Chapter 7 - Creditors and trading trusts

Options for reform

Strengthening the creditor’s derivative claim through the trustee’s right to indemnity

Option 2: Providing in statute that the right to indemnity cannot be modified or excluded

In 2002 the Law Commission recommended that the Trustee Act be amended to make it clear that the right to indemnity was not capable of being modified or excluded.309 There was widespread support from submitters when this was proposed in the Preliminary Paper. There is the opportunity to consider this proposal again. Such an amendment would bring New Zealand into line with the Australian states that also share this position. It would bring certainty to an issue that is currently undecided, but which several New Zealand commentators consider is likely to be the case already.310 It would provide some protection for unsecured creditors whose only means of accessing the trust assets is by way of subrogation to the trustee’s right of indemnity.

A drawback of this proposal is that it restricts the settlor’s ability to settle the terms of the trust as they wish, and the trustee’s freedom to accept a trusteeship without indemnity rights. Not all Australian jurisdictions have chosen to legislate in this way, and indeed some have provided for the opposite and allow indemnities to be excluded completely. Additionally, this change in itself does not address all the ways in which the trustee’s indemnity can be impaired. Creditors may still find themselves unable to rely on the right to indemnity if, for example, the trustee has committed a breach of trust and caused a loss to the trust assets.

There is an issue as to whether any legislative change in this area should apply to trusts generally, or only to trading trusts. If it is desirable only to target trading trusts, there are further difficulties as to how to appropriately restrict the provision.311 There is also a transition issue of whether such a change should be prospective only; this issue arises in relation to all of the reform options raised.

Option 3: Enhancements to creditors’ subrogation right

Even if the trustee’s right to indemnity cannot be excluded by the trust instrument, risks remain for creditors contracting with a trustee, as the indemnity can be impaired in a number of ways (because the trustee lacked the capacity or authorisation to enter into the contract, or was in breach of its equitable duties in doing so, or the trustee is indebted to the trust).

To address these issues, the Trust Law Committee312 in England proposed several reforms be provided for in legislation. The first was that where a trustee is indebted to the trust for reasons unconnected with a contract with a creditor, this indebtedness should not prevent the creditor from being indemnified out of the trust fund, although it may prevent the trustee from exercising their right of indemnity to the extent of the indebtedness.313

Secondly, subject to any contrary intention in the trust instrument, where a trustee’s entry into a contract with a creditor was in breach of the trustee’s equitable duties, this should not prevent the creditor having a right of indemnity out of the trust fund unless the creditor was dishonest.314 The Committee had considered that checking whether the trustee will be in breach of duty by contracting with the creditor is “the most difficult and unsatisfactory” barrier facing the creditor wishing to rely on the trustee’s right of indemnity.315 The Committee considered it “not far short of astonishing” that the creditor’s ability to recover depends on the trustee not acting negligently; this effectively requires the creditor to ensure that the trustee is not in breach of trust, and makes it assume some form of fiduciary duty to the trust and its beneficiaries.316

Notably, the Trust Law Committee elected not to recommend a proposal introducing an “indoor management” type rule that creditors could rely on to assume that trustees were acting with the requisite capacity and authorisation, instead “preserving a sufficient distinction between trusts and companies.”317 The Committee considered that it was legitimate to expect the creditor to investigate whether the contract was within the capacity and authorisation of the trustee.318 A reason for the Committee’s position against an indoor management rule may be because it could be said that in cases where a trustee did not have the requisite capacity or authority to enter into a liability, a trustee’s right of indemnity never arose in the first place, so it would be inappropriate to create or validate it via a rule. This is compared with cases involving breaches of trust, where the indemnity did come into existence, and is simply being preserved for the creditor’s benefit.319

But New Zealand need not necessarily follow the view of the Trust Law Committee regarding the need for an “indoor management” type rule for trusts. The authors of Equity and Trusts in New Zealand propose a scheme giving creditors priority over beneficiaries, where the creditor can assume the trustee is not in breach in incurring the liability, regardless of beneficiary cross-claims and attempts to limit or exclude the trustee’s right of indemnity (unless the creditor has knowledge of these circumstances).320

This option could provide that the creditor can rely on the trustee’s right of indemnity despite the trustee’s lack of capacity or authorisation, breach of trust, indebtedness to the trust resulting in a cross-claim, or a limited or excluded right of indemnity in the trust deed, unless the creditor is aware of these matters. It may be appropriate to cover some or all of these ways in which the indemnity can be impaired. This would ensure that the trustee is insulated against circumstances about which it has no knowledge but which may prejudice the creditor’s ability to subrogate to the trustee’s indemnity.

