Australia: Insolvent trusts – get your priorities straight

The High Court of Australia recently handed down its much anticipated decision in Carter Holt Harvey Woodproducts Australia v Commonwealth of Australia & Ors [2019] HCA 20. The court agreed that the priority regime in the Corporations Act 2001 (Cth) (Act) applies to payment of trust creditors of an insolvent corporate trustee.

More specifically, the court decided:

  • assets held by a trustee company on trust ('trust assets') are 'property of the [trustee] company' and, if subject to a circulating security interest, are subject to sections 433 and 561 of the Act, which require employee claims to be paid out of circulating assets in priority to a secured creditor; and
  • the proceeds of a trustee's right of exoneration can only be used to pay trust creditors, who must be paid in accordance with section 556 of the Act.

Background

A trustee is personally liable for any debts it incurs in its capacity as a trustee and has a right of indemnity over the trust assets (i.e. a right to have recourse to trust assets to repay itself for properly incurred expenses in performing its duties as trustee).

The right of indemnity remains where a company becomes insolvent or where the trustee is removed as trustee.

If the trustee has paid trust expenses from its own (non-trust) assets, its right of indemnity is referred to as the right of recoupment. Where the trustee seeks to pay trust expenses directly from trust property, the right of indemnity is referred to as the right of exoneration.

Amerind Pty Ltd (Amerind) carried on a business wholly as the trustee of a trading trust, which became insolvent. Amerind had no assets of its own and relied on its right of exoneration from the trust assets to pay its liabilities. Amerind's directors appointed voluntary administrators and Amerind's bank appointed receivers and managers (Receivers) on the same day.

By the time Amerind's creditors decided to wind up Amerind, the vast majority of the secured assets were realised, the bank's secured debt had been discharged (from non-circulating assets) and there was a surplus of approximately $1.6 million held by the Receivers from the sale of inventory. The Receivers sought directions as to how to distribute the funds, which (by the time the matter came before the High Court) were acknowledged to be circulating assets.

The Commonwealth of Australia, who was a priority creditor with the same ranking as employees (having paid approximately $3.8 million to Amerind's employees, for their accrued wages and entitlements, through the Fair Entitlements Guarantee Scheme), argued that section 433 of the Act applied to the Receivers and the surplus, and consequently, the surplus must be paid to the Commonwealth.

Carter Holt Harvey Wood Products Pty Ltd (Carter Holt), a trade creditor, argued that section 433 of the Act did not apply, and that the funds should be paid to Amerind's unsecured creditors pari passu (on equal footing).

Section 433

Section 433 applies where, prior to a company being placed into liquidation:

  • a receiver is appointed on behalf of the holders of any debentures of a company ... that are secured by a circulating security interest; or
  • possession is taken or control is assumed, by or on behalf of the holder of any debentures of a company ... of any property comprised in or subject to a circulating security interest.

If section 433 applies, the receiver ... taking possession or assuming control of property of the company must pay, out of the property coming into his, her or its hands, employee claims in priority to any claim for principal or interest in respect of the debentures.

Carter Holt argued:

  • the trust assets were not the property of the company and therefore, could not be the property of the company subject to a circulating security interest; or
  • the only asset of Amerind was its right of indemnity and it was not 'property comprised in or subject to a circulating security interest',

Carter Holt concluded that the preconditions for the operation of section 433 were not met.

Decision

Section 433

Although the High Court dismissed the appeal unanimously, three judgments were handed down. Kiefel CJ, Keane and Edelman JJ provided a joint judgment, as did Bell, Gageler and Nettle JJ. Gordon J, although agreeing with the latter three, presented her own reasons for dismissing the appeal.

Kiefel CJ, Keane and Edelman JJ focused on the fact that a trust is no more than a bundle of rights, and the obligations imposed on a trustee by the terms of the trust (generally, under a trust deed).

