Contents

Chapter 5
Trustees’ duties

Avoiding the consequences of a breach of trust

RECOMMENDATION

R4(1) The new Trusts Act should provide that:
(a) the terms of a trust must not limit or exclude a trustee’s liability for a breach of trust or grant the trustee an indemnity against the trust property in respect of liability for a breach of trust arising from the trustee’s own dishonesty, wilful misconduct or gross negligence;  
(b) a clause that purports to have the effect stated in (a) is invalid (and is effectively severed from the terms of the trust), provided it is found that the settlor’s overall intention was in fact to create a trust as opposed to some other type of relationship;  
(c) any paid trust adviser or trust drafter who causes a settlor to include a clause in the terms of the trust that has the effect of limiting or excluding liability for negligence, or of granting an indemnity against the trust property in respect of liability for negligence, must before the creation of the trust take such steps as are reasonable to ensure that the settlor is aware of the meaning and effect of the clause; and
(d) if a person who is paid to advise on the terms of a trust or the drafting of a trust deed fails to meet the obligation in (c) and is a trustee of the trust, the exemption or indemnity clause will have no effect in respect of that trustee.  
(2) Professional regulatory bodies relevant to trusts should provide guidance for their members as to what steps would be reasonable to ensure that a settlor is made aware of the meaning and effect of any trustee exemption clauses.
(3) The new Act should re-enact an equivalent of section 73 of the Trustee Act 1956, which gives the court the power to relieve a trustee wholly or in part from personal liability for a breach of trust if the trustee acted honestly and reasonably, and ought fairly to be excused.

Exemption and indemnity clauses

5.22If legislation is to assist people in clearly understanding the extent of trustees’ obligations, it needs to address potential modifications to the consequences of a breach of trust. By limiting or avoiding liability for a breach of trust or being indemnified against such liability, the importance of the duties can be undermined. Exemption clauses are not currently regulated by statute in New Zealand.

5.23We recommend a simpler statement of the law regarding clauses exempting trustees from liability and indemnifying trustees for breach of trust than that proposed earlier in the Preferred Approach Paper.172 Our recommendation is based on the law established by the English Court of Appeal in Armitage v Nurse that a trust deed can exclude trustees’ liability for a breach of trust arising from conduct that is not fraud.173

5.24The recommendation goes further by clarifying that exemption clauses cannot be used to exempt liability for gross negligence. It applies one rule regarding valid exemption and indemnity clauses across every type of breach of trust, instead of attempting to limit their use to a greater degree when they apply to mandatory duties.

5.25We considered including a provision that outlines circumstances in which the trustee can be indemnified or exempted from liability to a greater extent than is allowed by R4(1)(a) and (b), such as where they are directed to by the court or given permission by the beneficiaries. However, we do not think such a provision is necessary as these exceptions will apply regardless.

The case for reform of exemption and indemnity clausesTop

5.26Exemption and indemnity clauses enable trustees to manage their risks and provide protection for trustees from litigious beneficiaries. They can make trusteeship more attractive to a trustee and mean that insurance is more likely to be available to trustees. However, beneficiaries are vulnerable to the consequences of such clauses, because they will potentially lose out if the value of trust assets is reduced by trustees not conducting themselves in a way that trustees should. Where an exemption or indemnity clause applies, beneficiaries will probably have no effective means of redress for loss to the trust property. While settlors can be seen as representing the interests of beneficiaries when a trust is settled and the clause is agreed to, it seems that many settlors are not actually aware that beneficiaries might lose out as a result of an exemption clause.

5.27We are also concerned that allowing broad exemption and indemnity clauses may undermine the core trust concept, which requires that a trustee has obligations towards beneficiaries in respect of the trust property. Exemption and indemnity clauses do not remove the obligations from trustees, but they do remove the most significant consequences of a breach and leave beneficiaries without the most effective form of redress. While there are some other possible consequences of a breach of trust, such as the removal of the trustee, it can be argued that the duties of trustees are effectively empty if the trustee is exempted from liability for compensation or the trustee is indemnified from the trust property for the loss.

The types of conduct for which liability cannot be excludedTop

5.28We propose that legislation should clarify the types of conduct for which liability cannot be excluded by drawing a line between the type of conduct leading to breach of trust where liability should be able to be excluded and the type of conduct where it should not. We propose that this line should be drawn at gross negligence, so that exemption clauses excluding liability for negligent breaches of trust would be permissible but not those excluding liability for grossly negligent breaches (see draft clauses 27 and 28).

5.29In the Preferred Approach Paper we proposed to set this line at recklessness as a way of avoiding potential problems with defining gross negligence.174 Many submitters were in favour of this, although some submitters did prefer gross negligence. We now consider that there are fewer disadvantages with using a standard of gross negligence. Gross negligence has been used in a growing number of New Zealand statutes over the last 10 years.175 Countries such as Jersey and Guernsey have enacted statutory provisions to address exemption and indemnity clauses in trusts and have used the gross negligence standard.176 In February 2013, the Hong Kong Legislative Council introduced the Trust Law (Amendment) Bill, which proposes to regulate trustee exemption and indemnity clauses, and uses gross negligence to delineate the conduct for which liability cannot be exempted.177

5.30We received significant feedback on the proposal in the Preferred Approach Paper that exemption clauses should not be used to exclude liability for a negligent breach of a mandatory duty. There were concerns that this was a considerable restriction on the use of exemption clauses and that it would have the effect of discouraging professionals from acting as trustees. After reconsideration we were convinced that there is little sense in making distinctions and rules based on negligent breaches of mandatory duties as this is unlikely to arise in practice.

