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SINELS’ SIXTH ANNUAL CHANNEL ISLANDS TRUSTS LAW CONFERENCE 2010

SINELS’ SIXTH ANNUAL CHANNEL ISLANDS TRUSTS LAW CONFERENCE 2010. TRUSTS AND THE OPERATION OF THE NO REFLECTIVE LOSS PRINCIPLE. by Victor Joffe QC. What if the Trustee acts in Breach of Trust or Breach of Fiduciary Duty?. Removal as Trustee? Personal Liability : Art 30(1)

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SINELS’ SIXTH ANNUAL CHANNEL ISLANDS TRUSTS LAW CONFERENCE 2010

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  1. SINELS’ SIXTH ANNUAL • CHANNEL ISLANDS • TRUSTS LAW CONFERENCE 2010

  2. TRUSTS AND THE OPERATION OF THE NO REFLECTIVE LOSS PRINCIPLE by Victor Joffe QC

  3. What if the Trustee acts in Breach of Trust or Breach of Fiduciary Duty? Removal as Trustee? Personal Liability : Art 30(1) Equitable compensation – the restoration of the Trust Fund : Art 30(2) Litigation 2

  4. How can Trustee liability be avoided or mitigated? Exemption and anti-Bartlett clauses (Art 30(10) saving for trustee’s fraud, wilful misconduct or gross negligence) Release or indemnity by beneficiary: Art 30(6) and (7) Relief by Court: Art 45 Prescription: Art 57 3

  5. Reflective loss – Another Way to Avoid Liability? The paradigm fact situation: 1. Trustee: X Trust Co Limited 2. Holds shares in ABC Limited 3. Whose directors Mr D and Ms E cause ABC to enter into a transaction 4. Which causes loss to ABC 5. Which in turn causes value of Trust’s shares in ABC to fall in value 4

  6. What is reflective loss? G Limited is a company owned by H, its shares worth £250,000. It buys a piece of land for £100,000 to build on, but its Advocate negligently fails to notice a covenant prohibiting development Land is in fact worth only £10,000 – G Limited suffers loss Consequently, shares in G Limited worth only £160,000 and it can no longer pay dividends to H. H’s loss reflects that of G Limited 5

  7. General Rule: Shareholder cannot sue the wrongdoer for reflective loss – ONLY the company can sue: Johnson v Gore Wood & Co [2002] 2 AC 1 Exceptions: Company has no cause of action Shareholder suffers separate and distinct loss caused by breach of duty owed to him independently [Quaere] Wrongdoer disables company from suing 6

  8. Why a Rule Preventing Recovery of Reflective Loss? To prevent double recovery: protection of the Defendant To protect the company’s creditors: protection against the Plaintiff extracting value from the company 7

  9. Position where Shares are Held by Trustees of Trust Exactly the same as the General Rule: The Trustee (as shareholder), director (even if he is the Trustee or is appointed by the Trustee) and the beneficiary cannot sue for the loss suffered by the Company – ONLY the Company can sue 8

  10. Where the Trustee is the Wrongdoer Example: Trustee/director of Trust-owned company causes it to enter improvident transaction. The conventional position: Gardner v Parker [2004] 2 BCLC 554, 565: “…it appears clearly to have been determined in [Shaker v Al-Bedrawi [2003] 1 BCLC 157] that, even when the claim is brought by a beneficiary against a trustee for breach of fiduciary duty, it can be barred by the [no reflective loss principle]. ” 9

  11. Trustee Failure to Supervise the Directors of Trust-Owned Companies Example: Trustee fails to prevent directors of trust-owned company from misusing company’s assets or diverting them to third parties • Position in England: • Walker v Stones [2001] QB 902: Beneficiary can sue Trustee where • He can establish Trustee’s conduct has constituted a breach of some legal duty owed to him personally; • The breach of duty has caused Beneficiary personal loss, separate and distinct from any loss that may have been occasioned to any corporate body in which he may be financially interested.

