Publication

A round-up of recent cases

Trust Quarterly Review 2011, 9(2), 29‑33

Joseph Curl

The Kaupthing Bank: a modern Icelandic saga

The failure of the Icelandic banking system has given rise to considerable litigation. In particular, the failure of Kaupthing Bank has produced numerous judgments, both in England and elsewhere.[1] At the time of writing, Robert and Vincent Tchenguiz have recently been arrested amidst considerable publicity following investigations by the Serious Fraud Office into their invovement with Kaupthing.  As well as taking bank‑related litigation to a mass audience in this manner, the collapse of Kaupthing has also provided equity and trust lawyers with an insolvent bank against which long‑standing principles have been tested in a procession of cases. 

One recent example of this was the examination by the High Court of Justice of the Isle of Man, both at first instance[2] and appeal[3], of the principles underlying the trusts in Barclays Bank Limited v Quistclose Investments Limited[4] and In re Kayford Limited (in liquidation).[5]  Habana, a customer of the Bank, attempted to argue that the insolvent Bank (acting by its liquidators) held assets on trust for it on either a Quistclose or Re Kayford basis. The objective of Habana’s argument was to obtain priority in the insolvency. Usually, when a customer pays money into a bank in an ordinary deposit transaction, the bank is a debtor and the customer is a creditor for the money deposited. In the absence of some additional element to the transaction there is no fiduciary relationship. The old and often‑cited House of Lords authority for this is the nineteenth-century case Foley v Hill.[6]

The principle was articulated by Atkin LJ in Joachimson v Swiss Bank Corporation:[7]

‘The bank undertakes to receive money and to collect bills for its customer’s account. The proceeds so received are not to be held in trust for the customer, but the bank borrows the proceeds and undertakes to repay them…I think it is necessarily a term of such contract that the bank is not liable to pay the customer the full amount of his balance until he demands payment from the bank…’[8]

Habana was described in the proceedings as ‘an investment holding company’. It held a Euro deposit account with Kaupthing’s Manx subsidiary, Kaupthing Singer & Friedlander (Isle of Man) Limited (KSFIOM). Kaupthing also had a United Kingdom subsidiary called Kaupthing Singer & Friedlander Limited (KSFUK). KSFIOM was the first defendant and the second and third defendants were the liquidators of KSFIOM. On 4 August 2008, Habana had deposited €3,500,000 into its account with KSFIOM. It was common ground that at the time of the deposit the sum had not been paid for a specific purpose. At the point of deposit, KSFIOM was free to apply the money as it chose on the basis that legal and beneficial ownership had passed to KSFIOM. In return, Habana became the owner of a chose in action to demand repayment by KSFIOM.

On 6 October 2008, HM Treasury told United Kingdom banks to stop processing transfers for Icelandic banks. Habana gave a written instruction on 6 October 2008 to KSFIOM to transfer €2,360,000 to the Euro account of International Property Management Services Limited (IPMS), held at the Isle of Man branch of the Royal Bank of Scotland (RBS). The balance of Habana’s account when the instruction was given was €2,365,890.27. It was KSFIOM’s practice to transact its customers’ Euro currency transfers via KSFIOM’s Euro account held at Deutsche Bank AG in Frankfurt. On the morning of 7 October 2008, KSFIOM sent an instruction to Deutsche Bank to transfer €2,360,000 from KSFIOM’s account to the account of another company, called IPMS. IPMS held an account with RBS. Shortly afterwards, KSFIOM instructed KSFUK to credit €5,000,000 to KSFIOM’s account, with Deutsche Bank via HSBC Bank Plc as intermediary. A debit of €2,360,000 was subsequently posted against Habana’s account with KSFIOM during the afternoon of 7 October 2008. The transfer from KSFUK to Deutsche Bank Frankfurt was not completed and KSFIOM’s account with Deutsche Bank Frankfurt was never credited with the €5,000,000.

