TRUSTS AND THE NO REFLECTIVE LOSS PRINCIPLE

TRUSTS

AND THE NO REFLECTIVE LOSS

PRINCIPLE

by

Victor Joffe QC

2

Trustee’s Primary Duties under Jersey Law

1. Subject to the Trusts (Jersey) Law 1984, a trustee must carry out and administer the trust in accordance with its terms: Art 21(2)

2. In the execution of its duties and in the exercise of its powers and discretions, trustees must (Art 21(1)) –

(a) act (i) with due diligence, (ii) as would a prudent person, (iii) to the best of the trustee’s ability and skill; and

(b) observe the utmost good faith.

3

What if the Trustee acts in Breach of Trust or Breach of Fiduciary Duty?

1. Removal as Trustee?

2. Personal Liability : Art 30(1)

3. Equitable compensation – the restoration of the Trust

Fund : Art 30(2)

4. Litigation

4

How can Trustee liability arise?

1. Improper investment

2. Failure to supervise: Bartlett v Barclays Bank Trust Co [1980]

Ch 515

3. Failure to exercise discretion

4. Excessive compliance with wishes of settlor or beneficiaries

5. Fraud on power

6. Failure to keep proper accounts and records (Art 21(5))

5

How can Trustee liability be avoided or mitigated?

1. Exemption and anti-Bartlett clauses (Art 30(10) saving for

trustee’s fraud, wilful misconduct or gross negligence)

2. Release or indemnity by beneficiary: Art 30(6) and (7)

3. Relief by Court: Art 45

4. Prescription: Art 57

6

Reflective loss – Another Way to Avoid Liability?

The paradigm fact situation:

1. Trustee: X Trust Co Limited

2. Holds shares in ABC Limited

3. Whose directors Mr D and Ms E cause ABC to enter into a transaction

4. Which causes loss to ABC

5. Which in turn causes value of Trust’s shares in ABC to fall in value

7

What is reflective loss?

1. G Limited is a company owned by H, its shares worth £250,000.

2. It buys a piece of land for £100,000 to build on, but its Advocate

negligently fails to notice a covenant prohibiting development

3. Land is in fact worth only £10,000 – G Limited suffers loss

4. Consequently, shares in G Limited worth only £160,000 and it

can no longer pay dividends to H.

5. H’s loss reflects that of G Limited

8

General Rule: Shareholder cannot sue the wrongdoer for reflective

loss – ONLY the company can sue: Johnson v Gore Wood & Co [2002] 2 AC 1

Exceptions:

1. Company has no cause of action

2. Shareholder suffers separate and distinct loss caused

by breach of duty owed to him independently

3. [Quaere] Wrongdoer disables company from suing

9

Why a Rule Preventing Recovery of Reflective Loss?

1. To prevent double recovery: protection of the Defendant

2. To protect the company’s creditors: protection against the

Plaintiff extracting value from the company

10

Position where Shares are Held by Trustees of Trust

Exactly the same as the General Rule:

The Trustee (as shareholder), director (even if he is the Trustee or is appointed by the Trustee) and the beneficiary cannot sue for the loss suffered by the Company – ONLY the Company can sue

11

Where the Trustee is the Wrongdoer

Example: Trustee/director of Trust-owned company causes it to enter improvident transaction.

The conventional position: Gardner v Parker [2004] 2 BCLC 554, 565:

“…it appears clearly to have been determined in [Shaker v Al-Bedrawi [2003] 1 BCLC 157] that, even when the claim is brought by a beneficiary against a trustee for breach of fiduciary duty, it can be barred by the [no reflective loss principle]. ”

Trustee Failure to Supervise the Directors of Trust-Owned Companies

Example: Trustee fails to prevent directors of trust-owned company from misusing company’s assets or diverting them to third parties

Position in England:

Walker v Stones [2001] QB 902: Beneficiary can sue Trustee where1. He can establish Trustee’s conduct has constituted a breach of

some legal duty owed to him personally;2. The breach of duty has caused Beneficiary personal loss,

separate and distinct from any loss that may have been occasioned to any corporate body in which he may be financially interested.

Is Jersey any Different?

Freeman v Ansbacher Trustees (Jersey) Ltd [2009] JLR 1

The facts:

Assets of a discretionary trust held by a company, SDR, the shares in which were all held by the Trustee. The plaintiff beneficiaries alleged Trustee failed to supervise SDR in respect of three transactions which caused it loss.

Trustee sought to have the claim struck out, relying on the no reflective loss principle. The Royal Court proceeded on the basis that the claims raised were reflective of SDR’s losses, and held at that the principle formed part of the law of Jersey.

Does the No Reflective Loss Principle Apply to a Jersey Discretionary Trust?

Birt DB:

“I accept that, if the [no reflective loss] principle applies to the present case, the order of justice should be struck out. However, I am by no means convinced that the principle should necessarily be applied to a situation such as the present involving a discretionary trust. I think it is not entirely clear that the principle would necessarily be applied in England; but even if it were, I consider that there are strong grounds for believing that Jersey law should follow a different path…”

Possible Bases of Action against Jersey Trustee

1. Beneficiaries ask Trustee to replace directors so new directors can cause company to sue former directors

2. If Trustee refuses to replace directors, beneficiaries bring action against it for new breach of trust

3. Derivative action by beneficiaries

The DB’s Solution?

Where Plaintiff seeks reconstitution of the trust fund, the remedy is at the discretion of the court: the court could arguably direct the Trustee to reimburse or refinance the trust-owned company.

Thus the company would no longer have suffered any loss and could not bring any claim against its directors, thereby removing the danger of double recovery.

The Lesson to be Learned?