  12. Is Jersey any Different? • Freeman v Ansbacher Trustees (Jersey) Ltd [2009] JLR 1 • The facts: • Assets of a discretionary trust held by a company, SDR, the shares in which were all held by the Trustee. The plaintiff beneficiaries alleged Trustee failed to supervise SDR in respect of three transactions which caused it loss. • Trustee sought to have the claim struck out, relying on the no reflective loss principle. The Royal Court proceeded on the basis that the claims raised were reflective of SDR’s losses, and held at that the principle formed part of the law of Jersey.

  13. Does the No Reflective Loss Principle Apply to a Jersey Discretionary Trust? • Birt DB: • “I accept that, if the [no reflective loss] principle applies to the present case, the order of justice should be struck out. However, I am by no means convinced that the principle should necessarily be applied to a situation such as the present involving a discretionary trust. I think it is not entirely clear that the principle would necessarily be applied in England; but even if it were, I consider that there are strong grounds for believing that Jersey law should follow a different path…”

  14. Possible Bases of Action against Jersey Trustee • Beneficiaries ask Trustee to replace directors so new directors can cause company to sue former directors • If Trustee refuses to replace directors, beneficiaries bring action against it for new breach of trust • Derivative action by beneficiaries

  15. The DB’s Solution? • Where Plaintiff seeks reconstitution of the trust fund, the remedy is at the discretion of the court: the court could arguably direct the Trustee to reimburse or refinance the trust-owned company. • Thus the company would no longer have suffered any loss and could not bring any claim against its directors, thereby removing the danger of double recovery.

  16. The Lesson to be Learned? • The no reflective loss principle may not protect a Trustee from action where it has failed properly to supervise the directors of a trust-owned company. • The Trustee should check its PI policy.

  17. Stephen Whale Director - Private Wealth Qualifications: FCA, FCCA T: +44 (0) 1534 816 275 F: +44 (0) 1534 700 007 E:stephen.whale@jerseytrust.com

  18. Channel Islands Trusts Law Conference 2010 • Trusts and the operation of the no reflective loss principle: commentary Advocate Paul Tracey 25 November 2010

  19. What is the English position? • Walker v Stones [2001] QB 902 at 927: • - defendants’ conduct breached a duty owed to plaintiff personally • - that breach caused plaintiff loss separate and distinct from any loss suffered by company in which plaintiff has an interest • - what is meant by a separate loss?

  20. What is the English position? • But see now: Shaker v Al-Bedrawi [2003] Ch 350; Gardner v Parker [2004] 2 BCLC 554; Barnes v Tomlinson [2007] WTLR 377; Ellis v Property Leeds (UK) Limited [2002] EWCA Civ

  21. What is the English position? • All following Johnson v Gore-Wood & Co [2002] 2 AC 1 and authorities for the propositions that, first, “[t]he fact that the beneficiaries‘ claim may be a claim for breach of fiduciary duty is not a reason why the reflective loss principle should not apply” (Lewin at para 39-38) and “… the reflective loss principle normally does prevent the beneficiaries from recovering the diminution in the value of the trusts shareholding in a breach of trust action caused by a breach of duty by the trustee as adirector of the company concerned for which the company has a claim against the director” (ibid; emphasis mine)

  22. What is the English position? • But see also: • Giles v Rhind [2003] Ch 618: • Reflective loss principle does not apply if the defendant’s/s’ actions have stripped the relevant company of funds such that the company is unable to pursue action against the directors • and cf. Waddington Limited v Chan [2008] HKLR 1381

  23. What is the nascent Jersey position? • Freeman v Ansbacher [2009] JLR 1 • The case’s facts: • - “at all material times the shares in [the company] SDR were the sole significant asset of the Trust and all the underlying assets were owned by SDR or its subsidiaries.” • (id at 8) • - application to strike out an order of justice on ground, in part, “that the losses claimed … were merely reflective of the losses suffered by SDR and were not therefore recoverable at the instance of the beneficiaries” • (id at 28)

