Unexpected Risks in Changing the Corporate Trustee

The Australian Insolvency Journal | Jan - Mar 2014

The Federal Court recently considered whether the replacement of a corporate trustee was a significant factor to consider in appointing a provisional liquidator.

The family trust with a corporate trustee structure has long been used for asset protection. A common, although incorrect, belief amongst business owners is that if the corporate trustee gets into any form of financial trouble, changing the trustee will ensure the assets in the trust are protected from creditors.

In reality, if the old corporate trustee has been liquidated, it’s clear that the liquidator of the former trustee is entitled to access the assets of the trust (for the purposes of meeting trust liabilities). This is usually done by bringing a court application to have the liquidator appointed as a receiver over the assets of the trust with the power to realise those assets and then pay the proceeds to the trust creditors of the old corporate trustee.

Of course most insolvency practitioners are aware of this. But it’s often thought the change in the trustee will at least slow down any process by a creditor to recover assets, and give the trust more time to organise its affairs. The logic being that the liquidator must still gather the information, consider taking appropriate legal action and fund the costs of such a court application. It has been thought that no action can be taken by the creditors of the old trustee company to wind up the new trustee. A common view is that a separate court proceeding is required by a creditor against the old trustee and the new trustee to enforce any rights to the assets of the trust before the new trustee can be wound up.

There are certainly many cases where this strategy has been used and the assets have been dissipated by the new trustee before any action is taken against it either by creditors or the liquidators.

Potential risks

A recent case in the Federal Court, which was considered by two Judges, has shown that creditors can in fact take effective action i.e. to have a provisional liquidator appointed over the new trustee and wind it up immediately without having to issue any other proceedings first.

This case also shows that changing the trustee can, in itself, be a significant factor that justifies appointing a provisional liquidator.

Facts of this case

The circumstances of this case were as follows:

Carluke Capital Pty Ltd (Carluke) had been the trustee of the Carluke Capital Trust (the Trust) for a number of years. The ATO carried out an audit of Carluke and the Trust, and it issued position papers setting out that it considered Carluke would be liable for tax liabilities including penalty interest of over $12 million.

The ATO had updated the running balance account for Carluke to reflect this $12 million liability. One of the directors of Carluke had already gone bankrupt. The daughter of that director Carrie Hofmeister decided to incorporate a new company Eskdale South Capital Pty Ltd (Eskdale) and it became the trustee of the Trust. Carrie Hofmeister then gave herself a mortgage over three properties owned by the Trust to secure loans alleged to be owed to her.

Once the ATO discovered the change of the trustee it immediately applied to court to have both companies wound up in separate court applications on the just and equitable grounds under s 461(k) of the Corporations Act 2001 (Cth) and also sought orders appointing provisional liquidators over both companies pending the hearing of these winding up applications.

Can a creditor of the old trustee wind up the new trustee?

The main question in the case came down to whether or not the ATO as a creditor of Carluke had the necessary standing to apply to wind up Eskdale.

The ATO argued it had standing as a creditor against Eskdale on several grounds. The one that is important here is that the ATO had standing on the basis it was a creditor who would have the benefit of Carluke’s right of indemnity. Therefore it could be subrogated to the debt owed by the Trust to Carluke for the purposes of being a creditor under the Corporations Act, which includes a contingent or prospective creditor of the company.

This argument was challenged by Eskdale and Carrie Hofmeister by both junior and senior counsel. The main argument was that until such time as Carluke was liquidated and action had been taken to enforce the right of indemnity against Eskdale, no action could be taken by the ATO against Eskdale.

Both Justice Collier and Justice Logan had an opportunity to consider this argument. Justice Collier handed down her original Judgment on 30 July 2013.1

Decision of Justice Collier

In her judgment Justice Collier referred to the 2012 New South Wales Court of Appeal case of Agusta Pty Ltd v Provident Capital.2 She noted in summary that:

  • A trust is entitled to be indemnified over trust assets for all debts properly incurred either prospectively or retrospectively depending whether or not the trustee has paid for those expenses.
  • This right to be indemnified is often described as a charge or lien.
  • Before the trustee actually pays debts that have given it this preferred beneficial interest in the trust assets that interest is for the benefit of the unpaid creditors.
  • Creditors themselves may have resort to the assets of the trust to the extent of liabilities incurred by the trustee.

