Court of Appeal Puts Cart Where it Should Be After the Horse By Pieter Oomens | June 2009 Area of Expertise | Commercial Disputes & Insolvency
Summary The NSW Court of Appeal has considered the principles concerning the rights of indemnity of a trustee against trust assets and the lien which exists to protect such rights. Critical to these rights, however, is the establishment of a liability on the part of the trustee: Agusta Pty Ltd v Official Trustee in Bankruptcy [2009] NSWCA 129.
Who Does This Impact? The case impacts those who act in a trustee capacity generally and in particular, bankruptcy trustees who might act for such people; and the liquidators of trust companies.
What Action Should Be Taken? Assume a trustee (which includes, for example, the trustee of the bankrupt estate of such a person) wishes to claim indemnity from the trust. The starting point for determining a trustee’s right to indemnity (and the ancillary right to a lien) is identifying the liability (be it actual or potential) which underpins that right. That liability and the date of its creation then need to be considered in light of the person’s position as trustee.
Background In 1995 the Ferellas were appointed trustees of a unit trust (the ‘Trust’). On 19 April 2005 the Ferellas resigned and a company called Reva (NSW) Pty Limited (‘Reva’) was appointed trustee. The validity of that transaction was at issue in the proceedings at first instance. The Ferellas had been involved in proceedings with a Mr and Mrs Otvosis. The proceedings related to property which was the subject of the Trust (the ‘property proceedings’). On 23 September 2005, the Otvosis’ obtained an injunction in the property proceedings. On 14 October 2005, each of the Ferellas was made bankrupt and The Official Trustee was appointed trustee of their estates. On 1 November 2005, the judge in the property proceedings indicated a readiness to make a costs order in favour of the Otvosis’ but was precluded from doing so by reason of the Ferellas’ bankruptcy. No formal costs order was made but an assessment was prepared which referred to the amount of such costs as being in the order of $114,000. On 17 October 2005, the Ferellas applied to annul their bankruptcy. In or about mid-November 2005, the Ferellas made an application to stay their bankruptcy. On 10 March 2006 the applications made by the Ferellas were refused. On 11 April 2006 the property, the subject of the Trust, was sold by its mortgagee following which the net proceeds of $1.7m were paid to The Official Trustee (the ‘Fund’).
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Court of Appeal Puts Cart Where it Should Be - After the Horse by Pieter Oomens
The Status of Trusteeship At first instance, there was much controversy concerning the identity of the trustee of the Trust. One of the provisions in the Trust Deed was to the effect that upon the replacement of a trustee the departing trustee should cause to vest in the new trustee the property which was the subject of the Trust. No steps were taken by the Ferellas to implement this provision. The judge determined that the assets of the Trust remained vested in the Ferellas at the time of their bankruptcy. The judge also held that Reva had become the new trustee as a result of the Deed of 19 April 2005 but the Trust assets had never vested in it. On the appeal there was no challenge to these findings.
Claims Upon the Trust Property Various creditors (including the Otvosis’) had claims which related to the operation of the Trust. The Official Trustee claimed an entitlement to a lien over the Fund in respect of these claims. Both at first instance and on appeal it was conceded by the Ferellas that some of the claims were the subject of a lien in favour of The Official Trustee. Some claims were disputed and the appeal focused on the disputed claims. The disputed claims could be conveniently placed in three categories: •
There were claims by the Otvosis’ to costs in relation to the Ferellas’ applications for the stay and the annulment of their bankruptcies.
•
There was a claim by the Otvosis’ for the amount of $114,000 which The Official Trustee contended was a contingent liability in respect of the unassessed legal costs relative to the property proceedings.
•
The third and largest claim related to what was contended to be a contingent liability for capital gains tax which may have arisen as a result of the sale of the property and which resulted in the Fund.
A Trustee’s Entitlement to Indemnity and a Lien Over Trust Property At first instance ((Agusta Agusta Pty Ltd v The Official Trustee in Bankruptcy [2008] NSWSC 685) the judge set out the relevant principles relating to the rights of trustees to be indemnified out of a trust fund against liabilities incurred by them in the performance of their duties as such. These statements of principle were accepted by the Court of Appeal: •
A trustee is entitled to be indemnified from the trust assets against personal liability incurred in conducting the business of the trust, and for the purpose of enforcing the indemnity the trustee possesses a charge or right of lien over those trusts.
•
The trustee has a beneficial interest in the trust assets to the extent of his or her right to be indemnified out of those assets against personal liabilities incurred in the performance of the trust.
