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In brief - High time for a legislative regime to manage insolvent trusts 

Recent cases have highlighted the inconsistent approach taken by courts to several fundamental issues where insolvency and trust law meet. Until these issues are decided, those dealing with insolvent trusts should consider some practical steps to deal with automatic removal provisions contained in a trust deed. 

Creditors largely reliant on general trust law principles when pursuing insolvent trusts

It is estimated that there are more than half a million active discretionary trusts in Australia, approximately two-thirds of which are self-managed superannuation funds, and the other third trading trusts. Each of those trusts has a trustee, usually a company. 

Given those very large numbers, it is no surprise that there are a significant number of insolvencies amongst both trading trusts and superannuation funds. It is therefore a great shame that, unlike for companies and individuals, and even organisations such as clubs and incorporated associations, there is no insolvency regime that assists creditors of those trusts. Creditors are, largely, reliant upon general trust law principles and there are many instances in which those general principles are inconsistent with the much more developed insolvency law applying to insolvent companies and bankrupt individuals. 

Secured creditors can exercise rights directly over trust assets 

It is uncontroversial that a trustee incurs debts in its own right and as trustee of the trust, and a trustee acting in that capacity has a right of indemnity against the trust assets for those debts. The trustee has an equitable lien over the assets of the trust to secure the indemnity. Unsecured creditors who have debts against the trustee acting as trustee of the trust have a claim against the trustee, and are subrogated to the trustee's right of indemnity against the trust assets. 

The position is different for those secured creditors who have taken security directly over assets, such as real property. Those secured creditors are able to exercise their rights directly against the property. Holders of security over circulating assets, as a general statement, have fewer rights of self-help against the trust assets. 

Who can deal with trust assets?

When a trust becomes insolvent, it is not unusual for the corporate trustee to be wound up at the request of creditors, and a liquidator appointed. In an ordinary corporate liquidation, the liquidator has the obligation and the power to realise the assets of the company and distribute the proceeds amongst the creditors of the company. In the case of a corporate trustee, where the assets are held by the company on trust for the beneficiaries, there is a very real question about the ability of the liquidator to realise trust assets for the benefit of creditors, even where those creditors can be considered to be creditors of the trust. By that, we mean that all of the debts were incurred by the trustee in its capacity as trustee of the trust. 

Where the trustee remains trustee of the trust following liquidation, then there are two clear sources of power for the liquidator to sell trust assets: 
  • by express provision in the trust deed 
  • or failing that, every state has similar Trusts Acts that provide trustees with express powers of sale 

Liquidators often approach courts for orders to address a bare trustees' lack of a power of sale 

The difficulty arises in the all too common situation where the trust deed provides that a corporate trustee is automatically removed as trustee upon liquidation. In that situation, the former trustee will often remain in possession of the trust assets as what is known as a "bare trustee". A bare trustee has powers to preserve trust assets under their control, but no power of sale. 

The traditional approach for liquidators in this situation has been to approach the Court for orders appointing the liquidator as receiver and manager of the trust assets, with express powers of sale over the trust assets, and orders to distribute the proceeds amongst the creditors in accordance with the corporate insolvency provisions of the Corporations Act 2001. It is rare for a Court to refuse such orders, but the process takes time and costs money that in small liquidations could be a significant portion of the assets that would otherwise be available to creditors. 

In the case of Apostolou v VA Corporation [2010] FCA 64, Justice Finkelstein of the Federal Court held that section 477(2)(c) of the Corporations Act, which gives liquidators the power to sell property of the company, authorised the liquidator of a corporate trustee who had been automatically removed from office to sell trust assets for the benefit of creditors of the trust. His Honour's rationale was that the company had a legal interest in the assets as bare trustee and a beneficial interest in the trust assets through the trustee's equitable lien securing its indemnity. 

It should be noted that the decision was made in the context of a liquidator who had already sold the assets, and one reading of His Honour's judgment is that there was a practical motive in finding that a liquidator had such power to sell trust assets, thereby reducing the need for liquidators to seek Court orders in similar circumstances in the future. 

