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How creditors can recover unpaid debts from trustees

18 Mar 2022

| Author: Andrew Steele

Section 86 of the Trusts Act 2019 is entitled Creditor’s limited claim to trust property through trustee’s indemnity and gives creditors an important and powerful new tool to recover unpaid debts and liabilities incurred by trustees.

The first thing to note is that the section applies in either of two instances:

  • where a trustee incurs an expense or a liability to a creditor and the trustee and has a right to be indemnified from the trust property (s 86(1)(a)); and
  • where a trustee incurs an expense or a liability but is not entitled to be indemnified or fully indemnified from the trust property (s 86(1)(b)).
  • The second circumstance is itself circumscribed by three additional qualifications that, in connection with the particular ‘expense or liability’:
  • the creditor has given value (s 86(1)(b)(i)); and
  • the trust has received a benefit from the transaction between the trustee and the creditor (s 86(1)(b)(ii)); and
  • the creditor has acted in good faith (s 86(1)(b)(iii)).

So, not all trustee-debtor expenses or liabilities fall within the section. For example, a trustee enters into a sale and purchase agreement to buy a property but defaults on settlement, resulting in the vendor incurring a loss on re-sale.

The vendor may obtain judgment in damages against the trustee, but that liability will not fall within s 86 unless the trustee has a right of indemnity for the liability – an unlikely prospect.

If the trustee entered the purchase in breach of trust, so losing his/her right to an indemnity, the creditor’s ability to use s 86 depends on ticking off each of the three requirements of s 86(1)(b).

In the above example, the unfortunate creditor does not get past the first hurdle of ‘giving value’ in s 86(1)(b)(i) but in any event could not overcome the second hurdle as the trust received no benefit from the transaction as required in s 86(1)(b)(ii).

Of course, the trustee’s liability is personal (now codified in s 81(1)), but that is not much use if the trustee is impecunious or a $100 trustee company.

Where the ‘trust’ expense or liability involves the giving of value by the creditor and receipt of benefit by the trust, then the creditor (assuming he/she acted in good faith per s 86(3) – that is, had no reason to apprehend that the indemnity was imperiled) ends up in a similar position to the trustee-creditor in s 86(1)(a) – that is, where the debtor-trustee never lost or impaired their right of an indemnity from the trust property.

It seems fair enough that a trust-creditor should have rights against a trust’s property, given that they transferred value to enhance that property. Note that the three conditions in s 86(1)(b) echo the principles of unjust enrichment.

The fortunate creditor who falls within s 86(1) enjoys the benefit supplied by s 86(2), namely, the creditor becomes entitled to satisfy his/her claim by way of an indemnity directly against the trust property “… as if the creditor were in the position of a trustee who has a right to be indemnified from the trust property”.

Common law

It is apposite to reflect on the pre-Act common law position. As a general rule, a trustee-creditor had no direct claim against trust property. Instead, they were obliged to enforce their claim against the trustee personally who, in turn, indemnified themselves from the trust property to discharge the creditor’s claim – assuming the right of indemnity had not been impaired in some way.

An exception to the general rule existed when it was impossible to enforce the liability against the trustee personally – for instance, where the trustee has absconded, died or become insolvent.

In that event, the creditor could subrogate into a trustee’s right of indemnity (or step into the shoes of the trustee). Lewin on Trusts (18th edn para 21-10 paragraph 21.38) puts it this way:

  • Although unsecured creditors and other claimants do not have a direct claim against the trust property in respect to unsecured liabilities incurred by trustees in the administration of the trust, and cannot levy execution upon the trust property, they may by subrogation have a right to stand in the place of the trustee and enforce their liabilities against the trust property to the extent that the trustee would be so entitled. The trustee’s right of indemnity is an asset of the trust, and the trustee’s creditors are entitled by subrogation to reach this asset and so enforce their claims against the trust property.

Under the Trusts Act 2019, the common law pre-condition to subrogation, that the trustee was not available to have the expense of liability claimed against them, has been done away with.

And the unfairness in denying a creditor subrogation simply because a trustee happened to have lost/impaired their right of indemnity has been mitigated where the trust still received benefit from the creditor (in this latter case, the creditor’s claim is limited to the value of the benefit received by the trust per s 86(4)). These must be laudable changes to the law.

Enforcing the liability

Turning to the advantageous position of the trust-creditor for whom s 86 applies, they have a powerful new tool in their arsenal in terms of enforcing their expense or liability. This includes that:

  • the indemnity is proprietary in nature, such that it vests in the trustee (and now qualifying trust-creditor) a beneficial ownership interest in the trust property which has the characteristic of an equitable charge or equitable lien over that property;
  • because the interest is proprietary, it arguably constitutes a caveatable interest;
  • the indemnity affects all trust property, not just the particular property to which the expense or liability may relate;
  • the claim must be paid (together with interest calculated under the Interest on Money Claims Act 2016 (s 86(4)(a)) in priority over any payment to a beneficiary, unless the court orders otherwise (s 86(4)(b)); and
  • the claim is unaffected by the fact that the trustee who incurred the debt or expenses is no longer a trustee (s 86(5)).

At a practical level, a trust-creditor and a trustee are in starkly different positions in terms of what they can do with their right of indemnity.

As legal owner of the trust property, the trustee is the account-holder of the trust bank account, so he or she simply applies the trust property (ie, writes out a trust account cheque or electronically transfers the money) to discharge the expense or liability. If the only property is real property, then as registered proprietor the trustee may sell the property to meet the indemnity claim.

By contrast, the trust-creditor is unable to take such direct action. They are obliged to enforce their claim through the courts by seeking a declaration of their rights and applying for orders compelling application of the trust property, which may include orders to sell.

Andrew Steele is an Auckland barrister at Princes Chambers

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