As the role of the trustee has evolved, the question of liability has become more prominent. Sophie Mazzier reports on a Law Commission paper that has addressed issues of protection

The law Commission's consultation paper reviews the laws governing exemption clauses in various types of trusts. It looks at lay, professional and corporate trustees, together with pension and charity trustees, making provisional reform proposals, including the introduction of a statutory regime for the regulation of trustee exemption clauses.

A fundamental principle of trusteeship is that a trustee's failure to carry out their duties under a trust instrument is a breach of trust, and so the beneficiaries may take action to recover any loss flowing from that breach. Historically, families tended to rely on friends or family to fulfil the role of trustee, hence the definition of lay trustee. However, the nature of assets settled in trusts and their uses, particularly in a commercial context, have evolved considerably since the Knights Templar went off on the Crusades. The evolution of trust law to protect the interests of the beneficiary has not kept pace. With increasingly litigious beneficiaries and the proliferation of paid professional trustees – in circumstances inconceivable for our feudal forebears – trust draftsmen are now required to limit the potential liability of trustees as far as possible.

Modern trust deeds invariably contain clauses that purport to limit the extent of trustees' duties or their liability for certain acts they might undertake in carrying out their duties. More commonly in commercial trusts, there will be clauses that delimit the nature of the trustees' responsibilities, known as duty exclusion clauses, and often a trustee will incur no liability should they avail themself of such a provision. The consultation paper states that this is as much an exemption clause as the more obvious direct exclusion clause.

Current case law in Armitage v Nurse 1998 indicates that a trustee can be exempted from liability for loss or damage to trust property “no matter how indolent, imprudent, lacking in diligence, negligent or wilful”, so long as they have not acted dishonestly. But does this inspire confidence in an industry where many trustees are already covered by professional indemnity insurance and where they charge a fee for their services? Reassuringly, there cannot be a blanket limitation on a trustee's duties without the risk that the arrangement will fail altogether as a trust. The Court of Appeal held that there was an “irreducible core of obligations” owed to the beneficiary by the trustee, which is “fundamental to the concept of a trust”. This core consists of a duty to “perform the trusts honestly and in good faith for the benefit of the beneficiaries”.

The primary concern addressed by the Law Commission is that the extensive use of trustee exemption clauses, the breadth of these clauses and their liberal interpretation by the courts, serves to undermine the protection afforded to beneficiaries. The Law Commission made several provisional proposals addressing particular concerns.

The commission proposed that an absolute prohibition on trustee exemption clauses is not justifiable. It believes that the inherent benefits of the trust structure and its flexibility would be lost and that lay trustees may be deterred from accepting office.

The commission suggested that a distinction should be made between lay and professional trustees, the latter being subject to more stringent requirements. A professional trustee should not be able to rely on a clause that excludes liability for breach of trust arising from negligence. Any clause purporting to do so should not be effective. In determining whether professional trustees have been negligent, the court should have power to disapply duty exclusion or extended power clauses where reliance on them would be inconsistent with the overall purposes of the trust.

The paper stated that any regulation of trustee exemption clauses should apply to trusts governed by English law and to those carrying on a trust business in England and Wales, but not retrospectively.

Also suggested is that trustees should be given the power to purchase indemnity insurance for breach of trust out of the trust fund.

As a matter of good practice, the commission suggested that the trust draftsman should advise the settlor on the scope and effect of trustee exemption clauses and discuss alternative methods of protecting the trustees.

A comparison with other jurisdictions, such as Jersey and Guernsey, shows that professional trustees are not unduly hindered by statutory prohibition against relying on a provision in the trust instrument excluding liability for fraud, wilful misconduct or gross negligence. Indeed, the trust industry in such jurisdictions is thriving. The Law Commission's concern in following suit is the perceived need to distinguish clearly between 'negligence' and 'gross negligence'. While views are undoubtedly divided on this point, the commission's proposal is that any professional trustee should be denied the protection of a clause excluding liability for negligence, let alone gross negligence. This seems appropriate if professional trustees of family trusts are insured to act as such and charge for their services, leaving the presumably unremunerated lay trustee able to limit their liability if the clause satisfies a requirement of reasonableness. One wonders what impact this will have on the issue of joint and several liability, where the body of trustees comprises a mixture of lay and professional trustees.

Commercial corporate trustees use duty exclusion clauses, as opposed to negligence exemption provisions, as an important means of protection. If a trustee is asked to approve a modification to an issue, they will usually take extensive advice from their legal and professional advisers, as well as receiving a formal director's certificate from the issuer itself. Standard clauses protect a trustee from liability, and while no reputable trustee would rely purely on such a clause, they would, without doubt, gain an added measure of confidence to take decisions in difficult circumstances.

One probable consequence of not having protection clauses is that trustees might be reluctant to exercise their discretionary powers, except in straightforward situations. The consultation paper does not consider the possibility that trustees may simply refuse to accept discretionary powers in trust deeds, as in the US, on the basis that there is too much risk in operating them. From an issuer's perspective this must be highly undesirable, leading to a proliferation of meetings of holders with an ensuing additional delay and expense that might eventually result in the loss of many advantages of appointing a trustee. These costs could also affect trustee businesses, which might lose business in areas where use of a trustee is optional.

In view of the increasing development and use of trusts in the commercial arena and the continuing employment of professional trustees, this consultation paper is timely indeed. Comments are invited up until 30 April – thereafter, this will be a very interesting space to watch.

Sophie Mazzier is a professional support lawyer in the private client group at Allen & Overy