A Review of the Key Issues of winding up a Corporate Trustee for the benefit of creditors

By Alan Izra MICM*

A. INTRODUCTORY COMMENTS

1. The High Court’s decision in

Carter Holt Wood products

Australia Pty Ltd v The

Commonwealth [2019] HCA 20 (‘Amerind’) has been discussed in the previous AICM Magazine. 2. In summary, the High Court in the

Amerind held that –a. Section 433 of the Corporations Act 2001 (‘the CA’) applies on the receivership of a trustee company in the exercise of the trustee company’s right of exoneration; b. The statutory scheme of priority applies to distribution of the relevant trust property, being here the receivership surplus subject to the trustee’s right of indemnity; and c. Trust assets may only be used to pay trust creditors on exercise of the power of exoneration in a receivership or in the liquidation of a trustee company, but not non-trust creditors. 3. Notwithstanding Amerind’s decision, other matters remain unanswered in the winding up of corporate trustees. This article summarises the main issues and principles concerning the liquidation of corporate trustees.

B. KEY ISSUES ON APPOINTMENT

4. It is common that a trust deed will provide that the trustee is removed on liquidation of the company. In the circumstances, the corporate trustee becomes a bare trustee of the trust assets. Accordingly, the company’s obligations, powers and rights are limited to protecting the trust assets and do not include the power to deal with the trust assets. 5. In such instances, it is usual for liquidators to apply to Court for orders to1 –a. Confirm the liquidators’ power to deal with trust assets; or b. Appoint a receiver over the trust assets. 6. By virtue of paragraph 5 above, liquidators are encouraged to review the conditions of the trust deed to establish whether the company in liquidation is or will be removed as trustee on appointment.

Amending the trust deed

7. In order to avoid the removal of a company as trustee of a trust on a liquidator’s appointment, one option is to amend (i.e to remove ejectment clause) the trust deed before the automatic removal of a company as trustee of a trust. 8. The above option has been

specifically discouraged by the

Courts and accordingly, should not be adopted. The Courts established that an attempt to alter the trust deed were for the benefit of creditors, not the beneficiaries of the trust.2 The ideal method is for the liquidator to apply to Court for seeking directions to allow them to deal and/or sell trust assets. 9. In the decision of Brimson Pty Ltd (in Liq)3 (‘Brimson’), the Federal

Court delivers beneficial direction in circumstances where the corporate trustee ceases to be the trustee upon becoming insolvent. 10. Brimson highlights the need to approach the Court before the liquidator is able to realise the assets of the trust to meet the company’s liabilities. The decision is one of the first since the handing down of the High Court’s findings in Amerind concerning the nature of the right of exoneration and the limit of what it can be used to indemnify.

Background – Brimson

11. The case relates to the liquidation of three companies that, as trustees of three trading trusts, ran three franchises. Mr and

Mrs Brimfield were the ultimate beneficial owners of the franchises, and structured their business to run through three trustee companies. 12. On 22 May 2019, the franchisor issued breach notices to each of the three companies in relation to breaches of their franchise agreements. Shortly after this on 28 May, a liquidator was appointed to each company under a creditors voluntary winding up pursuant to s.491 of the CA. 13. Under the terms of the trust deeds, clauses operated to remove

the respective corporate entities as trustees upon the companies having liquidators appointed. This meant that the liquidator, while having power over the companies, did not have power concerning the trusts (or their assets). 14. Due to the operation of the automatic removal of a company upon liquidation, from the date of appointment of the liquidators, the companies themselves were removed as trustees and had no power to deal with the trust property. This means that the trust creditors did not benefit from the trust assets to pay any outstanding invoices. 15. As a consequence, the liquidator applied to the Court seeking the power to act as the receiver of the respective trusts and realise their assets to pay trust creditors. 16. The application was fairly straightforward in terms of how ➤

the law applied to the Brimson scenario. The Court recognised that –a. Where a corporate trustee enters liquidation, because the right of indemnity is an equitable lien, it persists despite the company having been removed as trustee. b. it was now settled law that the liquidator of a former corporate trustee cannot sell trust property without an order of the Court, or by appointment as the receiver over the trust’s assets. 17. The rationale behind this restriction confirms Amerind in that while the equitable lien is property of the company, it is merely a right of exoneration through the equitable lien.

