The opdu Report - Issue 17, November 2004

Advisory Service Forum
Trustee Exemption Clauses – An Endangered Species
Craig Monty

The role of trustee has never been one to take on lightly. It carries with it some of the most onerous duties and responsibilities known to the English legal system. These range from the fundamental fiduciary duties to act in good faith and in the interests of the beneficiaries, through duties to take skill and care in the administration of the trust, to absolute obligations to act in accordance with the terms of the trust instrument and not to act in a manner which is not authorised by that deed or by the general law. Given the range of these obligations it is perfectly possible, and indeed a commonplace, for trustees to find themselves in breach of trust and liable to the beneficiaries even though they have done their honest best in carrying out their duties.

All of this makes being a trustee a daunting and, on the face of it, unattractive proposition. That is particularly so if you are a lay person not versed in the complexities of trust law, but the risks are considerable even for the experienced professional trustee who makes his living from trusteeships. And that is all the more so in the field of pension scheme trusteeships where the last ten years have seen a plethora of new regulations aimed at increasing the protection given to scheme members. That regulatory burden will increase still further when the Pensions Bill comes into law. For example, clauses 236 to 238 of the Bill require individual trustees of occupational pension schemes to be conversant with or have knowledge and understanding of specified documents and matters relating to the performance of their functions. Thus, in the future trustees will be expected to be familiar with the statement of investment principles and the statement of funding principles, and possibly with the law in relation to pensions and trusts, the investment of assets and scheme funding.

It is little surprise, therefore, that pension scheme deeds routinely include trustee exemption clauses designed to give the trustees protection against actions for breach of trust. These clauses have been around for almost as long as the trust concept itself but they have come into their own in recent times as increasingly heavy demands have been placed on trustees with increasing scope for complaints about trustees’ conduct. The purpose of this article is to look at the current law on the construction and validity of such clauses, and then to consider how things are likely to change in the light of proposals made by the Law Commission.

The Current Law

A trio of cases concerning trustee exemption clauses came before the Court of Appeal in the late 1990s. In the first and most important of these, Armitage v Nurse [1998] Ch 241, the Court had to consider the meaning and effect of a typical exemption clause drawn from standard precedent books which provided as follows:

“No Trustee shall be liable for any loss or damage which may happen to Paula’s fund or any part thereof or the income thereof at any time or from any cause whatsoever unless such loss or damage shall be caused by his own actual fraud”.

It was argued by Paula, the beneficiary, that the reference to fraud must be taken to include “equitable fraud” so that the carve out from the exemption was much wider than at first appeared and covered conduct falling short of dishonesty. Millett LJ, with whom the other two judges agreed, was having none of this. It was clear to him that “actual fraud” meant what it said so that dishonesty was required and nothing less. This meant that a trustee found to have been negligent, even grossly negligent, was protected by the language of the clause. In Millett LJ’s words:

“[The clause] exempts the trustee from liability for loss or damage to the trust property no matter how indolent, imprudent, lacking in diligence , negligent or wilful he may have been, so long as has not acted dishonestly”.

The Court then had to consider Paula’s second line of argument to the effect that if the clause meant what Millett LJ said it meant then it was too widely cast and should be struck down on public policy grounds. In particular, it was argued that it was impermissible to exclude liability for breaches of trust that involved gross negligence. Millett LJ referred to academic literature which supported this view based on nineteenth century authorities and a line of Scottish cases. The judge found that these cases did not mean what the academics took them to mean so that there was no rule of law precluding the exclusion of liability for gross negligence. He accepted Paula’s argument that there is an irreducible core of obligations owed by trustees to beneficiaries and enforceable by them which is fundamental to the concept of a trust. But he did not accept that these core obligations include the duties of skill and care, prudence and diligence.

“The duty of the trustees to perform the trusts honestly and in good faith for the benefit of the beneficiaries is the minimum necessary to give substance to the trust, but in my opinion it is sufficient.”

So unless there is a subsequent conflicting decision from the House of Lords (leave to appeal in Armitage v Nurse itself was refused), the position on the cases is now clear – it is perfectly acceptable for a trustee exemption clause to exclude liability for everything save dishonesty.

