Winding up Corporate Trustees and Trusts - Is it a completely different regime now?

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For some time practitioners and the courts have been wrestling with the winding up of corporate trustee companies and trusts. The general trend has been
towards increasing court supervision and legal expense.

But given some of the recent developments, particularly Justice Brereton’s decision in Independent Contractor (No 2) [2016] NSWSC 106, it now appears there is effectively a very different insolvency regime that applies when dealing with trusts.

This regime is less efficient, involves far more court appearances, and distributes dividends to creditors quite differently to the Corporations Act (the Act). Insolvency practitioners are also remunerated far less under this regime, despite the extra costs and expenses incurred.

Historically trusts were not a dominant part of any insolvency or bankruptcy system. Clearly creditors and the trustee had to be paid first before beneficiaries, which was supported by a right of indemnity. But the law did not develop substantially beyond this point.

However, the tax advantages of trusts have led them to proliferate. According to the Australian Bureau of Statistics there are 478,951 businesses trading under a corporate trustee structure in Australia (Australian Bureau of Statistics, 26/2/2016). As a result insolvency practitioners have to deal with trust issues more frequently.

TRUSTS AND INSOLVENCY

Insolvencies involving corporate trustees are not new,
 and the remedy of appointing the liquidator as a receiver has been around for a long time (see Re Indopal (1987) 12 ACLR 54). However, insolvency practitioners often didn’t worry about the distinction between a company and a trustee company and would generally sell all the assets of the trustee company and deal with it as if it were a normal company.

Creditors and beneficiaries did not oppose this and generally applications to the court to appoint the liquidator as receiver of the trust only occurred when there was a dispute.

Even when these applications to the court were required, generally the court was willing to appoint a liquidator as receiver (which is still the case). On issues such as fees and priorities, there were no detailed reasons.

In my experience courts were often willing to make directions for creditors to approve liquidator’s fees as receiver (or at least where there was no objection to those fees, approve them) and make directions to apply the priorities of the Act. In other cases the liquidator simply applied those priorities.

However, over the last few years the court’s view of this area of law has changed. As each case has been handed down the regime for dealing with the winding up of trusts has become far stricter than what applies to the winding up of a company under the Act.

ABILITY TO SELL ASSETS

It is clear that a court application (or even getting advice
on such an application) is not required when a liquidator is selling the business assets of a company as opposed to a trust. But most practitioners would be aware that there are opposing court views on a liquidator’s ability to sell trust assets.

The case of Kitay [2014] FCA 670 held the liquidator had the power to sell trust assets without the appointment of a receiver or directions from the court. But Re Stansfield [2014] NSWSC 1484 expressly stated this was wrong and that a court application was required.

The need to apply to the court before selling trust assets significantly increases the costs of the liquidation for no other reason than the structure used by the business.

But a liquidator will be exposed to potential claims if the assets are sold relying upon Kitay and a superior court later sides with Re Stansfield.

PRACTITIONERS’ REMUNERATION

Generally, the courts have held that an insolvency practitioner dealing with trust assets can only claim for the work involved in dealing with the trust. If there are no other assets available from the company, then other work that must be done by the insolvency practitioner in the winding up that can’t be categorised as administering the trust cannot be recovered from the trust (Re SutherlandFrench Caledonia Travel Service Pty Ltd (in liq) [2003] 59 NSWLR 36, Re Dalewon Pty Ltd [2010] QSC 311).

The onus is on the liquidator to prove this connection between the work done and the administration of the trust (it has been suggested by Justice Finkelstein that if the company was just a trustee company that much of the work might be chargeable but the liquidator still needs to demonstrate this (13 Coromandel Place Pty Ltd v C L Custodians Pty Ltd (in liq) (1999) 30 ACSR)).

Of course if this was a normal company then the liquidator would be entitled to charge for all of the work involved in the liquidation provided there are sufficient assets (and subject to creditor approval).

COURT APPROVAL FOR FEES

In Independent Contractor Justice Brereton has expressly stated any fee approval in relation to a trust is subject
to the court, not creditors approving such fees. This appears to be the case whether or not the creditors object to the fees.

There are of course some situations where an insolvency practitioner must seek court approval, the most common being the appointment of a provisional liquidator.

However, in this instance, again the insolvency practitioner is forced to incur another cost (which also affects the creditors) in making a formal application to the court for their fees to be approved.

LIKELY REMUNERATION

If the reasoning of Justice Brereton in Independent Contractor is followed and the percentage of realisations is used as a basis of charging, then the remuneration that is approved by the court is likely to be substantially less than the amount of remuneration that would usually be charged and approved by creditors.

In that case the evidence was that the liquidator had work in progress in the amount of $115,146. The liquidator sought approval of $49,510 but his Honour only approved $30,000. This comes to just under a 75 percent write off on this le for the liquidator based on the work in progress figure.

LEGAL COSTS

Some might argue that creditors will receive a benefit
 from the reduced remuneration payable to practitioners.

However, this simply ignores the substantial legal costs that are incurred in applications of this nature and for which the courts are prepared to approve without restricting lawyers to a percentage of realisations calculation.

It should be noted that in this case Justice Brereton approved payment out of the trust fund of legal fees of
the liquidator in the sum of $52,179 for the first directions application (neither the solicitors nor the liquidators charged for the second application) plus $16,500 for the contradictors legal fees of the first application and $5,000 for the second application.