Direct recourse to trust assets

It can be argued that the option canvassed above by the Trust Law Committee, along with any reforms preventing the exclusion of the trustee’s right to indemnity by the trust instrument, do not go far enough. Tjio criticises the Trust Law Committee proposals for being concerned with enhancing a creditor’s subrogation rights only, rather than creating direct claims on the trust fund.321 He considers that the focus on addressing weaknesses in the creditor’s right of subrogation is misguided.322 Donovan Waters QC has echoed the concern that the “weakness” of the trust in many common law jurisdictions is that the trust creditor only has access to the trust assets when the (otherwise insolvent or bankrupt) trustee is entitled to indemnity.323 He considered that there is mounting pressure to introduce statutory reform introducing limited liability for trustees and direct access for creditors to the trust assets.324

Option 4: Giving trustees the power to grant charges for creditors over trust assets

An option to consider is providing in legislation for trustees to have the power to grant fixed or floating charges over trust assets for the benefit of third party creditors, enabling them to have a direct claim against trust assets (subject to any contrary intention in the trust instrument). As proposed by the Trust Law Committee in England,325 this could be a default rather than a mandatory provision. The charge avoids the need for creditors to rely on the trustee’s right to indemnity and circumvent the problem of unrelated indebtedness of the trustee by making this immaterial to creditors.326

This approach effectively partitions the assets of the trust so that it is treated as a de facto separate entity.327 It would not remove the need for the creditor to examine the terms of the trust deed to check that there is no restriction on the trustee’s ability to grant security over trust assets; most trust deeds that are professionally drafted contain express clauses rather than relying on default provisions.328

The authors of Equity and Trusts in New Zealand express doubt about the practicality of this proposal, and note that unless a default position was created whereby a charge was granted automatically, this approach would not assist the many creditors who would not be aware of the need to negotiate such a charge from the trustee.329 It may be that a reform of this kind would only assist the types of creditors who were likely to seek security anyway.

Option 5: A right of direct recourse to trust assets

A more straightforward but perhaps more radical option would be to provide for creditors to have direct recourse to trust assets, without needing to rely on the trustee’s right of indemnity. Providing for a direct claim on the trust assets in certain circumstances would avoid the unfairness of the creditor being deprived of the ability to recover because the trustee’s right to indemnity is impaired, for example due to the trustee’s unrelated indebtedness, and the beneficiaries receiving a windfall benefit.

Direct recourse to the trust assets may already be available, although it is not clear what approach New Zealand courts would take. A creditor might have a claim against the trust fund in unjust enrichment, to the extent that the trust fund is benefited at the expense of a creditor.330 A direct claim is also possible where the trust instrument provides for the trust fund to be liable.331 The contract between a creditor and a trustee may be construed as giving the creditor a direct claim against the trust fund, through implication, if the contract provides that the trustee is not to be personally liable but that the creditor is to look to the trust fund to satisfy the claim.332

Alternatively, a more narrow construction of such a provision is that the trustee’s own property is exempt but the creditor is not given a direct claim against the trust fund, and still must rely on the trustee’s right to indemnity to access the trust assets.333 Even if there is such a contractual provision to rely on, the creditor must still ensure that the contract is within the capacity of the trustee.334 Where the contract states that the trustee is not to be personally liable, the tendency in the United States is to construe the contract as giving a creditor a direct right of recourse to the trust fund, whether or not it specifically provides for this.335

The United States has seen the emergence of a doctrine of “direct access to the trust assets” or “binding the trust estate”.336 The courts and academics appear to agree that “a trustee can and should be permitted to exclude all personal liability, and that an unsecured trust creditor can and should be able to access directly the trust estate despite this, free of the clear accounts rule.”337 This is illustrated in the relevant sections of the Restatement of the Law of Trusts338 as well as the Uniform Trust Code.339 The second Restatement states that a trust creditor is permitted direct access to trust property in certain circumstances:340

