Saturday, March 25, 2017

Can trustees contract out of fiduciary liabilities?

[The following post is contributed by Shreya Rao and Vakasha Sachdev at Rao Law Chambers]

Trust law in India has not kept up with the times. The last few years have seen an increase in the incidence of sophisticated trust structures, particularly in the private wealth and fund industries. However, changes to the law governing trusts have substantially been introduced in ad hoc form by tax legislations, securities and other regulators and on occasion the courts. This has led to disharmonious, often confused positions on fundamental questions regarding the nature of a trust, the transactions of settlement/ management/ distribution by trustees and the status of beneficiaries in the trust structure.

Some examples of this vacuum & dissonance are as follows: The last amendment to the Indian Trust Act, 1882 (“Trusts Act”), in 2016, related to the list of “permissible investments” that may be made by a trust. Although the amended provision was certainly wider than the previously applicable Indian provision, it failed to ask why (if at all) the law should restrict the list of permissible investments for trustees. The UK, Canada and Australia, for example, had rules similar to ours, but amended their trust acts to allow trustees to invest as any other prudent investor.

In another case, the Supreme Court held last year that disputes arising out of trust deeds are not arbitrable, reversing a Bombay High Court ruling that they are. These two rulings swung on the question of whether the beneficiaries were party to the “arbitration agreement” contained in the trust deed to which the beneficiaries were not a party. However, neither case asked deeper questions regarding the status of beneficiaries in relation to a trust. More recently, the Finance Bill 2017 includes provisions which have been interpreted to result in a tax on the act of settlement in favour of a trustee, treating such settlements as any other transfer. This position ignores the fact that a trustee does not receive an asset, but the fiduciary obligation to manage/ apply the asset. These questions are all fascinating from a practical, legal as well as philosophical perspective.

One such question, which we will examine today, relates to the enforceability of trustee exculpation provisions. Simply put, the issue is as follows: does a trustee (i.e., a fiduciary of a trust) have the ability to disown fiduciary liabilities by entering into a contractual understanding with the settlor? This question is particularly relevant today, because of the increase in institutional trusteeship arrangements. Institutional trustees typically include exculpatory clauses (referred to hereafter as trustee exemption clauses) which protect them from liabilities arising from breach of trust, except in situations where such liabilities arise from gross negligence or fraud of the trustee. What should be the validity of such trustee exemption clauses?

We share some thoughts below.

Limitation of Liability Under Trust Law

The Indian Trusts Act, 1882 (“Trusts Act”) imposes a number of duties upon trustees, and also sets out the liability of a trustee for breaches of their duties (a “breach of trust”). However, it contains no express provisions regarding contractual limitation of liabilities. There is also no case law in this regard. Therefore, we need to derive a position from other parts of the Trust Act, which are discussed below.

- Acceptance of Trust: Under section 10 of the Trusts Act, a trustee is not bound to accept a trust. It is only valid if the trustee consents, which implies autonomy of a trustee and a contractual understanding. Further under section 11, a trustee must fulfil the purpose of the trust in accordance with the directions of the author of the trust. These directions are given at the time of the creation of the trust, i.e., in the trust instrument / trust deed. If the settlor agrees to certain limitations on liability in the trust deed, the trustee would only be bound to that extent, and the exculpation terms should govern the scope of the trustee’s liability in relation to the trust.

- Modifications of duties by contract: Further, certain provisions of the Trusts Act acknowledge that there may be modifications by contract or otherwise to the trust deed, even to change the nature of the duties of the trustee. For instance, section 15 of the Trusts Act, which imposes a duty on the trustee to deal with the trust property with prudence. This section expressly mentions the possibility of changing the duty of care applicable to a trustee, by way of contract. This implies that the broader underlying arrangement can be modified by means of contract.

- Scholarly commentary on the Trusts Act suggests that a trust deed may contain a trustee exemption clause that only allows for liability of the trustee when they have acted in bad faith. As a result, the insertion of trustee exemption clauses should validly exempt the trustees from a breach of trust when they have acted in good faith.[1]

- Liability of Trustee: On the other hand, under section 23, if a trustee commits a breach of trust, he is liable to “make good the loss which the trust-property or the beneficiary has sustained as a result”. This section does not refer to limitation of such liability by agreement. There is also some case law which suggests that a trustee’s liability cannot be absolved merely because he took sufficient care or acted in good faith.[2] However, this leaves open the question regarding whether the extent of the liability can be contractually agreed to.

Limitation of Liability under Contract Law

It is also apposite to examine whether contract law itself limits the ability of a person to limit liability. This question is particularly important since institutional trusteeship arrangements typically arise from an underlying contract.

- There is no general prohibition on the insertion of limitation of liability clauses in contracts under Indian law. However, under section 23 of the Indian Contract Act 1872 (“ICA”), any limitation of liability clauses must not defeat the provision of any law, be fraudulent in themselves, or be opposed to public policy.

- There has been no definitive case on the enforceability of trustee exemption provisions. While such clauses, if not fraudulent, should not defeat any provision of law (as discussed above), their position vis-à-vis public policy is tougher to predict. Indian courts have long refused to lay down any hard and fast guidelines on public policy, noting that what may be viewed as opposed to public policy is not constant,[3] and it is unlikely which of the generally established precedents (opposed to morality, or the interests of the state) would apply to trustee exemption provisions. 

