Further evidence that winding up a trust is becoming fundamentally different to the winding up of a company.
Some time ago, Bankruptcy and Insolvency Director, Andrew Lambros of our office, had an article published in the Australian Restructuring Insolvency and Turnaround Journal asking whether or not the winding up of a trust was becoming a completely different system to the winding up of a company.
A Victorian Supreme Court decision of Re Amerind has dealt with one of the potential issues raised in that article. In that decision his Honour has held that the priority payments to employees under the Corporations Act before payment of a secured creditor with a circulating assets security does not apply when a trust is being wound up.
This means that a secured creditor, such as a bank, will get paid before the employees when the trust is being wound up. It also means that the Commonwealth, which pays the employee entitlements under the Fair Entitlements Guarantee System (FEG) and then takes the priority of the employees will face significant shortfalls in the winding up of a trust. This is because it is still obliged to pay the employees their entitlements even though it won’t receive the benefit of the priority in return.
This is the complete opposite of what happens when a company (that is not a trustee company) is wound up. In that circumstance the employees and FEG get paid before the secured creditor with the circulating assets security (and other unsecured creditors).
Further, if there are no priority creditors in the winding up of the trust then a liquidator is only dealing with 2 classes of creditors secured and unsecured. This means after secured creditors all other unsecured creditors would simply be treated equally.
There is of course the possibility that this decision could be overturned if it is appealed. Although it should be noted that this decision follows an earlier decision in New South Wales that found priority payments under the Corporations Act for the applicant who obtained the winding up order don’t apply to trusts. There is the further possibility that as the Commonwealth is going to be significantly out of pocket under this approach that the government will change the law.
However, if this decision is upheld and followed by other courts it will have significant implications for business structuring. To name just a few possibilities:
- Having a trust structure increases the return to the secured creditor at the expense of the employees. As directors of smaller companies often guarantee the bank loans, having a trust structure, could reduce their personal liability to the bank in a liquidation;
- The improved security position of a trust, might make a financier more willing to provide funding to a trustee company, as opposed to a normal company;
- In group company structures, having security for intercompany loans could be more valuable, as the prospects of recovery from a subsidiary company trading as a trustee of a trust are better than if it was simply a company;
- Insolvency practitioners will find that this are will become more complex and require a number of court applications to resolve other issues associated with the trust structure, these additional expenses, may well reduce the return to unsecured creditors, and
- Conversely, where there is no secured creditor in place, unsecured creditors may receive better dividends, as the employees will not be entitled to be paid first before general unsecured creditors. Instead, they will be treated equally.
Given the way that case law is developing, in the winding up of trusts, it would seem certain this case of Amerind will not be the last time the court deal with the complexities of winding up trusts.
Call on Andrew Lambros T: +61 7 3001 2925 to ensure you have the best possible structure in place to protect your business and avoid the implications of insolvency and liquidation or to discuss the effect of your structure if you need to look at winding up your business.