5.31It could be argued that any restriction on the types of exemption clauses that may be relied upon is an undue limitation on a settlor’s freedom. We would contend that it is a reasonable consequence of the choice of the trust form that the trustee of the trust property be held to certain standards and face consequences for breaching those standards in sufficiently serious ways. The extension of the restriction on exemption clauses to include gross negligence reinforces the fact that trustee obligations are real.

Greater restrictions for professional trusteesTop

5.32We have considered whether the same limits should apply to non-professional trustees as would apply to professional trustees. The concern that exemption and indemnity clauses unfairly limit trustee responsibility is perhaps more acute in relation to independent trustees who are employed and paid to carry out this role. However, many trustees in New Zealand are not paid professional trustees. Allowing exemption and indemnity clauses to apply more broadly to lay trustees than professional trustees would leave open the concern that the duties of trustees are being undermined by the reduced consequences for a breach of trust. Having one standard for conduct that cannot be excluded, as opposed to the alternative of having differentiated rules, is simpler and easier to understand. The higher standard in what is expected of professional trustees will arise through the court’s interpretation of what constitutes fraud or gross negligence for professional trustees as opposed to lay trustees, and through the standard of care in the exercise of powers.

Requirement for settlors to be informedTop

5.33 Some settlors of trusts are unaware of the practical effect of the broad exemption and indemnity clauses that are included in many trust deeds. These clauses can be a key part of the arrangement negotiated with paid professional trustees for their services as trustees. Settlors may not realise that trustees will not be held liable for breaching the trust.

5.34Requiring a trust drafter or adviser to inform a settlor of the meaning and effect of an exemption clause addresses this issue (see draft clause 31 below). Settlors would be given an informed choice about the effect of including the clause at the time of settlement. This reform would not affect beneficiaries directly, but if settlors are better informed about exemption clauses they may choose not to include such broad clauses in their deeds or at least will have a more accurate understanding of the trust arrangement. It is not intended that settlors would necessarily be required to obtain independent legal advice. It is likely that a practice would develop where settlors would be required to sign a form certifying that they have been advised about the effect of exemption and indemnity clauses, which would constitute evidence that the advice was given. The advice would only be required to be given at the time that the settlor creates the trust. The recommendation may result in some additional time and cost in the creation of a trust, but we consider it should be an essential part of the process.

5.35We recommend that the professional bodies for lawyers, accountants and financial advisers should develop guidance, perhaps in their codes of conduct, to help ensure that their members develop appropriate practices. A breach of the statutory obligation to explain exemption clauses would likely result in disciplinary sanctions by the relevant regulatory body.178

Application to existing trustsTop

5.36The provisions recommended in R4(1)(a) and (b), restricting certain exemption and indemnity clauses, should apply to all trusts settled after the date of enactment of this Act and all trusts settled before enactment after the lapse of two years. These recommendations are an advancement on the law as it is understood by most people at the moment because of the prohibition on the use of exemption and indemnity clauses for gross negligence. While we do not consider that it is too onerous for these recommendations to apply to all trusts, existing trustees should be given the opportunity to reconsider their position.

5.37The provisions recommended in R4(1)(c) and (d), regarding the obligation to inform a settlor of the effect of an exemption or indemnity clause, should apply only to trusts settled after the enactment of this Act. They should also apply to new terms of existing trusts inserted after the enactment of this Act. These relate to what must occur when a new trust is settled so are not relevant to existing trusts. R4(3) should apply to all trusts regardless of when they were settled as it is a continuation of the existing section 73 of the Trustee Act. Section 73 may well be a useful tool for the courts in managing any difficulties arising from the transition to a new Trusts Act, as the courts will be able to consider relieving liability if the change to the law results in unfairness.

172At P8.
173Armitage v Nurse, above n 166.
174Preferred Approach Paper, above n 164, at [3.55]−[3.59].
175For instance, Corrections Act 2004, s197E; Private Security Personnel and Private Investigators Act 2010, ss 80 and 83; Canterbury Earthquake Recovery Act 2011, s 83; Retirement Villages Act 2003, s 40; and Weathertight Homes Resolution Services Act 2006, s 125F.
176Trusts (Jersey) Law 1984, s 30(10) and Trusts (Guernsey) Law 2007, s 39(7) and (8).
177Trust Law (Amendment) Bill 2013, cl 27. The Hong Kong Financial Services and the Treasury Bureau had earlier proposed that a recklessness standard be used (Hong Kong Financial Services and the Treasury Bureau Detailed Legislative Proposals on Trust Law Reform (Consultation Paper, March 2012) at annex H, 41W).
178This is similar to the approach taken by the Law Commission for England and Wales in Trustee Exemption Clauses (Law Com No 301, 2006) at 69.