Under Australian trust law, a trustee bears unlimited personal liability for all debts, liabilities and expenses incurred by a trust. In commercial trusts, such debts and liabilities may run to many millions of dollars and even billions of dollars.
Thus, trustees usually seek to limit their personal liability through a limitation of liability clause in the documents which they execute in their capacity as a trustee for a trust. However, across the Australian market, there is no uniformity in limitation of liability clauses, which often leads to frustration for both trustees and parties who enter into agreements with trustees.
The legal framework within which these clauses operate
Because a trust is not a legal entity with a separate legal personality, all debts, liabilities and expenses incurred by a trustee are personal. But a trustee may be indemnified under two different rights:
- a reimbursement right (the trustee’s right to replenish its own assets where it has discharged trust liabilities personally); and
- an exoneration right (the trustee’s power to apply trust assets directly to discharge trust liabilities).
Both rights are, however, subject to certain conditions:
- the liability to be indemnified must be incurred by the trustee in accordance with its duties; and
- a trustee’s right of indemnity is subject to its first making good any loss or damage caused to the trust fund by previous breaches of trust (“clear accounts” rule).
Both rights are commonly conflated, because they save trustees from the consequences of incurring trust liabilities. But the former is only to the trustee’s personal benefit, while the latter can be seen as simply part of the general power of the trustee to apply trust assets for trust purposes.
Moreover, these rights are backed by a proprietary right of the trustee to retain trust assets and use them to satisfy those rights. Consequently, trust creditors cannot obtain a writ of execution against trust assets.
Creditors may take steps to mitigate the risk that the first condition above is not satisfied, but there is little they can do to protect themselves against the risk inherent in the clear accounts rule. Indeed, the misconduct of the trustee may be unknown to the creditor and potentially even unknowable.
Subject to a well drafted limitation of liability clause, the trustee continues to be personally liable for trust liabilities whether or not the trust assets are sufficient to discharge them, even if that renders the trustee insolvent.
The parties’ overall objectives
Trustees generally want to limit their exposure for trust liabilities to the trust assets so that their solvency is not at risk. This is particularly important where a trustee is an external trustee, like members of the One Investment Group, that is appointed as a trustee for many trusts as opposed to a special purpose company with limited assets. Unsecured trust creditors may be asked by a trustee to look to the credit of the underlying economic entity (e.g. the trust estate or fund). If they are satisfied with that credit they are usually prepared to limit the trustee’s liability (or their own recourse) to the trust fund.
However, counterparties may wish to protect themselves from the possibility that access to the trust assets may be lost or impaired due to trustee misconduct, in which case they will want to look to the trustee and its own assets. This can be achieved by a correctly drafted limitation of liability clause in a contract.
The operation of trustee limitation of liability clauses
A limitation of liability clause seeks to achieve an agreed allocation of risk between the trustee and a counterparty entering into an agreement with the trustee in its capacity as a trustee of a trust. Limitation of liability clauses must be drafted with care because the courts will approach them with caution, as they operate to limit or reduce the extent of the legal remedies which the counterparty would otherwise have against the trustee.
Limitation of liability clauses were historically very short and simple, however limitation of liability clauses have become increasingly complex. Many current limitation of liability clauses use inaccurate technical concepts and some appear to misconstrue the law. Indeed, in the typical commercial transaction, there is neither the time nor the inclination to put them to rigorous analysis, particularly when there is much else to be negotiated.
The key elements required in a trustee limitation of liability clause
A professional trustee, or corporate trustee, such as members of the One Investment Group, typically have a very low risk appetite for taking personally liability for a trust liability. This is in order to ensure that the liabilities of any given trust are not able to place such trustees at risk potentially impacting other trusts.
An appropriate limitation of liability clause should address such issues in a manner that is consistent with commercial understandings and risk allocation decisions which are common in the Australian market.
A trustee limitation of liability clause:
- typically states that the trustee enters into the agreement as trustee and repeats the description and capacity in the list of the parties to the agreement;
- extends the concept to pre- and post-contractual conduct and also to the transactions carried out in connection with the document. But the trustee is and remains personally liable even though the clause limits liability and recourse to the extent of the trust assets;
- limits liability to the extent of the trust assets, and more particularly to the extent that a liability “can be satisfied out of the assets of the Trust”. It should be noted that there is no need for the limitation of liability clause to refer to the right of indemnity. Indeed, the words are sufficiently broad to cover assets available under the right of indemnity but also deal with other means of access which do not necessarily rely on the indemnity. The expression “can be satisfied” is deliberately chosen to capture both a legal and a practical ability to apply trust assets to discharge trust liabilities. There is an option in this paragraph to treat as trust assets, for the purposes of the clause, amounts actually received by the trustee to pay a specific liability so that the trustee would be required to hand such amounts over in satisfaction of that liability. Thus, if the trustee receives an amount to satisfy a specific liability, it ought to be required to pay it over and not simply to sit on it as a windfall, or count it as its own funds or apply it for other purposes;
- normally reinforces the principles above in listing the rights and remedies that can be exercised in respect of trust assets before listing actions that are barred. Some clauses do the reverse, but in substance there is no difference;
- typically preserves the right for creditors to participate in the liquidation or administration of a trustee for the liabilities so long as their claim is limited to trust assets. Further, it contains the right for creditors to seek to have the trustee placed in any form of insolvency administration;
- usually permits a counterparty to bring proceedings seeking orders with respect to trust assets. It would allow the appointment of a court-appointed receiver over trust assets, which may be a necessary remedy to protect trust assets from breaches of trust;
- allows the counterparty to exercise the rights bargained for, i.e. its security and contractual rights. Thus, the permission for a creditor to “enforce its security” would include the appointment of a receiver or receiver and manager in relation to some or all of the secured property or the secured creditor taking possession of some or all of the secured property;
- allows the counterparty to take proceedings which do not disturb the limitation on liability. Often there is a ban in on bringing proceedings against the trustee, but there can be express permission to bring proceedings which are directed only at trust assets, or other proceedings which would be subject to the limitation or would not offend it;
- describes the circumstances in which a trustee’s personal assets may be placed at risk and pursued in satisfaction of a liability that might otherwise be a trust liability. This exception is not absolute, but operates only to the extent that the relevant liability has been adversely affected;
- might address the situation where the trustee’s right of access to the trust assets is lost or reduced because of some failure on the trustee’s part. This can occur where the trustee either acts beyond power or acts within power “improperly” (e.g. breach of duty). Thus, the reference to acting “beyond power or improperly in relation to the Trust” is wide enough to encompass all circumstances in which the right of indemnity will be impaired; and
- might be restricted where the parties may agree that it is appropriate for the limitation not to apply in respect of the resulting loss or damages if certain core representations/warranties or undertakings are breached.
Members of the One Investment Group act as Corporate Trustee for in excess of 250 Funds with a wide variety of underlying asset classes including fund of funds, private equity, real estate, credit, cash and equities. As a result of members of the One Investment Group being an external trustee, these members have a low tolerance for accepting any liability resulting from their role as trustee.