KSFUK entered administration on 8 October 2008. KSFIOM entered provisional liquidation on 9 October 2008. On 29 October 2008, Deutsche Bank informed KSFIOM that the transfer from KSFIOM’s account had been cancelled owing to insufficient funds. KSFIOM reversed the debit in the sum of €2,360,000 against Habana’s account on 25 November 2008.

Habana had two principal lines of argument. Firstly, Habana argued that in accepting the instruction from Habana and in debiting Habana’s account with the sum of €2,360,000, KSFIOM constituted itself a resulting trustee under Quistclose trust principles. Upon failure of the specific purpose, Habana was entitled to the return of the funds as trust monies. Secondly, Habana submitted that KSFIOM had specifically appropriated €2,360,000 for the sole purpose of making the payment, which meant that Habana was entitled to the return of that sum under the principles in Re Kayford. KSFIOM’s liquidator’s response was that the relationship between it and Habana was the ordinary relationship of customer and banker, which was not a fiduciary relationship and that no question of there being a trust arose.

In the Quistclose case, Quistclose Investments Limited (Quistclose) lent money to Rolls Razor Limited (Rolls Razor) for the specific purpose of enabling Rolls Razor to pay a dividend. Rolls Razor banked at Barclays and had an overdraft. The Quistclose money was paid into a separate bank account recently opened for this purpose. Before the dividend could be paid, Rolls Razor entered liquidation. Quistclose successfully argued that the funds it had lent to Rolls Razor were held on trust by Rolls Razor for Quistclose because the specific purpose for which they had been lent had failed. In the Re Kayford case, a mail order company on the brink of insolvency opened a separate account with the objective of ensuring that new money paid by customers would be protected in a subsequent insolvency. In the liquidation, the question was whether the money was ringfenced as trust money for the customers or whether it fell into the company’s general assets to be distributed between all the creditors.  The question was answered in favour of the ringfenced customers. 

At first instance, His Honour Deputy Deemster Corlett held that the facts of this case were markedly different from those of the Quistclose line of authorities.[9]  It was held that cases where a Quistclose trust was imposed have concerned two situations. These were, firstly, where the relevant parties segregated funds in a separate account under the threat of impending insolvency and, secondly, where the bank was acting under a clearly expressed intention that the funds would be passed on to a third party and would not become part of its general funds.[10]  Deputy Deemster Corlett found that in order to establish a Quistclose trust, it is essential that new money be received for a specific purpose and accepted for that purpose.[11]  It was common ground that when the funds were credited to Habana’s account in August 2008 there was no suggestion either that the funds were anything other than ordinary deposits or that the relationship was anything other than one of lender and borrower.[12]  The absence of an injection of new funds shortly before insolvency meant that there would be no windfall for creditors if a Quistclose trust was not imposed.[13] 

Turning to the related Re Kayford species of trust, Deputy Deemster Corlett found that there was no suggestion that the parties were aware that KSFIOM was in difficulty or that steps were taken to delineate money for a particular purpose. The mere acceptance by a bank of instructions from its customer could not be analysed as a declaration of trust by the bank.[14]  He concluded that a proprietary remedy should only be imposed in well established scenarios supported by authority.[15] 

Habana brought an appeal on the basis that Deputy Deemster Corlett had erred in concluding that new money was essential for a Quistclose trust to arise. This argument was based on high authority. Firstly, in In re Goldcorp Exchange Ltd,[16] Lord Mustill had given the advice of the Privy Council in the following terms:

‘That a sum of money paid by the purchaser under a contract for the sale of goods is capable in principle of being the subject of a trust in the hands of the vendor is clear. For this purpose it is necessary to show either a mutual intention that the monies should not fall within the general fund of the company’s assets, or that having originally been paid over without restriction the recipient has later constituted himself a trustee of the money.’[17]

Habana argued that Lord Mustill’s words meant that there was no requirement for ‘new money’ for a Quistclose trust to arise, because a borrower could later constitute himself a trustee of monies initially advanced without restriction. Even if ‘new money’ was required, Habana argued that its instruction to KSFIOM to transfer €2,360,000 constituted a demand for payment and a presently enforceable debt, which satisfied the ‘new money’ requirement. Habana’s position was that the beneficial interest in €2,360,000 passed to Habana when its account was debited because the debit extinguished Habana’s chose in action against KSFIOM and constituted repayment of KSFIOM’s debt to Habana. Thereafter, Habana contended, KSFIOM held €2,360,000 on trust for Habana.

