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Cite as: Trustees' duty to defend - Look before you leap, when to leap and how high
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Trustees' duty to defend - Look before you leap, when to leap and how high.
by
Alan Sprince
Tutor, University of LiverpoolCopyright © 1995 Alan Sprince. First published in Web Journal of Current Legal Issues in association with Blackstone Press Ltd.
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Summary
Fear of exposure to costs is a dominant influence in concentrating the minds of litigants, actual and potential. Trustees considering entering into or defending proceedings connected with their trust are far from immune to such considerations. For them, however, the dilemma is more complex. For, they will need to reconcile what may be apparently prohibitive costs concerns with any duty to take positive steps in order to protect the trust. The precise nature of one such positive step - the duty to defend proceedings - was examined and refined by Lightman J in the recent case of Alsop Wilkinson (A Firm) v Neary ([1995] 1 All ER 431, Ch D).
Contents
- Introduction
- The facts
- The Beddoes application
- The pre-emptive costs application
- The nature of a trustee's duty to defend proceedings
- Conclusion
Introduction
Before considering the decision in Alsop Wilkinson v Neary , it may help to restate some of the general and interdependent principles that have traditionally influenced trustees when considering entering or defending proceeding.
First, it is trite law that trustees have a general (and somewhat onerous) duty to protect and preserve the trust estate for the benefit of the beneficiaries (Alsop Wilkinson v Neary [1995] 1 All ER 431, per Lightman J at 434). Secondly, the trustees' duty may extend to taking or defending proceedings (Fearns v Young (1804) 10 Ves 184). The latter aspect of this particular element in the trustees' equation was, as will be examined, the subject of intense scrutiny and some redefinition by Lightman J in Alsop Wilkinson v Neary. Thirdly, trustees can expect an indemnity out of the trust property in respect of all their costs and expenses in properly instituting or defending proceedings on behalf of the trust (Jenour v Jenour (1805) 10 Ves 562). Fourthly, in the event of any doubt as to the desirability of the intended proceedings (whether as plaintiff or defendant), trustees are able to apply to the court for directions. This can amount to a wise precaution. For, in making such an application, trustees will protect themselves from adverse costs consequences. If they are given leave to sue or defend in this way by the court, they will be entitled to an indemnity for their costs out of the trust fund. This procedure has become known as a "Beddoes application" (Re Beddoe, Downes v Cottam [1893] 1 Ch 547) .
Following the decision in Alsop Wilkinson v Neary, trustees will need to ensure the strictest compliance with the formalities necessary for the protection afforded by the fourth principle, though they may derive some comfort by the narrower definition of their duties under the second.
The facts
Neary (the first defendant and settlor) was a solicitor. He was a partner and then consultant in the plaintiff firm. Between May 1990 and December 1992 the settlor had misappropriated substantial sums from the plaintiffs' client account. Upon discovering this, the plaintiffs took proceedings against the settlor for recovery of the funds. In April 1994, the plaintiffs obtained judgment in the sum of £1,093,034.99 and an order that the settlor pay further damages to be assessed in relation to the forfeiture of a lease. The plaintiffs estimated that those damages would amount to a further £1m.
Materially, during the period of defalcation in September and December 1990, the settlor had made two settlements. The principal beneficiaries were the settlor, his wife and their issue. There were independent trustees.
In relation to these settlements, the plaintiffs brought a subsequent set of proceedings against the settlor, seeking a declaration that the transfers of the shares to the settlements were void as against the plaintiffs as transactions entered into for the purpose of putting assets beyond the reach of the settlor's creditors, contrary to s.423 of the Insolvency Act 1986. That section empowers the court to set aside transactions involving the transfer of assets for no consideration or at an undervalue if made for the "purpose" of putting them beyond the reach of present or future claimants or prejudicing the interests of such claimants. The plaintiffs joined the trustees as second, third and fourth defendants. Being "gifts" to the trustees, the settlor was unable to identify valuable consideration. However, he contended that he had made the settlements for the purpose of tax and estate planning, thereby denying the purpose required by the section. The existence or otherwise of that purpose was the main issue in the proceedings that came before Lightman J.
Additionally, it was considered relevant that the Inland Revenue had issued a bankruptcy petition against the settlor. If a bankruptcy order was to be made before September 1995 (being five years from the date of the earliest of the settlements), the effect of s.339 of the Insolvency Act 1986 would be to set aside the transfer to the trustees as being transfers to "associates" of the settlor at an undervalue, unless the settlor could establish that he was solvent at the time of, and immediately after, making such transfers. It was considered unlikely that he could do so.
On being made aware of the settlor's intention to contest the Insolvency Act proceedings, the plaintiffs had applied for summary judgment. The settlor obtained legal aid with a view to opposing the application. The settlor's wife called on the trustees to play an active role in the defence of the action and threatened proceedings for breach of trust if they declined to do so.
