The Law Commission is looking into whether the regulation of trading trusts gives enough protection to creditors and beneficiaries in circumstances of insolvency.

Submissions are due on the issues paper by 2 March 2012.

What is a trading trust?

For the purposes of the review, the Commission has defined a trading trust as a structure under which a company holds property on trust for nominated beneficiaries while holding few or no assets directly in its own right. But it is seeking feedback on what definition, if any, should be used in any new legislation.

Key themes explored in the review are:

  • the risks to creditors in the current regime
  • the risks to beneficiaries, and
  • the lack of clarity in the rules regarding the liquidation of trustee companies.

Risks to creditors

Liability of a trustee and the right of indemnity against trust assets

Issue: a creditor of a trading trust does not have a direct claim against the trust's assets so must rely on the trustee's indemnity. But creditors are often unaware of the extent of this indemnity and the law is uncertain as to whether a trust deed can limit or exclude the indemnity from the trust assets and, therefore, a creditor's rights to those assets.

  • Option 1: legislate that a trustee's right to indemnity cannot be modified or excluded by the trust deed. If this option is chosen, would it be restricted to trading trusts? If so, how would that category of trusts be defined?
  • Option 2: enhance the creditor's subrogation right. A creditor can only pursue the trust assets (by way of subrogation) where the right of indemnity is not limited in any way. One option is to allow the creditor to rely on the trustee's right of indemnity despite any lack of capacity or authorisation, breach of trust, indebtedness to the trust etc on the part of the trustee.
  • Option 3: provide creditors with direct recourse to the trust assets. However, there are concerns that this type of reform may dis-incentivise the use of a trading trust structure if the trust assets are no longer protected from the reach of creditors, a consequence which may or may not be desirable.
  • Option 4: give trustees the power to grant charges for creditors over specific trust assets. Creditors would still need to examine the terms of the trust deed to check that there was no restriction on the trustee's ability to grant security over the trust assets.

Liability of directors of corporate trustees

Issue: do the director's duties under the Companies Act 1993 impose sufficient constraints on the directors of corporate trustees of trading trusts?

  • Option 1: require directors to satisfy the solvency test (under the Companies Act 1993) before making a distribution to the beneficiaries of the trust.
  • Option 2: impose personal liability on directors for debts incurred by the company where the company does not have an indemnity out of the trust assets (other than where there are insufficient assets out of which the company can be indemnified). This may also discourage the corporate trustee from limiting or excluding the right of indemnity from the trust assets.
  • Option 3: status quo. The commission will consider this if it is satisfied that the difficulties for creditors caused by trading trusts are not sufficiently serious, widespread or identifiable to warrant intervention.

Creditors unaware of the fact they are dealing with a trading trust

Issue: creditors have no way of knowing or checking whether the company they are dealing with is a trading trust.

  • Option 1: require the director of the company to inform creditors or prospective creditors of the fact the company is acting as a trustee. Sanctions for failing to do so could result in personal liability for the director.
  • Option 2: create a register for trading trusts where the company is required to disclose its status through the companies register (i.e. an annual return).

Risks to beneficiaries

The Commission asks whether directors of a trading trust should have the same obligations to beneficiaries as if they personally were the trustees. This would provide additional protection in the event that the company had insufficient assets of its own to provide compensation for beneficiary losses.

However the Commission is yet to be persuaded that any reform is needed in this area and has signalled that it will be guided by the results of the consultation process.

Liquidating insolvent corporate trustees

Issue: is more certainty required as to the circumstances in which a corporate trustee should be liquidated? If a trustee company administers numerous trusts for entirely unrelated parties (such as a lawyer's or accountant's trustee company), should it be liquidated when it cannot pay the debts owed in respect of one of those trusts? Should more guidance be introduced into the Companies Act?

Issue: is there any uncertainty over whether trust assets can be used to meet the liquidator's expenses and remuneration? Does this create any practical difficulties?

Issue: should the insolvent transaction provisions apply to corporate trustees and trust creditors? Do they need to be modified to achieve the scheme's general purpose?

Other discussion points

The regulation of trading trusts – Is a register of trusts needed? Would a record keeping provision be helpful? What information should be recorded?

The regulation of trust service providers – Is stronger regulation needed of those providing services to trusts?

The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.