Insolvent trusts and the implications for those involved with them
Re Z Trusts 
The Z Trusts litigation relates to four judgments (three in 2015 and one in 2018) handed down by the Royal Court of Jersey in respect of the ongoing administration of eight family trusts and is another recent case where the court had to grapple with issues affecting insolvent trusts.
The trusts faced a variety of financial difficulties, with two of the trusts being viewed as ‘cash flow insolvent’. Equity Trust (Jersey) Limited (ETJL) was the original trustee of one of the insolvent Z Trusts, prior to its retirement in 2006. Upon retirement, ETJL entered into a Deed of Retirement under which it was granted an indemnity for any relevant losses incurred during its tenure as trustee.
ETJL subsequently sought to rely on the contractual indemnities afforded to it under the Deed of Retirement by requesting the reimbursement of £18 million, for the costs it had incurred whilst settling a series of English legal proceedings which had been commenced against the former directors of one of the trust companies.
However, there were additional unsecured creditor claims on the trust assets, including claims from family members who had made various loans to the trust (totalling £211 million), along with claims by Volaw (in its capacity as the ‘successor trustee’) for its professional fees.
The question of ‘priority’ over trust assets was therefore of critical importance for ETJL and accordingly the court was tasked with deciding whether the various creditors’ claims were to be ranked on a ‘first in time’ basis, or whether they ranked equally with one another (pari passu). The 2018 judgment covered the issue of priority, and the 2015 judgments covered the issue of how a trustee should administer a trust that is technically “insolvent”.
These judgments are extremely important to those operating and involved with trusts in offshore jurisdictions, as highlighted, below.
The rights of creditors
In its judgment of 3 July 2018 the Jersey Court held that a former trustee’s claim against trust assets under its right to indemnification would rank pari passu with that of a current trustee (and other creditors of the trust). It was found that a ‘first in time’ approach would essentially allow former trustees to “scoop the pot”, which would be an “unfair outcome” for creditors who had equally been involved in the due administration of the trust.
In addition, creating a temporal rule of priority between trust creditors was considered arbitrary and unfavourable for the good administration of trusts. Such a rule could give rise to increased claims for security on a transfer of trusteeship and increase reluctance in trust creditors to agree key novation documents.
This judgment represents the first time that any court, in any jurisdiction, has considered how current and former trustees’ respective rights of indemnity should rank in the circumstances of an insolvent trust.
Throughout the four Z Trusts judgments, the court has comprehensively considered the correct and proper conduct for trustees overseeing ‘insolvent’ trusts. Namely, upon realising that a trust has become insolvent, the court directed in this case that trustees are obliged to administer the trust in the interest of all creditors as one ‘class’. Ideally, trustees should obtain approval from either the court or trust creditors on how to administer the trust, which is analogous to the position under both company law and the administration of estates.
Furthermore, the court has confirmed that a trustee’s ability to charge remuneration based on the trust deed is directly conditional on its solvency. Upon insolvency, either creditor agreement or court protection is required for the charging of ongoing fees. Failure to do so may result in any further fees incurred ranking equal to, or behind, the claims of other creditors.
The Z Trusts litigation is of clear significance for Insureds and Insurers who conduct and write trust business. Importantly, it will have an impact on the ability of former trustees to recover liabilities they have incurred in third party litigation, and it also provides useful guidance to a trustee who is grappling with what is in effect an “insolvent” trust.
Read other items in Offshore Professional Risks Brief - June 2019