His Honour Judge of Appeal Tattersall and His Honour Deemster Doyle had no hesitation in dismissing Habana’s appeal. Although a good deal of weight was placed by Habana on evidence of the attitude of KSFIOM’s staff towards the significance of the debit to Habana’s account, this was held not to be relevant.[18]  Giving judgment, His Honour Judge of Appeal Tattersall found that Deputy Deemster Corlett had been right to find that a Quistclose trust requires trust monies to be transferred by a payor to a recipient on a common understanding communicated to the recipient before or at the time of the transfer and accepted by the recipient. If there is no communication and no acceptance, then the monies vest absolutely in the recipient.[19]  If Habana had either paid the money to KSFIOM on the express basis that it must be paid to RBS forthwith or had physically withdrawn €2,360,000 and then paid it back to KSFIOM on such an express basis, then a Quistclose trust would have arisen. Neither of these things had happened.[20]  While a borrower could subsequently constitute himself an express trustee of monies advanced without restriction (as had happened in Re Kayford), a Quistclose trust could not arise without a further payment of new money.[21]  Quistclose trusts arose when it was unconscionable for the recipient of monies not to honour the specific purpose communicated to and agreed by him.[22]  Re Kayford cases concerned express declarations of trust by persons in respect of their own property.[23]  The transfer instruction issued by Habana on 6 October 2008 did not constitute a demand for payment. In the case of a bank ‘transfer’, the debt owed by a paying bank was not extinguished until the recipient third party could draw against his own bank.[24]  Furthermore, Habana’s pleadings did not identify the subject matter of the trust. There was no specific property to which the trust relationship could apply because the posting of the debit entry did not amount to repayment of Habana’s loan to KSFIOM and nor was a separate beneficial interest created in the debited sum. There was simply no ‘sum’ capable of division into legal and beneficial interests. His Honour Judge of Appeal Tattersall held that:

‘Even assuming that the debit had some legal significance…the entries on Habana’s Deposit Account merely evidence the nature and extent of a debt owed by KSFIOM to Habana and not an asset of KSFIOM of which the beneficial interest was capable of transfer.’[25]

It is submitted that this shows the important differences between a Quistclose trust and the facts in Habana Ltd v Kaupthing. Although superficially similar (because both situations involved a bank), it is important not to lose sight of the fact that Habana’s argument depended on characterising the insolvent Bank as occupying the position of Rolls Razor (i.e. the trustee) in Quistclose, rather than that of Barclays Bank. In Quistclose, there was no suggestion that Barclays was a trustee of anything, in accordance with Foley v Hill principles. The issue in Quistclose was summarised in the Habana case on appeal[26] as:

‘…whether the money in the separate account was owned beneficially by Rolls Razor, in which case the Bank would be able to set it off against the overdraft or whether Rolls Razor had received the money as trustee and still held it on trust for Quistclose. The House of Lords decided that the money had been received upon trust to apply it for the payment of dividends and for no other purpose.’[27]

The issue in Quistclose was the beneficial ownership of the chose in action representing Rolls Razor’s right to be repaid the debt owed to it by Barclays. There was no suggestion that Barclays was anything other than solvent and good for the money: all that arose was beneficial ownership of the right to be paid. This was a contest between Barclays (seeking to exercise its right of set‑off) and Quistclose (which would be merely an unsecured creditor of Rolls Razor unless it could establish a proprietary ownership right over Rolls Razor’s personal right to demand payment by Barclays). By sharp contrast, the issue in Habana was the far more speculative and esoteric suggestion that (effectively) in pressing a button and making Habana’s credit balance disappear on a screen, KSFIOM had somehow appropriated some property in such a way that KSFIOM was a trustee of that property, which meant Habana should be paid before the other creditors. But what was the property that was supposed to have been appropriated?  It could not have been the chose in action, because this was indisputably already owned by Habana. It could not have been any actual money, because all that existed was a right to demand payment. Habana’s failure to identify the subject matter of the purported trust allows a clear distinction to be drawn from the Quistclose trust.