1. The no reflective loss principle may not protect a Trustee from action where it has failed properly to supervise the directors of a trust-owned company.

2. The Trustee should check its PI policy.

Protecting your Position as Trustee 2010

Trusts and the no reflective loss principle:

commentary

Paul Tracey

1 October 2010

1. What is the reflective loss principle?

• a company has suffered a loss caused by the breach of a duty owed both to the

company and to its shareholder/s

• Johnson v Gore – Wood and Co [2002] 2 AC 1:

“… where the company suffers loss caused by the breach of a duty owed both to

the company and the shareholder. In such a case the shareholder’s loss, insofar as

this is measured by the diminution in value of his shareholding or the loss of dividends,

merely reflects the loss suffered by the company in respect of which the company

has its own cause of action. If the shareholder is allowed to recover in respect of such

loss, then either there will be double recovery at the expense of the defendant or

the shareholder will recover at the expense of the company and its creditors and other

shareholders. Neither course can be permitted. This is a matter of principle; there

is no discretion involved. Justice to the defendant requires the exclusion of one

claim or the other; protection of the interests of the company’s creditors requires that it is

the company which is allowed to recover the exclusion of the shareholder. These

principles have been established in a number of cases, though they have not

always been faithfully observed.”

What is the reflective loss principle?

• an exclusionary principle

• a company law principle; not a trust law principle

• clear it applies to shareholders in a company with cause or

causes of action against directors (where the company also

enjoys a cause or causes of action against directors) but

should it apply to beneficiaries of a trust against a trustee

who has acted in breach of trust?

2. What is the rationale for the principle?

• Proper plaintiff in respect of loss suffered by a company is the

company, not its shareholders

• Prevention of double recovery

• Protection of company’s creditors (because any recovery would

go to shareholder/s, not company)

• How compelling are these reasons in a trust situation?

• Do these reasons have the same cogency, weight or

persuasiveness in the context of a trust compared with a

situation of pure breach of directors’ duty?

3. How does the principal operate in context of breach of duty by trustee causing loss to trust estate?

• Companies the issued share capital of which is held in whole or

in part on a trust (possibly through other companies)

• Who does the plaintiff want to sue? Directors or trustees?

• Lewin at para 39 – 37:

“Questions arise … whether recovery of [a] loss [to a trust fund or

estate] in an action against … trustees is barred by the rules

against recovery of reflective loss if the loss is one in respect of

which [a] company has, or has had, a cause of action and the

loss is reflected in the diminution in the value of the trust

shareholding.”

How does the principal operate in context of breach of duty by trustee causing loss to trust estate?

• May involve positive action by a trustee (eg authorising

the directors of the company to do something otherwise in

breach of their duty and which causes loss to the

company) or omissions by a trustee (eg failure to act or failure

to supervise directors)

4. What is the English position?

• Walker v Stones [2001] QB 902 at 927:

- defendants’ conduct breached a duty owed to plaintiff

personally

- that breach caused plaintiff loss separate and distinct

from any loss suffered by company in which plaintiff

has an interest

- what is meant by a separate loss?

What is the English position?

• But see now:

Shaker v Al-Bedrawi [2003] Ch 350;

Gardner v Parker [2004] 2 BCLC 554;

Barnes v Tomlinson [2007] WTLR 377:


All following Johnson v Gore-Wood & Co [2002] 2 AC 1 and

authorities for the propositions that, first, “[t]he fact that the

beneficiaries‘ claim may be a claim for breach of fiduciary duty

is not a reason why the reflective loss principle should not

apply” (Lewin at para 39-38) and “… the reflective loss principle

normally does prevent the beneficiaries from recovering the

diminution in the value of the trusts shareholding in a breach of

trust action caused by a breach of duty by the trustee as a

director of the company concerned fro which the company

has a claim against the director” (ibid; emphasis mine)


• But see also:

Giles v Rhind [2003] Ch 618:

Reflective loss principle does not apply if the

defendant’s/s’ actions have stripped the relevant company

of funds such that the company is unable to pursue action

against the directors

5. What is the nascent Jersey position?

• Freeman v Ansbacher [2009] JLR 1

• The case’s facts:

- “at all material times the shares in [the company] SDR were

the sole significant asset of the Trust and all the

underlying assets were owned by SDR or its subsidiaries.”

(id at 8)

- application to strike out an order of justice on ground, in

part, “that the losses claimed … were merely reflective of

the losses suffered by SDR and were not therefore

recoverable at the instance of the beneficiaries”

(id at 28)

What is the nascent Jersey position?

• The Bailiff’s judgment and reasons:

“(None of the English cases has had to consider the position where

there is a discretionary trust. It seems to me strongly arguable that the

two reasons for the principle may have no application in a case such

as the present. Rosanna has no entitlement to the trust fund. She will

not be entitled to receive any moneys paid out by Ansbacher. She is

merely seeking reconstitution of the trust fund. It seems to me strongly

arguable that the remedy, were breaches of trust on Ansbacher’s part

proved, is at the discretion of the court and, being an equitable

remedy, may be moulded to suit the circumstances of the case.


Thus, in the event of the breaches of trust being proved, the court could

arguably order Ansbacher to reconstitute the trust fund exactly by reimbursing

that particular part of the trust fund which had been primarily affected by the

breach of trust. Thus, the court could order Ansbacher to reimburse SDR from

where the funds had been lost in the first place. Alternatively, if it was felt that

the court could only order Ansbacher to reimburse the trust fund itself by putting

the appropriate moneys into the trust fund, it seems to me arguable that the

court could nevertheless direct as a term of such relief that the funds be used to

acquire new shares in SDR, so that the funds eventually find their way in to

SDR. This would have the effect of exactly reconstituting the trust fund

because it would take the value of the shares in SDR back to what they had

been previously and the financial position of SDR back to what it had been.

