A Trustee's Guardian Angel: Leave to Distribute in the Face of Third-party Claims

Where a trustee is on notice of an adverse claim against trust assets by a third party, the trustee may be personally liable if it deals with those assets in disregard of that claim (commonly known as the "Guardian Trust principle"). 

On the other hand, beneficiaries of the trust may still clamour for distributions, and the adverse claim has not been upheld yet – and may ultimately be rejected by the Court. In those circumstances, what is a trustee to do?

When faced with an adverse third-party claim, a trustee may apply to the Court for leave to take actions such as making a distribution or selling a trust asset notwithstanding the adverse claim (for convenience, this advisory refers simply to "leave to distribute"). The test to be applied on such an application has been the subject of some debate but the decision of the Royal Court in Representation of BOS Trustee Limited [2024] JRC 124  has clarified that leave to distribute will only be granted if the Court itself is satisfied that the third-party claim can be safely disregarded by the trustee as unarguable or specious.

Background

The question of leave to distribute arose in the context of ongoing proceedings before the Royal Court commenced by the trustee of a Jersey law discretionary trust (the "Trust"), BOS Trustee Limited (the "Trustee"). The proceedings primarily concerned challenges to certain letters of wishes written by the Settlor of the Trust, which his daughter ("C") alleged were invalid on the grounds that at the time the Settlor executed each letter of wishes (i) he lacked the requisite mental capacity to do, and/or (ii) the letters of wishes were vitiated by undue influenced exercised on the Settlor by his second wife ("B").

During the course of these proceedings C had filed Points of Claim which, in addition to claims of mental capacity and undue influence, alleged that certain of the Trust assets were "paraphernal" in nature as a matter of foreign law, meaning they were the exclusive property of the Settlor's first wife and C's mother ("G"), and therefore the Settlor did not have title to those assets when he purported to settle them on the terms of the Trust (the "Paraphernal Assets Claim"). 

In June 2023, the Royal Court struck out the Paraphernal Assets Claim as set out in C's Points on Claim on the basis it was hostile to the Trust and should be brought by way of a separate Order of Justice. Following this decision, C made it clear in correspondence that intended to do so.

In November 2023, the Royal Court declined to accept a surrender of discretion by the Trustee, who had made the application following requests by B for a distribution of £1 million out of the Trust assets, which had been strongly resisted by the other beneficiaries. Instead, the Court directed the Trustee to make a decision itself and to inform the Respondents of its decision within 21 days. On 24 November 2023, the Trustee notified the Respondents that it had decided to make the distribution to B, subject to obtaining authorisation from the Court. 

Throughout the preceding months, however, and again following the decision by the Trustee to distribute, C had intimated in correspondence on a number of occasions that the Paraphernal Assets Claim would be commenced and that all, or substantially all, of the assets settled into the Trust were the property of G. 

Application for Leave to Distribute

In the face of the representations by C that she would shortly be bringing the Paraphernal Assets Claim, the Trustee applied to the Royal Court for leave to make a distribution of £1 million to B, or alternatively, for a direction that the Trustee must not exercise its dispositive powers as trustee pending determination of the Paraphernal Assets Claim. Shortly before the hearing of the Trustee's summons, C sent to the parties a draft Order of Justice particularising the Paraphernal Assets Claim in full. 

On hearing the Trustee's summons, the principal question for the Court was what test was to be applied where a trustee seeks leave to make a distribution in the face of an adverse third-party claim against the assets of the trust. B argued that the Trustee's application should be decided on the usual blessing test for a momentous decision. On that basis, the applicable principles were those set out in Public Trustee v Cooper [2001] WTLR 922 (as adopted in Jersey in Re S Settlement 2001/154), and the applicable test should be the familiar test the Court applies when deciding whether or not to grant a blessing, namely:

1. Has the trustee formed its opinion in good faith?
2. Is the opinion one at which a reasonable trustee properly instructed could have arrived?
3. Is the court satisfied the opinion is vitiated by any actual or potential conflict of interest?

The Trustee and C, however, argued that the Public Trustee v Cooper basis was not appropriate in circumstances where leave was being sought to make a distribution in the face of an adverse third-party claim to trust property. Instead, they argued that the court should adopt the Guardian Trust Principle, a well-known principle of equity set out in the New Zealand case of Guardian Trust and Executors Company of New Zealand Limited v Public Trustee of New Zealand [1942] AC 115. In that case, the Privy Council held that if a trustee (or other fiduciary) is on notice that a trust fund is (or may be) claimed by a third party, he or she will be liable if he deals with that fund in disregard of that notice and the claim subsequently proves well-founded.

The Royal Court noted that the position as to when the Guardian Trust principle would apply was not "free from doubt" but it appeared that it would only apply to reasonably arguable claims and not ones that are specious and which have no arguable foundation.

The Applicable Test

The Court considered the two proposed approaches and noted that there is a principled difference between an application under Public Trustee v Cooper for a blessing of a momentous decision, and an application for leave to distribute in the face of an adverse third-party claim to trust assets. An application for a blessing is concerned with the relations between a trustee and its beneficiaries, and is designed to protect the trustee against a complaint by a beneficiary after it has exercised a power where the exercise may be in breach of duty.

By contrast, an application for leave to distribute notwithstanding a third-party claim is focused on the position between the trustee and the third-party claimant. The role of the Court on such an application is to determine whether the third-party claim has merit, not whether the trustee has acted reasonably and in good faith as it would in a blessing application. In making its determination, the Court itself must consider whether the third-party claim can be safely disregarded by the trustee on the footing that it is unarguable or specious.

In respect of the relief sought by the Trustee, the Court noted that it may have given leave to distribute prior to the filing of the draft Order of Justice by C, however, the position had now changed. The draft Order of Justice was lengthy and detailed, and averred that all or almost all of the assets in the Trust were inherited by G. On that basis, the Court held that it was clear it could not determine that the claim advanced by G's estate had no arguable foundation or was specious, and therefore declined to grant the Trustee leave to make the distribution sought. 

Conclusion 

The decision in BOS Trustee Limited provides welcome clarification as to the test the Court will apply where a trustee seeks leave to distribute in the face of an adverse third-party claim against trust property. In such an application, the Court is not merely reviewing the decision of the trustee and whether it has acted reasonably and in good faith, as it would on an application for the blessing of a momentous decision. Rather, the Court itself must assess whether the trustee can be safely disregard the claim as unarguable or specious.

While this decision provides clarity as to the test that will apply where a trustee seeks leave to distribute in the face of an adverse third-party claim, the consequence is that the threshold on such an application is higher than the test the Court will apply for a blessing of a momentous decision. On a blessing application, there may be a range of decisions that are reasonable and the Court will not refuse to grant a blessing simply because it would have made a different decision than the trustee. By contrast, on an application for leave to distribute, the Court is not reviewing the rationality of the trustee's decision to distribute, but is determining for itself whether the third-party claim can be safely disregarded by the trustee as unarguable or specious.

Trustees should therefore be cautious about dealing with trust assets when they have notice of a third-party claim, lest they fall foul of the Guardian Trust principle. Fortunately, trustees can mitigate this risk by an application for leave to distribute, which, if successful, will safeguard against future liability if the third-party claim turns out to be well-founded.

Marc Seddon appeared as Advocate for the successful party, C, in this matter.