Commercial Law Update - The decision in Killarnee – trading trusts, statutory priorities on the liquidation of trustee companies, lack of power to sell trust assets

Preliminary points  

(1) The nature of trusts

Before turning to a discussion of the case and judgments, three preliminary points may be useful. First, some general principles about trusts:

A trust has no legal personality. It is not an entity. It is an equitable collection of rights , duties and obligations between beneficiaries, trustee and property. The trustee is bound to deal with trust property for the benefit of the beneficiaries (in a private trust) and in accordance with the terms of the trust.

A trust is not capable of suing or being sued. Third parties dealing with a trust may only do so by dealing with its trustee, be that an individual or a company, both of which have a legal personality.

(2) The two types of trustee’s indemnity  

The second preliminary point which may be useful is a clear explanation of the difference between the two types of trustees’ rights of indemnity  – the right of recoupment / reimbursement, and the right of exoneration. Both of course arise after the trustee incurs a debt on the trust’s behalf, and becomes personally liable for payment of that trust debt.

The right of recoupment/reimbursement arises where the trustee has already paid a trust debt with its own money, and seeks recoupment or reimbursement from the trust. If a trustee exercises a right of recoupment, paying itself back with trust money, that money becomes the trustee’s own money. The money forms part of the trustee’s general estate without any attendant equitable obligation. The trustee can keep it, or use it to pay any creditors to whom it owes money (trust or non-trust). It has already paid the trust debt with its own money, and is entitled to the repayment from trust assets in its own right and capacity.

The right of exoneration is different. This is the type of indemnity that will more often be relevant in insolvency (where trust debts remain unpaid). Bear in mind that trustees are personally liable for trust debts. The right of exoneration entitles the trustee to take trust assets and apply them directly to pay trust debts, thereby exonerating the trustee for its personal liability to pay that debt, which is extinguished.

Here is a key difference between the two types of indemnity rights: when a trustee exercises a right of exoneration, those proceeds produced are not entirely the trustee’s own money, because they can only be used to pay unpaid trust debts. It is only for that purpose – the payment of trust debts – that the trustee may help itself to the trust assets in the first place. To then keep the money for itself, or use it to pay non-trust creditors, would be in breach of its duties as trustee, and the trusts with which the assets it holds are impressed. Hence the proceeds can only be used to pay trust debts. So says a line of authority culminating most recently in Derrington J’s bankruptcy judgment in Lane, re Lee v Deputy Commissioner of Taxation [2017] FCA 953 and now in the Full Court’s decision in the liquidation context in Killarnee. (As noted in my case review, the Victorian Court of Appeal in Amerind expressly left this question open.)

Both rights of indemnity have been held to be proprietary in character, although as explained above and as the Full Federal Court in Killarnee confirms, the right of exoneration is not free of constraints.

(3) A common trust deed term – automatic ejection as trustee

Thirdly, on the question of power to deal with trust assets, note that it is common for trust deeds to include a term that upon the bankruptcy or liquidation of the trustee, it is automatically removed as trustee. This will leave the trustee company in possession of trust assets, whilst no longer being trustee. Generally, the trustee company is said to then hold the assets as a bare trustee, with duties and power to hold and preserve the assets, but that’s it. Allsop CJ noted that the trustee company would also hold the trust assets pursuant to its indemnity and the associated lien, until all trust debts are paid, but the lien does not carry with it a power to sell either.

Note, however, it seems that most trust deeds do not include a term that has the same effect of ousting the trustee company upon its administration or receivership. Hence in those circumstances (as was in the case in Amerind), the trustee company would retain its powers conferred under the terms of the trust deed. (The receiver may also have powers under the security instrument.) Also, note in the case of a liquidation of a trustee company where a trust deed did not contain such a clause and the company remained in office as trustee, Allsop CJ observed at [90] that in his view the liquidator’s power under s 477(2)(m) would be engaged.