Therefore, the trust property itself cannot be regarded as property of the company. 18. The Court also made it clear that the proceeds from the realisation of the trust’s assets may only be used to satisfy the liabilities of the company that relate to the trust, and not the general debts of the trustee company unrelated to the trust. 19. Further to the above, two other recent decisions of the Federal

Court have affirmed the need for a liquidator of a corporate trustee to apply for a Court order either extending the scope of the liquidator’s power of sale, or appointing the liquidator as the receiver of the trust’s assets, in seeking to exercise the trustee’s right of exoneration over the trust assets.4

The types of right of indemnity under a trust deed

20. It is well known that there are two types of trustees’ rights of indemnity – the right of recoupment and the right of exoneration. Both arise after the trustee incurs a debt on the trust’s

“The right of recoupment arises where the trustee incurred a liability and then paid the liability from its own assets. The trustee then seeks reimbursement under its indemnity.”

behalf, and becomes personally liable for payment of that trust debt. 21. The right of indemnity is a beneficial interest in the trust provided for under a trust deed which passes to the appointed liquidator. 22. The right of recoupment arises where the trustee incurred a liability and then paid the liability from its own assets. The trustee then seeks reimbursement under its indemnity. 23. The right of exoneration differs and will more often be relevant in insolvency (where trust debts remain unpaid). The right of exoneration is: a) where the trustee has incurred the liability; b) The liability remains unpaid; c) The trustee takes trust property out of the trust to satisfy the debt pursuant to its indemnity. 24. In Amerind, the High Court was divided as to whether the ‘property’ accessible for the purposes of distribution and priority in the insolvency of corporate trustee was constituted by –a. The corporate right of exoneration against trust assets for debts properly incurred in its capacity as trustee. b. The trust assets themselves in which the trustee had a beneficial interest through its right of exoneration. 25. A liquidator appointed to a corporate trustee will normally be subrogated to the corporate trustee’s right of indemnity and therefore, able to use the trust assets to pay trust creditors.5

Power of sale

26. It is well known that a liquidator has the power to sell or dispose of

‘property’ of the company under s.477(2)(c) of the CA. 27. Previous cases have considered the question of whether a liquidator can exercise a power of sale of trust asset under s.477 of the CA and the nature of ‘property’. If the corporate trustee remains as trustee on appointment, the liquidator retains the power of sale of the trust assets, either under–a. express provisions of the trust instrument; or b. state or territory trust legislation that provides trustees with express powers of sale. 28. However, in the event the corporate trustee is removed as trustee on liquidation, the position is ambiguous. 29. On one hand, the liquidator has the power to sell trust assets under s.477 of the CA on the basis that the company retains legal title in those assets and also an equitable interest in those assets via the right of indemnity.6 30. On the other hand, the liquidator has no power of sale of trust assets under s.477 of the CA on the basis that the trust assets are not property of the company, as opposed to the right of indemnity against trust assets, which is property of the company.7 31. The above authorities state that the company’s indemnity is secured by an equitable lien over trust assets. However, while the company holds legal title in those assets, it does not hold

any beneficial interest in them.

By virtue of s.477 of the CA, the liquidator has no greater interest in trust property than the company has. 32. Other cases have established that the liquidator, acting through the company as bare trustee, has the power of sale of trust assets under specific provisions of particular state trust legislation.8

C. PROCEEDS OF TRUST

ASSETS

33. Assuming that a liquidator has obtained the power to sell trust assets by Court order, then proceeds of sale must then be distributed appropriately (to trust creditors). 34. It is well known that a nontrustee companies in liquidation, the statutory priority regime in ss556 and 560-562 of the CA expressly applies. However, there is no specific and dedicated statutory regime that applied to the distribution of assets of a corporate trustee in liquidation. 35. In the circumstances, it is necessary to consider the statutory priority regime under the

