Many New Zealand businesses operate through a trading trust. In this structure, a company is appointed as trustee and carries on the business: it signs contracts, employs staff, borrows money and holds the business assets for the benefit of beneficiaries or for a permitted purpose. The directors make those decisions on the company's behalf.

It is easy to assume that in this structure the directors are shielded by the company from any liability arising from the business. To an extent, they are. But while the company structure provides important protection, it is not a complete shield. If the business fails, or a beneficiary challenges the trustee company's actions, the directors may face personal exposure.

This risk is heightened in a trading trust structure because a trustee company typically has no assets of its own. Its ability to meet liabilities therefore depends on its right to use trust assets under the trustee’s right of indemnity. If that right is lost or impaired, creditors, beneficiaries or a liquidator may look closely at the decisions made by the company’s directors.  

Duties of trustee company directors

A director of a trustee company is not personally the trustee. Ordinarily, directors do not owe trustee duties directly to beneficiaries and they are not automatically liable for the company’s debts.

They do, however, owe the usual directors' duties under the Companies Act 1993, including duties to:

• act in good faith and in what is believed to be in the company's best interests (s 131);
• not cause or allow reckless trading (s 135);
• not agree to the company incurring an obligation unless the director believes, on reasonable grounds, that the company will be able to perform it (s 136).

The company also has duties in its capacity as trustee, including duties to act honestly and in good faith, comply with the trust deed, exercise its powers for proper purposes and, unless modified or excluded, exercise reasonable care and skill. Although those duties are owed by the trustee company, its directors control how the company performs them.

Directors must therefore ensure that the company’s decisions are proper both from a company law perspective and under the trust deed and general trust law.  

Directors' potential exposure  

If the trustee company enters liquidation, the directors’ conduct may be investigated and claims may be brought for losses caused by breaches of their Companies Act duties. In some circumstances, a liquidator, creditor or shareholder may apply to the Court for orders against a director.

A beneficiary may also challenge the actions of the trustee company if they consider it has acted in breach of trust. That does not automatically make the directors personally liable. However, if a breach of trust has caused loss to trust assets, a beneficiary could say the director did not act in the trustee company's best interests, thereby breaching their section 131 duty.  

Directors may also be exposed if they knowingly participate in or assist a breach of trust by the company.

The trustee company's indemnity is crucial  

A trustee is liable for expenses and liabilities it incurs as trustee. Ordinarily, a trustee acting reasonably on behalf of the trust can use trust assets to meet those liabilities. This is known as the trustee's right of indemnity.

The right of indemnity is how a trading trust structure can operate. Because the trustee company may hold little or no assets in its own right, its ability to pay business creditors relies on the right of indemnity.

The indemnity may be lost if the company acts outside its trustee powers, breaches its trustee duties, incurs unauthorised expenses or distributes trust assets without allowing for unpaid or potential creditor claims. If the indemnity is unavailable or impaired, the trustee company becomes assetless and is unable to meet its liabilities.  

At that point, a liquidator, creditor or beneficiary is likely to examine how the situation arose and what the directors knew and did. The directors may face personal claims if their own conduct amounted to a breach of their Companies Act duties or involved knowing assistance in a breach of trust.

One decision, overlapping duties

When making decisions in relation to a trustee company, directors must consider both the company's and the beneficiaries' interests.  

Suppose the directors of a trustee company, faced with a contingent claim by a creditor, propose to make a substantial distribution to beneficiaries. That distribution may be justified as being in the interests of the beneficiaries, but the trustee company's interests are not advanced. If the distribution removes the assets supporting the company’s indemnity and leaves the company unable to meet the creditor's claim, the director may not have acted in the company's best interests.

The same consideration is needed when borrowing, granting security, selling assets or continuing to trade while the business is under financial pressure.

A board resolution stating that a transaction is in the company's interests may not, by itself, show that the relevant beneficiary interests and trust powers were considered. Equally, a board resolution referring only to the interests of the beneficiaries may overlook the directors' duties to the trustee company.

Practical steps for directors

Directors of trustee companies should keep an up-to-date copy of the trust deed and understand what the company can and cannot do as trustee. Important decisions should be properly recorded, with the minutes showing that the board considered both the company’s position and its obligations as trustee. Any decision to reduce the value of the trustee company's right of indemnity, even if it is to the benefit of beneficiaries, should be informed and considered, with those considerations documented.

These steps do not remove commercial risk, but they give directors a robust footing to defend their decisions if they are challenged.  

A trustee company can provide directors with an important layer of protection, but that protection has limits. Directors need to understand not only their duties under the Companies Act, but also the trust structure within which the company operates.

How we can help

We advise directors of trustee companies on their duties, the scope and protection of the trustee’s right of indemnity, and the steps they can take to reduce their risk of personal exposure. If your company operates a business as trustee, our experts can review the structure and trust deed, identify areas of risk and help ensure that important decisions are made and recorded appropriately.