(a)where the trustee is entitled to exoneration (that is, indemnity)
(section 268);

(b)where the trust estate has benefited (section 269);

(c)where the terms of the trust provide for the liability of the trust estate (section 270);

(d)where the contract binds the trust estate (section 271);

(e)other situations where it is equitable to permit satisfaction (section 271A): the commentary on this section observes that this principle has emerged as a modern trend that has “gradually become established.341

The revised version of the Restatement appears as though it will simplify the position considerably. Halbach states:342

Trusts Third can be expected to reverse the position of previous Restatements of Trusts by providing that third parties’ suits against trustees normally result in a judgment against the trustee in a representative capacity (that is, one “against the trust”).

The draft of the third Restatement provides in section 105 that a third party may assert a claim against a trust for a liability incurred in trust administration by proceeding against the trustee in the trustee’s representative capacity, whether or not the trustee is personally liable.343 Section 106 states that a trustee is personally liable on a contract only in certain circumstances: if the trustee committed a breach of trust; if the trustee’s representative capacity was undisclosed and unknown to the third party; or if the contract so provides.344 Thus, the starting point is that the creditor is given a direct claim against the trust assets, unless certain circumstances are met – the opposite of the approach taken in the second Restatement, where the scenarios involving direct access to the trust assets were still expressed as the exceptions. D’Angelo observes that now, while a trustee in the United States can assume personal liability, the contract must expressly state this, which is the reverse of the Australian (and New Zealand) position.345

 

The prospective change in the Restatement is in line with section 1010 of the Uniform Trust Code, headed “Limitation On Personal Liability of Trustee”, which provides:

(a) Except as otherwise provided in the contract, a trustee is not personally liable on a contract properly entered into in the trustee’s fiduciary capacity in the course of administering the trust if the trustee in the contract disclosed the fiduciary capacity.

(b)

(c) A claim based on a contract entered into by a trustee in the trustee’s fiduciary capacity … may be asserted in a judicial proceeding against the trustee in the trustee’s fiduciary capacity, whether or not the trustee is personally liable for the claim.

On this point, Scott and Ascher on Trusts comments:346

Third parties who contract with the trustee are permitted … to assert their claims directly against the trust estate … In short then, though there remain some instances in which the trustee is personally liable, such as when the contract so provides or when the trustee fails to disclose that the trustee is acting on behalf of the trusts, [section 1010] generally relieves the trustee of personal liability on contracts entered into on behalf of the trust estate.

This change is very significant for creditors contracting with a trustee, as it shifts the risk of dealing with an insolvent or misbehaving trustee from the creditor to the trust estate.347 Such a shift is said to be appropriate because “the trust is the ‘enterprise’ that has generated the contract” and should therefore bear the costs of performing the contract; additionally, the choice of trustee is within the settlor’s control, and it is manifestly unfair for a third party to bear the consequences of a poor choice of trustee by the settlor.348

Provision could be made in legislation in New Zealand for creditors to have a direct claim against the trust assets in certain circumstances. This would not necessarily need to entail change to the current law on trustee liability. Enabling creditors to take a claim against the trust assets via a legislative provision could be drafted so that the claim is available independently of the trustee’s right of indemnity. In this way the provision would circumvent the problems arising where a creditor cannot satisfy their debt because the trustee’s indemnity is impaired.

Against the advantages for creditors that such a reform might provide, it could be argued that permitting direct access to the trust assets would cut across basic contractual and equitable principles (such as trustees’ personal liability). It could also result in two “classes” of unsecured trust creditor, depending on whether or not they were able to make a direct claim, which could lead to unfairness.349 The interests of beneficiaries also need to be considered if the creditors are able to access trust assets. Overall, this type of reform might disincentivise the use of a trading trust structure if the trust assets are no longer protected from the reach of creditors, a consequence which may or may not be desirable.

A question arises about the circumstances, if any, in which a direct claim should be permitted. There was support in a submission to a previous Issues Paper for allowing a direct claim on the trust assets where the relevant liability is incurred for the benefit of the trust as a whole, although it was acknowledged that it would not assist creditors in an insolvency situation.350 This proposal is in line with section 269 of the second Restatement.