CA and the general principles of trust law. 36. The authorities that considered the dealing of trust assets where the trustee company is in liquidation (while not entirely settled) provide the following –a. Trust assets are generally available to meet –ii. Debts paid personally by the trustee and liabilities properly incurred by the trustee in the execution of the trust (trust creditors)9 – only if the company has a right of indemnity against trust assets; and iii. Once trust creditor’s claim is satisfied, beneficiaries’ claim.10 b. In the event that the corporate trustee is in liquidation, the statutory priority regime applies to distribute the proceeds of sale of trust assets between trust creditors, so that the liquidator is required to pay certain priority trust creditors (Eg. Employee entitlements) ahead of other trust creditors. c. Trust assets are not accessible to general (non-trust) creditors of the insolvent corporate trustee.12 37. It remains uncertain in what way trust assets are to be distributed if the insolvent company acted as trustee of another trust (where one trust creditor has access to more than one pool of assets –doctrine of marshalling).

D. THE ASSISTANCE OF THE

COURT BY SEEKING ITS

DIRECTION

38. If the liquidator is unclear about their powers and/or obligations to deal with trust assets, the main course remains to apply to Court for directions. Namely –a. An order for the appointment of liquidator as receiver in respect of the trust assets; b. Guidance to authorise the liquidator to deal with, and exercise power of sale of trust assets; c. An order for appointment of a new trustee under the relevant state trustee legislation; and d. Accidentally selling trust assets in the absence of any power to do so;

E. CONCLUDING REMARKS

39. It is important for credit managers to ensure that their Company’s

Application for Credit Account adequately identifies the corporate trustee (by listing the name and ABN of the trust) and their security has been registered correctly against the trust and the corporation. 40. This paper highlights that where a creditor is a trust creditor, it

may benefit from a wind up of a corporate trust in accordance with the statutory priority regime set out in the CA. 41. Members of a Committee of

Inspections are encouraged to understand the basic principles highlighted in this paper (Amerind and subsequent authorities) to sufficiently represent the interests of creditors in a winding up of a corporate trust. 42. Expert legal advice should to be sought before creditor/liquidators apply to Court seeking directions and guidance on how to best address such claims.

*Alan Izra MICM Lawyer McMahon Fearnley Lawyers

FOOTNOTES:

1 Re Suncoast Restoration Pty Ltd (in liq) [2003] FCA 355 (Re Suncoast at [14,[27] and [48]; Bruton Holdings Pty Ltd (in liq) v Federal Commissioner of Taxation [2011]

FCAFC 79 (Bruton) at [21]. 2 Gembook Investments Pty Ltd (in liq) [2019] FCA 1143; Caneland Holdings Pty

Ltd (in liq) [2019] FCA 1144. 3 [2019] FCA 1023. 4 See Triumph N Triumph Pty Ltd (in liq) (No 2) [2021] FCA 405 and Scope Plastics Pty

Ltd (in liq) [2021] FCA 437. 5 Re Killarnee, applied in Ross v Manpack

Holdings Pty Ltd [2018] FCA 548. 6 Apostolu v VA Coporation AUST Pty Ltd (2010) 77 ACSR 74; (Barnet), in the matter of Fulkoto Pty Ltd (in liq) [2013] FCA 595. 7 Re Stansfield DIY Wealth Pty Ltd (in liq) (2014) 291 FLR 17. See also Re Suncoast at [14],[27] and [48]; Bruton at [21] and Re

Killarnee at FCR [85]-[92]. 8 For example, in Queensland and Western

Australia. See Fulkoto; South West

Kitchens.

9 Amerind at [25] and [28]. 10 Amerind at [80]-[83]. 11 Amerind at [29]. Affirming Re Suco Gold;

Killarnee.

12 See Amerind.

DISCLAIMER: All material contained in this paper is written by way of general comment. No material should be accepted as authoritative advice and any reader wishing to act upon material contained in this paper should first consult McMahon Fearnley Lawyers Pty Ltd for properly considered professional advice, which takes into account specific solutions.