As the Trustee of a Trust, there may be times when you face litigation from the beneficiaries, or your co-trustees.
Litigation is often a pricey exercise, even if you are the successful party, so naturally as a trustee you may be thinking, “I’m only facing this litigation because of my position as a Trustee, surely the Trust will therefore fund my legal fees?”.
As a starting point, section 81 of the new Trusts Act 2019 provides that a Trustee may be indemnified out of the Trust property for any expense incurred when acting reasonably on behalf of the Trust. Additionally, the Act states that the operation of that indemnity is to be governed by the rules of common law and equity as they relate to Trusts.
However, the common law (law made by the Courts) muddies the position significantly, and Trustees should not assume that they will receive an indemnity out of the Trust for all litigation. Trustees seeking an indemnity out of the Trust assets for legal fees will need to make a so-called Beddoe Application. A Beddoe Application is an application to the Court by Trustees seeking directions for how to act. In this case, the Beddoe Application would be dealing with whether the Trustees could correctly use the Trust assets to indemnify themselves for legal fees prior to the proceedings.
These principles will also apply to executors of an estate, who are effectively Trustees of that estate.
Trustees can traditionally be indemnified from the Trust fund if they can meet three requirements:
- Show that the cost arose from an act within the scope of the Trustee’s duties;
- Was incurred in carrying out an obligation of the Trustee; and
- If in the circumstances the expense was reasonable.
Further, the Court of Appeal in Pratley v Courteney considered that litigation against Trustees generally falls into one of three categories:
- Proceedings brought to seek the guidance of the Court on aspects of Trust administration or construction. For example, proceedings in relation to a dispute between Trustees as to how Trust property should be invested;
- Proceedings brought by third parties against the Trust. For example, proceedings brought by a creditor of the Trust to enforce payment;
- Proceedings brought by beneficiaries disputing the correctness of actions taken or not taken by Trustees. For example, proceeding brought by beneficiaries alleging that a Trustee took Trust property for their own benefit (this is often called “Hostile Litigation”).
Courts have considered as a general rule that Trustees can make (and will often be granted) a Beddoe Application to seek the directions of the Court to use the Trust funds to defend a claim made under the first two categories. In the case of the third category, Hostile Litigation, where the Trustees are effectively defending the correctness of their own actions, Courts have considered it is not appropriate for the Trustees to have their legal fees indemnified by the Trust until the Court establishes the correctness of the Trustee’s actions.
If, in the Hostile Litigation, Trustees’ actions are upheld by the Court, generally speaking the High Court Rules provide that the unsuccessful parties should pay the winning parties’ costs; any shortfall will likely be made up from the Trust assets. On the other hand, if the Trustee’s actions are not upheld, the Trustees will not be entitled to an indemnity from the Trust assets, and will be personally liable.
However, this analysis can only occur after the fact; until the conclusion of proceedings a Trustee defending the correctness of their conduct will have to wear the cost of their legal fees.
In the case of Pratley an executor was defending proceedings from a creditor of the estate (the son of the testator, who was also a beneficiary of the estate) who had funded the palliative care of the deceased during his final days. The Court considered that this claim fell into the second category, as although the individual bringing proceedings against the executor was a beneficiary, the claim was brought in the context of a creditor-debtor relationship.
A more recent High Court decision, Mclaughlin v Mclaughlin, involved the Trustees defending proceedings brought on a variety of grounds, including; for the removal and replacement of Trustees on the basis of mismanagement and breach of fiduciary duties, seeking direction from the Court as to the investment and distribution of Trust property, and alleging breach of Trust and fiduciary duty by the Trustees.
The Trustees made a Beddoe Application seeking their legal fees to be indemnified out of the Trust assets for all the proceedings. The Court held that the only claim for which the Trustees were entitled to be indemnified from the Trust assets in respect of legal fees incurred were the proceedings seeking directions as to the investment of Trust property.
The Court justified this on the basis that Beddoe Applications should only be granted where granting that application was in the best interests of the Trust. The Court considered that indemnifying the legal fees of the Trustees where breach of trust was the issue was unlikely to be in the best interests of the Trust until the Trustees actions’ were upheld (i.e. the allegations of a breach of trust were found to be unsubstantiated).
Mclaughlin has since been followed in another High Court decision, In Re McCallum. In McCallum, the executors of an estate were defending a variety of claims including breach of trust, knowing receipt of estate assets, and an application to remove the executors. The Court further considered that factors contributing to whether the Beddoe Application was in the best interests of the estate included:
- The nature of the claim;
- The nature of the Trust; and
- The substantive merits of the claim.
The Court granted the Beddoe Application fully only in respect of the proceedings relating to breach of moral duty (a claim against the estate that the applicant had not been adequately provided for in the will), and in respect of the application to have the executors removed (but only because the application laid down no clear legal or factual basis justifying the removal of the executors).
Before taking on the responsibility of becoming a Trustee, or before making decisions in your capacity as a Trustee, it is important to understand the full implications of these decisions. As discussed above, a Trustee who needs to defend themselves from litigation because of their role as Trustee will not necessarily be able to rely on the Trust assets to provide an indemnity for their legal fees.
Haigh Lyon can provide further information and advice to assist you in making decisions that will reduce the risk of facing so-called Hostile Litigation, and the risk of being saddled with legal fees as a result of this.