D’Angelo thought that the circumstance referred to in section 271 of the second Restatement, where a contract that provides that a trustee is not personally liable can be taken as implying that the trust estate will carry the liability, might be palatable in Australia. This concept did not involve a radical departure from current trust and equity principles.351 In contrast, he thought the concept in section 271A, that a direct claim is permitted where it is equitable to do so, conferred altogether too broad and too discretionary jurisdiction on the courts.352 Certainly section 271 “involves a less precise concept of equity”;353 it may be challenging for the courts to apply and create uncertainty for parties.

Option 6: Liability of directors of trading trusts

Another option to consider for protection of creditors is the liability of directors of a corporate trustee. Directors contract on behalf of the company, and it is the company, a separate legal entity, that is liable for repayment of any liabilities incurred. Creditors are clearly vulnerable if the corporate trustee is a limited liability company with only nominal capital assets.354 At present, the directors of a company that is a trustee are subject to the same obligations as the directors of any company; as Heath J has said:355

A company is a company is a company. Whether a company is a trustee or operating on its own behalf, it remains a company subject to statutory, common law and equitable rules.

A director is a director is a director. A director of a company owes the same duties to a company, whether the company is a trustee or operating on its own behalf.

Directors of corporate trustees are accordingly subject to the directors’ duties in the Companies Act 1993. Directors must ensure that distributions of the company’s wealth are not made unless the company is solvent:356

For the creditor who does not know that it is trading with an assetless corporate trustee, the protection against the suffering of loss lies in the duties owed by directors to the company, breach of which will enable liquidators to recover sufficient moneys to meet creditors’ claims; assuming the directors are themselves solvent and are able to pay in full. On the other hand, if the directors consider carefully the company’s financial position and make a decision on reasonable grounds that creditors would not be prejudiced by any distribution they make, they will not be held personally liable for any distribution to beneficiaries.

In particular, sections 131, 135, 136 and 137 of the Companies Act will apply. Section 131 imposes a duty on directors to act in good faith and in the best interests of the company.357 Section 135 prohibits directors causing or allowing the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors. Section 136 prohibits a director from agreeing to a company incurring an obligation unless the director reasonably believes the company will be able to perform the obligation required. Section 137 requires a director, when exercising or performing duties, to exercise the care, diligence and skill that a reasonable director would exercise in the same circumstances, taking into account the nature of the company and the decision, the position of the director and the nature of responsibilities undertaken by him or her. In addition, sections 344–350 of the Property Law Act 2007 prevent dispositions of property with intent to defraud creditors.

A director who breaches their duties to the company may be liable to the company for any losses the company suffers, and on liquidation a liquidator or creditor can bring an action against a director to recover losses suffered by the company as a result of the director’s breach of duty. A director of a corporate trustee may even be in a more precarious position than a director of an ordinary company, if the corporate trustee has limited assets of its own.358 Depending on the availability of the trustee’s right to indemnity and the value of the trust assets, a director may well be liable for reckless trading under section 135 or incurring an obligation without reasonable grounds to believe that the company will be able to perform the obligation under section 136.

If the company has been placed in liquidation, then the creditor, liquidator or shareholder can apply for an order under section 301(1) for repayment of money or property to the company’s assets or to the creditor directly, if a director has misapplied money or property, or acted negligently or in breach of trust or duty in relation to the company. However, orders in favour of an individual creditor under section 301 are limited.359

In Levin v Ikiua two directors of a corporate trustee were found to be in breach of their duties to the company in making distributions to beneficiaries once they were aware of a claim by a creditor, so that distribution was likely to result in loss to the creditor. The directors were ordered to pay to the liquidators the amount distributed.360 It was said the breaches could be on the basis of breach of fiduciary duty or the principle in Nicholson v Permakraft (NZ) Ltd,361 being the duty of the director not to authorise distribution of the assets of the company for the benefit of third parties to the detriment of a person known to be a creditor.362

The question is whether these obligations impose sufficient constraints on directors of corporate trustees in trading trust structures, or whether the liability of directors should be extended. The Commission would be interested in views on this. If it was desirable to impose further liability on directors, the next question is how this is best achieved. It is likely that any reform would require an amendment to the Companies Act.