Faced with this dilemma, itself magnified by their lack of liquid funds, the trustees issued two summonses for directions in the plaintiff's proceedings. First, they applied for directions as to whether they should take any active steps to defend the action in relation to the settlements. This was a Beddoes application, as referred to above. Secondly, they applied for an order that their costs of and incidental to the action be discharged in any event, on an indemnity basis, from the assets of the trust (a "pre-emptive costs application"). The fate that befell these two specific summonses will be considered first, before turning to the more general propositions of law expounded by Lightman J.
The Beddoes application
His Lordship held that the trustees' attempt to acquire the costs protection afforded by such an application was technically flawed and should, thus, fail ([1995] 1 All ER 431, at 436). In what will serve as a warning to trustees in future cases, he referred to two fundamental defects in the trustees' application.
First, the application had been made in the plaintiff's action, rather than, as required, via separate proceedings. Lightman J. confirmed that the rationale behind the requirement for separate proceedings was that it enabled a separate court to view the trustees case in its entirety. In exposing both the strengths and weaknesses of the trustees' case in this way, his lordship said that "it would be quite inappropriate for all this to be revealed to the court which has to try the case or the other parties to the litigation" ([1995] 1 All ER 431, at 436).
The second flaw in the Beddoes application was that it failed to bring all "necessary parties" before the court ([1995] 1 All ER 431, at 436). Neither the settlor's wife nor their issue were represented. Lightman J. contended that an essential basis of the protection afforded to trustees under Beddoes is that the beneficiaries have been given an opportunity to make representations to the court. This requirement was strict. Consequently, it would not be sufficient to argue that it would be obvious what the representation of those beneficiaries would have been nor that they might be incapable of affecting the trustees' decision.
The pre- emptive costs application
The trustees had argued that they would be unable to defend the action unless they obtained an order that their costs be paid out of the trust assets. Therefore, they "tacked" such an application on to the previously mentioned Beddoes application. In the event, the application was similarly and emphatically dismissed by Lightman J.
His Lordship considered the principles relevant to such applications as set out in the judgment of Mary Arden QC (sitting as a deputy High Court judge in the Chancery Division) in Re Biddencare Ltd ([1994] 2 BCLC 160). On the first such principle (the strengths of the case), though anxious not to anticipate the trial of the action, Lightman J. was dubious as to the settlor's chances of refuting the existence of the "purpose" relevant to s.423 of the Insolvency Act. The second of the Biddencare principles requires the court to consider the likely order for costs. Having previously dealt a body blow to the Beddoes application, his Lordship was able to revert to the general rule that, in hostile litigation in a "trust dispute" (considered below), the usual order would be that the trustees would have to bear the risk of their own costs. The third relevant consideration was the justice of the application. Again, Lightman J. was emphatic in asserting that the scales of justice weighed heavily against the settlor - "...justice requires the settlor to be just before he is generous......his assets should be available to his creditors before they are available to himself and his family" ([1995] 1 All ER 431, at 437). Finally on such an application, the court are invited to consider any special circumstances relevant to the issue of potential costs protection. In this connection, his Lordship referred to the potential bankruptcy (via the Inland Revenue's aforementioned petition), the effect of which would be to invalidate the settlements in any event. Thus, he found yet another factor that he considered militated against the overall desirability of a pre-emptive costs order being made.
The nature of a trustee's duty to defend proceedings
The dismissal of both of the trustees' applications was sufficient to put paid to their attempt togging costs protection in the event that they acceded to the settlor's wife's demands that they must join in the active defence of the Insolvency Act proceedings. But what of the settlor's wife's assertions, based on her assumption that the trustees had a duty to defend actively?
Of immense future use for trust lawyers, Lightman J's judgment did not restrict itself to the costs protection aspect of the trustees' dilemma. For, in the lengthiest section of the judgment, his Lordship reconsidered the precise nature of a trustee's obligation to defend proceedings, in isolation from any Beddoes costs protection considerations. In other words, the moral of Lightman J's deliberations on the Beddoes application is that trustees ought to look before they leap and look carefully. The question to which his Lordship further directed his attention was "when to leap and how high?"
Lightman J. categorised three types of dispute in which trustees may be involved. First, he referred to a "trust dispute", defining it as "...a dispute as to the trusts on which [the trustees] hold the subject matter of the settlement" ([1995] 1 All ER 431, at
434). Such a dispute might be friendly, for example concerning the true construction of the trust instrument. Alternatively, as in the instant case, it might be hostile, such as a challenge to the validity of the settlement. In argument made necessary to support the previously referred to submissions as to costs, Counsel for the trustees had relied on the wide general principle laid down by Kekewich J. in Ideal Bedding Company Ltd v Holland ([1907] 2 Ch 157) to the effect that, in the case of a trust dispute, a trustee has a duty to defend the trust. In that case, the plaintiffs had obtained against the trustees an order that the settlement was void as against the plaintiffs and other creditors. Consequent upon the principle referred to, Kekewich held that a trustee who had defended the action was entitled to his costs out of the trust estate.
