Sofer v SwissIndependent Trustees: Is it a loan or is it a distribution?
The case concerned a trust settled in 2006 by the Claimant’s deceased father Hyman Sofer (described in the judgment as a wealthy South African bookmaker and investor), and known as the Puyol Trust. The Defendant in this case, SwissIndependent Trustees SA (a professional Swiss trustee), was the trustee of the Puyol Trust. It was originally intended that the Claimant would be the main beneficiary of the trust, but shortly after it was created, the Claimant’s father was added as a beneficiary. Alongside the Puyol Trust, the settlor created two further trusts (the Xavi Trust and the Gabri Trust). It was intended that these trusts would benefit, respectively, the settlor’s daughter and her descendants.
The trust deeds included a restriction preventing the trustee from making distributions out of the trust until the settlor had died. However, the trustee was permitted to lend money to the beneficiaries; in fact, there was an express power to lend trust assets to any of the beneficiaries.
The trust deed also included an exoneration clause, providing that the trustee would not be liable for any loss unless it has “been caused by acts done or omissions made in personal conscious and fraudulent bad faith by the Trustee”.
Over a period of 10 years from 2006 to 2016, $19.2m was paid out from the Puyol Trust to the Claimant’s father, the settlor, at his request. The payments were recorded by the trustee as loans, but did not include any provision for security, interest or repayment. For context, payments were also made to the settlor out of the Xavi Trust and the Gabri Trust. A total of 148 payments were made from the three trusts, which amounted to about $61.5m of the total trust assets of $78m. Some small amounts were repaid, but the estate of the Claimant’s father after his death ultimately did not have sufficient funds to repay the vast majority of the amount outstanding.
The Claimant had entered into a deed of indemnity with the trustee in respect of several of the payments to his father, the purpose of which was to indemnify the trustee in respect of the amounts lent to his father. In particular, around $3.27m of the funds paid out of the Puyol Trust was used by the settlor to fund a significant tax payment required under a dispute with the Australian Tax Office. In connection with this payment, the trustee sought an indemnity from the beneficiaries (including the Claimant) which was signed in September 2012.
The Claimant sought to recover the amounts paid to his father by the trustee. He argued that these payments, although described as loans, were in fact outright distributions in breach of the trust deed, which contained an outright prohibition on such payments being made. The Claimant alleged in particular that the trustee made no enquiry of the settlor as to why the payments were required, did not enquire into the financial position of the other beneficiaries under the trusts, and failed to consider the settlor’s ability to repay the “loans”. His claim sought to force the trustee to reconstitute the trust fund, and to remove the trustee from office.
The case considered two key issues.
- Were the payments made by the trustee in fraudulent bad faith, the result of which would be that the exoneration clause would not protect the trustee from being held liable for the loss to the trust funds?
- Even if the exoneration clause did not protect the trustee, did the deeds of indemnity entered into by the Claimant prevent the Claimant from being able to claim for these amounts against the trustee?
The case was a preliminary hearing, and the court was not ruling on the merits of the parties’ arguments; the trustee had applied to strike out the Claimant’s case on the basis that there were insufficient particulars of dishonesty, so the Court was instead tasked with determining whether the Claimant had a reasonable prospect of success in his arguments.
The High Court ruled in favour of the trustee, and struck out the Claimant’s case for breach of trust against the trustee. Addressing each question above:
- it was accepted that to show fraudulent bad faith, which was required in order to hold the trustee liable for the payments, the Claimant was required to evidence dishonest breach of the trust by the trustee. Applying the test set out in Fattal v Walbrook Trustees (Jersey) Ltd  EWHC 2767 (Ch) (as set out below) for dishonest breach of trust, the High Court held that the Claimant’s particulars of claim were not sufficient to evidence dishonest breach of trust by the trustee. In particular, the High Court held that the Claimant had failed to set out proper details of the trustee’s alleged knowledge of or indifference to the interests of the beneficiaries; and
- the High Court held that since the Claimant had signed deeds of indemnity in respect of the payments to his father out of the trust, he would not be able to succeed with his claim even if the trustee could not rely on the exoneration clause. The Claimant therefore had no real prospect of success, and he was therefore precluded from advancing his claim.
Court of Appeal
The Claimant appealed against this decision. The Court of Appeal disagreed with the High Court and
allowed the Claimant’s appeal. In practice, the Court of Appeal ruled that the claim should not have been struck out, and that the Claimant should have been allowed to amend his claim in order to set out further details of the trustee’s alleged dishonesty.
Evidence of fraudulent bad faith
The Court of Appeal agreed with the High Court that the appropriate test for determining dishonest breach of trust is the test set out in Fattal, but disagreed with the High Court’s conclusion that the Claimant had not set out sufficient particulars to sustain a case of dishonesty. Applying the Fattal test, in order to show dishonest breach of trust, the Claimant must show:
- a deliberate breach of trust;
- committed by a professional trustee:
– who knows that the deliberate breach is contrary to the interests of the beneficiaries; or
– who is recklessly indifferent whether the deliberate breach is contrary to their interests or not; or
– 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.
