Insolvency Law Reform – Has the time come for seismic change? – Issue 4

In our article Insolvency law reform - has the time come for seismic change? released on 24 July 2023, I provided a summary of the findings from the report handed down on 12 July 2023...

In our article Insolvency law reform – has the time come for seismic change? released on 24 July 2023, I provided a summary of the findings from the report handed down on 12 July 2023 (Inquiry Report) from the Parliamentary Joint Committee on Corporations and Financial Services inquiry into corporate insolvency in Australia (the Inquiry).

In issues two and three, my fellow principal John Laird worked through the recommendations as they specifically related to the role of government agencies in insolvency and the impact on illegal phoenix activity on corporate insolvency.

In this fourth and final article, I will be focusing on one of the areas that was recommended to form part of a comprehensive review of the current system, that being the treatment of trusts with corporate trustees during insolvency.

The report recommends that the Corporations Act be amended to expressly clarify the treatment of trusts with corporate trustees during insolvency.

This has long been an area of contention and confusion for external administrators and creditors alike, with one of the fundamental issues arising from the operation of a trust deed in the event of an external administration appointment to the trust’s corporate trustee.

It has been raised numerous times in previous reports, including the 1988 Harmer Report, which recommended that the treatment of trusts facing insolvency be clarified to provide certainty surrounding the powers of an external administrator to administer trust property, which to date have not been adopted.

A trust is an obligation imposed on a person or other entity with respect to property held for the benefit of a beneficiary of the trust.

A person or company (the trustee) holds assets (trust property) in ‘trust’ for its beneficiaries. This is often described as a fiduciary relationship between the trustee and the beneficiary. This relationship is not a separate legal entity, but a set of recognised rights and responsibilities which means a trust cannot incur debts, sue or be sued in its own right. The relationship operates in accordance with a trust deed, which sets out the conditions, terms and rules for establishing and managing the trust.

It is often the case there is an automatic termination clause included in the trust deed which results in a “bare trust” scenario upon the appointment of external administrators.

This effectively restrains the external administrator from dealing with the assets of the trust, via the corporate trustee in the ordinary course of the winding up and the general principles of trust law, and the operation of the trust deed, then determines how the individual trust is to be wound up.

Under the general principles of trust law, the former corporate trustee maintains a right of indemnity against the trust assets for any debts it incurred on behalf of the trust whilst it was the corporate trustee, however practically, this is often difficult to enforce.

In order to take control and realise those assets, and in effect exercise the right of indemnity, the external administrator is required to seek orders from the court, often to be appointed as a receiver over those trust assets, so as to realise those assets for the benefit of the corporate trustee and its creditors.

This is often a costly and time-intensive exercise which is ultimately borne by creditors and results in lower returns to them then may otherwise be available in the ordinary course of a winding up.

Given the prevalence of trusts with a corporate trustee (some 700,000 at last count), an amendment to the Corporations Act to clarify their treatment in insolvency would seem to be an obvious and welcomed area of reform.

Further reading:

Issue 1: Insolvency Law Reform – Has the time come for seismic change? (cathropartners.com.au)

Issue 2: Insolvency Law Reform – Has the time come for seismic change? – Issue 2 (cathropartners.com.au)

Issue 3: Insolvency Law Reform – Has the time come for seismic change? – Issue 3 (cathropartners.com.au)

Cathro & Partners are experts in providing insolvency and restructuring services that help to create and preserve business value. The firm specialises in restructuring, turnaround, personal and corporate insolvency, safe harbour, secured enforcement services, government advisory services and pre-lending services.

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