Those rights include the rights to acquire and own assets, to use the assets to earn income, to use the assets to pay liabilities associated with a trust and so on. The term 'trust assets' is no more than a description of the rights held on trust by the trustee for the beneficiaries. The trustee's right of indemnity is another right held by a trustee.

To the extent that the right of indemnity gives a trustee the power to use the trust assets for its own benefit (in order to satisfy the right of indemnity), the trust assets are the property of the company, and if they are subject to a circulating security interest and in the hands of a receiver, section 433 applies to them.

Bell, Gageler and Nettle JJ noted that a trustee, as the legal owner of the trust assets, has all the powers incidental to ownership subject only to the power of the beneficiaries to compel the trustee to exercise the trustee's powers in accordance with the terms of the trust.1

Until the trustee' right of indemnity has been satisfied, 'the beneficiaries cannot compel the trustee to exercise the trustee's powers as legal owner of the trust assets for their benefit'.2 In that sense, the beneficiaries' interest is not 'to be conceived of as cut out of the trustee's legal estate but rather as engrafted onto it as a restriction on the manner in which the trustee may deal with trust assets'.3

Bell, Gageler and Nettle JJ held that the trust assets themselves were 'property of the company' which came into [the receivers'] hands', out of which they were to pay the priority 'debts or amounts'. The inventory and its proceeds, over which the receivers were appointed were subject to a circulating security interest and that attracted the operation of Section 433.4 Amerind's right of indemnity was also the property of Amerind, but this was not a circulating asset and was not subject to a circulating security interest.

Gordon J while agreeing with Bell, Gageler and Nettle JJ, that the trust assets themselves were the property of the company, wrote her own reasons out of 'principle and practice' and went on to clarify some collateral issues as discussed below.

Section 561

Given their findings, all judges also agreed that section 561 of the Act, which (similar to section 433) requires liquidators to pay employee claims in priority to the claims of secured creditors to circulating assets, applies to trust assets subject to a circulating security interest of a company in liquidation.

Section 556

Bell, Gageler, Nettle and Gordon JJ5 held the statutory order of priority for the payment of unsecured creditors set out in section 556 of the Act should apply to the distribution of the proceeds of realisation of a trustee's right of indemnity. In doing so, they accepted that the reasoning in In re Suco Gold Pty Ltd (In liq)6 should be preferred over Re Enhill.7 Whilst not expressly saying that section 556 applies, the judgment of Kiefel CJ, Keane, and Edelman JJ also leads to that natural conclusion.

As they said:

'It would be perverse if the Corporations Act operated to deny employee creditors a particular priority over the holders of a circulating security interest solely for the reason that the company which employed them was, perhaps even unknown to the employees, trading as a trustee. Secondly, as Allsop CJ observed in Jones v Matrix Partners Pty Ltd; Re Killarnee Civil & Concrete Contractors Pty Ltd (In liq),8 s 433 was enacted in 2001 as part of the Corporations Act at a time when the decision in In re Suco Gold Pty Ltd (In liq) had stood for 17 years and "was both well-regarded and followed (though by no means universally) including in relation to priorities and liquidator's costs".

Use of the proceeds of the right of indemnity

All judges agreed that the proceeds of the right of exoneration can only be used to pay properly incurred trust liabilities and cannot be used to pay non-trust liabilities. On the other hand, the proceeds of the right of recoupment are available to pay non-trust creditors and any trust creditors to the extent they remain unpaid from the proceeds of the right of exoneration.

Court approval for payment of expenses and remuneration.

Gordon J agreed with the approach put forward by King CJ in In Re Suco Gold Pty Ltd (in liq)9 that the liquidation costs and expenses of winding up a company which acts as trustee of a trading trust are to be regarded as debts of the trustee and able to be paid out of the assets of the trust pursuant to the trustee's right of indemnity in accordance with the section 556 priorities.10 Whilst the other judges did not expressly discuss this issue, Bell, Gageler and Nettle JJ's acceptance that section 556 applies to the distribution of the proceeds of a trustee's right of indemnity and Kiefel CJ, Kean, and Edelman JJ's tacit approval of In re Suco Gold Pty Ltd (In liq) 'in relation to priorities and liquidator's costs' leads to the conclusion that they also accept this position.