In 2002 the Commission recommended providing that a trading trust may make a distribution to a beneficiary of the trust only if the requirement in section 52 of the Companies Act (the solvency test) have been satisfied, and applying the same criminal and personal liability to directors in the event of breach of this provision as are found in sections 52(5) and 56.363 Submitters to the Preliminary Paper were generally not in favour of this proposal, as discussed in paragraph [6.25]. In light of concerns raised by submitters about the shorthand importation of the test in section 52 and the lack of support for this option, it is proposed not to pursue it further, but the Commission is open to submitters’ views to the contrary.

In Australia the main legislative development to protect creditors dealing with trading trusts has been in relation to directors of corporate trustees; a similar provision could be adopted in New Zealand. Section 197 of the Corporations Act 2001 (Cth) applies where a corporation incurs a liability while acting or purporting to act as a trustee. Subsection (1) provides that directors are personally liable for debts incurred by the company where the company does not have an indemnity out of the trust assets. The section provides:364

197 Directors liable for debts and other obligations incurred by corporation as trustee

(1)A person who is a director of a corporation when it incurs a liability while acting, or purporting to act, as trustee, is liable to discharge the whole or a part of the liability if the corporation:

(a)has not discharged, and cannot discharge, the liability or that part of it; and

(b)is not entitled to be fully indemnified against the liability out of trust assets solely because of one or more of the following:

(i)a breach of trust by the corporation;

(ii)the corporation’s acting outside the scope of its powers as trustee;

(iii)a term of the trust denying, or limiting, the corporation’s right to be indemnified against the liability.

The person is liable both individually and jointly with the corporation and anyone else who is liable under this subsection.

Note: The person will not be liable under this subsection merely because there are insufficient trust assets out of which the corporation can be indemnified.

(2)The person is not liable under subsection (1) if the person would be entitled to have been fully indemnified by 1 of the other directors against the liability had all the directors of the corporation been trustees when the liability was incurred.

This section was first introduced in 1986.365 Its purpose was to ameliorate the consequences for creditors where there is no access to trust funds to meet liabilities incurred by a corporate trustee.366 One aim was that the imposition of personal liability on directors would have the effect of discouraging the insertion into trust deeds of provisions limiting or excluding the company’s right of indemnity from trust assets. It was also intended to encourage trust deeds to be drafted so as to minimise or eliminate the possibility that a trustee would be in breach of trust.367 The basis was that it is reasonable to encourage all directors of companies acting as trustees to ensure that the company does not enter into trust deeds which deny creditors access to trust assets to meet liabilities incurred by the company.368 As Cooper has described:369

The archetype of the mischief sought to be addressed is the situation where a creditor is owed money by a corporate trustee with a $2 share capital and either the terms of trust or the conduct of the trustee deny the creditor access to the trust assets via subrogation to the trustee’s right of indemnity.

In the event, litigation involving section 197 has been limited. There has been little commentary and there was no significant judicial consideration of its predecessors.370 A significant issue with the interpretation of section 197 arose in 2003 following a decision of the South Australian Full Court in Hanel v O’Neill;371 Hanel was the first time that the section had been considered. The version of section 197(1)(b) at that time did not contain the text from “solely because of …” onwards, or subparagraphs (i) to (iii). The note after paragraph (b) read ambiguously, “This is so even if the trust does not have enough assets to indemnity the trustee”. The majority in Hanel interpreted section 197(1) as saying that a director of a corporate trustee will be liable for liabilities incurred by the trustee, merely because there are insufficient trust assets to meet them, even if the trustee has a legal right to indemnification. The majority decided that insufficiency of assets meant that the corporate trustee was not “entitled” to be fully indemnified, thereby triggering liability under section 197(1). They concluded that Parliament, when rewording the section in 1999, had intended to reverse the previous position that an insufficiency of assets, by itself, did not mean that a director would be taken not to be entitled to be fully indemnified. The decision was criticised by subsequent courts and commentators372 who considered the interpretation to be incorrect. The problem was the major expansion of directors’ personal liability that effectively treated directors of corporate trustees as guarantors of any liability entered into on behalf of the trust.373

The decision in Hanel was soon overridden in 2005 by an amendment that replaced subsection (1) and the accompanying note with the current wording set out in paragraph [7.68].374 There appears to have been no further judicial consideration of section 197 as amended. The Second Reading of the amending Bill indicated that it would “address concerns that have arisen” after Hanel, “restore the long-standing interpretation of section 197” and “clarify the circumstances in which directors or corporate trustees are liable to discharge a liability incurred by the corporation, acting in its capacity as trustee”.