On that basis Justice Collier stated that Carluke clearly had a right of indemnity against the assets of the Trust.

But more importantly, the ATO also had a right of subrogation against those assets as a creditor both of Carluke and of the Trust.

Therefore she determined the ATO had the necessary standing to bring a winding up application against Eskdale and ordered a provisional liquidator be appointed.

Change of trustee reason to appoint provisional liquidator?

Of particular interest is that it’s clear from that judgment that Justice Collier considered the very fact the trustee had been changed to be a significant factor in justifying the appointment of a provisional liquidator.

While there are other facts that clearly justified such an appointment her Honour found that this change of the trustee, along with the other acts, demonstrated an unwillingness to be bound by the clear right of indemnity such that Eskdale could not be allowed to continue to operate under the control of Carrie Hofmeister.

This clearly raises an issue in relation to other change of trustee appointments that occur shortly before liquidation or when there are known financial problems with the old trustee. This case makes it clear the Court will carefully scrutinise the appointment of the new trustee and may consider it to be a significant factor justifying appointing a provisional liquidator over the new trustee company.

This reasoning could also be used to justify appointing a receiver over the trust as well, in the same application.

Therefore, while the change of trustee has not offered complete protection of the assets of the trust for the reasons outlined above, it now also increases the possibility that a Court will look at justifying winding up the new trustee or appointing a provisional liquidator or receiver if there appears to be an attempt to keep assets from creditors. The Court will not accept the technical argument that the creditor has no standing against the new trustee company to take such enforcement action.

Decision of Justice Logan

Carrie Hofmeister then sought leave to appeal from the decision of Justice Collier. This application for leave to appeal was heard by Justice Logan.3  Justice Logan also had to consider the question of standing of the ATO in relation to the application against Eskdale. His Honour considered in some particular detail whether the right of subrogation gave the ATO a standings a creditor. However, his Honour went beyond this to consider whether or not it would make the ATO at least a contingent creditor, which would be sufficient to bring a winding up application.

Justice Logan quoted from the High Court case of Octavio Investments Pty Ltd v Knight (1979) 144 CLR 360, which deals extensively with the issues of trustee’s indemnity in bankruptcy and liquidation. However, he did not consider that in itself was sufficient to conclude that the ATO was at least a prospective or contingent creditor.

His Honour referred to the cases regarding the definitions of prospective or contingent creditors and the two lines of authority, a narrow approach,4 and the other which suggests a broader view of this definition.5

His Honour indicated that his preference was for the broad definition as set out in the decision of Justice Mansfield in Simionato Holdings, which Justice Logan considered was sufficient to determine the ATO would at the very least be a contingent or prospective creditor.

His Honour did however acknowledge that this is an area of some controversy and while this was his preferred view, if the matter had got to the Full Court he would not have dismissed this argument out of hand and he certainly would have considered it. Ultimately, due to the fact that on other grounds the ATO was clearly a contingent creditor, he refused leave to appeal.

While it’s acknowledged that these are single judge decisions of the Federal Court, given there are in effect two decisions where the judges have concluded that a creditor has the rights to bring winding up proceedings against the new trustee company, it’s likely that these cases will be followed in the future.

Practitioners should carefully consider the impact of these two cases in advising clients in relation to trusts and the potential change of the trustee.

1 Deputy Commissioner of Taxation v Eskdale South Cattle Company Pty Ltd, in the matter of Eskdale South Cattle Company Pty Ltd [2013] FCA 740. 2 Agusta Pty Ltd v Provident Capital Limited [2012] NSW CA 26. 3 Eskdale South Cattle Company Pty Ltd v Deputy Commissioner of Taxation [2013] FCA 1125. 4 Commissioner of Taxation v Simionato Holdings Pty Ltd (1997) 15 ACLC 477. 5 Roy Morgan Research Centre Pty Ltd v Wilson Market Research Pty Ltd [1996] 39 NSWLR 311.

 

 

Authors

Andrew Lambros is a Director at Bennett & Philp Lawyers

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