Inter vivos or testamentary?

The case of BQ and others v DQ and others[28] required Chief Justice Ground of the Supreme Court of Bermuda to undertake a careful consideration of whether certain settlements had been made inter vivos or whether they should properly be construed as testamentary.  This question had arisen because the deceased settlor’s sons had made an application for a declaration that the settlements were testamentary.  The issue was important, because if the settlements were indeed testatmentary, then they had been revoked.  The background facts were that two trust instruments were executed in 1976 by the settlor.  Both trusts were in similar terms and took the form of an agreement between the settlor and himself as trustee.  The settlor was sole trustee until 1982, when his wife was appointed co‑trustee.  Article I of each of the trusts provided that they were revocable during the settlor’s life.  Article II gave the settlor the right to the entire net income and such capital as the trustee should determine during the settlor’s life.  Article III provided that on the settlor’s death, the trusts became irrevocable to be held in equal shares either for his sons or his grandchildren respectively.  Article VIIIH permitted the settlor to release any trustee of liability to any person arising from the trusts. 

An application was made by two of the settlor’s sons (who were beneficiaries) for declarations that both trusts were testamentary in nature and consequently were revoked either by the settlor’s marriage or his last will, both in 1978.  If the declarations were granted, the property would fall into the trusts established by the last will.  In order that the arguments in support of validity as an inter vivos disposition were properly put, the court appointed Francis Barlow QC as amicus curiae. 

Written evidence was given by the settlor’s widow and by one of the plaintiff sons.  In view of the fact that the settlor’s widow was over ninety, her evidence was accepted without cross‑examination.  She asserted that her understanding was that the trusts were not effective until the settlor’s death.  No explanation was given for her appointment as a trustee in 1982.  Despite her appointment as trustee, the settlor’s widow was not a signatory on any trust bank account.  She painted a picture of the settlor as a man who would not willingly relinquish control of his property, a view supported by the evidence of the settlor’s son.  He stated that his father was a man of strong personality who made it clear his businesses belonged to him.

The Chief Justice summarised the position as being that a trust that only comes into real force and effect on a settlor’s death is a testamentary disposition and has the same formal requirements as a will.  Crucially for the instant case, such a testamentary disposition will be revoked on a subsequent will or marriage, in the same way as a will.[29]  Given that the settlor had both remarried and made a last will in 1978, the trusts before the Chief Justice would be revoked it they were testamentary.  What matters is whether the settlement is intended by the settlor to take effect during his life, or whether it is “dependent upon his death for its vigour and effect” (as the principle was formulated in Cock v Cooke[30]). The degree of control retained by the settlor during his life can provide guidance on this point. 

In support of the proposition that the trusts should be treated as inter vivos, the amicus identified the trend in modern United States authority, which tends to uphold an inter vivos trust no matter how extensive the powers reserved by the settlor.[31]  The amicus pointed out that section 57 of the Restatement of Trusts was modified as long ago as 1957 to say that a disposition is not testamentary simply because the settlor retains a lifetime interest and a power to revoke.  However, the Chief Justice disposed of the US authorities on the basis that they were not decisive because sometimes the US evolved differently from England and the Commonwealth.[32]  The Bermuda statute stated that the reservation of rights and powers by a settlor was “not necessarily inconsistent” with a settlement being inter vivos.  Chief Justice Ground considered that the words “not necessarily” implicitly contemplated that sometimes such reservation would be inconsistent with the existence of a lifetime trust. 