  24. What is the nascent Jersey position? • The Bailiff’s judgment and reasons: • “None of the English cases has had to consider the position where there is a discretionary trust. It seems to me strongly arguable that the two reasons for the principle may have no application in a case such as the present. …. [The plaintiff] is merely seeking reconstitution of the trust fund. It seems to me strongly arguable that the remedy, were breaches of trust on Ansbacher’s part proved, is at the discretion of the court and, being an equitable remedy, may be moulded to suit the circumstances of the case. Thus, in the event of the breaches of trust being proved, the court could arguably order Ansbacher to reconstitute the trust fund exactly by reimbursing that particular part of the

  25. What is the nascent Jersey position? • trust fund which had been primarily affected by the breach of trust. Thus, the court could order Ansbacher to reimburse SDR from where the funds had been lost in the first place. Alternatively, if it was felt that the court could only order Ansbacher to reimburse the trust fund itself by putting the appropriate moneys into the trust fund, it seems to me arguable that the court could nevertheless direct as a term of such relief that the funds be used to acquire new shares in SDR, so that the funds eventually find their way in to SDR. This would have the effect of exactly reconstituting the trust fund because it would take the value of the shares in SDR back to what they had been previously and the financial position of SDR back to what it had been. Such remedies may not be available in all cases but it seems to me strongly arguable that they are available where the company in question is wholly owned by a discretionary trust.” (id at 37-8)

  26. What is the nascent Jersey position? • Further: • “It is of the first importance that beneficiaries of a trust whose assets have been mismanaged should have a simple and effective remedy available to them, whether such assets are held directly by the trustee or through a wholly-owned company. I consider that it is strongly arguable that the law of Jersey provides this simple and effective remedy in a case such as the present by enabling the court to order the defaulting trustee to reconstitute the trust fund by reimbursing the company for its losses, thereby removing both reasons for the application of the Prudential principle.” (id at 42)

  27. Should Jersey follow England here? • Lewin: “… it is necessary to consider whether the reasons for exclusion of recovery of reflective loss outside of a trust context apply also in the trust context” (para 39-40) • Trust investments and/or trading all but invariably carried out through companies • Obvious injustice arises from rigid and unbending application of principle • Any justification for not applying principle or applying it with greater discrimination where there is also loss to a trust estate?

  28. Should Jersey follow England here? • Mischief at which principle directed can be prevented otherwise in a trust context (at least, where relevant company’s shares wholly owned on the trust) • How convincing is the Bailiff’s reasoning in Freeman v Ansbacher? • How much weight do the English authorities have in Jersey compared with the Bailiff’s decision in Freeman v Ansbacher? • Where in English authorities is the reasoning for an unbending application of the principle in a discretionary trust context?

  29. Channel Islands Trusts Law Conference 2010 • Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care Advocate Paul Tracey 25 November 2010

  30. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The questions • The statutory provisions in Jersey and England • The content of the duty • The fiduciary nature of the duty • Breach of duty and its remedial consequences • Limiting liability • Conclusions and checklist

  31. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The questions • What is breach of trust under Jersey law? and what do we mean when we use that phrase? • What are the duties of a trustee under Jersey law? • Does a Jersey trustee have a duty to exercise reasonable care and skill in carrying out his or her office? • Is a breach of duty by a Jersey trustee always a breach of trust?

  32. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The statutory provisions in Jersey and England • art.1(1), Trusts (Jersey) Law 1984 (“TJL”): • “ ‘breach of trust’ means a breach of any duty imposed on a trustee by this Law or by the terms of the trust” • art.1(2) TJL: • “This Law shall not be construed as a codification of laws regarding trusts, trustees and persons interested under trust.”

  33. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • 2 The statutory provisions in Jersey and England • What is a Jersey trustee liable to do? See art.21(1), TJL: • “A trustee shall in the execution of his or her duties and in the exercise of his or her powers and discretions – • (a) act – • (i) with due diligence, • (ii) as would a prudent person, • (iii) to the best of the trustee's ability and skill; and • (b) observe the utmost good faith.”

  34. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The statutory provisions in Jersey and England • art.21(3), TJL: • “Subject to the terms of the trust, a trustee shall – • (a) so far as is reasonable preserve the value of the trust property; • (b) so far as is reasonable enhance the value of the trust property.”

