Trusts and Insolvency – Will We Get Clarity Anytime Soon?

Trusts and Insolvency. For anyone who has come across this area and the interaction between trust law and the Corporations Act (Act), you would understand there is significant conjecture...

Trusts and Insolvency. For anyone who has come across this area and the interaction between trust law and the Corporations Act (Act), you would understand there is significant conjecture, at both a legal and practical level, around the priority of different stakeholders, the availability of assets and the division of those assets in an insolvency appointment involving a corporate trustee.

On 15 October 2021, the treasury department of the Australian government commenced a consultation process to clarify the treatment of trusts under the current insolvency regime. Submissions in relation to this consultation process are set to close on 10 December 2021.

This is a welcome development that will hopefully assist both business and insolvency practitioners in understanding how stakeholders are treated in the winding up of a corporate trustee.

What happens presently when a trustee company becomes insolvent?

Under the Corporation’s Act, when an external administrator is appointed to a company that isn’t a trustee company, they are empowered to take control of and realise all company assets for the benefit of its creditors. The assets were then distributed in accordance with the priorities found in s556 of the Corporations Act.

In circumstances where the Company is a trustee company, several complicating factors may limit the external administrators access to those assets. Those factors include the contents of the trust deed and the interaction of the Act and the applicable trust law which differs across the states.

What’s in the Trust Deed?

The trust deed ultimately governs the operation of the trust and is administered under the applicable trust law rather than the Act, which applies to companies, including corporate trustees. In my experience to date, it may provide for the automatic termination of the trustee company’s role as trustee of the trust upon it being placed into external administration.

Under trust law, if a trustee properly incurs liabilities as trustee, it generally has a right to discharge those liabilities by paying the relevant trust creditors out of trust assets.

Unless they hold security, creditors of the trustee company do not have direct access to trust assets, nor will an external administrator. Creditors will have indirect access by being subrogated to the trustee’s right of exoneration or indemnity. This is problematic for both creditors and external administrators.

How does the external administrator get access to the trust assets?

Practically, in these circumstances, the external administrator often applies to the court to be appointed as a receiver over the trust’s assets to deal with those assets for the benefit of the corporate trustee creditors. Within that application, the external administrator will have to demonstrate to the court that the trust’s assets should be available to discharge the liabilities of the trustee company on the basis that the liabilities were incurred by the trustee company on its behalf. Suppose the trustee company is the trustee of multiple trusts? This further complicates that process as there is then the requirement to apportion assets and liabilities to the different trusts the company is the trustee of. It also adds another layer of cost to the process; the court application process is an added expense not ordinarily required to be incurred in the insolvency process, decreasing the pool of assets available to distribute to creditors.

Why is the government consulting the public about this?

There is currently no specific insolvency regime applicable to trusts. If a company that is a trustee becomes insolvent, it may be placed in liquidation, administration, or receivership. In that case, the insolvency provisions in the Act apply, but trust law also applies.

So how do those two legal frameworks intersect? Should trust assets be dealt with under the Act and be regarded as company assets for that purpose? Should the trust’s assets only be available to be distributed to trust creditors or all trustee creditors?

The courts have attempted to grapple with these questions over an extended period and to date, several conflicting views have been reached which have muddied the water when it comes to the application of priorities under any insolvency appointment.

In 2019, the high court, on appeal, dealt with some of these considerations in its decision in Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20 more commonly referred to as the Amerind decision.

The Amerind Decision

The court found that in that instance, the corporate trustee held a proprietary interest in trust assets and that circulating asset realisations made by a corporate trustee must be distributed in accordance with the priorities stipulated in s433, s561 and s556 of the Corporations Act.

It also found that where the trustee’s indemnity (in respect of liabilities it has incurred as trustee) against trust assets is exercised by way of “right of exoneration”, the proceeds can only be applied in satisfaction of the trust liabilities to which the right relates. That is, the proceeds cannot be used to meet non-trust liabilities.

Why do we need the review?

The court in Amerind acknowledged that if a single corporate trustee is the trustee of multiple trusts, or a single trustee incurs trust and company liabilities, these issues complicate the application of the priority sections usually applied under the Act and that additional directions from the Court may need to be sort dependent on the specific circumstances of the matter.

By reviewing the treatment of trusts in insolvency, the government appears to have acknowledged the complexities currently impeding the administration of insolvent trustee companies. I suspect that the review’s outcome and any amendments made to legislation will decrease the costs and complexities involved in administrating insolvent trust entities and provide more certainty to businesses in Australia.

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