Having heard full argument and considered the authorities, the Chief Justice concluded that the cumulative effect of the trust documents was that the settlor as trustee could not be called to account during his lifetime.  Where beneficiaries had no rights enforceable against the trustee, there were no trusts.[33]   Consequently, the trusts were illusory during the settlor’s lifetime.  Crucial to this conclusion was Article VIIIH, which allowed the settlor to absolve himself from any and all breaches of trust.[34]    There was nothing to indicate that the settlor or his wife consciously acted as trustees.[35]  No recognition was made by the settlor of his duties as trustee and he continued to exercise what appeared to be unfettered control over his business affairs.[36]  When the settlor executed the trust agreements, he understood that he would retain sole dominion over the assets during his lifetime.  This was supported by the settlor’s subsequent administration of the assets and the way he treated them as his own.[37]  The effect of all this was that the settlements were testamentary dispositions and had been revoked by the settlor’s marriage in 1978. 

Test for rectifying a settlement

A genuine inter vivos settlement was the subject of Chisholm v Chisholm,[38] where Susan Prevezer QC (sitting as a deputy High Court judge of the Chancery Division) considered an application for rectification. The applicant was the settlor and co-trustee of two settlements executed in July 2006 in favour of his two minor children (the third and fourth defendants) as beneficiaries. One settlement provided for the third defendant to be contingently entitled to capital on attaining 25 years, with the fourth defendant similarly contingently entitled, subject to the third defendant’s entitlement. The other settlement was in identical form, with the third and fourth defendants’ positions reversed. The applicant sought to rectify each settlement to provide a bare trust for the third defendant and a bare trust for the fourth defendant.

Evidence indicated that the applicant had sought to protect his children’s inheritance from potential claims his former partner might make and to mitigate inheritance tax liability. The applicant had been advised that post-2006, a bare trust was the only kind of trust for the benefit of minor children that could be used without attracting an inheritance tax liability. However, the settlements were not bare trusts but were instead contingent on the beneficiaries attaining 25 years. The applicant submitted that he had believed that he was creating bare trusts and had specifically instructed his solicitors to create bare trusts. This account was also corroborated by the evidence of the trustees (the first and second defendants) and was not contradicted by the evidence of his solicitors.

If the settlements were not rectified then the applicant would be taxed on a total lifetime chargeable transfer of £1 million, attracting a liability of £143,000. Her Majesty’s Revenue and Customs (HMRC) did not seek to be joined to the application but asked for Racal v Ashmore[39] and Allnutt v Wilding[40] to be drawn to the Court’s attention. These cases were authorities for the proposition that the court’s jurisdiction to rectify did not extend to rectifying mistakes that were purely as to the fiscal advantages of a transaction.

It was submitted by the applicant that he had not agreed to the creation of contingent entitlements but had instead sought simply to extend the maturity date of the trusts to 25 years, with a prevailing intention to create bare trusts. He had sought not only to save inheritance tax but to save it in a particular way. Had the applicant been advised that extending the maturity date to 25 years prevented the settlements from being bare trusts, then he would not have agreed to it. Contemporaneous correspondence indicated that the applicant had believed he had created bare trusts.

The Deputy Judge decided that the application must be allowed and the trusts rectified. Although she held that the jurisdiction did not extend to rectifying mistakes that were purely as to the fiscal advantages of a transaction,[41] it was clear on the evidence that the applicant would not have agreed to the contingency of attaining 25 years had he been advised that this prevented the settlements from being bare trusts.[42]  The applicant’s submission about not merely saving inheritance tax but saving it in a particular way by creating bare trusts was accepted. On this basis the case could be distinguished from the HMRC’s authorities Racal v Ashmore and Allnutt v Wilding.[43]  Consequently, it was ordered that each settlement would be rectified so as to make one settlement a bare trust for the third defendant and the other a bare trust for the fourth defendant.[44]    

Availability of assets to a beneficiary

In B v B[45] Mr Justice Moylan sitting in the Family Division of the High Court considered whether assets settled in a Jersey trust were available to a husband in ancillary relief proceedings.  The parties met in 1995 or 1996, started living together a year later and married in 2001.  In 2007, the parties separated with children aged two and six.  On the wife’s ancillary relief application dated 23 May 2007, an issue arose as to the husband’s available assets.  The husband’s admitted assets were £6 million but the wife sought to bring into account a further £14.5 million held in a Jersey trust.  It was contended by the husband that members of his family in Sweden were the principal beneficiaries. 

