Part 1 of a series on ‘The trustee and the trust‘
The duties of a trustee are well-known. The trustee must, among other things, acquaint themselves with the terms of the trust, comply with the terms of the trust and must ‘get in’, protect and preserve trust property. When exercising their powers, a trustee must act with reasonable care and diligence and take as much care of the trust property as an ordinary reasonably prudent businessperson would take of their own.
Lesser known, however, is the trustee’s right to reimburse themselves out of the property of the trust, often referred to as the trustee’s right of indemnity. This article examines the scope and application of the trustee’s right of indemnity.
Relationship of trust
A trustee’s role is fiduciary, requiring them to manage trust property with loyalty, a proper purpose and intent, with care, and to act in the best interests of beneficiaries. The trustee must act faithfully and prudently, and in return is entitled to rely on certain fundamental protections.
One such protection is the right of the trustee to be indemnified for liabilities properly incurred. The legal justification for the right of indemnity is that it would be unjust to impose strict duties on trustees, without at the same time enabling them to be reimbursed for expenses the trustee incurs when acting in that capacity.
Right of indemnity
The position at general law is that a trustee is personally liable for debts and liabilities incurred in their capacity as trustee.1 Thereafter, a trustee is only entitled to be indemnified out of the trust fund against expenses that are ‘properly’ incurred.2
In practical terms, whether a liability is properly incurred often depends on whether the trustee has strictly adhered to the terms of their mandate, often contained within the relevant trust deed. So, for example, the indemnity is not available if the activity which generated the liability involved a breach of trust, a breach of a duty, was beyond the power given to the trustee or was criminal or fraudulent in nature.
In cases of serious misconduct, a trustee will be unable to recover their liabilities from trust property. Courts have consistently affirmed:
‘trustees should not be deprived of their right of reimbursement unless they have clearly been shown to have acted improperly, with the onus resting on those who seek to deny the right’.3
This is sometimes referred to as the “negative test” – namely that a trustee will be denied their right of indemnity if a liability or an expense is shown to have been improperly incurred. It is not for the trustee to demonstrate that every expense or liability or expense was properly incurred and seek indemnity in each instance.
One example of where the right of indemnity did not arise was examined by the Court in the decision in Fairfield Pastoral Holdings Pty Ltd ato Piney Ridge Trust v Van Niekerk4. The trustee (FPH) entered into a contract (and paid a $305,000 deposit) on behalf of a trust (PRT) without any reason to believe that the trust would be able to fund the $3 million purchase price. The Court held that there was no right to indemnity because:
‘the liability… [fails to meet] the test of having been incurred “reasonably”. It was undertaken without sufficient regard to whether FPH would be able to complete the contract (failing which it — and therefore the PRT — would be out of pocket to the tune of $305,000) let alone whether the acquisition of the Whale Beach property, heavily encumbered as it would have been, represented a sensible investment for the PRT’.5
At a practical level, a breach of certain “core” duties of a trustee will often result in a loss of the right of indemnity. For all other breaches, including more technical or minor breaches (often involving the exercise of a discretion or a decision-making power), the answer will depend on the terms of the trust deed and whether that breach was in bad faith, outside the relevant power or exercised with an absence of care and diligence that a person of ordinary prudence would exercise.
Key takeaways
1. The trustee’s right to indemnity is not automatic
Courts continue to reinforce that trustees are generally entitled to reimbursement from trust assets for liabilities properly incurred in administering the trust. However, that right can be lost where conduct crosses the line to be improper.
2. Serious misconduct or a breach of trust will defeat the right of indemnity
The threshold for refusal of the right of indemnity is deliberately high. Mere errors, oversight or even poor administration will not usually deprive a trustee of indemnity. Loss of indemnity typically arises only where the trustee acts dishonestly, obtains an unauthorised benefit, acts in conflict, or commits a breach of a duty requiring strict compliance.
3. The burden to refute the right to indemnity lies with those challenging the trustee
Beneficiaries, liquidators and counterparties carry the onus of proving that a trustee acted improperly and therefore should not be afforded the right of indemnity. In cases of doubt, the trust estate will generally bear the trustee’s costs. Challenges to the right of indemnity can be difficult to run.
4. Sound governance and documentation is crucial
While the indemnity right is resilient, trustees still need to demonstrate that liabilities were incurred reasonably and in good faith. Accurate records, documented decision‑making, proactive conflict management and adherence to trust deed requirements significantly reduce the risk of disputes and increase the likelihood that the right of indemnity will be upheld by a court.
5. Early legal advice can avoid costly litigation and protect indemnity rights
Indemnity issues often arise in high‑pressure scenarios such as insolvency, collapsing schemes, disputes between beneficiaries or regulatory scrutiny. Obtaining timely legal advice can prevent inadvertent breaches, preserve access to the trust fund and minimise exposure to personal liability.
For further information, reach out to Alan Wrigley from the Litigation & Dispute Resolution team.