The revised section 197 is still not without its difficulties. The drafters of the amendment elected to list the circumstances of extinguishment or limitation of the right of indemnity, in subparagraphs (i) to (iii), rather than leaving the question to be determined by the general law.375 Austin and Ramsay have pointed out that due to the amendments, a director would not be liable if the trustee’s right of indemnity is lost for a reason other than those listed.376

Lang Thai considers that the section is unacceptable for several reasons. While directors in Australia can be held liable under the insolvent trading provisions in section 588G of the Corporations Act 2001, section 588H offers four defences. Directors being sued under section 197 have no similar defences, so directors of trustee companies are treated more harshly under section 197.377

Thai is also concerned that section 197 leaves open the potential for abuse by directors of certain trustee companies, especially smaller ones, if the company has a full indemnity or a limited but reasonably extensive indemnity under the trust deed, but the director ensures that the trust has insufficient funds to fulfil the company’s right of indemnity.378 He advocates a legislative provision requiring the directors of trustee companies to discharge all company debts and out of pocket expenses before proceeding to distribute the balance of trust funds to the beneficiaries.379 He also considers that there should be a requirement for a trustee company to publicly document the extent to which the trustee company is legally entitled to indemnity (through lodgement of the trust documents with the Australian Securities and Investments Commission).380 Thai further comments that he would like to see reincorporated into section 197 the defence provision protecting “innocent directors” which was found in the section prior to its rewording in 2000.381

If New Zealand were to incorporate a provision based on section 197 of the Australian Corporations Act 2001 into legislation (albeit with improved drafting), this reform would negate the effect of any limitation or exclusion of the trustee’s right to indemnity in the trust deed by shifting liability to the directors. The need for such a provision would be reduced if legislation were introduced providing that the right to indemnity cannot be excluded in the trust instrument. A provision similar to section 197 might have a similar effect by incentivising trustees to ensure that trust deeds do not restrict the right of indemnity. It would also provide another avenue of protection to creditors in the event of a breach of trust or ultra vires conduct by the trustee.

Nonetheless, there are clearly many issues arising from the introduction of a provision such as section 197, including those highlighted in Australia. Moreover, such a change would not by any means provide a full guarantee for repayment of creditors; repayment as a matter of personal liability would depend on the available asset base of the directors. However, it might focus the attention of directors on their conduct and right to indemnity if their personal liability is affected. A New Zealand equivalent section could cover the same circumstances of exclusion or limitation of the right of indemnity as listed in section 197(1)(b)(i) to (iii), or could define the scope of this more widely or narrowly, or leave it to be determined by the courts under a general provision.

There remains a question about how to deal with directors distributing assets to beneficiaries so that, while the company may be indemnified against trust assets, there are no assets available to fulfil the company’s right of indemnity. The interaction of a new section with the existing Companies Act provisions, particularly the directors’ duties, would need to be considered. There may be legitimate concerns about the impact that such a section would have on the willingness of persons to act as directors of corporate trustees, if their personal liability were expanded; extra costs may be incurred in indemnity insurance. The availability of appropriate defences would need to be addressed. There is also an issue as to whether the section ought to apply to all trusts (as the Australian provision does) or to certain trusts only.

The Commission would be interested in views on whether statutory intervention is necessary to hold directors of corporate trustees liable to creditors, and if so, in what circumstances liability should attach.

Option 7: Retain the status quo

A further option would be to retain the status quo and make no changes in relation to creditors dealing with trading trusts. This is the preferred option if the difficulties for creditors caused by trading trusts are not sufficiently serious, widespread or identifiable to warrant intervention. A fundamental argument against reform is that the types of issues raised by trading trusts are no different to risks ordinarily faced by unsecured creditors looking to do business with a company that is not a trustee, for example that the company’s assets are subject to a charge. It could be said that a creditor always runs the risk that the party they are contracting with will not be able to meet their obligations, whether that party is an individual person, a corporate trustee, or an ordinary company. On this view there is no compelling reason to set the trading trust structure apart and apply additional rules to assist creditors who have failed to take security.