Three Jersey trusts had been set up by the husband.  In 1993, the husband settled his share of the proceeds of the sale of the family business on the C Trust, of which he was principal beneficiary.  By 2008, all the assets had been dissipated primarily on the funding of two unsuccessful businesses.  In 1994, the husband set up the F Trust, into which was settled funds derived from his father.  In 1996, the husband set up the O Trust, which was also settled with funds derived from his father.  The beneficiaries of the F Trust and the O Trust were the husband and his family’s foundation, although the husband argued that the assets were not held for his benefit.  In 2006, the funds comprising the F Trust and the O Trust were both settled into the C Trust and became known as the A fund and the B fund respectively.  At the date of trial, the assets in each fund were worth just over £7 million. 

The husband gave evidence that the trustees had always regarded the A fund and the B fund to be primarily for the benefit of his parents and sister and the family’s charitable foundation.  It was further asserted by the husband that the trustees considered his father’s wishes and would go to his father first before deciding how to act.  The husband’s position was that these funds were really his father’s assets and the appropriate ancillary relief award was £3 million.  It was contended by the wife that the trust assets were readily available to the husband and the appropriate award was £6.5 million.  At a preliminary hearing in March 2008, the profesional trustees of the trusts had been invited by the court to cooperate.  The trustees provided some documentation (principally attendance notes of meetings) but did not participate as witnesses. 

Having considered the husband’s evidence, Mr Justice Moylan found it remarkable that the documentary evidence shed so little light on the matter.  Attendance notes of meetings involving the husband’s father during 1992 and 1993 contained no relevant information and did not record the father taking an active role.  Only one document was produced for the years 1994, 1995 and 1996.  There was no further documentary record of the father having any involvement with the trustees until 2008.  This was considered by Moyland J to be remarkable given the husband’s evidence.  Moylan J found that it was self-evident from the documents that had been disclosed by the trutsees that the information provided to the trustees was not consistent with the assertion that the funds were not considered to be for the husband’s benefit.[46]  The husband’s oral evidence that certain attendance notes kept by the trustees were inaccurate was not accepted.[47]  His evidence was not only not supported by documents but was undermined by the attendance notes.[48] 

Moylan J recapped the test for whether trust assets are relevant in an ancillary relief application.  Trusts assets are relevant in an ancillary relief application where they are or may be available to one of the parties.  Whether this is a two-stage test, firstly, whether the party had any potential interest at all; and secondly, what legitimate expectation he has and the extent to which the assets are available or likely to be available in the future.[49]  The evidence demonstrated that the A and B funds had been considered by the husband for a considerable period of time to be assets that were available to him.  There was evidence that the information being given to the trustees had changed but this post-dated the application and was self‑serving and inconsistent with the other evidence.[50]  On the balance of probabilities, Moylan J considered that the interests of other trusts or other beneficiaries would not be damaged by the release of capital or income to the husband and if the husband were to request advances, the trustees would be likely to agree.[51]  The wife was awarded £4.5 million, considerably less than the wife had sought but considerably more than the husband had suggested.

Mr Justice Moylan’s judgment is noteworthy for the frustration expressed by the judge arising from the trustees’ decision not to participate in the proceedings.  While the judge could understand why the trustees had not sought to become parties, he could not understand why they did not participate as witnesses.  Moylan J asked:

“Why should trustees consider it in their beneficiary’s or the trust’s interests to take a risk that this court might obtain an inaccurate picture?  I would hope they would decide that it is not.”[52]