Such remedies may not be available in all cases but it seems to me strongly

arguable that they are available where the company in question is wholly

owned by a discretionary trust.” (id at 37-38)


• “Like Sir Christopher Slade, I consider that there are strong policy reasons

for thinking very carefully before applying the Prudential principle in all its

rigour to claims by beneficiaries of a discretionary trust in respect of alleged

mismanagement of a company which is wholly owned by the trust and

where the remedy sought is reconstitution of the trust fund. The case of

Bartlett v. Barclays Bank Trust Co. Ltd. … (which confirmed the duty

of trustees to supervise the affairs of a company of which they were the

controlling shareholder) is a case engraved on the hearts of all trust

lawyers. Like Sir Christopher, it seems to me that, if the Prudential principle

is to be applied fuly to cases such as the present, that case must have

been wrongly decided and it is difficult to envisage when such an action

could ever be brought in future because the loss suffered by the trust will

almost invariably be reflective of the loss suffered by the company.”

• (id at 40)


• “I accept that these options are available to the beneficiaries. But they are

complex and far removed from the real complaint, which is that the trustee

failed to ensure that its employees (in the form of directors of the company)

managed the investments prudently. Once can, for example, envisage the

possibility of difficulty in finding a new trustee willing to embark on litigation

against the old trustee or against the directors of the company.

Alternatively, the new trustee might differ from the beneficiary on the strength

of the case. A Beddoes application (with its additional costs) would

certainly be necessary. In relation to the first alternative, one can

envisage questions about when such a breach of trust would become

actionable. Would the beneficiaries have to wait until the limitation period f

or the company to claim against the directors had expired? All of the

options would involve the beneficiary in becoming involved in satellite

litigation rather than addressing the real complaint.” (id at 42)


• “In my judgment, it would not reflect well on the law or on Jersey as

a centre for the administration of trusts if beneficiaries had to go

through these considerable hoops unless it was absolutely

unavoidable. It is of the first importance that beneficiaries of a trust

whose assets have been mismanaged should have a simple and

effective remedy available to them, whether such assets are held

directly by the trustee or through a wholly-owned company. I

consider that it is strongly arguable that the law of Jersey provides

this simple and effective remedy in a case such as the present by

enabling the court to order the defaulting trustee to reconstitute the

trust fund by reimbursing the company for its losses, thereby

removing both reasons for the application of the prudential

principle.” (ibid)

6. Should Jersey follow England here?

• Lewin: “… it is necessary to consider whether the reasons for

exclusion of recovery of reflective loss outside of a trust context

apply also in the trust context” (para 39-40)

• Trust investments and/or trading all but invariably carried out

through companies

• Obvious injustice arises from rigid and unbending application of

principle

• Any justification for not applying principle or applying it with

greater discrimination where there is also loss to a trust estate?

Should Jersey follow England here?

• Mischief at which principle directed can be prevented otherwise

in a trust context

• How convincing is the Bailiff’s reasoning in Freeman v

Ansbacher?

• How much weight do the English authorities have in Jersey

compared with the Bailiff’s decision in Freeman v Ansbacher?

• Where in English authorities is the reasoning for an unbending

application of the principle in trust context?

Should Jersey follow England here?

• One clear situation where principle will not apply:

trustees’ authorisation (as sole shareholder/s) of

prejudicial corporate action which, in absence of such

authorisation, would be the basis of claim by company

against directors (act of authorisation as shareholder a

breach of duty as trustee but prevents company suing

directors)

Litigation and dispute resolution solicitors

How safe are your trusts’ assets?

The risks faced by third party tracing claims and fraud

By Virginia Rylatt


Investment in English Companies

• Reliance on auditors’ reports to confirm accounts of a company give a true and fair view?


Caparo Industriesv

Dickman

[1990] 2 AC 605


Stone & Rolls Limited In Liquidation

v Moore Stephens (a firm)


Komercni Banka A.S.(“K.B.”)

Stone & Rolls

Funds paid to 3rd parties connected to Mr Stojevic

(S&R’s Manager, Shadow Director and Mr Stojevic held a Power of Attorney)

FundsFundsFalse letters or creditFalse letters or credit


Ex Turpi Causa

The principle of public policy Ex Turpi Causa was explained by Lord Mansfield CJ in Holman v Johnson (1775) 1Cowp 341.

“No court will lend its aid to a man who founds his cause of action on an immoral or an illegal act. If, from the Plaintiff’s own stating or otherwise,

the cause of action appears to arise Ex Turpi Causa....there the court says that he has no right to be assisted”.


Whether the knowledge of Mr Stojevic of the fraud

should be attributed to the Company. If so thenthe Company itself will be part of the fraud and the

“Ex Turpi Causa” principle would apply;


Whether the “Ex Turpi Causa” principle applied in respect

of the auditors’ duty to spot fraud which was “the very thing”it was engaged to do.


Moore Stephens application to strike out Stone & Roll’s

claim failed before Langley J.


Moore Stephens’s Case

Stone & Rolls liable for its dishonest acts


Liquidator’s Case

Stone & RollsA victim of fraud with a £94m judgment against it.


Re: The Hampshire Land Company [1896] Ch 743

The Hampshire Land Principle

A company will not have attributed to it knowledge of a fraud when

that fraud is against the company itself


Moore Stephens’s Case

In a one person company the directing mind and will of that person

(Mr Stojevic) must be imputed to the company soThe Hampshire Land principle does not apply.


