Trustee's have, by default, a right to be repaid out of the assets of a trust (of which they are trustee) for costs incurred in the running of the trust. Putting to one aside the issue of what may be legitimate costs, this right is either one of exoneration or recoupment. Together these rights are known as the trustee's rights of indemnity.
The rights can be confusing, especially in an insolvency setting. Therefore, the analogy of an office petty cash fund will be used to help explain how they work (for all you overly technical lawyers out there who like to nit pick, this example is used by way of illustration only to clarify the the way the rights work).
The right of exoneration, is the right to draw from the trust directly the funds required for a particular action. Think of taking money out of petty cash to buy some pens for the office.
The right of recoupment though, operates quite differently. Imagine, that you purchased those pens for the office out of your own money, and then sought to be reimbursed out of petty cash. That is how the right of recoupment works.
There are three issues surrounding the rights that have caused no small amount of trouble.
The first is how the rights are treated in bankruptcy. Under the Bankruptcy Act 1966 (Cth), s 116, if a person becomes personally bankrupt, but they are also a trustee, then those assets held on trust are not available to their creditors. The confusion arises where they have unexercised rights of recoupment or exoneration. The question is whether these rights become available to creditors. There has been conflicting authority under Australian law, but the presently accepted position, and the most logical one, is that only the right of recoupment is available to satisfy personal creditors, but the right of exoneration is not: Re Suco Gold (1983) 33 SASR 99.
Returning to the petty cash example above, if you have spent your own money buying office supplies, then the office owes you money. This is a debt owed to you. If you were to become bankrupt, then this debt could be called in, and the money owed to you would be available to your creditors.
If however, you had taken money from the petty cash to buy the office some pens, this money (and the pens purchased with them) belong to the office. You are merely holding the money and/or pens on trust. As explained above, property held on trust is not available to a bankrupt's personal creditors.
This leads to another situation of a creditor seeking payment of money owed by the trustee, and the debt was incurred in service of the trust. Returning to our example, imagine that you went to buy the pens for the office, but forgot to take any money with you. The store, knowing you well, lets you take the pens on the promise that you will get the money to pay it back shortly (so, store credit, basically).
Say in this situation you become bankrupt. The store still wants its money for the pens, in which case, it claims through your right of exoneration from petty cash. Even if you don't have enough money to pay your other creditors, and they too would like access to the office petty cash, those other debts were not incurred on behalf of the office, only the purchase of the pens were.
The second issue is what happens when a trustee is in breach of their obligations under the trust. The problem here is that the rights of exoneration and recoupment are treated as being subject to any breaches of the trust. Therefore, say you had bought some paper clips using petty cash, but there was change leftover of $2. You forgot to repay this money, and so you now owe $2 to petty cash. Now you pay for the office pens using your own money, lets say $5. You have a right of recoupment for $5, but you still also owe the $2. The net effect is that you may only take $3 from petty cash to reimburse yourself for the purchase of the pens (5 - 2 = 3). Likewise, your creditors may only take $3 from the trust fund. This rule applies even if you're claiming through the right of exoneration.
The third issue is that, importantly for creditors is that the trustee's rights of exoneration and recoupment are the only way they have to access the property held on trust. If these rights were somehow gotten rid of, then no one would be able to access the trust assets.
The problem is that in at least two Australian jurisdictions, it appears that the rights of exoneration and recoupment may be excluded by the terms of the trust deed (the document that establishes the trust): Trustee Act 1958 (Vic), s 2(3); Trustees Act 1962 (WA), s 5(3). The remaining States and Territories take the opposite view, whether by the express terms of statute or judicial decisions.
A caution though. The exclusion of the rights of exoneration and repcoupment, is not an annihilation of them. Thus even if their availability to the trustee and creditors is excluded, they still operate by way of the fact that they are the only means of accessing the trust assets. Just because you turn off a light, doesn't mean it isn't there.
What we have in the rights of exoneration and reocupment are not necessarily logically consistent rights, but rather rules that must be understood and applied. It is hoped the above has somewhat assisted in doing so.