  35. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The statutory provisions in Jersey and England • What do the English equivalent provisions say? • s.1, Trustee Act 2000: • “(1) Whenever the duty under this subsection applies to a trustee, he must exercise such care and skill as is reasonable in the circumstances, having regard in particular – • (a) to any special knowledge or experience that he has or holds himself out as having, and

  36. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The statutory provisions in Jersey and England • (b) if he acts as trustee in the course of a business or profession, to any special knowledge or experience that it is reasonable to expect of a person acting in the course of that kind of business or profession. • (2) In this Act, the duty under subsection (1) is called ‘the duty of care’.”

  37. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The statutory provisions in Jersey and England • s.4,Trustee Act 2000: • “(1) In exercising any power of investment, whether arising under this Part or otherwise, a trustee must have regard to the standard investment criteria. • (2) A trustee must from time to time review the investments of the trust and consider whether, having regard to the standard investment criteria, they should be varied.”

  38. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The statutory provisions in Jersey and England • “(3) The standard investment criteria in relation to a trust, are – • (a) the suitability to the trust of investment of the same kind as any particular investment proposed to be made or retained and of that particular investment as an investment of that kind, and • (b) the need for diversification of investments of the trust, in so far as is appropriate to the circumstances of the trust.”

  39. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The statutory provisions in Jersey and England • s.5,Trustee Act 2000: • “(1) Before exercising any power of investment, whether arising under this Part or otherwise, a trustee must (unless the exception applies) obtain and consider proper advice about the way in which, having regard to the standard investment criteria, the power should be exercised.

  40. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The statutory provisions in Jersey and England • (2) When reviewing the investments of the trust, a trustee must (unless the exception applies) obtain and consider proper advice about whether, having regard to the standard investment criteria, the investments should be varied. • (3) The exception is that a trustee need not obtain such advice if he reasonably concludes that in all the circumstances it is unnecessary or inappropriate to do so.

  41. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The statutory provisions in Jersey and England • (4) Proper advice is the advice of a person who is reasonably believed by the trustee to be qualified to give it by his ability in and practical experience of financial and other matters relating to the proposed investment.”

  42. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The content of the duty • a professional trust company? See Midland Bank Trust Co (Jersey) Ltd v. Federated Pension Services [1994] JLR 276 at 290: • “There is, in our view, a higher duty imposed on those who … claim a long and detailed expertise in the field in which they practise.” • contexts: trust investments (funds, bonds, listed shares etc.), wholly owned private companies, partially owned private companies

  43. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The content of the duty • general investment power a usual provision in trust powers; trustee will also usually be empowered to trade, to borrow, to give guarantees and indemnities, to give security and to exercise voting rights • The classic statement: “[W]hat is the liability of a trustee who undertakes an office which requires him to make an investment on behalf of his cestui que trust[?] It seems to me thaton general principles a trustee ought to conduct the business of the trust in the same manner that an ordinary prudent man of business would conduct his own, and that beyond that there is no liability or obligation on the trustee. In other words, a trustee is not bound because he is a trustee to conduct business in other than the ordinary and usual way in which similar business is conducted by mankind in transactions of their own. It never could be reasonable to make a trustee adopt further and better precautions than an ordinary prudent man of business would adopt, or to conduct the business in any other way. If it were otherwise, no one would be trustee at all”: Speight v Gaunt (1883) 2 Ch 727, 739-40 per Jessell MR

  44. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The content of duty • An objective, external standard independent of the trustee’s personal special skill and prudence? • What would a reasonably prudent and careful person have done in like circumstances? Trustees’ behaviour tested by this standard or else “[i]n every case where neglect of duty is imputed to a body of trustees, it would necessitate an exhaustive inquiry into the private transactions of each individual member, - the interest of the trustee being to show that he was a stupid fellow, careless in money matters: and that of his opponents to prove that he was a man of superior intelligence and exceptional shrewdness.”: Knox v Mackinnon (1888) 13 App Cas 753 per Ld Watson at 766-767

  45. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • 3 The content of duty • Past performance of trustees judged by standards of the relevant period and not judged by “what the trustee then did or failed to do by the light of later events that could not then have been surely foreseen. They are relevant in determining what loss resulted from the breach if there was one. They do not help to determine whether or not there was one”: Elder’s Trustee and Executor Co Ltd v Higgins (1963) 113 CLR 426 at 448; see also Re Hurst (1892) 67 LT 96 at 99 and Nestle v National Westminster Bank [1994] 1 All ER 118 per Staughton J at 134: “the trustees’ performance must not be judged with hindsight”.