Court of Appeal

Hampshire Land will only apply where the Agent intendsto harm the company or it is the target (as opposed to

here when the bank was the target)


Exception to the Ex Turpi Causa principle:

“The Very Thing” argument.


Where “The Very Thing”

= commission of a criminal offence

No exception to Ex Turpi Causa principle


Stone & Rolls’ Claim

Struck Out


Lord Walker

Lord Brown of Eaton-under-Heywood

• Stone & Rolls defrauded Bank K.B.

• Ex Turpi Causa Defence applies

• So Stone & Rolls’ claim v. Moore Stephens should be struck out.


Lord Scott

Mr Stojevic’s Power of Attorney does not authorise fraud on Bank K.B.


Lord Scott

“That abuse of the Power of Attorney was an essential featureof Mr Stojevic’s fraudulent scheme and, as it seems to me,

Stone & Rolls was a victim of that abuse”


Lord Scott

• Abuse of Power of Attorney causes Stone & Rolls to pay away monies received from Bank K.B.

• Corporate Veil cannot be lifted where Mr Stojevic not absolute beneficial owner.

• No attribution of Mr Stojevic’s dishonesty to Stone & Rolls.

• Stone & Rolls a legal Person in its own right.


Lord Scott

• Any benefit to Mr Stojevic would offend the Ex Turpi Causa rule.


Lord Scott

No reason why the Ex Turpi Causa rule based on public policyshould bar action against the auditors based on auditors’breach of duty to the company.


Stone & Rolls claim v Moore Stephens – Strike Out?

Lord Walker and Lord Brown

Lord Scott

YesYes

NoNo


Lord ManceShareholders

Stone & Rolls v

Mr Stojevic

• Ex Turpi Causa would not apply.• Stone & Rolls a separate legal entity from Mr Stojevic.• Mr Stojevic conduct a fraud on Stone & Rolls.


Lord ManceMr Stojevic

100% share holder

vMr Stojevic

1. If Stone & Rolls solvent – possibly no claim2. But if Stone & Rolls insolvent (as it was)

– Mr Stojevic in breach of his duties to the company, in this he failed to have regard to interests of creditors.

– Stone & Rolls could sue Mr Stojevic and Ex Turpi Causa would not apply.

Stone & RollsStone & Rolls


Lord ManceShareholders

Stone & Rollsv

Moore Stephens

• Ex Turpi Causa defence would not work to defeat claim v.Moore Stephens for failing to detect the very fraud that they asserted and relied by way of that Defence.


Lord ManceMr Stojevic

100% share holder

v

1. Stone & Rolls solvent – no actionable breach by Moore Stephens

2. But as insolvent – – “Just as Mr Stojevic was in breach of his duty to have regard to the

interests of the creditors so the auditor’s duty to the company extended beyond the interest of the shareholders to the interest of the creditors.”

– Ex Turpi Causa - Not a Defence.

Stone & RollsStone & Rolls

Moore StephensMoore Stephens


Stone & Rolls’ claim v Moore Stephens – should it be struck out?

Lord Walker and Lord Brown

Lord Scott and Lord Mance

YesYes

NoNo


Lord Phillips

Stone & Rolls bound by Mr Stojevic’s conduct.


Lord Phillips Fraudulent business was

“The business of Stone & Rolls carried on in the first instance to benefit Stone & Rolls”.


Lord Phillips The Hampshire Land principle did not apply.


Lord Phillips Duties of auditors test per Lord Hoffmann in

Banque Bruxelles Lambert SAv

Eagle Star Insurance Co Ltd(sub nom South Australia Asset Management Corporation

vYork Montague Limited)

– Duty of Care is very specific.


Lord Phillips

To recover damages, S & R would have to establish that Moore Stephens’ duty of care was owed for the benefit of those that the company might defraud.

No prospects of establishing this


Lord Phillips

• Ex Turpi Causa does provide a Defence.

• Claim by Liquidators of Stone & Rolls v Moore Stephens struck out.


Lord Mance

Company v

Auditors


Lord Mance

Q. Should Auditors have duties towards a company which requirethem to have detected and reported fraud?

A. Yes.


Tracing provides route for total recovery –

Not just one of a member of creditors.


• Establish your right to trace – • Need to establish your ownership of the money

• A debt owed to you by a bank does not give you a tracing claim.


England & Wales Tracing e.g. £5,000 Bank account

BUT NOT into a mixed fund Bank account

Common LawCommon Law

£5,000£5,000

£3,000 + £5,000 £8,000

£3,000 + £5,000 £8,000


In can trace into a mixed fund but “There must be a fiduciary relationship which calls the equitable jurisdiction into being” per Fox L.J. in Agip (Africa) Ltd v Jackson & Others [1991] Ch 547.

EQUITYEQUITY


Devaynes v Noble, Clayton’s case (1816) 1 Mer 572

(1) A£10,000

So (1) + £10,000 (2) + £10,000

(3) - £10,000

A’s money has been spent so he has lost his tracing claim – as only B’s money remains in the account.

FIRST IN FIRST OUT RULEFIRST IN FIRST OUT RULE

B Innocent Volunteer


Tracing in Jersey


Peter Shalson & OthersV

Onofrio Russo & Others[2005] 2WLR 1213


Where a Trustee uses money from a fund in which he has mixed those

monies with his own, he uses his own monies first.

