Trustee Exoneration Clauses and Pleading Dishonesty

In this article, we consider the Court of Appeal’s judgment in Sofer v SwissIndependent Trustees SA [2020] EWCA CIV 699


10 November 2020

In the latest update in our series of topical issues for trustees, our colleagues in our Dispute Resolution team focus on the Court of Appeal’s judgment in Sofer v SwissIndependent Trustees SA, which confirms that it is possible to plead a sustainable case of dishonesty against a trustee, based on inference and that such claims will not be liable to strike out.

The Court of Appeal concluded that strike out will not be available if it can be inferred from the facts that the trustee deliberately or recklessly acted in breach of trust and against the interests of the beneficiaries as a whole. Trustees who act properly in the best interests of their beneficiaries ought to have nothing to fear. However, the case highlights that the best possible defence to such allegations is ensuring a comprehensive paper trail of documents which demonstrate that the trustee acted with a reasonable belief that its actions were taken in the interests of the beneficiaries of the trust. Trustees should consider reviewing their record keeping practices in light of this decision.

Scope of exoneration clauses under English law

Following the Court of Appeal decision in Armitage v Nurse, the position in English law is that exoneration clauses can validly exempt trustees from liability for all breaches of trust except fraud. In order to be valid, exoneration clauses must be clear and unambiguous and their existence and effect should have been drawn to the attention of the settlor prior to the creation of the trust.

The precise scope of the conduct exempted by an exoneration clause will depend upon its terms. However, they are generally worded by reference to fraud, dishonesty and/or wilful default (or similar terms) on the part of the individual trustee sought to be made liable.

Sofer v SwissIndependent Trustees SA

Background

This case concerns the Defendant’s trusteeship of the Puyol Trust. The Puyol Trust was one of three linked trusts settled by the Claimant’s father in July 2006 and whilst discretionary in nature, it was the settlor’s intention that the Puyol Trust would benefit the Claimant.

In August 2006, shortly after the Trust was created, the settlor was added to the class of discretionary beneficiaries and the Trustee started making payments to him from the Trust.

The key terms of the Trust were:

  • Clause D3(3) - The Trustee may: 'lend any money forming the whole or any part of the assets of this Trust to any person who may for the time being be a Beneficiary upon such terms as to repayment and interest or interest free as the Trustees may in their absolute discretion think fit'.
  • Clause M1(1) - The Trustee 'must not pay convey or transfer any part of the corpus of the Trust to any Beneficiary for any purpose' prior to the date of death of the settlor.
  • Exoneration Clause - The Trustee shall not be liable or responsible for any loss or damage: 'except where the same shall be proved to have been caused by acts done or omissions made in personal conscious and fraudulent bad faith by the Trustee charged to be so liable'.

Over the course of 10 years between 2006 and 2016, the Trustee made multiple payments to the settlor totalling approximately $61.5m from the three trusts, of which nearly $19.2m was booked to Puyol. Whilst the Trustee recorded these payments as loans, no provision was made for security, interest or repayment. 

The Claimant’s position is that the payments made by the Trustee were not loans (permitted under Clause D3(3)), but gifts which (pursuant to Clause M1(1)) the Trustee had no power to make.

The particulars relied upon by the Claimant in Sofer can be summarised as:

  • The Trustee knew that it had a power to lend money but not to make gifts.
  • The Trustee decided to gift very substantial sums of money to the settlor over a 10 year period without ever asking why he needed the money, whether he was able to repay it and without making any enquiries into his or the other beneficiaries’ financial positions. The gifts were also made in circumstances where none of the usual common place provisions relating to the lending of funds (i.e. interest, security or repayment) were ever discussed.
  • The Trustee then disguised the gifts as loans in the Trust accounts in an attempt to conceal them from the other beneficiaries of the Trust and the Australian authorities.

By way of example, one of the documents supporting the Claimant’s case in this regard is an email from the general manager of the Trustee to the settlor which stated: 'Payments out of the structure to or for the benefit of Mr Sofer cannot be treated as distributions to him, in accordance with the provisions of the three trusts and so are treated as loans, now borne equally by three trusts and ultimately owing to them by Mr Sofer (or his estate).'

The 2020 decision of the Court of Appeal considered the preliminary question of whether or not to uphold the High Court’s decision to strike out the claim.

The question for the Court of Appeal was therefore whether the Claimant’s claim, as formulated in a draft amended pleading, assuming the allegations to be true, was sufficient to amount to a valid cause of action, taking into account the exoneration clause (i.e. whether it was sufficient to overcome the threshold imposed by the exoneration clause).