The facts

The facts are summarised from [7]. The key facts were these –

• The company Killarnee Civil & Concrete Contractors Pty Ltd carried on business as trustee of one trust. It did not conduct business on its own account. It did not conduct business on behalf of any other trust. All its assets were held on the terms of the trust. All claims and liabilities were entered into or incurred in furtherance of the trust. There were no non-trust creditors.
• In its voluntary administration, the administrators had the Company realise certain assets held as trustee of the trust including the collection of debts, and the sale of its business and some plant and equipment. The proceeds totalled some $9.5 million which was largely applied to meet the administrators’ remuneration and expenses in carrying on the business and then effecting the sales, to meet the administrators’ remuneration and expenses in relation to the administration, and to pay $500,000 to Westpac as secured creditor.
• Upon the commencement of liquidation of the Company, a clause of the trust deed operated to remove the company as trustee. The Company then held the trust assets as bare trustee, with powers and duties only to hold and preserve the trust assets, with a right of indemnity and lien as former trustee.
• The Liquidators (there were several initially) received the balance of the proceeds from the administration of over $2.5 million, and caused the Company to realise further assets of the trust totalling over $3 million. They also recovered $4.5 million from the ATO as an unfair preference.
• After various payments including some employee entitlements out of funds subject to Westpac’s charge, the Liquidator held over $4 million representing both the unfair preference proceeds, and proceeds of the realisation of trust assets.
• The debts and claims in the winding up comprised approximately $200,000 for liquidator’s remuneration and expenses, over $2 million in priority unsecured employee entitlements within s 556(1)(e)-(h) including amounts to which the Commonwealth was subrogated by virtue of FEGS, and nearly $19.5 million in ordinary unsecured debts and the debt of over $1.5 million owed to Westpac as secured creditor.

It may be useful for practitioners to be across the views expressed by the members of the Full Court. Hence I will summarise them here, under the heading of each proposition distilled from the decision and set out in my post (here).

1. The right of exoneration and lien are property of the trustee company; and

2. Power – Trust assets are not trustee company assets hence not assets in the winding up, and the Liquidator generally lacks power under s 477 to sell them. 

Upon the intervention of insolvency and the appointment of a liquidator, the liquidator takes control of the property of the company. That includes the assets of the trust for the purpose of indemnification of the trustee – by recoupment or exoneration (at [82]).

As in Amerind, Allsop CJ held that the right of exoneration and the lien in its support are property of the trustee company. That question now appears to be resolved. (The Full Court was undivided on this: see Allsop CJ at [79]; Farrell J at [210]-[211]; Siopis J does not put it in those terms, but see [142]). Both Allsop CJ at [81] and Farrell J at [210] held that the right and the lien in its support are “property” within the meaning of s 9. The Chief Justice went on to say that this does not mean that it is a proprietary interest unattended by inhering equitable obligation. Its nature and character are that it is exercisable only to pay trust creditors (at [79]) – this is discussed further below.

However the fact that the right an lien are property of the trustee company did not mean that the Liquidator had power under s 477 to sell the trust assets in reliance upon the trustee’s lien. Allsop CJ rejected a submission that the proprietary character of the right of exoneration, together with the lien, was sufficient to engage a liquidator’s powers to permit the sale of trust assets under s 477(2)(c) (power to sell/dispose of property of company) when read with s 477(2)(m) (power to do all other things as are necessary for the winding up of the company’s affairs and distributing its property). The Chief Justice observed at [89] that –

• The trustee’s interest in trust property does not mean that the trust assets can be sold without Court order. It cannot. The lien does not confer a power of sale of the assets, and if sale be necessary a court order or the appointment of a receiver to sell is required – see [89] and [44].
• The beneficiaries retain their interest in the trust property also, and sometimes the trustee’s interest will not exhaust the trust asset – [89]
• If the trustee’s interest in the trust property does not include a power to sell the trust property, that cannot be supplied by s 477(2).
• Section 477(2)(c) should not be read as referring to the sale or disposition of property which is not company property, but which is trust property in which the trustee has an interest by way of lien or charge to secure its right of exoneration. In such circumstances, the lien or charge is not being sold or disposed of. The whole asset is.
• It would be the assets held on trust that are the subject of sale, not the right of exoneration or the lien or charge. Section 477(2)(m) does not assist either.
• The power to deal with the assets of the company – the lien or charge to secure the right of exoneration – does not authorise the liquidator to exercise the lien and sell the underlying assets which had been held on trust for the beneficiaries – all at [89].
• However if the trustee company remained as trustee post-liquidation – that is if the particular trust deed did not contain the usual term removing a trustee upon bankruptcy or liquidation – then “the affairs of the company” for the purposes of s 477(2)(m) would include administering the trust – see [90] and authority there cited.

