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Trusts have a number of benefits including asset protection, succession planning and tax planning. While an active trust is required to file an income tax return, from a legal point of view a trust is NOT a separate legal entity. This means a trust is not an entity that holds property or enters into contracts. Instead it is the TRUSTEES that actually hold property or enter into contracts on behalf of the trust.

This is different from a company which is in legal terms a separate entity capable of holding property and entering into contracts in its own name. This also means that the company is the entity liable under the contract and not the directors (unless some exception applies). This is the basis of the concept of a limited liability company.

Consequences of a trust not being a separate legal entity

Since the trust is not a separate entity and the trustees enter into contracts on behalf of the trust, it is the trustees who are liable under such contracts.

Further, the liability of trustees under a contract will be personal and not limited to the assets of the trust.  This is unless the contract contains an express clause stating the liability of the trustee under the contract is limited to the assets of the trust. So trustees must include a limitation of liability clause in contracts they sign otherwise their personal assets may be used to meet any liabilities under the contract.

It will not be sufficient to state that a trustee is signing as a trustee of a trust – an actual clause stating the liability of the trustee is limited needs to be included. Trustees should consult a lawyer to ensure the wording of the clause is effective.

This legal principle was illustrated in a recent case Frimley Estate Limited v Stonewall Homes Limited where the parties entered into an agreement for sale and purchase of property in Hastings. Stonewall was the purchaser and failed to settle and one of the arguments in its defence was that it entered into the agreement as a trustee of the Stonewall Properties Trust and was not itself a party to the agreement. The Court disagreed and re-iterated that a trust is not a separate legal entity. Stonewall was held to be a party to the agreement and the party liable as purchaser. Fortunately though, there was a trustee limitation of liability clause so Stonewall was only liable up to the amount of the assets of the trust.

Note though that the inclusion of a limitation of liability clause is a matter of commercial negotiation along with the rest of the terms of the contract. The other party to the contract may seek to make you personally liable to ensure compliance with your obligations. Also a bank will not agree to a limitation of liability clause in a loan contract if you are both a trustee and a beneficiary of the trust – the bank will only tend to agree to a limitation clause for a trustee who is an independent trustee not entitled to benefit under the trust.

Summary

The court has said that “the concept of trust is used more often than it is understood”.  If you are the trustee of a trust you must understand and be aware of all your duties and potential liabilities as a trustee. One important risk is that when you enter into a contract as trustee you will be personally liable unless you include a trustee limitation of liability clause in the contract.