Commercial Law Update - High Court pronounces on what “property of the bankrupt” vests in the trustee in bankruptcy where property had been held on trust

In a last Amerind-tinged gift before Christmas, the High Court has today handed down another judgment on an issue which lies at the intersection between insolvency law and trust law, although this time in the bankruptcy context. It is the latest in a string of unfolding legal developments at this intersection, including the High Court’s decision in June in Amerind and the Full Federal Court’s decision last year in Killarnee. (For more in relation to those decisions see here (Amerind) and here (Killarnee).)

The High Court unanimously dismissed an appeal from the Full  Federal Court concerning whether property held by a bankrupt on trust for another vests in the bankrupt’s trustee in bankruptcy under s 58 of the Bankruptcy Act 1966 (Cth). The decision – which stems from a bankruptcy which has been before the Courts more than once – is Boensch v Pascoe [2019] HCA 49.

The case arose from a claim by the bankrupt Mr Boensch for compensation under s 74P(1) under the Real Property Act 1900 (NSW) on the basis that his trustee in bankruptcy Mr Scott Pascoe had lodged, and later refused or failed to withdraw, a caveat without reasonable cause. Mr Boensch’s claim for compensation was unsuccessful at each stage.

To give you a snapshot of the principles and reasoning on the key issue –

1. Upon a person becoming bankrupt, section 58 of the Bankruptcy Act vests “property of the bankrupt” in the trustee of the estate of the bankrupt.
2. The “property of the bankrupt” includes real or personal property and any estate or interest in real or personal property belonging to the person at the time of bankruptcy and divisible among the bankrupt’s creditors:  s 5(1) of the Bankruptcy Act (definitions of “property” and “the property of the bankrupt”).
3. Excluded from the “property of the bankrupt” which vests in the trustee in bankruptcy is property held in trust by the bankrupt for another person: s 116(2)(a) of the Bankruptcy Act.
4. It was settled in Octavo that where a person who is a trustee becomes bankrupt, and he/she has incurred liabilities in the performance of the trust, that person’s right to be indemnified out of trust property gives rise to an equitable interest in the property held on trust. This takes that property outside the exclusion in s 116(2)(a), on the basis that the exclusion is limited to property held by the bankrupt solely in trust for another person:  [2] per Kiefel CJ, Gageler and Keane JJ.
5. The bankrupt’s entitlement in equity to be indemnified out of the trust property is property belonging to the bankrupt that is divisible among the bankrupt’s creditors. The right of indemnity is therefore property that vests in the trustee in bankruptcy:  [2] per Kiefel CJ, Gageler and Keane JJ.
6. Octavo left open the question of whether the legal estate in the property held on trust by the bankrupt also vests in the bankruptcy trustee, where the bankrupt as trustee held a right of indemnity. This is part of the more general question of whether the legal estate in property held on trust by a bankrupt in which the bankrupt has an equitable interest vests in the bankruptcy trustee: [3] per Kiefel CJ, Gageler and Keane JJ.
7. The more general question was substantially answered in Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth (Amerind):  [3] per Kiefel CJ, Gageler and Keane JJ.
8. The short answer is yes it does. Under the Bankruptcy Act, where a trustee has no beneficial interest, the legal estate does not pass; but where he has, it does pass: [4] per Kiefel CJ, Gageler and Keane JJ, quoting with approval from Sir George Jessel MR in Morgan v Swansea Urban Sanitary Authority (1878) 9 Ch D 582 at 585. (However note that where, as here, the trust property is real estate, then pending registration on title, what is vested in the bankruptcy trustee by s 58(2) is the equitable estate: [5] per Kiefel CJ, Gageler and Keane JJ; [94] per Bell, Nettle, Gordon and Edelman JJ.)
9. This answer is informed by a recognition of two things: (1) the fundamental nature of an equitable interest as something that “is not carved out of a legal estate but impressed upon it“; and (2) consistency with the objects of the Bankruptcy Act that the bankruptcy trustee automatically obtains the legal estate in property held by the bankrupt in which the bankrupt has an equitable interest in order better to secure the realisation of that equitable interest for the benefit of creditors: [4] per Kiefel CJ, Gageler and Keane JJ.

Their Honours held here that by reason of his having an entitlement to indemnification out of the trust property, the bankrupt Mr Boensch had an equitable interest in the Rydalmere property which subsisted at the time of his bankruptcy. It followed that that equitable interest, and with it the equitable estate in the Rydalmere property, vested in Mr Pascoe as the trustee in bankruptcy of the estate of Mr Boensch. The equitable estate so vested in Mr Boensch was a caveatable interest:  [10]-[11] per Kiefel CJ, Gageler and Keane JJ.

Interestingly, the High Court decided this issue in the absence of a determination by the primary judge and the Full Court on the question of whether the bankrupt held a right of indemnity against the trust property, although the question was raised by the pleadings of the trustee in bankruptcy Mr Pascoe. Both judgments discuss this matter.

Takeaways

Broadly, where a bankrupt held property as a trustee and had a right of indemnity in the trust assets, the property will vest in the bankruptcy trustee, subject to the trust: [93] per Bell, Nettle, Gordon and Edelman JJ.

However where a bankrupt held property on trust for another but held no interest in the property at all, whether vested or contingent, and no matter how remote, that property will not vest in the bankruptcy’s trustee upon bankruptcy: [87] per Bell, Nettle, Gordon and Edelman JJ.

To put it this way, at [92] their Honours Bell, Nettle, Gordon and Edelman JJ quoted with approval from Farwell LJ in Governors of St Thomas’s Hospital v Richardson [2910] 1 KB 271 at 284 –

The property of the bankrupt does not include property held by the bankrupt on trust for any other person. But it does include property held by the bankrupt on any trust for his own benefit, and when … he holds property to secure his own right of indemnity in priority to all claims of any cestui que trust, and the retention of such property is necessary to give full effect to such right, it follows that the property, ie the legal estate, and right to possession vest in the trustee in bankruptcy to the extent to which they were vested in the bankrupt...

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