3. Power lacking if company mere bare trustee of trust assets post-liquidation; and

4. Power to sell trust assets in reliance upon lien can be acquired by seeking an order for judicial sale, preferably with appointment as receiver of trust to carry out the sale and the distribution of the proceeds

The Chief Justice confirmed that the trustee’s right of exoneration and supporting lien are property of the company within the meaning of s 9 of the Corporations Act (at [81]). Upon the intervention of insolvency and the appointment of a liquidator, the liquidator takes control of the property of the company. That includes the assets of the trust for the purpose of indemnification – by recoupment or exoneration (at [82]).

At this point the question then becomes one of power to deal with the trust assets. We have seen the Full Court’s position as to the liquidator’s lack of power under s 477. But what of the company’s powers as trustee or former trustee?

Where a company ceases to be trustee of the trust upon its liquidation under the terms of the trust, it will lose its powers conferred under the trust deed, and generally hold the trust assets as bare trustee (and as former trustee liable for unpaid trust debts, retaining its right of indemnity against those assets). As bare trustee, the Company has a “duty to maintain and protect the trust property and to refrain from active management that does not fall within this duty”: Bruton Holdings Pty Ltd (in liq) v Federal Commissioner of Taxation [2011] FCAFC 79; (2011) 193 FCR 442 at [21]. The bare trustee has limited powers and these do not include a power of sale: Caterpillar Financial Australia Ltd v Ovens Nominees Pty Ltd [2011] FCA 677 per Gordon J at [28].

I pause here to note that one method of addressing this lack of power, taken in some cases of liquidation of trustee companies, has been to approach the court seeking a conferral of power on the bare trustee under the relevant state trusts legislation – for example in Victoria the relevant provision is s 63 of the Trustee Act 1958 (Vic), in NSW it is s 81 of the Trustee Act 1925 (NSW) – as well as for directions as to a proposed distribution and any associated questions that have arisen. The relevant line of authority includes Caterpillar Financial Australia Ltd v Ovens Nominees Pty Ltd [2011] FCA 677per Gordon J at [30] and [36], and Riddle v Riddle [1952] HCA 12; (1952) 85 CLR 202, 221 per Williams J. This was done in a recent case in which I appeared of Re Mamounia Pty Ltd (in liq) (No 3) [2018] VSC 65.

In Killarnee, the Full Court made its position clear that it expects liquidators to approach the courts for authority to sell the trust assets, stating variously that this is “required” or “needed” (see [44] and [91] per Allsop CJ, [139] per Siopis). A trustee’s right of exoneration and its lien remain over trust assets in respect of unpaid trust debts after a trustee is removed. This is the case even though it then only holds the trust assets as bare trustee. As Allsop CJ observed, a trustee (or former trustee) may exercise its right of indemnity without judicial intervention where property is not required to be sold. But the lien does not confer a power of sale, and if sale be necessary a court order or the appointment of a receiver to sell is required (per Allsop CJ at [44]).

Siopis J agreed that the trustee company, through its liquidator, may rely upon the lien to approach the court to authorise the sale of trust assets by way of equitable execution for the purpose of paying the trust creditors and so vindicating its right to exoneration. As his Honour observed, this is usually done by asking the court to appoint a receiver for the purpose of selling the trust assets and distributing the proceeds among the trust creditors. In most cases, it is the liquidator who is appointed receiver for these purposes (see [142]). In this way vindication of the insolvent former corporate trustee’s right of indemnity through the exercise of the equitable lien, and the distribution of the proceeds of that exercise, takes place under the supervision of a court exercising power in its equitable jurisdiction [147].

Usefully, Siopis J notes at [144] that where a liquidator of an insolvent former corporate trustee does not make such an application, it would be open to the trust creditors exercising their right of subrogation to apply to the court joining the liquidator, for the appointment of a court appointed receiver to sell the trust assets and distribute the proceeds. I would suggest that this may apply as much to priority creditors who may be trust creditors, such as the Commonwealth representing the Department of Employment (having made advances to employees under FEGS), as to ordinary trust creditors.