  46. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The content of duty • a duty to act positively?: trading trusts or where active management of trust assets needed • a duty of supervision?: investment managers, agents, private companies in which the trustee has an interest(possibly a controlling interest) • a duty to provide trading and financial information to the beneficiaries? See now The Cats’ Protection League v Deans & Anor [2010] NZHC 130

  47. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The content of duty • a duty of supervision: the particular position of a controlling interest in a private company: see Re Lucking’s Will Trusts [1967] 3 All ER 726 per Cross J at 733: • “Now what steps, if any, does a reasonably prudent man who finds himself a majority shareholder in a private company take with regard to the management of the company's affairs? He does not content himself with such information as to the management of the company's affairs as he is entitled to as shareholder, but ensures that he is represented on the board. He may be prepared to run the business himself as managing director or, at least, to become a non-executive director while having the business managed by someone else. Alternatively, he may find someone who will act as his nominee on the board and report to him from time to time as to the company's affairs. In the same way trustees holding a controlled interest ought to ensure so far as they can that they have such information as to the progress of the company's affairs as directors would have. If they sit back and allow the company to be run by the minority shareholder and receive no more information than shareholders are entitled to, they do so at their risk if things go wrong.”

  48. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The content of duty • a duty of supervision: the particular position of a controlling interest in a private company: see also Bartlett v Barclays Bank Trust Co Ltd [1980] Ch 515 per Brightman J at 533-534: • “[Cross J] was merely outlining convenient methods by which a prudent man of business (as also a trustee) with a controlling interest in a private company can place himself in a position to make an informed decision whether any action is appropriate to be taken for the protection of his asset … Alternatives which spring to mind are the receipt of copies of the agenda and minutes of board meetings, the receipt of monthly management accounts in the case of a trading concern or quarterly reports. Every case will depend on its own facts … The purpose to be achieved is not that of monitoring every move of the directors, but of making it reasonably probable … that the trustees or one of them will receive an adequate flow of information in time to enable the trustees to make use of their controlling shareholding should this be necessary for the protection of their trust asset, namely the shareholding … It was not proper for the bank to confine itself to the receipt of the annual balance sheet and profit and loss account, detailed annual financial statements and the chairman's report and statement, and to attendance at the annual general meetings and the luncheons that followed, which were the limits of the bank's regular sources of information. Had the bank been in receipt of more frequent information it would have been able to step in and stop, and ought to have stopped the board embarking on the Old Bailey project.”

  49. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The content of duty • a duty of supervision • judged by performance of portfolio overall or by reference to individual component parts? (see Nestle v National Westminster Bank (1993) 1 WLR 1260) • Remember art 30(3), TJL: “[w]here there are 2 or more breaches of trust, a trustee shall not set off a gain from one breach of trust against a loss resulting from another breach of trust.”

  50. Identifying and assessing the remedial consequences of a Jersey trustee’s liability for breach of duty to exercise reasonable care • The content of duty • Do we have any conclusions as to the content of the Jersey trustee’s duty to exercise reasonable care? What should a trustee do to discharge this duty? • Remember the absolute key words: “due diligence”, “a prudent person”, “to the best of the trustee’s skill and ability”, “the utmost good faith” • What else?: “[s]ubject to the terms of the trust … so far as reasonable preserve … [and] enhance the value of the trust property” • But, it remains the case that “[e]ssentially, to succeed in a claim that negligent or unfair investment of the trustees caused loss, a claimant beneficiary has to prove that no trustee, acting with the requisite minimum care and skill and suffering from the bad luck that can affect investors, could possible have ended up with a trust fund of the complained-of value.”: Underhill & Hayton, 17th ed’n at para. 53.71

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