Ignorance is amiss

Trusts are usually designed to benefit their beneficiaries. ?But this generally comes at a ?cost to third parties: governments deprived of tax revenues; future, and ?in some jurisdictions contingent, creditors deprived of assets; offspring ?or dependants disinherited; or, occasionally, taxpayers who participate in the scheme (when the trust structure is part of, and receives funds from, a tax scheme that fails).

There is nothing inherently wrong with any of these third-party costs per se. However, the trustees could be in danger of being pursued if any of these third parties become aware that they may have done something actionable ?in creating or administering the trust.

Trustees are often advised that they are primarily obliged to comply with the trust instrument and any authorising statute, which is true regarding their liability to beneficiaries. They have also long been aware of the significant risk of third-party responsibilities including anti-money laundering compliance.

But trustees can easily attract third-party liability in the course of their obligations by, for example, causing a car accident en route to meeting the beneficiaries or making a misrepresentation to someone about ?the financial affairs of the trust.

Purporting to comply with a trust instrument's provisions is no defence to any third-party claim. However, it will probably provide an indemnity (although there may not be sufficient assets to meet the claim).

Negligence can easily become dishonesty. 'I was just following orders' has been an unpopular defence to ?third-party claims for a very long time. Those who turn a blind eye to the nature of the property and the purpose of a transaction can be held to have wilful ignorance or "Nelsonian knowledge" (Professionals and Fiduciaries: Perils and Pitfalls, Simon Baughen), which can be sufficient to find deceit.

A particularly interesting feature of non-contractual third-party liability is the impossibility to know in which jurisdiction a trustee may face such allegations. To whom duties of care ?are owed varies greatly - even within ?the common law world, never mind outside it. England and many international financial centres take a relatively restricted view compared ?with other jurisdictions.

Courts generally face this issue in the context of proceedings rather than an academic debate. In those proceedings, when determining whether a duty of care was owed to a certain claimant or plaintiff, an innocent party in the jurisdiction of the court has been harmed and suffered loss caused by the defendant. It may sound rich to argue that the innocent party was not within the class of people to whom the defendant owed a duty of care.

Major losses

Ontario Superior Court of Justice's relatively recent judgment in Cannon v Funds for Canada Foundation et al 2012 ONSC 399 is a salutary example for trustees. The decision granted an application for certifying a class proceeding against various defendants, including a corporate trustee operating in Bermuda, alleging that the defendants had participated in or facilitated a tax scheme that was either fraudulent or negligent in design or application resulting in more than $100m in losses.

Significantly, the outcome merely certified the class proceeding and the plaintiff was only required to establish "some basis in fact" that there were the causes of action to be certified, that there was an identifiable class ?with common issues, that the class proceeding would be the preferable procedure and the purported class representative was appropriate.

However, the court noted that, assuming the allegations made against ?the trustee were true, the trustee as a creator of the tax scheme owed a duty of care to the Canadian participants in the tax scheme. There has not been a trial about the merits of the claims against the defendants.

Finding a duty of care by a trustee to third parties affected by a tax scheme in another jurisdiction should not be surprising. Before accepting a trusteeship, trustees need to understand, among other things, "the size and nature of the trust investments" (Lewin On Trusts 18th ed), the trust property they administer, the investments contemplated by the trust and the nature of any payments contemplated by the trust instrument or otherwise. These are generally duties owed to the beneficiaries.

However, if they were fulfilled and the trustee was aware that the trust was part of a circle of payments that resulted in losses (whether by negligence or design) to a third party, the trustee would generally be held liable for ?those losses.

No knowledge

The Ontario proceedings are interesting because the trustee alleged they knew nothing about the purpose of payments from the trust - apparently even as to whether they were investments or distributions. And, assuming the allegations are true, they did not appreciate these funds (having been increased by a certain margin) were eventually coming back into the trust (via a circuitous route) as returns on some rather unusual trust property.

It is very awkward for a professional trustee to explain to the court why they failed to fulfil those obligations, even in the context of third-party claims. A court may find it difficult to accept that a trustee could be ignorant of the trust property as well as the nature or purpose of payments made from the trust. It may be easier to accept that the trustee fulfilled their fiduciary obligations but turned a blind eye to the implications of the trust structure for third parties.

This too should not be surprising. It is not uncommon in trust litigation to find that the relevant employees of a corporate trustee have left the business and often the jurisdiction. It may be difficult to first track them down then get their focus on a dispute about one of many trusts they administered years ago. Even where this is not the case, memories tend to be reconstructed rather than refreshed when trust files ?are reviewed.

It will be very interesting to see if the Ontario court goes on to decide that the trustee may be liable to the third-party class where it meets its fiduciary obligations to the beneficiaries but not where it breaches them.

However, even if the court finds that the trustee was ignorant of the scheme, it is possible that the court may attribute Nelsonian ignorance to the defendants.

Of course, if the court finds the alleged circle of payments has not been established, these issues are moot. But after reading the certification judgment, this is unlikely.