Many modern businesses are carried on through a “trading trust”, with a private company serving as trustee. However, while this type of arrangement is not uncommon, there is still a great deal of uncertainty about correct protocol when a corporate trustee becomes insolvent. Questions arise such as:
Over the years these issues have been considered by various Courts in a number of different jurisdictions. Nonetheless, the recent decision of the Full Court of the Federal Court of Australia in Killarnee, demonstrates that there remains a lack of judicial consensus with respect to many of the abovementioned issues.
Selling the trust property
Section 477 of the Corporations Act 2001 (Cth) (the Corporations Act) allows a liquidator of a company to sell and distribute property of the company. Because, strictly speaking, trust property is not property of the company, the Court held that this section does not give liquidators power to sell trust property.
However, that does not mean liquidators cannot sell the trust property at all, and indeed the Court was cautious to emphasise that, although there is no statutory power to sell trust property, the power may (and will most likely) be granted by a court exercising equitable jurisdiction.
The basis for a Court exercising equitable jurisdiction to allow the sale of trust property is the right of indemnification, which allows trustees to have recourse to trust assets to discharge debts properly incurred as trustee. This right is considered to be company property and vests in liquidators upon a company entering into liquidation.
Availability of the proceeds to certain creditors
As a trustee’s right of indemnification takes priority over the rights of beneficiaries, beneficiaries will almost inevitably miss out on a piece of the pie. The more pressing and controversial issue is: should the funds realised from the sale of trust assets be distributed to creditors of the company, or creditors of the trust only?
The Court differentiated between two components of the right of indemnification:
Chief Justice Allsop, who delivered the lead judgment in this case, held that if payment has already been made, the right of recoupment is “a generally available asset”, whereas if payment has not already been made, the right of exoneration due to its nature and character (it being that a right over, or in respect of, trust property to be used for trust purposes) “is an asset available for trust creditors” (as distinct from company creditors).
It is telling that this conclusion is contrary to the conclusion reached by the Victorian Supreme Court of Appeal some months prior in Amerind.
Distributing the proceeds
As trust assets are not sold pursuant to the Corporations Act, the Court considered whether the regime governing distributions set out under the Corporations Act was applicable.
On this point, Chief Justice Allsop and Justice Farrell held that proceeds from the realisation of trust assets should be applied in accordance with the priorities regime, whereas Justice Siopis dissented because he thought the scenario was not one contemplated by the legislation.
The majority’s conclusion supports a similar conclusion reached in Amerind, but notably diverges from other recent decisions.
Killarnee supports the view that funds realised from a liquidator’s sale of trust property should be available to trust creditors (as distinct from company creditors generally) and should be distributed so that liquidators’ costs/remuneration and employee entitlements have priority over claims of other trust creditors.
Although Killarnee remains the most current authoritative decision on these matters, it is safe to say that the law remains in a state of flux. This uncertainty recently resulted in the Supreme Court of New South Wales agreeing to adjourn the balance of an application for three months to allow the High Court (if special leave was granted) to authoritatively resolve the controversies arising from Amerind and Killarnee.
Thankfully, on 17 August 2018 the High Court granted an applicant special leave to appeal the Amerind decision. It can therefore be expected that the above issues will be unequivocally determined by the High Court in the near future. Until then, it would be prudent to approach the Killarnee decision with caution.
Guy Edgecombe, Partner
Mitchell Byram, Associate