Case alert - Trading Trusts and insolvency

The High Court of Australia has released its decision in Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20 (concerning Amerind Pty Ltd, "Amerind").   This clarifies the priorities for distributing assets of an insolvent trading trust, resolving some of the uncertainties that have arisen from inconsistent decisions in Australia.  The High Court unanimously dismissed the appeal and held that the employees of a trading trust had a statutory priority under the relevant payment waterfall.

The Court issued three judgments:

  • The first by Kiefel CJ, Keane and Endelman JJ;
  • The second by Bell, Gageler and Nettle JJ; and
  • The last by Gordon J, agreeing with the second judgment but also stating reasons separately.

Issue

The overall issue on appeal was whether employees of a trading trust have a statutory priority over assets under the payment cascade in s433 of the Corporations Act 2001 (Cth), equivalent of s30(2)(c) of the Receiverships Act 1993, referring in turn to Schedule 7 of the Companies Act 1993.  Alternatively do employees have no statutory priority because the assets are held on trust [2]?

Facts

On 11 March 2014, administrators and receivers were separately appointed to Amerind.  The receivers continued to trade the business for one month whilst seeking a purchaser of the business, then they began a wind down phase in which they realised the vast majority of the stock.  At the second meeting of creditors, it was resolved to place the company into liquidation, with the administrators then becoming liquidators. By then the receivers had a surplus (generated from the sale of inventory) and were in a position to retire, but faced competing claims to the balance.  One claim was from the Commonwealth of Australia under subrogated employee rights arising under the Fair Entitlements Guarantee Scheme.  The other was from Carter Holt as a creditor, which argued that employees had no statutory priority over assets held on trust.

Trust analysis

The first judgment began with observing that a trust is not a separate legal entity, so the expressions "trust assets" and "trust creditors" are simply shorthand for the rights held on trust by the trustee, and those creditors of the trustee whose debts were properly incurred with authority in the course of trust business [24]. The rights held by a bankrupt on trust do not generally form part of the bankrupt's estate [25]. This principle has generally been applied to companies in liquidation, even though there is no express exclusion of those assets in the legislation [26].  However, this general principle of exclusion does not apply to the extent to which the trustee is permitted to benefit personally, including by exercising the right of indemnity [28].  There are two such powers: "recoupment" (reimbursement of trust expenses paid by the trustee personally) and "exoneration" (directing that funds be used to pay debts directly) [31], [80], [130].  The power of "exoneration" can be described as conferring "a proprietary interest" in the trust assets akin to (but not necessarily the same as) an equitable charge or lien [32], [81], [83], [132], [139].  The trustee's right to apply trust assets in satisfaction of trust liabilities is proprietary in that it may be exercised in priority to the beneficial interests of the beneficiaries [84], [142] and [143].

Exoneration in insolvency

Trust creditors take the insolvent trustee's power of exoneration as they find it [34], [143]. They can enforce the power by subrogation but can be no better off than the trustee. A trustee in bankruptcy or a liquidator is constrained in the same way. The purpose of the power of exoneration is to exonerate the trustee's estate only from authorised liabilities incurred in the course of the business of the trust [40], [92]. 

Answers to questions

The two questions examined by the High Court, specific to the wording of s433, were [21]:

  • Precondition for operation of s433(3): Was the precondition for the operation of s433(3) met, namely had the receivers been appointed over "property comprised in or subject to a circulating security interest"?
  • Application of proceeds: Were the surplus funds trust property, which was therefore not subject to the duty to pay "out of the property coming into [the receivers'] hands"?

The High Court held that the precondition was met, agreeing with the Court of Appeal on that issue [46]-[52], [87], [186].  The New Zealand equivalent requirement is that s30 applies only in respect of accounts receivable and inventory.  Amerind's right of indemnity was not "property [of the company] comprised in or subject to a circulating security interest" [86], [108], [186].  It was the inventory itself that was the circulating asset [86], and Amerind had a right of indemnity out of those assets [87].  The policy behind statutory priorities being conferred over such floating assets was described in paragraph [88] of the second judgment.

On the second question, the Judges held that by reason of the company's right of indemnity for properly incurred trust obligations, the trust assets are "property" of the company available for the payment of creditors [55], [95], [141] and [145].  Where a trustee in bankruptcy or other administrator assumes control of the property of a bankrupt, the trustee in bankruptcy or assignee takes the bankrupt's property subject to equities, but otherwise as property divisible amongst creditors [94].  That allows for the payment of creditors out of property held on trust to the extent that the bankrupt has a beneficial interest in the trust assets, and thus to the extent of the bankrupt's right of indemnity [94].  Similarly, the liquidator of a company assumes control of the company's assets subject to equities [95].  To the extent that the company has a beneficial interest in the trust assets, as it has by reason of the company's right of indemnity in respect of properly incurred trust obligations, the trust assets are "property" of the company available for the payment of creditors [55], [95].  There was therefore no reason why the statutory order of priorities should not be followed in the distribution of the proceeds of the trustee's right of indemnity among trust creditors [96].

Complications may arise in cases where a corporate trustee carries on business as a trustee of more than one trust [97], [159]-[172], or with marshalling issues [56], but such situations were not regarded as insuperable [97]. Also, Gordon J emphasised that circulating assets which are the subject of the right of exoneration can only be applied to satisfy trust debts and are not available for distribution to creditors generally [156]. 

Conclusion

This case should provide helpful guidance in New Zealand, where there had been some uncertainty about the extent to which the preferential regime applies to trust assets —  see Heath and Whale on Insolvency (online looseleaf ed, LexisNexis) at [46.8(c)(i)] and [46.9(b)].