The decision in Meritus Trust Company Limited v Butterfield Trust, a decision of the Supreme Court of Bermuda, considers the practical matter of whether a removed trustee can retain sufficient trust assets against which to enforce its indemnity in relation to a contingent costs liability. In this case the contingent costs liability was estimated at $5 million and related to the defence of the threatened claim in respect of the removed trustee’s management of the trust assets.
As noted in the decision “The changing of the guard took place under the dark cloud of a threatened claim against the former Trustee and so the transfer process was, from the outset, somewhat prickly.”
In simple terms the removed trustee wanted to retain some trust assets so that it was protected for its costs; the new trustee was of the view that all assets should be transferred to the new trustee.
The Supreme Court of Bermuda concluded that the removed trustee “… is neither entitled to retain any part of the trust assets as security for its equitable indemnity as former Trustee of [the Trusts] nor to an equitable contractual indemnity.
Note that s 27(d) and 30 of the Trustee Act 1975 (Bermuda) are substantially based on s 39(2) and 40 of the Trustee Act 1925 (England and Wales), which are substantially similar to s 45 and 47 of the Trustee Act 1956 (New Zealand).
The reasoning for this decision provides a useful overview of the law regarding trustees rights of indemnity. The discreet point highlighted in the decision is that trustees have no right of retention of trust property after trusts assets have vested in a new trustee. See Lewin in Trusts’ Nineteenth Edition:
“17-031 A trustee’s rights of indemnity under the general law consist of reimbursement, exoneration, retention and realisation. A trustee who ceases to hold office and to have the trust property vested in him must lose his right of retention for he has ceased to retain the trust property….An outgoing trustee might retain his rights of retention by deferring vesting of some or all of the assets pending settlement of claims….
17-033 Further, retention of assets by an outgoing trustee is inconsistent with the statutory provision which requires that on an appointment of new trustees any assurance or thing requisite for vesting the trust property in the new trustees should be executed or done. We do not consider that this statutory provision imposes an absolute bar on retention by a former trustee as an incident of his right of indemnity, and indeed there is English6, Australian and Cayman authority suggesting that there is a continuing right of retention against new trustees. But normally the trust property will be vested in the new and continuing trustees and the former trustee will be protected either under his continuing rights of reimbursement and exoneration under the general law or, most often, under express indemnity and, where appropriate, express security arrangements.” [Emphasis added]
The following consideration of whether a trustee’s equitable right to an indemnity included a right of retention which could be asserted against a new trustee by Brerton J in Lemery Holdings Pty Ltd v Reliance Financial Services Pty Ltd is a useful consideration of the relevant authorities:
“13 The relevant principles concerning a trustee’s right of indemnity against trust assets include the following, for which I am indebted in large part to the analysis by Austin J in Trim Perfect Australia v Albrook Constructions  NSWSC 153, .
14 First, as against a third party, a trustee is personally liable for debts and liabilities incurred in its capacity as trustee [Vacuum Oil Co Pty Ltd v Wiltshire (1945) 72 CLR 319; Octavo Investments Pty Ltd v Knight (1979) 144 CLR 360, 367].
15 Secondly, however, the trustee has a right of indemnity out of the trust assets for expenses or liabilities incurred by the trustee, by recoupment of expenditure and exoneration from liability [Octavo Investments, 367; Chief Commissioner of Stamp Duties for New South Wales v Buckle (1998) 192 CLR 226, 245].
16 Thirdly, this right of indemnity, recoupment and exoneration is secured by an equitable lien over the trust assets, which arises by operation of law and confers a proprietary interest, in the nature of a security interest, in the trust assets, and takes priority over the claims of beneficiaries [Octavo Investments v Knight, 367, 370; Chief Commissioner of Stamp Duties v Buckle, 246].
17 Fourthly, this equitable lien extends to all of the trust assets, save only those that are specifically excluded by the trust instrument [Dowse v Gorton  AC 190; Octavo Investments v Knight, 367].
18 Fifthly, being an equitable lien, the security is enforceable by the trustee only by judicial sale or appointment of a receiver, and not by foreclosure nor by sale out of Court [Tennant v Trenchard (1869) LR 4 Ch App 537; ANZ Banking Group Ltd v Intagro Projects Pty Ltd  NSWSC 1054, ; Melbourne Tramways Trust v Melbourne Tramway & Omnibus Company Ltd (1887) 13 VLR 487, 490; Re Pumfrey (1882) 22 Ch D 255, 265; Re Stucley  1 Ch 67; Davies v Littlejohn (1923) 34 CLR 174, 184; Hewett v Court (1983) 149 CLR 639, 663; Sykes & Walker, The Law of Securities, 5th ed, (1993) Lawbook Co, 198].
19 Sixthly, the right of indemnity accrues at the time the obligation is incurred [Xebec Pty Ltd (in liq) v Enthe Pty Ltd (1987) 18 ATR 893; Southern Wine Corp Pty Ltd (in liq) v Frankland River Olive Co Ltd  WASCA 236; (2005) 31 WAR 162, ], and is not subsequently lost by cessation of office, whether by retirement or removal [Xebec v Enthe, 898; Coates v McInerney (1992) 7 WAR 537; Southern Wine Corp v Frankland River Olive Co, ; Dimos v Dikeakos Nominees Pty Ltd (1996) 68 FCR 39, 43].
20 Seventhly, upon bankruptcy or liquidation of a trustee, its right of indemnity vests in its trustee in bankruptcy or liquidator [Official Assignee of O’Neill v O’Neill (1898) 16 NZLR 628; Jennings v Mather  1 QB 108, 117; Savage & Whitelaw v Union Bank of Australasia Ltd (1906) 3 CLR 1170, 1188, 1196; Octavo Investments v Knight; Re Suco Gold Pty Ltd (in liq) (1983) 33 SASR 99, 109; (1983) 7 ACLR 873, 882].
21 Eighthly, if the trust property is transferred to a new trustee, the lien survives and the new trustee takes subject to the lien of the old trustee – except perhaps in the exceptional case of a bona fide purchaser for value without notice [Belar Pty Ltd (in liq) v Mahaffey  QCA 2;  1 Qd R 477, ; Octavo Investments v Knight, 370; Chief Commissioner of Stamp Duties v Buckle, 246; Re Exhall Coal Co Ltd (1866) 55 ER 970].
22 Ninthly, a trustee is entitled to retain possession of trust property against a beneficiary until its indemnity is exercised [Octavo Investments v Knight, 369-370; Chief Commissioner of Stamp Duties v Buckle, 246; Re Exhall Coal Co Ltd, 972; Re Enhill Pty Ltd  1 VR 561].
Also see S and S Limited v XYZ Limited where the New Zealand High Court declined to uphold caveats that had been lodged against former trust property to support an equitable lien arising from a trustee’s right of recourse to trust assets distributed from the trust of which the plaintiff to a subsequent trust to discharge liabilities incurred and recoup expenses paid as a trustee. Note that the liabilities referenced were potential liabilities that had not crystalised.