Under the status quo, existing trust and company law obligations would continue to apply to corporate trustees and their directors. This approach places the risks of dealing with an assetless corporate trustee mainly with the third party looking to contract with it, although the corporate trustee and its directors would still be bound by duties under the Companies Act and the Fair Trading Act 1986. Creditors would continue to have their primary claim against the trustee personally, and rely on the trustee’s right of indemnity to recover their debts if the trustee has insufficient assets. Creditors would bear the risk that the indemnity is not available, possibly leaving them with no recourse to have their debt satisfied. It would be open to settlors to exclude the right to indemnity via the trust instrument and trustees to accept the position with this limitation (although it is as yet unclear in New Zealand whether such a provision would undermine the existence of the trust).

The current position puts the onus on the creditor to protect their position, either by taking security, or by establishing for themselves the extent of the trustee’s indemnity, whether it is limited or excluded by the trust instrument, and whether the trustee is acting within its capacity and authority in entering into the contract. Smaller or less sophisticated creditors may be constrained in their ability to obtain such protections, due to lack of awareness about the need for them or limited negotiating power.

Ibid, at 14.

For example Heath, above n 290, at 530. 

See para [8.32].

The Trust Law Committee was set up in 1994 under the auspices of King’s College London, comprising legal academics and practitioners who conduct research to analyse weaknesses in trust law and ways of improving it.  It has produced consultation papers and reports on various areas of trust law including the rights of creditors against trustees and trust funds. The Committee worked with the United Kingdom Law Commission to develop the Trustee Act 2000.

Trust Law Committee “Report on the Rights of Creditors”, above n 285, at [3.4] and [10.2].

Ibid, at [10.3]. “Dishonest” is meant in the sense established by Royal Brunei Airlines v Tan [1995] 2 AC 378.

Ibid, at [3.9].

Ibid, at [3.9]; Hans Tijo “Lending to a Trust” (2005) 19 TLI 3 at 11.

Ibid, at [3.8].

Ibid, at [3.5]–[3.6].

Tjio, above n 316, at 19.

Butler Equity and Trusts, above n 264, at 463.

Tjio, above n 316, at 19.

Ibid, at 20.

Donovan Waters QC “The Future of the Trust – Part II” (2007) 14 Journal of International Trust and Corporate Planning 1 at 12.

Ibid at 11–12.

Trust Law Committee “Report on the Rights of Creditors”, above n 285,  at [3.1] and [10.1].

Ibid, at [3.1].

Tjio, above n 316, at 14.

Ibid.

Butler Equity and Trusts, above n 264, at 462–463.

Trust Law Committee “Rights of Creditors Against Trustees and Trust Funds” (Consultation Paper, April 1997) at [2.30] [“Consultation Paper on Rights of Creditors”].

Ibid, at [2.31]–[2.32].

Ibid, at [2.33]–[2.36].

Ibid, at [2.35].

Tjio, above n 316, at 19.

Ibid. See American Law Institute Restatement of the Law, Second, Trusts (2nd ed, 1959) at s 271.

See Nuncio D’Angelo “The unsecured creditor’s perilous path to a trust’s assets: Is a safe, more direct US-style route available?” (2010) 84 ALJ 833 at 848–854.

Ibid, at 854.

Restatements of the law are produced by the American Law Institute.  These are not statutes and do not have the force of law (unless accepted by the courts of a state) but are highly authoritative, and seek to collect and summarise the law and sometimes resolve ambiguities: D’Angelo, above n 336, at 848. The second Restatements were published in 1959; since then further revisions have been carried out and the draft has been approved, but the relevant volumes of the third Restatement have not yet been published.

A Uniform Trust Code, covering express trusts, was developed by the National Conference of Commissioners on Uniform State Law, and is intended to provide a default statute.  See s 102 (Scope) and Comment, and Comment on Article 1. It was promulgated in 2000 and updated in 2005, and has now been accepted in some form in 24 states, with three more in the process of introducing it in 2011: see < www.nccusl.org/ > Legislative Fact Sheet: Uniform Trust Code. Once enacted in a state, it becomes part of the law of that state: see D’Angelo, above n 336, at 848.