The Court of Appeal noted that the Claimant’s case was built on an inference of dishonesty from the facts set out in the particulars. Specifically, the Claimant argued that the amount of the payments, the length of time over which they had been made and the fact that the trustee had not investigated the
prospects of the loans being repaid supported his case that the trustee had deliberately breached the terms of the trust. The Claimant also argued that for part of the period the settlor was suffering from dementia and that this was known by the trustee – and that this meant that he was incapable of making a request for a loan. Further, the Claimant’s case was that the trustee either:
- knew the payments were being made contrary to the beneficiaries’ interests;
- was recklessly indifferent to the beneficiaries’ interests in making the payments; or
- was wholly unreasonable in believing that the payments were in the beneficiaries’ interests.
Moreover, the fact that the Claimant’s father was a beneficiary did not absolve the trustee from considering the position of other beneficiaries. In Lord Justice Arnold’s view, the Claimant’s particulars of
claim did contain sufficient details (if the facts set out in the particulars of claim were proved) to infer that there had been a dishonest breach of trust by the trustee, which could be sufficient to overcome the trustee exoneration clause. The judgment confirmed that where there is an allegation of dishonesty, the proper approach is for the Court to consider the facts in the round. The judge also noted that where there is a corporate defendant there is no need for the Claimant to identify in their initial claim particular individuals (employees or officers, for example) whose knowledge is attributable to the company in order to establish that there has been dishonesty, as long as those details are provided as soon as possible. The Claimant therefore had a reasonable prospect of success and should be allowed to proceed with his claim.
Deeds of indemnity
In respect of the deeds of indemnity, the Court of Appeal considered it arguable that the indemnity was subject to an implied term that disapplied the indemnity where the trustee acted dishonestly.
The High Court had also rejected the Claimant’s arguments that the indemnity only applied to payments which were in reality loans, and not to payments which were really gifts. The judge had rejected this argument on the basis that it would greatly reduce the scope of the indemnity and therefore make it “uncommercial”. The Court of Appeal disagreed with this argument and considered that it was arguable that the indemnity provided to the trustee was only intended to apply if the payments described in the document were in fact loans (and not distributions which were prohibited by the trust deed).
Based on these factors, the Court of Appeal concluded that the Claimant had a reasonable prospect of succeeding in his argument that the deeds of indemnity did not protect the trustee from any claims.
Although the Court of Appeal did not rule on the merits of the Claimant’s case, this case nevertheless serves as a reminder to trustees that characterising a payment to beneficiaries as a loan does not definitively make it so. Real thought needs to be given as to whether:
- the beneficiary has, or will ever have, adequate funds to repay the loan;
- the loan will in fact be repaid; and
- the trustees have considered the interests of other beneficiaries when making a loan.
This includes considering whether the loan should bear interest, whether there should be a fixed repayment date and whether any security should be provided. This case highlights that if a loan is made without a prospect of repayment, that loan could rightly be characterised as a distribution rather than a loan.
Loans are often used by trustees as a tax efficient method for beneficiaries to receive benefits from a trust, but it should be borne in mind that there is an inherent risk in making open-ended, unsecured and interest-free loans without an intention to ever be repaid. Trustees should consider the interests of all the beneficiaries when making loans, even when the loan is to a beneficiary, as this could be determinative of whether a court (with the benefit of hindsight) considers there to have been a dishonest breach of duty by the trustees.
Furthermore, although an exoneration clause in a trust deed goes some way to providing protection for the trustees, trustees should bear in mind that the test for proving fraudulent bad faith in order to overcome such a clause is not the same as fraud or common law dishonesty. For trustees to be considered as acting with fraudulent bad faith there does not need to be any intention to benefit themselves; in accordance with the Fattal test, all it requires is for the trustees to have knowledge that they are breaching the terms of the trust and for them to give insufficient thought to the position of the other beneficiaries. This is a lower threshold than proving the trustees were fraudulent or dishonest in their actions.
Finally, trustees should note that the existence of an indemnity from other beneficiaries of the trust in respect of claims does not automatically preclude a claim from being made, particularly where the nature of the matter as described in the indemnity differs from the reality. Trustees should be wary of narrowly drafted indemnities, as these may not protect them against claims.
If trustees are aware that their actions could potentially be construed as a breach of trust, then to ensure that their actions do not fall outside the terms of the indemnity it would be sensible for them to obtain a widely drawn indemnity and be able to evidence that the beneficiary was made aware of any specific concerns.
Finally, in terms of practical points for litigants, the Court of Appeal decision implies that where a Claimant’s particulars of claim are somewhat lacking in detail it may be possible to overcome this as long as the relevant particulars are provided as soon as is feasible. This may dissuade defendants from applying to strike out claims such as this where their application relies on a perceived lack of detail in the claimant’s documentation.
The next step will be for the substantive hearing to take place, and it will no doubt be interesting to see how the arguments develop. We look forward to commenting further on that judgment in due course.