Judicial indecision 

Over the following three to four years, there have been a number of cases in which liquidators in similar circumstances have sought orders either allowing them to sell trust assets, or absolving them of liability for having already sold trust assets. Only one of those cases (Kitay, in re South West Kitchens [2014] FCA 670) considered Apostolou, and that case largely accepted Apostolou as valid precedent on the basis that it was the only decision that had squarely considered the issue of section 477(2)(c). The rest of the relevant cases did not consider Apostolou, but were decided on the basis of general trust principles and the Trusts Acts in the relevant states. 

Justice Brereton in the NSW Supreme Court case of Re Stansfield DIY Wealth [2014] NSWSC 1484 reconsidered the issue of the liquidator's power of sale of trust assets, and decided that Apostolou was incorrect. His Honour found that neither the company's legal interest as trustee's bare trustee nor the equitable lien securing the trustee's indemnity gave rise to a beneficial interest in the trust assets in favour of the trustee, so that the "property of the company" was the lien, rather than a beneficial interest in the actual trust assets. Therefore, section 477(2)(c) did not apply and the liquidator had no power to sell trust assets. He found that the correct course of action for the liquidator of the former trustee company was to apply to be appointed as receiver and manager of the trust assets with appropriate powers.

Companies should consider trust deed's terms prior to appointment of liquidator

This issue is by no means decided, but it would be a brave liquidator who proceeded to sell trust assets without approaching a court to be appointed as receiver and manager of the trust assets. 

There is an important practical lesson to be learnt, given the ease with which this problem can be avoided. If the company in liquidation remains trustee of the trust following the appointment of liquidators, then there is no doubt that the company, under the control of the liquidators, has the power to sell trust assets. Therefore, prior to appointment of a liquidator, it is worthwhile for a company or its advisors to consider the terms of the trust deed and, if that trust deed includes an automatic removal provision, amend the trust deed to remove that provision or arrange for the reappointment of the company as trustee following the automatic removal. 

Postscript - NSW Supreme Court decision creates uncertainty for the practical administration of insolvent trusts

Justice Brereton has thrown a further cat amongst the insolvent trustee pigeons in his recent decision in Re Independent Contractor Services [2016] NSWSC 106 (ICS), in which he disagreed with the longstanding precedent set out in Re Suco Gold (1983) 7 ACLR 873. Re Suco Gold held that the proceeds of realisation of trust assets should be distributed to creditors of the trust (that is, creditors of the corporate trustee acting in its capacity as trustee of the trust) in accordance with the creditor priority provisions of the South Australian Companies Act (in similar terms to the Corporations Act). In ICS, His Honour Justice Brereton, decided that section 556 of the Corporations Act only applies to property of the company, and given that the trustee's equitable lien did not give rise to a beneficial interest in the trust assets, they were not property of the company. Therefore, any proceeds from realisation of those trust assets should be distributed amongst creditors of the trust in accordance with trust principles, rather than the priority principles set out in the Corporations Act

In the Victorian Supreme Court, Justice Riordan dealt with similar facts to ICS in Freelance Global v Bensted [2016] VSC 181. His Honour did not refer to the section 556 issue identified by Justice Brereton as it has been accepted in Victoria based on Re Suco Gold and an earlier Victorian Full Court decision in Re Enhill Pty Ltd [1983] 7 ACLR 873 that the recoveries by the liquidator under the trustee's right of indemnity are "property of the company" to then be dealt with in accordance with the priorities under section 556 of the Corporations Act.

Justice Brereton may well be correct, but what he has done is both create and highlight differences between our state and federal courts as to the practical administration of companies which acted as trustees of insolvent trusts, which has created a great deal of uncertainty for the practical administration of insolvent trusts. 

Given the growing inconsistency between the corporate insolvency regime and trust principles, which largely developed in a time when trusts were passive and should not become insolvent, the time seems right for the introduction of a legislative regime to manage insolvent trusts. 
 

This article has been published by Colin Biggers & Paisley for information and education purposes only and is a general summary of the topic(s) presented. This article is not specific legal advice. Please seek your own legal advice for any questions you may have. All information contained in this article is subject to change. Colin Biggers & Paisley cannot be held responsible for any liability whatsoever, or for any loss howsoever arising from any reliance upon the contents of this article.​