Restatement of the Law, Second, Trusts, above n 335. 

Ibid, at s 271A, comment a.

Edward C Halbach “Uniform Acts, Restatements, and Trends in American Trust Law at Century’s End” (2000) 88 California Law Review 1877 at 1883.

American Law Institute Restatement of the Law, Third, Trusts (Tentative Draft No 6, 2011) at s 105.

Ibid, at s 106.

D’Angelo, above n 336, at 849.

Austin Wakeman Scott, William Franklin Fratcher and Mark L Ascher Scott and Ascher on Trusts (5th ed, vol 4, Wolters Kluwer, 2007) at 1875–1876.

Ibid, at 1877.

Ibid, at 1879.

D’Angelo, above n 336, at 857.

Submission of Taylor Grant Tesiram on Review of Trust Law in New Zealand: Introductory Issues Paper (submission dated 28 February 2011) at 8.

D’Angelo, above n 336, at 855.

Ibid, at 854.

JD Merrals “Unsecured Borrowings by Trustees of Commercial Trusts” (1993) 10 Aust Bar Rev 248 at 257.

D’Angelo, above n 336, at 774.

Heath, above n 290, at 537.

Ibid, at 539.

See for example the director of a corporate trustee found liable under s 131 in Vance v Lamb HC Wellington CIV-2007-485-343, 2 December 2008.

Paul Heath and Michael Whale Heath and Whale on Insolvency (online looseleaf ed, LexisNexis) at [46.5(f)].

See Insolvency Law & Practice (online looseleaf ed, Brookers) at [CA135.06(3)] and [CA301.08(3)]; Mitchell (t/a D L Mitchell Plumbing & Drainage) v Hesketh (1998) 8 NZCLC 261,559.

Levin v Ikiua [2010] 1 NZLR 400 (HC) at [138]–[147]. Confirmed by the Court of Appeal in [2010] NZCA 509 at [73].

Ibid, at [146].

Ibid, at [139] and [142], citing Nicholson v Permakraft (NZ) Ltd [1985] 1 NZLR 242 (CA). 

Law Commission Some Problems in the Law of Trusts (NZLC R79, 2002) at 14. 

Corporations Act 2001 (Cth), s 197. Subsections (3) to (5) respectively provide that this section does not apply to a liability incurred outside Australia for a foreign company, a registrable Australian body outside its place of origin, or to an Aboriginal and Torres Strait Islander corporation.

The provision was originally introduced as s 229A of the Companies Codes through the Companies and Securities Legislation (Miscellaneous Amendments) Act 1985 (Cth) in March 1986.  Subsequently the Corporations Law replaced the Codes and the provision was renumbered to s 233. Then in the Corporations Act, brought in in 2001, the provision was replaced with s 197 and some changes in wording were made.

Explanatory memorandum at [277].

Ibid, at [280].

Ibid.

Cooper, above n 255, at 315. See also Second Reading Speech by Mr Lionel Bowen, Attorney-General, on the Companies and Securities Legislation (Miscellaneous Amendments) Bill 1985, House of Representatives, Weekly Hansard, No 14, 1985, at 1923.

Thai, above n 259, at 22–23.

Hanel v O’Neill [2003] SASC 409 at [67].

Edwards v Attorney-General (NSW) (2004) 60 NSWLR 667 at [142]–[152]; Saffron Sun Pty Ltd v Perma-Fit Finance Pty Ltd (in liq) (2005) 65 NSWLR 603 at [31]; RJK Enterprises Pty Ltd v Webb [2006] 2 Qd R 593; Intagro Projects Pty Ltd v Australia and New Zealand Banking Group Ltd (2004) 183 FLR 462 at [61]–[63]. Cooper, above n 255; Thai, above n 259.

Dal Pont, above n 260, at [27.40].

Corporations Amendment Bill (No 1) 2005, introduced in June 2005.

RP Austin and IM Ramsay Ford’s Principles of Corporations Law (14th ed, LexisNexis Butterworths, 2010) at [20.170].

Ibid at [20.170].

Thai, above n 259, at 32–33.

Ibid, at 33.

Ibid.

Ibid, at 34.

Ibid.