the debts they incur in carrying out transactions in performance of trust obligations. Therefore, prima facie, the trustee assumes the risk of the assets of the trust not being adequate to meet the trustee’s right of indemnity.
What is a trustee’s right of indemnity?
The first step in answering that question is acknowledging that a trust is nothing but a mere relationship. It is not a separate legal entity. A trust is formed when a trustee (being the legal owner of an asset) is bound to deal with the asset for the benefit of a beneficiary. Therefore, it is the fiduciary obligation of the trustee that creates the relationship of a trust.
The next logical questions is, if a trust is merely a relationship and not an entity, who enters into transactions in relation to trust assets and in performance of the trust obligations? The trustee of course! Therefore, it is the (unfortunately occasionally naive) trustee that is liable to creditors of the trust. However, trustees are not expected to become philanthropists, splashing cash and taking on commercial risk for the benefit of eager beneficiaries and out of the kindness of their own hearts. Such a concept would indeed be amusing, however, one might find that suddenly the ‘trust’ model would lose its sheen in the commercial sphere. To reinstate the balance and provide some commercial sensibility, the trustee is entitled to a right of indemnity and reimbursement out of the trust estate.
What happens if the trust assets aren’t sufficient to reimburse the trustee for liabilities they’ve incurred in their role as trustee? What should the trustee do to protect themselves?
So, we finally get to the crux of the matter, can a trustee’s liability to third party creditors be limited by way of clever drafting? Yes!
It is at this point that a well drafted Trust Deed is invaluable. If you are considering taking on the responsibility of the role of a Trustee, the right of indemnity clause is one of the first clauses you should seek to negotiate.
For further advice, contact Longton Legal on (02) 8355 9999.