Requirements for a Pleading of Dishonesty

Given the terms of the exoneration clause, it was common ground between the parties that, in order to succeed with his claim, the Claimant would be required to show that the Defendant had committed a dishonest breach of trust, the test for which was stated in Fattal v Walbrook:

a) 'A deliberate breach of trust;

b) Committed by a professional trustee:

i. Who knows that the deliberate breach is contrary to the interests of the beneficiaries; or

ii. Who is recklessly indifferent whether the deliberate breach is contrary to their interests or not; or

iii. Whose belief that the deliberate breach is not contrary to the interests of the beneficiaries is so unreasonable that, by any objective standard, no reasonable professional trustee could have thought that what he did or agreed to do was for the benefit of the beneficiaries.'

Limb (a) - Deliberate Breach of Trust

The judge at first instance held that, in order to satisfy the first limb of the test, it was necessary to allege that the defendant knew it was in breach of trust. It was not sufficient for a trustee to have been recklessly indifferent as to whether it was a breach or not.

The Court of Appeal noted that this point remained in dispute between the parties but did not consider it necessary for it to decide the point. The question therefore remains as to whether reckless indifference on the part of a trustee will be sufficient to overcome the first limb of the test.

Limb (b) - Knowledge or Belief as to whether it is in the Best Interests of the Beneficiaries

In order to overcome the second limb of the test, a claimant must demonstrate that the defendant deliberately acted in breach of trust with one of the three states of mind identified in (i) to (iii) above.

If a trustee knowingly commits a breach of trust but does so with a genuine belief that what they were doing was for the benefit of the beneficiaries (and that belief is not so unreasonable that no professional trustee could have believed it), the trustee’s conduct will not be sufficient to be ‘dishonest’.

Application of the test

Applying the Fattal v Walbrook test to the Claimant’s particulars, the Court of Appeal concluded that the facts pleaded by the Claimant were sufficient to amount to a valid case of dishonesty against the Trustee.

In reaching this conclusion, the Court of Appeal accepted that the Claimant’s case was one of inference and that the Court was required to consider the totality of his particulars as supporting not only his case that the Trustee had committed deliberate breaches of trust (limb (a) of the test) but also that the Trustee had done so with one of the states of mind identified in limb (b). Accordingly, the facts pleaded by the Claimant could serve as primary facts from which the Court could infer that the Trustee had consciously or recklessly failed to take into account the interests of the beneficiaries as a whole.

In considering limb (b) of the Fattal v Walbrook test, the Court of Appeal also helpfully clarified that a claim for dishonesty would not be precluded by the fact that the recipient of the payments was himself a beneficiary under the Trusts. That the payments were in the interests of only one of the beneficiaries did not absolve the Trustee from considering the position of the other beneficiaries.

Implications 

The Court of Appeal’s judgment in Sofer acknowledged that the Claimant’s case was one of inference and followed previous authority to enable the Claimant to rely on the 'totality of the particulars as permitting that inference to be drawn'.

Exoneration clauses can provide a comforting safety net against claims by beneficiaries but the Court of Appeal has made it clear that strike out will not be available if it can be inferred from the facts that the trustee deliberately or recklessly acted in breach of trust and against the interests of the beneficiaries as a whole.

Whilst this is not new law, the Court of Appeal’s decision may worry trustees. Trustees who act properly in the best interests of their beneficiaries ought to have nothing to fear, but perhaps even the best trustees might find that, in some situations, cases based on inference can be made against them. 

Those cases will no doubt be ones where the documentary evidence, to the extent it exists, is not just on the fence, but, taken together with other matters, supports an inferential case which is capable of surviving the terms of the relevant exoneration clause. It must therefore be in the interests of trustees to consider whether they should be reviewing their record keeping practices in light of this decision. The best possible defence to such allegations must be a comprehensive paper trail of documents which demonstrate that the trustee acted with a reasonable belief that its actions were taken in the interests of the beneficiaries of the trust.

On the other hand, the Court of Appeal’s approach will give comfort to beneficiaries feeling stonewalled by trustees they consider to be acting improperly. The survival of their claims to disclosure and exchange of witness evidence may enable them to access the evidence they need to prove a dishonest breach of trust on the balance of probabilities and hold the trustees to account. 

If you would like further guidance on how to approach trustee exoneration clauses, please contact Kevin Kennedy or Caroline Emslie in our trust disputes team.

This article was written by Caroline Emslie.

Key contact

Kevin Kennedy

Kevin Kennedy Partner

  • Agricultural Disputes
  • Trust and Probate Disputes
  • Estates and Land

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