This comes to a total of $72,179, not too far off the amount the liquidator wrote off for his own fees (and substantially more than the remuneration he sought court approval for).

SECTION 556 PRIORITIES OF THE
 CORPORATIONS ACT DON’T APPLY


An issue that doesn’t appear to have been considered until Justice Brereton handed down his decision is that his Honour has held the priorities of the Act don’t apply and all creditors share in any distribution from the trust on a pari passu basis.

If this case is followed and those priorities don’t apply, then there are a number of consequences that follow. Firstly, it’s unclear if the petitioning creditor is entitled to be reimbursed for their reasonable costs of obtaining the winding up order.

Secondly, employees will not receive any priority for
 their entitlements (this was expressly stated by Justice Brereton in Independent Contractor). This would probably mean that the government will be more exposed since they’ll pay out the employee entitlements through FEG in full but will only be entitled to a proportional distribution from the trust as opposed to having those entitlements repaid back in full as a priority (when there are assets available).

POSITION OF SECURED CREDITORS

Another potential outcome of Justice Brereton’s decision is that the position of secured creditors might be significantly enhanced. Assuming proper security is held over the trust assets the secured creditor would still be paid first. A significant benefit to the secured creditor however is that employee entitlements may not have to be paid ahead of the secured creditor from any circulating assets.

This is because s 561 of the Act gives employees a priority for their claims under s 556 of the Act ahead of secured creditors in relation to circulating assets. If s 556 priorities don’t apply to a trust (as stated by Justice Brereton) it’s hard to see how s 561 could apply either.

A secured creditor would then still be able to appoint a receiver privately who would be free to deal with these trust assets, it would appear, without incurring the expense of any court orders. It would also appear that such a privately appointed receiver would not need to go to court to have remuneration approved either.

This potentially could lead to banks and other secured creditors requiring a trust structure to be used given
the potential benefits available to them in an insolvency situation.

CUMULATIVE EFFECT

Any one of these issues above obviously creates challenges for the insolvency practitioner winding up a trust. However, the total effect of all of these issues leads to a completely different outcome in the winding up of a business in a trust structure than if it was simply a company under the Act.

To give a very basic example, consider a business with assets of $500,000 that have been realised, $400,000 owing to a secured creditor (but assume $150,000 relates to circulating assets), employee liabilities of $150,000 and insolvency practitioner fees of $100,000.

In a trust situation the legal fees of the various court applications could be approximately $70,000.

Under a trust scenario the secured creditor would be paid in full (assuming s 561 doesn’t apply either due to the decision of Justice Brereton in Independent Contractor). Of the $100,000 which remains after the legal fees are deducted $30,000 would be paid to the insolvency practitioner and nothing to the employees.

For a company under the Act the legal fees would not be incurred.

In that scenario the secured creditor only receives $250,000. The insolvency practitioner receives $100,000 for fees and the employees are paid the $150,000 they are owed. There might be an argument with the secured creditor over the fees of the insolvency practitioner but this is the likely distribution subject to that issue.

Again it must be emphasised that this only arises due to the use of a trust structure, there is no other reason for such a drastic difference.

POTENTIAL SOLUTIONS

One obvious solution is for the government to clarify the powers of the liquidator to sell trust assets and confirm the priorities and remuneration provisions of the Act apply to trusts as well.

However, if this doesn’t occur, practitioners may be able to take certain steps to try to avoid some of the costs and complications when dealing with a trust. They could:


  • Try to ensure in any court liquidation they are appointed as a receiver to any trusts at the same time (of course if the creditor is unaware of the trust this won’t help).
  • See if an agreement can be reached to appoint a new trustee (maybe the practitioner) to carry out the sale of these assets on agreed terms and for an agreed price (this could be risky and of course exposes the practitioner to a potential conflict).
  • Try to get an agreement with creditors, beneficiaries and a new trustee on priority and fees (this probably won’t work if the decision by Justice Brereton is followed on court approval for fees being required and priorities under the Act not applying).
  • Apply to the courts and after disclosing the decision of Justice Brereton argue it shouldn’t be applied.

None of these are great options and they all have clear limitations and serious risks attached to them.

Some problems have no obvious solution. This includes how to sell the assets of a small business that isn’t worth the costs of making an application to court to be appointed as a receiver, or what to do when the funds available to pay the fees of the practitioner would be exhausted in the legal costs of making an application to the court for fee approval.

THE ROAD AHEAD

The development of trusts law has not kept pace with insolvency law and in particular the Act. Obviously this is due to the fact the relevant areas of trust law involve the common law or state based legislation that has not been updated re insolvency in a long time. The entire priorities section of the Act has no equivalent in trusts law and this has been the subject of substantial amendment over time.
 
Previous case law in this area has been making it progressively difficult to effectively wind up a trust but it has been manageable. However, it did not completely change the outcomes of the winding up based upon the structure of the business.

This latest decision of Justice Brereton, effectively creating a significant distinction for businesses set up under a trust structure, means practitioners will have to deal with numerous challenges when winding up trusts.

Unless there are major changes made by the government (which is possible given the increased shortfall it is going
 to incur through FEG) it’s likely there will be many more expensive court arguments and applications that insolvency practitioners are unlikely to be fairly compensated for.

Authors

Andrew Lambros is a Director at Bennett & Philp Lawyers

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