•
For the purpose of indemnification, the trustee is entitled to possession of the trust property as against the beneficiaries. His or her interest in the property is a proprietary interest which will pass to his or her trustee in bankruptcy for the benefit of creditors of the trust’s trading operations should the trustee become bankrupt.
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Court of Appeal Puts Cart Where it Should Be - After the Horse by Pieter Oomens
•
If the trustee has discharged the liability he or she is entitled to reimbursement out of the trust property. If he or she has not discharged the liability, then there is an entitlement to resort to the trust property for the purpose of discharging the liability. If the trustee is bankrupt and the trust liabilities have been discharged, the trustee in bankruptcy is entitled to reimburse the bankrupt estate out of the proceeds of the trust property. If the liabilities have not been discharged the trustee in bankruptcy may apply the trust property to the payment of the trust liabilities thereby exonerating the bankrupt estate to the extent of the value of the available trust assets.
•
The lien is ancillary to the right of indemnity. The rights conferred pass to the trustee in bankruptcy and enable him or her to obtain and retain possession of the trust property until the right of indemnity has been exercised and to realise the trust property in the course of exercising it.
•
As it is an equitable lien, it is a right against property which arises to secure the discharge of an actual or potential indebtedness. It is a form of equitable charge over the subject property in that it does not depend upon possession and, when the lien is over a fund, may be enforced by an order for payment from that fund.
•
A trustee has a lien over the trust fund for all of his or her liabilities as a trustee, including proper costs and expenses, which extends to an indemnity against future and outstanding contingent liabilities.
•
The trustee is entitled to have all the trust property remain available to protect his or her rights of indemnity against it until such rights have been ascertained and discharged.
Dealing with the Disputed Claims At first instance, The Official Trustee succeeded in establishing its entitlement to an indemnity from the Fund and a lien over the Fund in respect of the disputed claims. The legal principles articulated by the judge at first instance were endorsed by the Court of Appeal and yet The Official Trustee lost on its claim to an indemnity and lien in respect of the disputed claims. Why? The critical factor in this case was not the law but the facts. When did the liabilities, the subject of the disputed claims, arise? The first of the disputed claims was a claim in respect of legal costs relative to the annulment and stay applications. By definition, such claims arose after sequestration. When did the so called contingent liability in relation to the legal costs of the injunction proceedings arise? In this regard, reference was made to the High Court decision in Foots v Southern Cross Mine Management Pty Limited [2007] HCA 56. There it was held that an untaxed order for costs made after bankruptcy is not a debt provable in bankruptcy. To be provable a costs order needs to be made before a sequestration order is made even if the order is taxed subsequently. The present case was somewhat different from the facts which existed in Foots. Here, the question was whether the Ferellas as trustees of the Trust (and by extension The Official Trustee standing in the place of the Farellas) were entitled to a right of indemnity with respect to a potential liability to pay the Otvosis’ costs of litigation. That litigation was determined adversely to the Ferellas before bankruptcy. The litigation related to property of the Trust. However, no order for costs had been made against the Farellas in favour of the Otvosis before sequestration. In considering this particular issue, the Court of Appeal made the point that the claim to indemnity cannot arise without there being an underlying liability in respect of which the indemnity is sought. What Foots made clear was that the liability for such a costs order could not arise unless such order had been made prior to sequestration. Absent a
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Court of Appeal Puts Cart Where it Should Be - After the Horse by Pieter Oomens
personal liability on the part of the Farellas, the claim by The Official Trustee for indemnity against the Trust had to fall away. Considering the issue of the potential CGT claim, it is worthwhile recalling the fact that the sale of the property, conducted by the mortgagee, occurred on 11 April 2006 whereas the Farellas had become bankrupt on 14 October 2005. It is not surprising that the Court of Appeal questioned senior counsel for The Official Trustee at the commencement at the hearing for an explanation for the legal basis upon which it could be asserted that The Official Trustee had a right of indemnity with respect to the disputed claims referred to above given that each only arose after the date of the sequestration orders. Senior counsel for The Official Trustee conceded first, that The Official Trustee had no personal liability with respect to post-sequestration order costs or liabilities incurred in the administration, or arising out of the affairs, of the Trust; and second, that no right of indemnity with respect to those costs or liabilities could arise until they became an actual or potential liability of the Trust.
Conclusion The principles set out at first instance and endorsed on appeal give considerable comfort to those persons who act as trustees or who are placed in a position of protecting the interests of those who are trustees (for example, liquidators of trustee companies). However, this case reminds us that the first critical step is to ensure that the facts fit the principles. The cart should be after the horse.
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Court of Appeal Puts Cart Where it Should Be - After the Horse by Pieter Oomens
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