International position

United Kingdom (UK)

Trustee exemption provisions have been held to be enforceable in English case law. For instance, the judgment in the leading case of Armitage v. Nurse[4] upheld a clause that excluded a trustee’s liability for damage caused to the beneficiary except where caused by the trustee’s actual fraud. Usefully, in this case, it was held that the enforcement of such a clause would not be contrary to public policy. This case should hence have persuasive value in arguing that the test of public policy under section 23 of the ICA is also satisfied. Armitage continues to be good law despite the introduction of the Trustee Act 2000 (which seeks to codify the duties of trustees) in England and Wales, as confirmed in subsequent case law.[5] Also see Bogg v Raper.[6]

- There is also a STEP UK guidance note that acknowledges that trustee exemption clauses are valid in the UK, although this advises that the settlor of the trust be made aware of the existence of such a clause and its implications.[7]

- We should note that UK trust law is not exactly similar to Indian trust law. However, the differences should not impact our ability to derive persuasive value from UK material in this regard.

United States (US)

- Most American states and the federal American model trust law take a similar view. Trustee exemption clauses are widely considered enforceable in the US, as long as they do not affect liability for fraud, bad faith, and wilful recklessness, and the insertion of the clauses themselves are not a result of fraud or bad faith.[8]

- The position adopted in the American Uniform Trust Code (the federal model law) is that trustee’s duties are default rules generally, including the duties of prudence, loyalty and impartiality. At the same time, it also recognises certain mandatory rules which are immutable, including the duty to act in good faith and in accordance with the terms and purposes of the trust.[9]

- Here, it is relevant to mention that certain states in the US have seen substantial litigation in the context of waiver of fiduciary duties of directors of corporations versus limited liability companies, where the question has been framed in terms of the difference between a common law fiduciary duty of good faith versus a contractual duty of good faith. If these questions are carried into trust law, it would suggest that fiduciary standards of good faith are different from (possibly wider than?) contractual duties.  

Some philosophical questions

We cannot ignore the philosophical questions regarding the nature of fiduciary responsibilities and their source.

- If they derive from a voluntary understanding (as argued by Edelman, for example), it is theoretically possible that the understanding can be modified by an agreement to limit the liability of a fiduciary. If on the other hand a fiduciary obligation derives from a broader duty of care (as argued by Miller, for example), liability cannot be limited by agreement. We would then need to identify the nature of that duty of care and delineate its boundaries.

- Unfortunately, private law philosophy is yet to reach a consensus on these issues due to the peculiar complexities of the fiduciary relationship. These complexities may also manifest themselves differently depending on the kind of trust – an express trust for instance, is voluntarily accepted by the trustee and would therefore suggest proximity to a contractual relationship. However, a constructive trust (created by circumstance) suggests that the fiduciary is governed by a broader duty of care. 

Concluding Thoughts

Based on the analysis above, existing Indian law, read with the persuasive weight of international precedents, suggests that trustee exemption provisions should be valid, to the extent that the trustee continues to be held responsible for the more serious forms of breaches (gross negligence, fraud etc.). However, it is likely that an analysis will be necessarily dependent on the specific kind of trust and the nature of the exculpation provision. Thus, the specific question, and Indian trust law in general, continues to provide fertile ground for both legal and philosophical debates. We hope to continue to draw more attention to this space through subsequent posts.

- Shreya Rao & Vakasha Sachdev


[1] Aiyar, Commentary on Indian Trusts Act (8th edition) at 247.

[2] Tirupathirayadu Naidu v. Lakshminarsamma, (1989) 2 Mad LJ 385, cf Aiyar, Commentary on Indian Trusts Act (8th edition) at 275.


[4] [1998] Ch 241, 250. The case also includes an analysis of Scottish law that comes to the same conclusion.

[5] Barraclough v Mell, (2005) EWHC 3387; Baker v JE Clark & Co (Transport) UK Ltd, [2006] EWCA Civ 464.

[6] (1999/2000) 1 ITELR 267.




[9] Louise L. Hill, Fiduciary Duties and Exculpatory Clauses: Clash of the Titans or Cozy Bedfellows, 45 U. Mich. J. L. Reform 829 (2012) at 837.

2 comments:

Aditya Swarup said...

Very insightful article. I was wondering if the analogy to director's fiduciary duties can also be used. If, as existing in the UK, the law allows an exclusion of certain fiduciary duties/liabilities of a director (who is akin to a trustee) to a company by a contract, could it not be argued that the same rationale can be extended to express trusts?

Shreya Rao said...

Hi Aditya, thanks for your comment. It's not completely accurate that a director is akin to a trustee - they are both fiduciaries, true. However, rules such as the business judgment rule give directors of a company greater leeway in decision making than trustees of a trust. Guardians of minor children are also fiduciaries - but they have more independence in decision making than both directors and trustees. This is part of what makes fiduciary law complex from a normative/ philosophical perspective - that different categories of fiduciaries can be subject to highly varying standards of duty and care.

Coming to your point regarding the express trust, I would agree that conceptually the two <> not be different. However, because the duties of trustees are governed by a legislation specific to trusts, the validity of exculpation provisions needs to be examined in light of the specific obligations imposed by the Indian Trusts Act. You can't just draw inference from practice in a Companies Act context.

This is why provisions like s.23 of the Trusts Act become important. The question we should be asking ourselves here is - if directors/ trustees have certain specified duties under the law, can they contract out of liability for breach if the law doesn't allow for it? The answer would probably be no. The position in the article is based on the fact that the Trust Act is silent, which is why some extent of exculpation should be allowable, except in cases of grave breach that would violate the very spirit of the fiduciary relationship. My two cents.