Lightman J. doubted whether Kekewich J's principle was "...correct or in accordance with modern authority" ([1995] 1 All ER 431, at 435h). Instead, he preferred a narrower and more precise definition of a trustee's duty to defend in a hostile trust dispute and stated that "...in a case where the dispute is between rival claimants to a beneficial interest in the subject matter of the trust, rather the duty of the trustee is to remain neutral and .....offer to submit to the court's directions, leaving it to the rivals to fight their battles" ([1995] 1 All ER 431, at 435). In particular, his Lordship appeared to have sought analogy in the decision in National Anti-Vivisection Society Ltd v Duddington, The Times, 23 November 1989. In that case, the trustee's neutrality in a trust dispute was held to be sacrosanct. The trustee had actively (but unsuccessfully) defended a trust action and was held not entitled to an indemnity for costs out of the trust assets because his acts were such as to prefer one class of beneficiaries over another.
In acting in accordance with the narrower principle, Lightman J. concluded that trustees would be entitled to an indemnity from the trust estate in respect of costs necessarily incurred in, for example, serving a defence agreeing to submit to the court's directions. However, if, instead of contenting themselves with the benign neutrality enshrined in his Lordship's main principle, the trustees took their chances and pursued an active defence of the action (for the purpose of this scenario, without affording themselves the prior protection of a Beddoes application), different results would ensue. In such an event, Lightman J. asserted that, if successful, the trustees might be entitled to costs out of the trust fund on the basis that they had preserved the interests of the beneficiaries under the trust ([1995] 1 All ER 431, at 435, citing Re Holden ex parte The Official Receiver (1887) 20 QBD 43). However, if the trustees failed in their defence, their "reward" for choosing valour as the better part of discretion and neutrality would be a failure to obtain an indemnity in respect of costs (National Anti-Vivisection Society Ltd v Duddington, The Times, 23 November 1989). His Lordship conceded that, even in such a case, there might be exceptional circumstances in which the trustee might be awarded indemnity costs (Bullock v Lloyds Bank Ltd [1954] 3 All ER 726).
It is important to restate that his Lordship's general principle and the scenarios considered in its wake deliberately take no account of the potential success of a Beddoes application, which might serve as an effective costs shield. Therefore, on the material facts of the case, Lightman J., was able to temper the harsh effect of the technical failure of the Beddoes and pre-emptive costs applications. The result of his redefinition of a trustee's duty to defend would enable the trustees to remain passive and resist the settlor's wife's threatened proceedings for breach of trust.
His Lordship's second category of dispute was a "beneficiaries dispute". This was "...a dispute with one or more of the beneficiaries as to the propriety of any action which the trustees have taken or omitted to take" ([1995] 1 All ER 431, at 434). Lightman J. suggested that an action under this head might include an allegation of that the trustees were in breach of trust and that they should be removed. In the event of a beneficiaries dispute such as this, the trustees would have little option but to defend actively. So far as their costs would be concerned, his Lordship cited Hoffmann LJ in McDonald v Horn ((1994) 144 NLJ 1515), in which it was held that such disputes are ordinary hostile litigation in which costs follow the event and do not come out of the trust estate.
The third category was termed a "third party dispute" and defined as "...a dispute with persons, otherwise than in the capacity of beneficiaries, in respect of rights and liabilities, for example, in contract or tort, assumed by the trustees as such in the course of the administration of the trust" ([1995] 1 All ER 431, at 434). In dealing with disputes under this head, Lightman J. was unwilling to lay down a hard and fast rule governing trustees' duty to defend. Instead, his Lordship preferred to restate the trustees' general duties and entitlement to costs as set out in the early part of this note, advising prudent recourse to Beddoes in cases of doubt.
Conclusion
Lightman J's categorisation of disputes and refinement of the principles applicable to the trustee's duty to defend proceedings should be of benefit to trustees in that they deal also with how the trustee might be obliged to behave where there might be a duty to defend proceedings. Bearing in mind the reference to the costs anxiety that opened this note, it is submitted that the automatic "call to arms" suggested by a simple "duty to defend" has long since merited more precise and restricted definition.
In particular, in narrowing the precise nature of the trustee's duty to defend proceedings in a hostile "trust dispute", this may help such trustees to resist pressure from one party to play amore active role. In this way, it may be easier for trustees now to remain passive and reconcile the costs dilemma and the other elements of the equation referred to at the start of this note, without necessarily having to resort to a Beddoes application.
However, it is suggested that trustees may still prefer to rely on the safety of a successful Beddoes application protecting them in costs, rather than Lightman J's principle protecting them in breach of trust proceedings. In the light of this, it is tempting to suggest that the Beddoes principle itself may be the subject of future judicial intervention if trustees are unwilling to rely on Lightman J's principle even in a case where it would obviously afford them protection. Nevertheless, if Beddoes is to remain the safe port favoured by trustees, then they should navigate it with the utmost care and ensure that the key technical requirements referred to by Lightman J. are satisfied.