The Jersey Court of Appeal has given a detailed judgment in the Re Z Trusts litigation confirming that a former trustee’s lien over trust assets takes priority to successor trustees’ liens.
The dispute was essentially between Equity Trust, as former trustee of the Z II and Z III Trusts, and E, as the executor of the Z Trusts’ settlor’s estate. After retiring as trustee, Equity Trust entered into a settlement agreement in relation to separate proceedings where it incurred a total liability in excess of £18 million. It subsequently claimed reimbursement out of the assets of Z II Trust which it said it incurred in the defence of those proceedings.
Equity Trust maintained its claim took priority over the Z II Trust’s other creditors. This was relevant because the current liabilities of the Z Trusts far exceeded their assets and the trusts were described as ‘insolvent’ (while acknowledging a trust is not a distinct legal person that can be insolvent in strict legal sense). If Equity Trust were successful in its claim, then it would recover all of the assets of the Z II Trust (about £6 million); if not, it would rank pari passu with the Z II Trust’s other creditors and receive a much smaller amount.
The Court of Appeal agreed with Equity Trust, overturning the Commissioner’s decision that the claims against all trustees and the liabilities of all trustees ranked pari passu.
The Court of Appeal was satisfied that the right of lien of a former trustee is an equitable right which ranks in priority of time ahead of the right of lien of a successor trustee, and it does so in accordance with the basic rule which applies to the ranking of equitable securities. That ranking in priority exists whether the trust is solvent or insolvent.
The former trustee obtains its priority because it incurred liabilities as trustee at a point in time before liabilities are incurred by the successor trustee. None of the usual exceptions to the basic rule apply in a situation where a successor trustee takes on the office of a trustee with knowledge of the pre-existing and continuing equitable interest in the trust property of that former trustee.
As the Court of Appeal relied on English law authority for its reasoning (there being no Jersey authority on point), this decision will be relevant to all other trust jurisdictions whose law is based on or guided by English trust law. In particular, both third-parties contracting with current trustees and potential successor trustees replacing retiring trustees may wish to be more cautious in undertaking due diligence to assess potential liabilities of the former trustees, the likelihood of the trust becoming insolvent, and protecting themselves with additional security where appropriate.