Cementing the treatment of insolvent trading trusts?

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By Ariel Borland, Partner, Nirupa Manoharan, Special Counsel, and Dean Brayley, Associate

Introduction

In our last update we discussed the decision of the Victorian Court of Appeal in Commonwealth v Byrnes and Hewitt [2018] VSCA 41 (commonly referred to as the “Amerind” decision). In that decision, the Court unanimously found that the trustee’s right of indemnity was ‘property of the company’ and as such the statutory priority regime in the Corporations Act 2001 (Cth) (Act) applied to trust assets realised to satisfy the indemnity.

In the very recent decision of In the matter of Killarnee Civil & Concrete Contractors Pty Ltd (in liq) [2018] FCAFC 40, the majority judges of the Federal Court of Australia supported the decision in Amerind.  In Killarnee, the majority of the Court held that the trustee’s right of indemnity (whether by way of exoneration (before a debt is paid) or recoupment/reimbursement (after a debt is paid)) was indeed property of the company.  The Court cautioned that creditors do not, as a result of this conclusion, become beneficiaries of the trust; rather the right of indemnity remains property of the trustee but “its nature and character are that it is exercisable only to pay trust creditors.

Questions addressed by Killarnee

Killarnee addressed the following four questions in relation to the trust assets held by the insolvent corporate trustee:

  1. Were the assets of the trust at the time of winding up of the company assets in the winding up so that the liquidator had the power to sell the trust assets?

The Court unanimously answered “no” to this question.

On its insolvency, the company, under the trust deed, was disqualified from acting as a trustee.  As a ‘bare trustee’, the statutory powers of a trustee (including powers of sale) arising under the Trustees Act were not available to the trustee. Similarly, the powers of a liquidator under section 477 of the Act to deal with assets of the company were also stated to be distinct and separate from the authority of the liquidator to exercise a lien and sell underlying assets which had been held on trust.

Accordingly, in order to effect a sale of the trust assets in these circumstances the liquidator (as bare trustee) and in reliance of his or her equitable lien, would need to “approach the court to authorise the sale of trust assets by way of equitable execution for the purpose of paying the trust creditors and so vindicating its right to exoneration, notwithstanding that it is a bare trustee.”

Although in Killarnee the liquidators had failed to apply to the Court for equitable intervention before they sold the trust assets the Court was still minded to grant the liquidators the requisite relief.

The case is therefore a useful reminder to liquidators appointed to corporate trustee companies that they will need to check the trust deed to confirm what impact the winding up may have had on the company’s ability to continue dealing with trust assets and to seek a direction from Court prior to attempting to sell any assets if, following the winding up, that company only holds assets as a bare trustee.

  1. Are the proceeds of realisation of trust assets to be applied in accordance with the priority regime under the Act?

The court found 2:1 in answering this question in the affirmative with Chief Justice Allsop and Justice Farrell answering “yes” but Justice Siopis answering “no”.

In support of the “well regarded” reasoning set out in Re Suco Gold, Allsop CJ stated that the company’s property, including any right of exoneration and funds obtained from exercising that right, should be distributed in accordance with the statutory priorities under the Act in circumstances where the corporation had only ever acted as a trustee of one trust and that had been the totality of its affairs.

Accordingly, and in contrast to the Amerind decision discussed in our previous alert, the majority judges in Killarnee preferred the reasoning in Re Suco Gold over that of Re Enhill. To recap, Re Suco Gold held that a liquidator should apply the proceeds of the company’s exercise of its right of indemnity only to repay trust creditors whilst Re Enhill suggests that the proceeds could be used to repay all creditors, including general creditors of the company.

In his dissenting judgment, Siopis J stated that the purpose of the right of exoneration was limited to using trust assets to pay trust creditors and, on exhaustion of this right, it was incapable of contributing to the fund contemplated by the Act to be distributed in accordance with the priority regime under the Act.  In other words, in Siopis J’s view, the “property of company” under the Act did not include the company’s right of indemnity.

  1. Should the liquidators deal with the proceeds of realisation of the trust asset as assets in the winding up of the Company?

Again, and for the reasons stated above, the Court was split with two out of the three judges answering this question in the affirmative.

  1. Finally, should the liquidators distribute the trust proceeds to unsecured creditors of the trust pari passu after providing for the costs of the administration only?

The Court unanimously answered “no”.  Acknowledgment was specifically given to employees as a body of unsecured creditors to be protected, on public policy reasons, in the aftermath of insolvency and, in this regard, “there is every reason for Equity to follow the statute in applying its principles of distribution concerning employees conformably with the public policy in the statute…”.

Take away points

Killarnee provides a cautious note to liquidators appointed to insolvent corporate trustees in dealing with trust assets where the corporate trustee only holds those assets in its capacity as a bare trustee following its winding up. The authorities now weigh in favour of orders being required prior to an administrator or liquidator of a bare trustee dealing with the trust assets.  The absence of such an order would leave the trustee open to a claim for breach of trust and also allow creditors to exercise their right of subrogation to apply to the Court for the appointment of a court appointed receiver to sell all the trust assets and distribute the proceeds.

Killarnee also further strengthens the need for legislative reform in the area of the administration of insolvent corporate trusts.  For example, where an administrator or a liquidator is appointed to a corporate trustee which operates in multiple states and/or as a trustee which potentially administers more than one trust and/or conducted affairs in its own right and as trustee of the trust, the proper distribution of the trust assets in these circumstances is very uncertain and will no doubt require a series of complex (and potentially costly) Court directions to be sought.  Whilst the task of amending the Corporations Act to address these issues is by no means straightforward, there is good public policy reasons for change given the position that such trusts occupy in Australia’s economy.

For further information, please do not hesitate to contact us.

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Restructuring & Insolvency

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