In Bogg v Raper (1998/99) 1 ITELR 267, the Court of Appeal had to determine whether a trustee exemption clause, on its true construction, was apt to protect the trustees against the allegations there made. Millett LJ (again) gave guidance on the correct approach to be adopted. It was common ground that the clause should be restrictively construed and that anything which was not clearly within it should be treated as falling outside it; liability could only be excluded by clear and unambiguous words. Counsel for the beneficiaries asked the Court to go further than this and to invoke a principle taken from the law of contract that in situations of ambiguity the words of a document are to be construed more strongly against the party who made the document. Millett LJ noted that in a contractual setting this makes perfect sense because the party seeking to rely on the clause will typically be the party who has drafted the document in which it is contained. But that is not so in the trust setting where the clause is the work of the settlor. Millett LJ held that since trustees accept office on the terms of a document for which they are not responsible they are entitled to have the document fairly construed according the natural meaning of the words used. Applying this approach, the Court found that the clause did indeed give protection to the trustees.

The third in the trio of Court of Appeal cases was Wight v Olswang (No 2) (1999/2000) 2 ITELR 689 in which the Court had to interpret a trust deed containing two exemption clauses which were inconsistent. The first clause appeared to apply to trustees generally and excluded all liability save for wilful and individual fraud and wrongdoing. The second clause provided that no trustee (other than a trustee charging remuneration for so acting) should be liable for any error of judgment or mistake of law or other mistake or for anything save wilful misconduct or wilful breach of trust. The express carve out of paid trustees from the second clause suggested that they were to be liable for errors of judgment etc, but that was contradicted by the first clause which appeared to exculpate all trustees for all conduct save for fraud. Something had to give, and the Court found that it was the first clause. That clause had to be read subject to the second so that paid trustees could indeed be made liable for errors of judgment etc.

The Law Commission Consultation Paper

Although the general approach of the Court of Appeal (and Millett LJ in particular) may be thought to be sympathetic and highly favourable to trustees, Millett LJ acknowledged in Armitage v Nurse that the view was widely held that trustee exemption clauses had gone too far and that trustees who charge for their services should not be allowed to rely on such clauses to relieve them of liability for gross negligence. He noted that trustees in Jersey are not allowed so to rely and that the matter was being looked at by the Trust Law Committee. Millett LJ concluded with the thought that if exemption clauses were to be denied effect then it was better for Parliament to do so after wide consultation with interested bodies.

Parliament subsequently took up the invitation issued by Millett LJ and the Lord Chancellor referred the matter to the Law Commission. The Commission issued a Consultation Paper in December 2002 expressing preliminary recommendations and canvassing views of interested parties.

The Commission clearly felt that the current law gives too much protection to trustees at the expense of beneficiaries. It noted that the only generally applicable restriction is that identified in Armitage v Nurse (ie the rule against excluding liability for fraud) which it felt is, in truth, no restriction at all. A contractual attempt to exclude liability for negligence would be subject to the Unfair Contract Terms Act 1977; the point has not been tested in the Courts but the better view is that this Act has no application to trustee exemption clauses. In the pensions context, section 33 of the Pensions Act 1995 prohibits attempts to exclude liability so far as investment duties are concerned but apart from that there is no statutory restriction.

The Commission considered a number of options for reform all of which draw a sharp distinction between lay trustees and professional trustees. The Commission felt that exemption clauses, unrestricted save by the Armitage v Nurse rule, could be justified in the case of lay trustees and have an important role to play in ensuring that lay trustees continue to be willing to act as such. But there had to be regulation in relation to professional trustees and the proposal which the Commission provisionally preferred would preclude professional trustees from relying on exemption clauses to exclude their liability for breach of trust arising from negligence.

This is a radical proposal which, if adopted by Parliament, would have far reaching consequences for professional trustees, those that employ them and those that are members of pension schemes administered by them. The proposal goes further than the position urged on the Court of Appeal in Armitage v Nurse by counsel for Paula and further than the legislature in Jersey and Guernsey have gone – what is proposed by the Commission would prohibit the exclusion of liability for any type of negligence, not just gross negligence. The proposal also goes much further than the Unfair Contract Terms Act with its test of whether it is reasonable to allow reliance on an exemption clause in the particular circumstances of the case. What is contemplated by the Commission is a blanket prohibition

If the Commission stands by its proposal following the consultation process and the proposal is passed into law, it seems inevitable that indemnity insurance premiums will increase. And it is equally inevitable that professional trustees will seek to pass those increases on to the schemes they administer by way of increased charges. The Commission recognised these as likely consequences but felt on balance that it was preferable for beneficiaries to have a right of recourse in the event of negligent breach of trust even if they had to bear the cost of the insurance that would provide that recourse.

The Law Commission’s final report and draft Bill is awaited with interest by those in the pensions industry and by professional trustees in particular. They are expected to be published early in 2005.

Craig Monty
Partner Dickinson Dees
0191 279 9000
craig.monty@dickinson-dees.com