It logically follows that an administrator or liquidator will no longer need court approval to pay properly approved remuneration and expenses properly incurred in acting as administrator or liquidator of the trustee of a trading trust from the proceeds of the trustee's right of indemnity.

However, this does not mean that a former trustee has an automatic right to repossess trust assets where they are in the possession of a new trustee, or to sell trust assets, in order to satisfy the trustee's right of indemnity and court approval should still be sought in those circumstances.

Multiple trusts

Gordon J considered the position of an insolvent trustee of multiple trusts and held that the right of exoneration of a trustee in relation to a particular trust can only be used to pay creditors of the relevant trust. That meant that the proceeds of the right of exoneration of each trust fund should be kept separately and section 433 applied to each trust fund. Bell, Gageler, and Nettle JJ11 commended the approach suggested by King CJ in In re Suco Gold Pty Ltd (In liq) of construing section 556 as if the liquidator held separate funds for each different group of creditors, but noted that complications may arise in its application.

In respect of an administrator's or liquidator's costs and expenses in administering a trustee of multiple trusts, Gordon J held that the costs and expenses should be apportioned across each trust to the extent of the work of the administrator or liquidator related to each trust. If there any was difficulty in doing so, the administrator or liquidator could apply to the court for directions. This accords with the approach suggested by Bell, Gageler, and Nettle JJ in construing section 556 more generally.

Trustees in bankruptcy

In Lane v Deputy Commissioner of Taxation,12 Derrington J held that the priorities under section 109 of the Bankruptcy Act 1966 (Cth) did not apply to the proceeds of the right of exoneration of a trustee in bankruptcy because His Honour concluded that the right of exoneration did not produce 'proceeds of property of the bankrupt' which section 109 applies to and governs distribution of.

Gordon J held that Derrington J was wrong in his conclusion.13 Following the same reasoning used for corporate insolvency (i.e. that trust property is property of the trustee, albeit, subject to limitations as to its use), Her Honour held that the proceeds of the right of exoneration were the proceeds of property of the bankrupt and therefore the priorities under section 109 of the Bankruptcy Act 1966 (Cth) did apply to their distribution. This does not alter, and is still consistent with, Derrington J's other findings, including that the proceeds of the right of exoneration in bankruptcy are only available to trust creditors.

Conclusion

The decision finally clarifies some of the divergent views from 40 years of case law and provides certainty for receivers and liquidators when distributing trust assets where the trustee company acted solely as trustee for a single trust.

The High Court was not presented with the opportunity to consider in detail the situation where a company owns assets in its own capacity and as trustee and has incurred liabilities in both capacities, or where a company acts as trustee for multiple trusts. In these circumstances receivers, administrators and liquidators may still need to seek directions from the Courts where there is uncertainty as to how the costs of administering the different assets should be allocated or how the funds realised should be distributed to creditors.

Read the full judgment or read the summary issued by the High Court.

References:

  • 1 [2019] HCA 20 [82]
  • 2 [2019] HCA 20 [83]
  • 3 [2019] HCA 20 [82]
  • 4 [2019] HCA 20 [86]
  • 5 [2019] HCA 20 at [93] and [98].
  • 6 [2018] FCAFC 40; 260 FCR 310.
  • 7 [1983] 1 VR 561.
  • 8 [2018] FCAFC 40; 260 FCR 310.
  • 9 (1983) 33 SASR 99.
  • 10 [2019] HCA 20 [168]-[171].
  • 11 [2019] HCA 20 [97].
  • 12 (2017) 253 FCR 46.
  • 13 [2019] HCA 20 [174]

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.

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