01 June 2007

Fraud and trust litigation news - summer: Breach of trust

Barnes & Others v. Tomlinson & Others [2006] EWHC 3115, Chancery Division (Kitchin J)

Facts of the case

The Claimants sued the Defendants who had been trustees of a family settlement (“the Trust”) established by the First Claimant in 1973.  The Defendants were also directors of a private company engaged in property development whose shares formed the principal asset of the Trust.  The First Claimant had procured substantial bank loans taken out in the name of the Trust and this coupled with the collapse of the property market in the mid 1970s led the Defendants to believe the Trust was insolvent.  However, the Defendants spent considerable time and effort restoring the fortunes of the development company by paying off loans and developing a residential site in which the company had an interest.  As the company's financial condition improved, the Defendants paid themselves emoluments.  The Second Defendant resigned as a director of the company in 1997 because of other business commitments and eventually all three Defendants retired as trustees in 2000.  The Claimants at that stage issued proceedings against the First Defendant and another director of the company K, against both of whom the Court awarded substantial damages for misfeasance.  In these proceedings the Claimants argued that the Second and Third Defendants (against whom there had been no findings of misfeasance in the earlier proceedings) had received excessive emoluments as directors and had failed to take any steps as trustees to remove the First Defendant and K from their directorships and that these omissions had caused significant losses to  the Trust. 

The decision

Mr Justice Kitchin dismissing the claim, said it was accepted that under the exoneration clause contained in the Trust Deed, the Second and Third Defendants were exempted from liability except for wilful and individual fraud or wrongdoing.  This meant that to succeed against the Second and Third Defendants (D1 had died shortly before the issue of proceedings) the Claimants had to prove dishonesty.  It was for the Court to determine what was the normally acceptable standard of honest conduct.  Following the Privy Council decision in Barlow Clowes International Limited v. Eurotrust International Limited [2006] 1 WLR 1476, it was irrelevant that a Defendant genuinely believed he had not fallen below that standard.  The test of honesty in this context was whether the Trustees were conscious that they were committing a breach of duty or were recklessly indifferent as to whether they were.  Upon examining the amount of work the Trustees had undertaken in an honest effort to restore the trust fortunes, all of which was evidenced by voluminous documentation, the level of emoluments taken was not unreasonable and did not exhibit dishonesty.  The Second and Third Defendants could not be held responsible for the activities of the First Defendant and K. The accounts did not reveal any evidence of mismanagement and the Trustees under the terms of the Trust Deed were entitled to leave the conduct of the company's affairs to the Board of Directors.  The Judge ruled the Second and Third Defendants had acted in good faith and honestly at all material times.  The Court accordingly awarded both the Second and Third Defendants' their costs on the indemnity basis.  The Second Defendant was represented by Withers LLP

Points of interest

The Judge applied the test of dishonesty laid down in the Barlow Clowes case (which concerned an offshore investment scheme) in the context of an express family trust.  The Judge also made it clear that in seeking to make Trustees liable for misfeasance in a company whose shares were held as part of the Trust assets, provided that the Trust deed had the usual provision relieving the Trustees of the obligation to concern themselves in the day to day management of that company, then the clearest possible notice of that misfeasance would be required to make the Trustees liable. 

Category: Article