Re: Hallet’s Estate [1880] 13ChD 698


Not an inflexible rule

Oatway HertsletV

Oatway [1903] 2 Ch 356




Thank youThank you

Virginia Rylatt

Protecting your Position as Trustee 2010

How safe are your trusts’ assets?: the risks posed

by third party tracing claims and fraud:

commentary

Paul Tracey

1 October 2010

1. The claims against trust assets: a plan of action for trustees

• Claims against trust assets

• Outsiders or beneficiaries

• Challenging trust’s existence or disputing legal or equitable

ownership of trust property

2. You still have the money or the property

• How should you deal with a claim, arising from outside the trust, to

money or property given to you to be held on the trust?

2.1 A Jersey trustee’s duty when faced with litigation hostile to the trust

• What you do as trustee in responding to a claim to the trust’s

assets should be informed by your duties as trustee

2.1.1 The key question determining whether to defend the trust of stay neutral and pre-empting the issues of costs in litigation hostile to the trust

• A duty to defend trust assets

• Beneficiaries’ views and indemnities

• The importance of an early Beddoe application

2.1.2 Continuing exercise of powers during pendency of litigation and surrender of discretions

• Notice of claim and dealing with the claimed trust property

• Again – the Court is there to assist you

2.1.3 Joining beneficiaries to the proceedings

• All beneficiaries’ views to be elicited and considered

• Who should be joined to the proceedings?

2.1.4 Costs

• Hostile proceedings

• cf. administration proceedings

• Prospective costs order protection as possible part of

Beddoe application

2.1.5 Guidelines for dealing with litigation successfully

• Advise the beneficiaries immediately and elicit their attitudes

• Seek to elicit as much information as possible as quickly as you

can so that you can determine (by way of independent advice) whether

the claim is bona fide or not

• Obtain independent advice as to what you should do (based on

the first two steps of assessing of the claim and eliciting the

beneficiaries’ attitude towards it) including advice as to the form in

which an application to the Court should be made

• Apply to the Court for directions including, in particular, directions

for indemnity on costs incurred by you as trustee before and after the

application

2.2 Revisiting Re Esteem [2002] JLR 52: tracing and proprietary claims against trust property in Jersey

• Understanding the claim

• What do we mean by proprietary claims and tracing?

• What is tracing?

• Tracing is the process of following value in substitutions of assets:

“Tracing … is neither a claim nor a remedy but a process. It is the

process by which the plaintiff traces what has happened to his

property, indentifies the persons who have handled or received it, and

justifies his claim that the money which they have handled or received (and

if necessary which they still retain) can properly be regarded as

representing his property.”

Boscawen v Bajwa per Millett LJ (as he then was)

2.2 Revisiting Re Esteem [2002] JLR 52: tracing and proprietary claims against trust property in Jersey

• In Jones & Jones (Trustees) v Jones Millett LJ repeated that

“tracing is neither a right nor a remedy but merely the process

by which the plaintiff what has happened to his property and

makes good his claim that the assets which he claims can be

properly regarded as representing his property.”

• Tracing part of Jersey law: Re Esteem

• Claimant may follow his or her value (the equitable proprietary

base) into property you hold as trustee for the purpose of then

making a proprietary claim so that trust property or a personal

claim against you as trustee

3. What if the money or property has gone out of the trust?

• Why you are at greater risk if the claimed money or property

has gone out of the trust

3.1 Liability for receipt of funds misdirected in breach of trust or fiduciary duty

• Understanding the claim:

what do we mean by liability for receipt of property or knowing

receipt?

3.2 The basis of liability

• Receipt or knowledge?

3.3 The defence of change of position

• Bona fide change of position in reliance on or on faith of

receipt

• Can a trust distribution operate as a change of position by the

trustee?

PROTECTING YOUR POSITION AS TRUSTEE 2010

Hiren B. Mistry1 October 2010

Proceeds of crime and third party attacks on trust assets: resisting and discharging saisies

judiciaires and freezing orders

§1 Introduction

1. Trustees need to be concerned about the Court’s powers to freeze a legal or natural

persons’ assets before or during the course of legal proceedings for two main reasons:

1.1 relationship with the client

1.2 being brought into legal proceedings due to the attack on the trust’s assets

Introduction cont

2. These types of freezing orders are/will happen more often in

increasing quantities due to:

2.1 the increased efforts by different jurisdictions to clamp

down on alleged criminal activities;

2.2 governments attempting to increase revenue streams

during this global recession; and

2.3 wide powers given by statue to the Courts to freeze assets

and the lowering the legal tests in both the civil and criminal

jurisdictions of the definitions of assets.

Introduction cont

3. This is a vast area of law and there is not enough time to look at all of the

intricacies today. This talk will therefore concentrate on the following:

3.1 Criminal proceedings and saisies judiciaires orders in relation to

non party assets;

3.2 Defences to saisies judiciaires orders and their discharge;

3.3 Civil proceedings and freezing injunctions in relation to non party

assets;

3.4 Defences to freezing injunctions and their discharge;

3.5 What trustees should do if brought into proceedings as a non party.

§2 Criminal Proceedings: saisies judiciaires orders

1. The Proceeds of Crime (Jersey) Law 1999 (“the 1999 Law”) allows the authorities to

take possession of property and to manage or otherwise deal with it in accordance

with the directions of the Court. This is known as a saisies judiciaire, which has been

described as[1]:

“…a provisional order but, unlike the restraint order made under the

equivalent English legislation, vests the realisable property of the

defendant in the Viscount. Some may think that this is a draconian

process. It is certainly a strong thing to divest a defendant of all

of his property in the jurisdiction on an ex parte application in

private.”

