Privy Council judgment on private international law and trustee liability

The judgments have a number of important implications for trustees and their counter-parties in relation to trustees’ limitations on liability. The Privy Council also dealt with aspects of private international law with implications that reach beyond the trust industry.

The litigation was long-running and complex, but there are two points of wider application that we focus on in this note.

Background

The main proceedings relate to a Jersey law trust, the Tchenguiz Discretionary Trust (the TDT), established for the benefit of Robert Tchenguiz and his family in March 2007. The original trustees of the TDT were Investec Trust (Guernsey) Ltd and Bayeux Trustees Ltd (now the former trustees).

The relevant claims, for the purpose of this note, were made by certain BVI companies (the BVI companies) for repayment of liabilities said to be owed to them by the former trustees.

The BVI companies were formerly held within the TDT structure but when Kaupthing Bank (a significant lender to the TDT structure) encountered serious financial difficulty in October 2008, it exercised its security rights over those and certain other companies within the TDT. Acting through their liquidators, the BVI companies then sought repayment of the liabilities they claimed to be owed by the former trustees.

Privy Council proceedings

The principal issue before the Board of the Privy Council (the Board) was whether or not Article 32 of the Trusts (Jersey) Law 1984 (Article 32) operated to exclude the former trustees’ personal liability and limit the BVI companies’ claims to the trust property.

Article 32 provides:

32      Trustee’s liability to third parties

(1)     Where a trustee is a party to any transaction or matter affecting the trust –

(a)     if the other party knows that the trustee is acting as trustee, any claim by the other party shall be against the trustee as trustee and shall extend only to the trust property;

(b)     if the other party does not know that the trustee is acting as trustee, any claim by the other party may be made against the trustee personally (though, without prejudice to his or her personal liability, the trustee shall have a right of recourse to the trust property by way of indemnity).

(2)     Paragraph (1) shall not affect any liability the trustee may have for breach of trust.

There was no dispute in the proceedings that the BVI companies were “knowing creditors” under Article 32(1)(a).

Application of Article 32 - private international law

In order to determine whether Article 32 applied, the Board had to decide on the correct analysis of the former trustees’ liabilities as a matter of private international law (applying Guernsey law principles).

The Board applied the three-stage test laid down in the case of Raiffeisen Zentralbank Osterreich AG v Five Star Trading LLC [2001] QB 825, which sets out the mechanism for selecting which system of law should be applied in circumstances where there is an international element to a transaction. Under this test, a court will: (i) consider how to characterise the relevant issue; (ii) select the rule of conflict of laws which lays down a “connecting factor” for that issue; and (iii) identify the relevant system of law which ties the issue to the connecting factor.

The Board considered four ways in which this test could be applied in this case, one of which (advanced by the BVI companies) led to the conclusion that Article 32 did not apply and the other three (advanced by the former trustees) led to the conclusion that it did:

• The BVI companies argued that the law which governs the discharge of a contractual liability should be the same as the law of the underlying contract. Lord Mance agreed with this so-called “discharge rule” and gave a dissenting judgment to the majority view set out below. (The lower courts had not considered it necessary to make a finding on the law applicable to the loans, save that it was not Jersey law, but were willing to assume that it was Guernsey law.)
• The majority found in favour of the “status strand” of the former trustees’ arguments – that the substantive law under which an entity is formed will determine the legal nature of the entity so created.
  
  The Board considered a number of cases in which the courts have previously grappled with the issue of a foreign entity involved in litigation in England, but where the domestic law of the entity contains limitations of liability. The Board used the example of a partnership, where the law of the partnership’s formation will determine (a) whose liability is engaged; and (b) the limits of that liability, concluding:
  
  “In the Board’s opinion, the time has come to recognise that as a general rule the common law will recognise and give effect to limitations of liability which arise under an entity’s constitutive law by reason of the particular status or capacity in which its members or officers assume an obligation.”
  
