For the first time in more than 30 years, the Federal Government is undertaking a comprehensive inquiry into Australia’s corporate insolvency laws. One aspect of the inquiry is the treatment of corporate trustees in the insolvency context, which, despite receiving increased judicial attention in recent years (including by the High Court in Carter Holt Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20), remains attended by significant uncertainty.
Practical Law’s Insolvency and Restructuring team recently spoke with former New South Wales Supreme Court and Court of Appeal Judge and Practical Law Advisory Board member, the Honourable Reginald Barrett AO, about his views on potential areas for reform in relation to the treatment of corporate trustees in insolvency.
Q. Is it surprising to you that we still do not yet have a framework to govern the winding up of a corporate trustee, especially when the trading trust structure is long-entrenched in commercial Australia? Why, in your view, is legislative reform necessary?
A. Yes, it is surprising. The trading trust with a company as trustee has been part of the Australian commercial landscape for generations. As the Privy Council recently noted in Equity Trust (Jersey) Ltd v Halabi [2022] UKPC 36 (at [95]), this has caused Australian courts to give significant consideration to certain trust issues that have not arisen in the same way elsewhere. But answers to some quite basic questions about the insolvency of corporate trustees have been elusive. Many of the questions were exposed in Professor Ford’s famous article “Trading Trusts and Creditors Rights” (1981) 13 MULR 1 in 1981, two years before the fundamentally conflicting appeal court decisions in Re Enhill Pty Ltd [1983] 1 VR 561 and Re Suco Gold Pty Ltd (1983) 33 SASR 99 ushered in 30 years of uncertainty about a centrally important issue. In 1988, the Australian Law Reform Commission’s report No 45 (known as the “Harmer Report”) recommended specific statutory reforms in the area. The recommendations were left to languish in their pigeon-hole, while courts continued along a path of piecemeal development as they grappled with doubts and difficulties over the next three decades.
The debate about legislative reform has gathered pace in the wake of Treasury’s consultation late last year, “Clarifying the treatment of trusts under insolvency law”. The 25 responses to that consultation agreed that action is required at the legislative level. Although responders differed on some matters, they spoke with near unanimity about a need for greater clarity and certainty and a need to reduce costs. There was consensus that courts have often struggled to provide clear and consistent guidance. This sums up why legislative reform is necessary.
It is heartening to see “trusts with corporate trustees” flagged as an area for specific attention in the recently announced terms of reference of the inquiry into corporate insolvency laws by the Parliamentary Joint Committee on Corporations and Financial Services. I get the feeling that the ball is well and truly rolling.
Q. In Carter Holt Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20 the High Court determined that where a corporate trustee is being wound up the statutory priority regime under the Corporations Act 2001 (Cth) applies to the distribution of trust assets among trust creditors. What does this tell us about the winding up of a company acting as a trustee which also operates on its own account?
A. Carter Holt produced a degree of certainty for cases in which a company acts exclusively as trustee of a single trust. It gave us two important points of clarification:
- First, and as you say, it confirmed that the statutory order of application of assets applies in the winding of a company where all the assets are trust property.
- Second, it established that “the property of the company” – over which the liquidator has control and to which the liquidator’s statutory powers apply – includes the whole of that trust property; and that it is incorrect to treat as “property of the company” only the proprietary interest in the trust property that the company has as trustee because of its right of exoneration out of that property for trust liabilities properly incurred.
But Carter Holt left in the air, as it had to, issues about a company operating both as trustee and on its own account or as trustee of several trusts. Justice Gordon showed the greatest willingness to venture into the hypothetical. She postulated approaches that courts might take to the insolvency of a multiple capacity company – referring (at [163]) to “the vacuum left by the failure of the statute to deal expressly with multiple trust funds”.
Q. Given the diversity of trust structures that exist, if a regime is introduced to govern the winding up of insolvent corporate trustees, what do you say are some of the key provisions that would need to be included?
A. Let me say first what should not be included. There should be no concept of insolvency of a trust. There can only ever be insolvency of a legal person. The trust property out of which a legal person, as trustee, is entitled to be indemnified and made whole for debts properly incurred as trustee may be insufficient to meet those debts. But the debts are debts of the legal person, and the whole of the person’s financial resources, including what we may call its “personal assets”, is available to meet them. A situation of insolvency exists only when the personal assets plus the trust assets to the extent of the indemnity are insufficient to pay as they fall due the whole of the person’s debts, including debts incurred as trustee; and that insolvency is insolvency of the legal person.
As to the structure of a new statutory regime, I think a good conceptual starting point was identified by Justice Gordon in Carter Holt. Speaking of the insolvency of a multi capacity company, she said (at [160]): “the liquidator of an insolvent corporate trustee of multiple trusts should be viewed as holding multiple funds, each directed to different groups of creditors”.
Under a model based on that thinking, the company’s assets and liabilities could be notionally divided into “estates”:
- One estate (the “corporate estate”) would consist of assets held and liabilities incurred otherwise than as trustee, plus any liabilities incurred as trustee for which the company had no right of indemnity out of trust property.
- Each other estate (a “trust estate”) would consist of all property held by the company as trustee of a particular trust and liabilities for which the company is entitled to be indemnified out of that property.
Although most assets and liabilities would naturally fall into a particular estate, some would require special provisions. On the assets side, for example, proceeds of liquidator recoveries for voidable transactions and the like would be allocated according to the liquidator’s decision as to the estate to which the generating activity or circumstances related. On the liabilities side, shared costs, such as liquidator’s remuneration, would be divided according to some equitable measure.