[1] In the Representation of O’Brien [2003] JLR 1 at para 16

Criminal Proceedings: saisies judiciaires orders cont

2.1 When can A saisie judiciaire order be made?

1. Article 15 of the 1999 Law provides that a saisies judiciaire may be made where:

1.1 the Court has made a confiscation order;

1.2 proceedings have been instituted in Jersey against the Defendant for any

offence in Jersey for which a person is liable for conviction to imprisonment for a

term of one year or more (this definition extends to offences occurring outside of

Jersey, which would have constituted such an offence if occurring in Jersey)[3];

1.3 the proceedings mentioned in para 1.2 above have not been

concluded;

1.4 either a confiscation order has been made outside of Jersey, or it

appears to the Royal Court that there are reasonable grounds for believing that

such an order may be made in the proceedings.

[3] Arts 1 and 15(1) (b) of the 1999 Law


2.2 What constitutes realisable property under the 1999 Law?

1. The 1999 Law gives a broad definition of what “realisable property held by

the defendant in Jersey”[4] means. Article 2(1) of the 1999 Law defines

“realisable property” as:

1.1 any property held by the Defendant;

1.2 property held by a person to whom the Defendant directly or

indirectly made a gift; and

1.3 any property which the defendant is beneficially entitled.

[4] Art 16(4) (a) of the 1999 Law


2.3 When can a saisies judiciaire order be discharged/varied?

1. A saisie judiciaire order may be discharged or varied in relation to any property such

an order has been made against, such an application being made to the Bailiff in

chambers by any person affected by it and the Bailiff may rule upon the application or

may, at the Bailiff’s discretion, refer it to the Court for adjudication[5].

[5] Arts 16(6) and (7) of the 1999 Law

§3 Defences

3.1 Where does the burden of proof lie in a discharge application of a saisie

judiciaire order?

1. The Royal Court has adopted an approach based on proportionality and balance:

“In our judgment the question for the court on an application to discharge a saisie

judiciaire is whether, having regard to the policy objectives of the 1999 Law, viz to

deprive criminals of their ill-gotten gains, it is fair, reasonable and proportionate to

maintain the order in force. That does not involve placing a burden of proof on either

the applicant or the Attorney General. It does involve weighing in the balance of all

relevant considerations before arriving at a conclusion.”[6]

[6] Re Kaplan (ibid) para 17

Defences cont

3.2 Assets not the assets of the Defendant but the trust

1. The Royal Court has made it clear that it should interpret widely the 1999 Law:

1.1 In Re the Representation of Batalla-Esquival[7] the Royal Court rejected the

Representor’s submissions that a saisie judiciaire should be discharged

on the basis that it was not the Defendant’s property as the assets

were settled into a trust, where the Defendant had no interest.

1.2 In Re Kaplan[8], the Royal Court stated that it should not adopt a restrictive

approach to the 1999 Law and where possible it should adopt a position which

“will facilitate the smooth working of the scheme of legislation established

by the Act, which will avoid producing or prolonging artificiality in the law, and

which will not produce anomalous results.”[9]

Defences cont

2. This is a cause of concern for trustees, as it shows the Court’s willingness to freeze

trust’s assets, even where trusts have been legitimately formed. The aim is to

deprive the criminal of his ill-gotten gains.

[7] [2001] JLR 160

[8] Ibid

[9] Ibid at para 11

Defences cont

3.3 No reasonable expectation that an external confiscation will be made

1. The Royal Court has made it clear that the 1999 Law places an obligation on the Court to satisfy

itself, before making a saisie judiciaire, that there are reasonable grounds for believing that a

confiscation order will be made and by looking at wider evidence[10].

3.4 The Dual Criminality Test

2. The dual criminality test requires the Royal Court to be satisfied before granting a saisie judiciaire

where proceedings have been initiated outside of Jersey that there is an equivalent offence in

Jersey, which has been committed in the external jurisdiction and that such an offence would carry

a sentence of one year or more in Jersey.

3.5 Realisable Property in Jersey

3. A saisie judiciaire order requires that there are realisable assets in Jersey for the Viscount to

manage and take control off. As long as the assets are held and controlled in Jersey i.e. a Jersey

administrator/trust, regardless of where the assets are in the world, this would be sufficient to

satisfy this test. However, the Court will look at the reality of the situation and whether In fact the

Viscount’s Department can manage and take control of the asset.

• [10] Re Kaplan (ibid)

§4 Case study: Re Kaplan [2009] JRC 082

4.1 The facts

1. Gary Stephen Kaplan (“Mr Kaplan”) is a US businessman who saw commercial

opportunity in 1995 of online gaming:

2. Mr Kaplan’s businesses:

1995 Mr Kaplan established a sports book business in Aruba, and moved the

business to Antigua where he obtained a sports book operating licence.

1998 Mr Kaplan expanded his business to Costa Rica.

2003 Mr Kaplan expanded further into the Dominican Republic.

2004 Mr Kaplan floated his company on the Alternative Investment Market in

London, his businesses operated by BETonSPORTS plc, which when

floated made him substantial personal profits.

3. Although Mr Kaplan’s businesses operating outside of the USA (where in most states

gaming is illegal), the majority of the registered customers, circa 1.2m, were US

citizens.

Case study cont

4. Mr Kaplan’s profits from the sale of the above company found their way into two Jersey trusts, the Bird

Charitable Trust and the Bird Purpose Trust (collectively “the Trusts”). The trustee was at the material

time the Basel Trust Corporation (C.I) Limited (“Basel”).

5. Criminal Proceedings against Mr Kaplan and a saisie judiciaire order:

01/07/06 Indictment against Mr Kaplan laid before State of Missouri in relation to the legality of his operations.

28/03/07 Mr Kaplan was successfully extradited from Dominican Republic to the USA.

24/05/07 Ex parte application of the Attorney General, at the request of the US State Department to the Royal

Court. The Deputy the Bailiff ordered a saise judiciaire of Mr Kaplan's realisable property pursuant

to the 1999 Law.

