A semi-recent case from the NSW Supreme Court provides some timely reminders about how trust law works, even if a trustee of a trust is replaced by a new trustee.
- A trust cannot incur a debt, only the trustee can.
- Assets of a trust are held for the benefit of beneficiaries, but those assets are subject to the trustee’s right of indemnity to cover its costs and debts incurred in performing its duties/obligations for the trust.
- A former trustee of a trust is generally entitled to this indemnity, but it depends on the terms of the trust deed and any relevant trust legislation in your jurisdiction.
- This right of indemnity may be in the form of a “right of exoneration” (ie the right to be covered for debts incurred on behalf of the trust).
- Or it may also be in the form of a “right of recoupment” (ie the right to be covered by trust assets for debts/costs paid for by the trustee from its own monies).
- This right of indemnity is a proprietary right, which confers an equitable lien in favour of the former trustee over the trust. This lien may likely elevate the former trustee to a position higher than, for instance, a secured creditor of the successor trustee.
- A new or successor trustee owes a fiduciary duty to the former trustee, including not to deal with the assets of the trust in a way that might “destroy, diminish or jeopardise” the former trustees’ right of indemnity.
- A creditor of the former trustee is subrogated to the right of the former trustee to not only the right of indemnity, but also to enforce that fiduciary duty.
- To the extent the successor trustee breaches this fiduciary duty, that creditor may take appropriate legal steps to impugn any unlawful dealings/transactions by the successor trustee.
Article written by Matthew Hudson (Associate Director) – Brisbane