The estates, once assembled, would be administered by the liquidator separately but concurrently, with each being treated as if it were a company and with all the winding up provisions and powers of a liquidator applying accordingly. In particular, the statutory order of application of assets would apply within each estate.
These are the bare bones. A great deal of flesh would be needed but one aim should be to keep courts in the background. The liquidator should be given broad powers to make the system work fairly and efficiently, but with a court able, as at present, to give the liquidator advice and to determine an objection raised by a person aggrieved by a decision of the liquidator. Subject to that, a suitably armed liquidator should operate without a need for anyone to seek the assistance of a court.
Q. Adopting this regime, are there circumstances in which the assets of one estate would mingle with another, for example, if it emerged that there was a surplus in one estate could it be used to “top-up” a deficit in another?
A. In due course, collection of assets and proof and admission of claims would see a surplus or deficiency arise in each estate. Because a trustee is personally liable for debts incurred as trustee, any deficiency in a trust estate would be transferred to the corporate estate. But, because a trustee cannot resort to trust property to meet personal debts, a deficiency in the corporate estate would never be transferred to a trust estate. After all transfers of that kind had been made, an ultimate position of surplus or deficiency would emerge in each estate.
Any ultimate surplus in the corporate estate would be applied as if it were a surplus in the winding up of the company. Basically, it would go to the contributories. Any ultimate surplus in a trust estate would be directed in some appropriate way to persons interested under the trust. Because different trust structures entail different rights and expectations of beneficiaries and potential beneficiaries, it would be necessary for the liquidator to have power to disburse the surplus in a way that was just and equitable having regard to the terms of the trust.
Q. Should any new regime apply only to the winding up of a corporate trustee in insolvency or should it extend to cover other types of external administration (for example, winding up on just and equitable grounds)?
A. A regime of this kind should be applied to all windings up in which the company’s assets are insufficient to pay all claims in full. It would not apply to voluntary administration or provisional liquidation since they don’t involve the administration of assets. Winding up in insolvency, in the Corporations Act sense, and creditors voluntary winding up should obviously be covered.
In relation to other forms of winding up, such as on the just and equitable ground, I think the suggested regime could be applied, particularly if it were extended to cater for cases where, despite winding up, the trust business can be separated out in a viable form. Where a suitable new trustee can be found, the company does not have any proprietary interest in the trust property on account of trust liabilities, and commercial deployment of the property remains feasible despite the intervention of the winding up, the liquidator could be empowered to re-launch the trust by appointing a replacement trustee and vesting the trust property in it.
Q. Is it your view that the new regime should mandatorily apply to the winding up of a corporate trustee, notwithstanding any term in the relevant trust instrument to the contrary?
A. Yes. An insolvency event affecting the trustee often causes an “ejection clause” in the trust instrument to bring about vacation of the office of trustee. An implicit assumption is that someone willing to be a replacement trustee will be found and that machinery to install that person will operate efficiently. But, because this is meant to happen in the context of corporate collapse, probably with no clear pathway back to even-keel operation, the assumption will most often be unwarranted, and automatic ejection will leave a void that causes problems.
Pending replacement of the ejected trustee – which, in practical terms, may never happen – that entity is a bare trustee with skeleton powers only. Because this places the trust property in jeopardy, the liquidator may need to take the expensive and otherwise unproductive course of applying to the court for appointment as a receiver of that property.
There is a strong case for legislation that avoids this situation and invalidates ejection clauses triggered by an insolvency event. This could be subject to an exception if some interested person established to a court that the operation of the ejection clause would produce some positive benefit for the persons interested in the trust.
Q. Is the simplified liquidation process appropriate to apply to the winding up of a corporate trustee? Or should a new and different “simplified” liquidation regime be established for small businesses that operate as trustees of a trading trust?
A. The simplified winding up process made available for small companies in 2021 applies to creditors voluntary windings up, including those that follow on from voluntary administration. I can see no reason why a new regime for corporate trustees of the kind outlined should not work in those cases.
Q. If a new regime were introduced to govern the winding up of corporate trustees, would that necessitate consequent reform governing the way trading trusts operate in the usual course? For example, if a company acts in its own right as well as in a trustee capacity, should it be required to disclose that arrangement publicly (particularly to creditors and employees) through a register or some other means?
A. That’s an interesting question. When a trustee is entering into a transaction, it may see practical advantages for itself in not disclosing the trustee status. But the counterparty has a clear interest in the scope of the trustee’s powers and whether the transaction is to the beneficiaries’ advantage. That party will be alive to possibilities of breach of trust and consequent danger to the trustee’s right to resort to trust property.
Today, I think, trustee status is generally volunteered or quickly flushed out. For example, a trust will usually have its own ABN. Compulsion to disclose would enhance transparency and be unlikely to disadvantage anyone. Consider, in similar vein, the new director ID requirements.
The Hon Reginald Barrett AO, NSW Supreme Court and Court of Appeal (retired)
Reg Barrett served as a Judge (2001-2015), Judge of Appeal (2012-2015) and Acting Judge of Appeal (2016-2020) of the Supreme Court of New South Wales after practising corporate and securities law for more than 30 years as a partner of both Allen Allen & Hemsley and Mallesons Stephen Jaques and general counsel at Westpac Banking Corporation. He is an assistant editor of the New South Wales Law Reports, a member of the editorial board of the Company and Securities Law Journal, a part-time mentor to Practical Law Australia, and a former general editor of Robson’s Annotated Corporations Legislation.