17/12/07 The Viscount made an ex parte application to the Bailiff in chambers seeking directions as to the

management of Mr Kaplan’s realisable property.

22/02/08 The US State Department requested and were granted a seizure order of two of Mr Kaplan’s bank

accounts holding cash and other liquid assets in Switzerland.

02/07/08 Mr Kaplan made a representation to the Royal Court to have the saisie judiciaire discharged or

failing that, declarations seeking to limit the scope of the order.

Case study cont

4.2 Mr Kaplan’s arguments in the Royal Court to discharge the saisie judiciaire

1. The Royal Court held that the burden of proof in discharging a saisie judiciaire involved weighing in the

balance all of the relevant considerations, and the burden of proof did not lay on one party[11].

4.2.1 Assets not the assets of the Defendant but of the trust

2. The Royal Court did not accept that the argument that because Mr Kaplan’s assets were held on trust they

did not belong to him and could not be classed as his realisable property. It stated clearly that it would not

take a restrictive approach on such determination and would try to avoid anomalous results[12].

3. Further, Mr Kaplan argued that there were no realisable assets that he owned in Jersey and so the saisie

judiciaire order should be discharged i.e. the assets were outside of the jurisdiction, albeit that the trusts

owned them through various structures.

4. The Royal Court looked at the definition of property for the purposes of a saisie judiciaire, defined as “all

property, whether movable or immovable, or vested or contingent, and whether situated in Jersey or

elsewhere”[13] and further considered Article 2(1) (b) of the 1999 Law, which defined realisable property as

any property held by the Defendant, property held by a person to whom the Defendant directly or indirectly

made a gift and any property.


[12] Ibid at para 11

[13] Article 1(1) of the Proceeds of Crime (Enforcement of Confiscation Orders) (Jersey) Regulations 2008

Case study cont

5. Mr Kaplan argued that the Trusts, The Bird Charitable Trust & The Bird Purpose Trust,

held assets which he did not strictly own. For the Court to find that he did own the

assets, it would have to pierce the corporate veil, ignore the trusts or claim that the

trusts were a sham.

6. The Royal Court disagreed and held:

6.1 the assets were undoubtedly given directly or indirectly by Mr Kaplan to Basel

on trust;

6.2 on that basis it was not strictly necessary for the Court to look at whether he

was beneficially entitled to the trust property[14]. It had established that the

Defendant directly or indirectly made a gift pursuant to the 1999 Law.

6.3 the trust property was and continues to be held by Basel, registered and

controlled in Jersey and the fact that the underlying assets are outside of

Jersey is immaterial.


4.2.3 No reasonable expectation of an external confiscation order

1. The Royal Court held that the 1999 Law places an obligation on the Court to satisfy itself that be made,

and by looking at wider evidence of US Law and not just relying on the affidavit evidence of the US

State Attorney, it satisfied itself that there was sufficient evidence that an external confiscation order will

be made in this case.

4.2.4 The Dual Criminality Test

2. The Royal Court found that the Gambling (Jersey) Law 1964 made gambling unlawful, including online

gaming. Breaches of the Law also carried a sentence of a level 4 fine and more than one year’s

imprisonment, which satisfied the dual criminality test.

4.3 Discharging the saisie judiciaire

3. The Royal Court found that the balance tipped in the favour of discharging the saisies judiciaire against

Mr Kaplan’s assets as the Viscount was unable to fulfil his duty, with assets being held in Switzerland,

which have been frozen and assets in Costa Rica which are beyond the reach of the Viscount’s

Department.

4. The Royal Court also stated that Jersey should not assume the role of the world’s policeman.

Case study cont

§5 Civil Proceedings: freezing orders and attacks on trust assets1. It is not uncommon for the Courts to grant a Mareva injunction (freezing injunction) in

civil proceedings to lock down assets to preserve the same where there is a real risk

of dissipation.

2. Mareva injunctions in Jersey may be granted not only during proceedings which are or

anticipated in Jersey, but also to assist foreign proceedings even if the only

proceedings in Jersey are for the injunction itself[1].

3. Mareva injunctions are similar to saisies judiciaires orders; however, they normally

restrict the use of the assets rather than having the assets vest in someone else.

There are instances though that the Court can order receivers to take control of

assets, which see similar problems for trustees and trust’s assets, where they can find

themselves subject to an injunction as a non party.

[1] Solvalub Ltd v Match Investments Ltd [1996] JLR 361

5.1 Case Study: Akai Holdings Ltd (in compulsory liquidation) and others v Ho Wing On and others [2009] HKCU 1451

5.1.1 Background

1. Accolade Inc (“Accolade”) is a limited company registered in the BVI and

trustee of the Ho Family Trust (“HFT”). Mr Christopher Ho (“Mr Ho”), the

settlor and Defendant in these proceedings constituted the HFT on 31 July

1993, when he transferred most of his wealth into it.

2. The memorandum of wishes stated, inter alia, that the trustees hold the whole

of the capital and income for Mr Ho absolutely and before exercising all of its

powers and duties and also with regard to the management and

administration, should consult with him. HFT was to be a discretionary trust.

•

3. The shareholders of Accolade were Dr Sabrina Ho and Ms Christine Asprey

(both sisters of Mr Ho). The directors of Accolade were Alistair Asprey, Mr

Ho’s brother in law and Eleanor Crosthwaite.