  Therefore, Article 32 applied to limit the former trustees’ liability under the proper law of the trust, irrespective of the proper law of the liabilities.
• The majority also agreed with the remaining two strands of the former trustees’ arguments, which arose more specifically in relation to Guernsey law, that:
  • Guernsey domestic law contained a sufficient indication (through the provisions of its own trust law) that the proper law of the trust determines the nature and extent of the trustees’ liabilities to third parties; and
  • the symmetry between Guernsey’s own domestic law limitations of liability and Article 32 should be sufficient for the Guernsey courts to apply Article 32 under the Raiffeisen test.

In relation to the latter point, the Court considered it would be a surprising result if the courts of Guernsey, where the local trust law contains an almost identical exclusion of personal liability for trustees (albeit which only applies to Guernsey law trusts), would override such an exclusion in favour of the proper law of the contract (one might add, more particularly, where the lower courts had been willing to assume the loans themselves were Guernsey law loans).

Although Lord Briggs and Lord Mance dissented from the majority’s agreement with the broader “status” argument, only Lord Mance dissented from these more Guernsey-specific strands.

Practical considerations

The Board’s findings on matters of private international law have far-reaching implications for those who contract with entities created under the laws of other jurisdictions. The Privy Council’s findings suggest that it will usually be necessary to take local advice in respect of an entity’s formation documents and legal status, regardless of the governing law of the obligations assumed by that entity.

These “pragmatic” complications were highlighted by Lord Mance in his dissenting judgment on this issue, where he argued against the “status” approach and against the application of Article 32 in this case.

Of course, taking local advice where a foreign entity is involved in a transaction may well already be part of many standard due diligence procedures. The majority of the Board were unsympathetic to the suggested difficulties of such enquiries when contracting internationally.

Interpretation of Article 32 - trustee liability

The Board’s judgment represents a major milestone for jurisdictions such as Jersey which have enacted statutory provisions to limit trustees’ liability. It is now clear that such limitations do operate to limit a trustee’s liability and not solely when the relevant obligation is also governed by the same proper law.

The Privy Council’s interpretation of Article 32 was that “[t]he limitation of the trustee’s liability is achieved by treating him as having two legally distinct capacities and two legally distinct estates”. In circumstances, where the counter-party is aware he is dealing with a trustee “[o]nly his capacity as trustee is relevant and only the trust estate is engaged”.

However, the Board confirmed that trust assets are exposed to liability for trust transactions in an indirect manner via a right of subrogation. The trustee is entitled to an indemnity out of the trust assets, and a creditor may be subrogated to that right, but Article 32 does not create a direct right to the trust assets for creditors. The significance of this is that, as under English law (Re Johnson), a trustee may be deprived of their indemnity if they have committed a breach of trust for which they have not made good any loss. Therefore, where Article 32 applies to a trustee who has acted in breach of trust, a knowing creditor may have no right to pursue the trustee personally, and the trustee may have no right of indemnity to which the creditor can seek to be subrogated. The majority considered that this was not an unfair outcome on the basis that creditors were usually voluntary and could therefore take steps to protect themselves.

Implications for English law

In light of the Privy Council’s findings it is clear that the approaches of jurisdictions such as Jersey have diverged from the common law position as it still exists in England and elsewhere. In England and Scotland, the default position is that liabilities which a trustee incurs are fully enforceable against the trustee’s personal assets, whether or not those liabilities affect the trust assets. This may have implications for non-UK trustees acting as trustees of trusts governed by, for instance, English law.

However, under the common law, a trustee may expressly limit its liability to the trust assets and one aspect of these proceedings dealt with the former trustees’ argument that their liability was limited as a matter of construction of the documents which created the liabilities. The Privy Council did not need to reach a decision on this point in light of its findings in respect of Article 32, but the court noted that the Guernsey Court of Appeal had held that, as a matter of construction, the former trustees did not incur personal liability to the BVI companies.

Accordingly, even trustees without the benefit of such statutory protections can continue to limit their liability, but one can expect both trustees and their counterparties to pay close attention to both statutory and contractual limitations in future.

Macfarlanes LLP acted for the former trustees throughout the proceedings in conjunction with Mourant Ozannes in Guernsey and Investec's General Counsel, Lauren Ekon.