The best of times, the worst of times: trust assets in liquidations and receiverships - Insolvency/Bankruptcy

The recent decision of the New South Wales Supreme Court in Independent Contractor Services (Aust) Pty Limited ACN 119 186 971 (in liquidation) (no 2) [2016] NSWSC 106 found that the statutory scheme of priority does not apply to realisations from circulating trust assets. This decision has potentially profound impacts for both employees and secured creditors in the context of both liquidations and receiverships.

A SUMMARY OF THE CASE

Independent Contractor Services (Aust) Pty Ltd (Company) was trustee of the Independent Contractor Services Trust (Trust). The sole function of the Company was to administer the Trust. In 2012, the Company was wound up. At that time, however, there were amounts standing to the credit of the Company in its bank account. The liquidator was unsure about whether those amounts were:

the property of the Company (and should therefore be distributed in accordance with the statutory scheme of priority laid down by section 556 of the Corporations Act); or
held on trust for the beneficiaries.

In an earlier, related decision, the Court held that the evidence proved the existence and validity of the Trust and the liquidator would not be entitled to treat the amounts standing to the credit of the Company or collected by the liquidator since their appointment, as beneficially owned by the Company. In other words, the funds were to be treated as being held on trust for the beneficiaries.

After that decision, the Australian Tax Office (ATO) lodged a proof of debt which included an amount in respect of the superannuation guarantee charge (SGC), being a tax liability of employers calculated by reference to the wages an employer has paid to its employees.

Section 556(1)(e) of the Corporations Act affords priority to any SGC payable ahead of claims of ordinary unsecured creditors.

WHAT WERE THE LIQUIDATOR'S CONTENTIONS?

In light of the earlier decision of the Court that the funds standing to the account of the Company were to be treated as trust assets, the liquidator applied to the Court for a direction that the funds realised from the trust assets should be applied towards that part of the ATO liability which related to the SGC in priority to unsecured creditors, in accordance with section 556(1)(e).

In proposing such a direction, the liquidator relied on the prevailing case law which held that the priority scheme in section 556 does apply to trust assets.

As the payment by the Company of distributions to its contractors was an authorised function of the Company in its role as trustee, the liability of the Company to the ATO in respect of the SCG was incurred in the administration of the Trust.

It is well-established that a trustee is entitled to be indemnified from the trust assets for liabilities incurred by them in administering the trust. That right of indemnity is secured by a lien over the trust assets which confers a right in the trust assets (in the nature of a security interest) which has priority over the rights of the beneficiaries of the trust. Upon the liquidation of the trustee, the right of indemnity and the lien vests in the liquidator. A creditor of the trust is then entitled to be subrogated to the rights of the liquidator (in other words, stand in the shoes of the liquidator) in respect of their right to indemnity and the lien.

Accordingly, the liquidator contended that the Company had a right to be indemnified from the trust assets in respect of the liability to the ATO, and the ATO (as a creditor of the Trust), was entitled to be subrogated to the rights of the liquidator in respect of the right to indemnity and the lien.

WHAT WERE THE COURT'S FINDINGS?

The Court found that the liability to the ATO did not fall within section 556(1)(e). The Court looked at the definition of "employee" in section 556 and concluded that the contractors were not in fact employees within the meaning of section 556.

The Court also found that section 556 does not apply to trust assets. In doing so, the Court commented that it's view was that long standing authority was incorrect because section 556 deals with the distribution of assets which are beneficially owned by a company and not assets which are held by it on trust.

For that reason, the Court held that in the present case, the Company had a right of indemnity from, and a lien over, the trust assets for liabilities incurred in administering the Trust, which then passed to the liquidator. That right took priority over the interests of the beneficiaries of the Trust.

As all of the Company's liabilities were incurred in its capacity as trustee of the Trust, all of its creditors (including the ATO) were entitled to be subrogated to the liquidator's lien. As the statutory priority in section 556 was found not to apply to trust assets, all of the Company's creditors were to share equally in the trust assets.

WHAT ARE THE IMPLICATIONS OF THE DECISION ?

This decision contradicts long standing authority, which held that the priority regime in section 556 does apply to trust assets in circumstances where the trustee company is in liquidation, or indeed receivership (where the secured assets are subject to a circulating security interest).

However, importantly, it means that secured creditors will have priority over the claims of employees in respect of circuiting security interests and therefore has application both in a liquidation or receivership environment.

In respect of a liquidation, section 561 of the Corporations Act provides that employee entitlements, including payment of the SGC as referred to in section 556, must be paid in priority over the claims of a secured party in respect of a circulating security interest.

In respect of a receivership, section 433 of the Corporations Act affords the same priority to employees entitlements (including payment of the SGC). Given that section 556 is no longer said to apply to trust assets, the priority given to employee entitlements over secured creditors in sections 561 and 433 respectively, by virtue of section 556, also no longer applies.

The result of this is that secured creditors now stand to recover the entirety of the proceeds of trust assets which are subject to circulating security interests.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.