Case study cont

5.1.2 Litigation

1. The claim arose out of litigation brought by Akai Holdings Limited

(“the First Plaintiff”) and other Plaintiff companies in the Akai Group. The

Plaintiffs claimed that as a result of covert agreement made in November

1999 between Mr James Ting (“Mr Ting”), the de facto controller of the

Akai Group, and Mr Ho, Mr Ho and others took control of Akai and its

subsidiaries from Mr Ting and in so doing became de facto and/or shadow

directors of the Plaintiffs.

2. It was claimed that the controller’s actions were tantamount to a

blatant disregard of the interest of Akai and the Akai Group. The

recoverable loss were said to be hundreds of million US Dollars.

Case study cont

3. Order of Stone J on 9 February 2009:

3.1 the Plaintiffs were granted a Mareva injunction against Mr Ho as well as disclosure

orders against Mr Ho;

3.2 the Court described the controllers actions as “a ‘Double Mugging’ first at the hand of

Mr Ting, and thereafter, upon the latter’s departure from the scene at the hands of Mr Ho

and the Grande Defendants who had removed what assets had remained after the pillaging

that Akai already had received at the hand of Mr Ting” [16]

3.3 Mr Ho’s private assets held through opaque corporate structures in differing

jurisdictions around the world through various shareholding structures in various private companies

and trusts as at February 2008.

3.4 whilst the liquidators had no evidence of Mr Ho actually disposing of his personal

assets, there was a clear risk that Mr Ho will do so and the fact remains that in terms of private

BVI companies i.e. Accolade, Mr Ho, as controller and major shareholder, must be

regarded as affectively the “puppet master”.

4. Stone J granted a Mareva Injunction as well as a disclosure order.

[16] Akai Holdings v Ho Wing on [2009] HKCU 1451 para 10

Case study cont

5. On 17 March 2009, Mr Ho issued a “Summons to Clarify a Mareva Order” which was

heard before Stone J on 19 March 2009.

6. Stone J refused to accede to the request to modify the terms of the order since he did

not consider any amendments which were mooted to be necessary and accordingly

the application was dismissed with costs.

7. Mr Ho appealed against this decision.

Case study cont

5.1.3 Arguments against the Mareva injunction applying to the trust

1 The assets of the subsidiary company were not to be considered to be treated as assets of the parent

company and that the judgment of the Court upon the substantive application reflected the underlying

intention that Mr Ho should be restrained from taking actions as shareholder in respect of his beneficial

interest in Grande.

2. The Court of Appeal disagreed with these arguments saying that Mr Ho controlled the assets and the trust.

5.1.4 Freezing trust assets

3. Stone J in relation to arguments about the trust/corporate structures said:

“…on the available evidence, this is the “substantive reality”: see, for example, the trenchant comments of

Robert Walker LJ in International Credit and Investment Co (Overseas) Ltd v Adnam [1998] BCC 134 at 136:

‘….It is becoming increasingly clear, as the English High Court regrettably has to deal more and more often

with major international fraud, that the Court will, on appropriate occasions take drastic action and will not

allow its orders to be evaded by the manipulation of shadowy offshore trusts and companies formed in

jurisdictions where secrecy is highly prized and official regulation is at a low level….’[17]

[17] Akai Holdings (i bid) at para 43

Case study cont

4. The Court of Appeal held, agreeing with Stone J:

• 4.1 extending a Mareva Injunction over the assets of a non party was permissible if there is good

reason to suppose as against the non party that the assets of/or held by the non party would be

susceptible to a procedure which would lead to satisfaction of a judgment, “…the width of an injunction of a

non party depends upon what it is that there is good reason to suppose”. [18]

4.2 the Court has undoubtedly a jurisdiction to make a freezing injunction against a third party, the

exercise of which can occur where there is good reason to suppose that the assets of the

third party are, in truth, the assets of the injuncted Defendant.[19]

4.3 A classic case where there would be good reason for supposing that the assets are, in truth,

the assets of the Defendant is where there is good reason to suppose that the assets are held by

the third party on bare trust (or as nominee) for the Defendant.

4.4 Re a Company [1985] BCLC33 at 337-338 was relied on where Cumming-Bruce LJ indicated

that the Court would use its powers to pierce the corporate veil if it were necessary to achieve justice,

irrespective of the legal efficacy of the corporate structure under consideration.

[18] This is sometimes referred to as the Chabra Jurisdiction, after the decision of Mummery J in TSB Private Bank International SAV Chabra [1992] 2 All

ER 245

[19] Akai Holdings (ibid) at para 46 quoting SCF Finance Co Limited v Masri [1985] 2 ALLER 747 at 753

Case study cont

5. The Court of Appeal found that for the present purposes it is sufficient if there is

good reason to suppose that Mr Ho has substantive control over HFT assets,

injunctive relief could stand against a non party. The nature and degree of control

may have to be investigated in due course; however Mr Ho represented to the whole

world that he was the beneficial owner of the trust.

6. The Court of Appeal also indicated that in relation to ownership, a determination in

advance of the main action could be made, depending on each case and on what is

just and convenient.

§6 Conclusion

1. It is clear from the above cases that the trend in both civil and criminal cases is to

widen the Court’s jurisdiction and not to be deterred by the form of the structure.

2. The purpose of this talk is not to look at what trustees should do in such

circumstances, moreover, to highlight the increased cases both in the civil and

criminal courts where non parties have been made subject to injunctions, which is

becoming more and more prevalent in today’s age.

3. Trustees must remain cautious and vigilant as they may find themselves involved in

litigation and subject to freezing injunctions as non parties, even when there are no

proceedings in Jersey. In these circumstances, the trustee must proactively consider

what is in the best interest of the trust/its beneficiaries and seek legal advice

immediately/prior to notice of such proceedings.

Documents

TRUSTS AND THE NO REFLECTIVE LOSS PRINCIPLE