The facts in Amerind differed in a material respect from the facts in Killarnee.  In Amerind there was no suggestion that when the receivers sold the trust assets they lacked power to do so. As Siopis J noted at [137], presumably, they did so exercising powers of sale under the security instruments, and under the trust deed which appointed Amerind as trustee (it was in administration and receivership, not liquidation). Further, the receivers obtained court directions confirming they were justified in selling the trust assets.

In Killarnee, however, when the liquidators sold trust assets, the Company had been removed from its position as trustee and the liquidators had no authority to sell the trust assets as liquidators (at [138]). Accordingly the only basis upon which the Company could sell the trust assets was in reliance upon its equitable lien, and that required intervention of a court exercising equitable jurisdiction to effect a judicial sale and often to appoint a receiver to carry out the sale and the distribution of the proceeds (at [139]). Neither had occurred here. Siopis J took the view that on the application of the liquidator of Killarnee the Court was likely to grant relief nunc pro tunc to the liquidators in respect of the previous unauthorised sale of assets, and approve the proposed sale of the other as yet unsold trust assets (at [140]).

In the case of Killarnee, the right of exoneration was going to exhaust the trust property, hence Allsop CJ took the view that the liquidator could be given power to sell the property without the need to be appointed a receiver to hold trust property for the benefit of beneficiaries after exhaustion of the right of exoneration. In his Honour’s view the proceeds of sale could then be dealt with by the liquidator (as the proceeds of the exercise of the right of exoneration) in accordance with the Corporations Act (at [91]).

5. The statutory scheme of priorities applies – mostly, and

6. The sting – some elements of the priority scheme may not apply in every case

On this issue the way forward is somewhat clearer for practitioners in liquidating trustee companies…but there are new doubts.

The Full Court majority of Allsop CJ and Farrell J (the latter reluctantly) agreed with Amerind that the statutory scheme of priorities laid down in the Corporations Act in ss 556 and 561 applies to the distribution of assets where a company in liquidation was trustee of a trading trust and the assets are subject to a right of exoneration and supporting lien. That conclusion appears confined to the simpler case, where the company has only ever acted as corporate trustee for one trust (not for more than one, and not also in its own capacity) – see [102] and [200]. And as noted in my alert last week, their Honours answered the question as to whether the statutory scheme applied to the distribution of the proceeds of sale of trust assets in the circumstances of the case before them in the affirmative 2:1.

However, as explained below, Farrell J’s support of this position preferred to rest on alternative basis, and neither Farrell J nor Allsop CJ endorsed the entire scheme, only parts of it. Siopis J dissented, but left a window of light open by noting that adoption of the scheme of priority could be achieved by directions to receivers appointed by the court over trust assets. Farrell J recognises this prospect also. In practice, this may well be the answer, until clear guidance is given by the High Court of the legislature.

Specifically –

• Employee entitlements – both Allsop CJ (by application of the Corporations Actat [108] alternatively by application of Equity at [111]-[120]) and Farrell J (by application of Equity, at [201]) strongly endorsed the according of priority to employee entitlements on a distribution of the proceeds of the trustee’s right of indemnity,
• Liquidators costs – both Allsop CJ at [106]-[107] and Farrell J at [201] (see also [217]-[221] endorsed liquidators costs being accorded priority,
• Costs of the winding up application – Farrell J did not accept that the costs of an application to wind up the corporate trustee constituted a trust debt and would be covered by the trustee’s indemnity (at [201]). Allsop CJ declined to say whether those should be accorded priority, as it did not arise in this case (at [104]),
• Other priority debts – other priority debts such as administrators’ costs were not addressed.

As Allsop CJ pointed out at [26], the proposition that the statutory scheme of priorities follows under both Re Enhill and In re Suco Gold, but for different reasons.

In Killarnee, the parties agreed that the proceeds of the unfair preference claim should be treated in accordance with the statutory priority regime. Allsop CJ cited the authorities in support of that approach, but noted that given the lack of argument, he would adopt the approach of the parties without undertaking any legal analysis – see [93]-[94]. Farrell J followed suit (see [199]) as did Siopis J at [149], though noting that the question is “certainly not free from doubt”.

As to the proceeds of realisation of trust property in exercise of the right of exoneration – Allsop CJ noted that the impressed character of the property becomes relevant upon the exercise of the right of exoneration. The proceeds of the exercise of the right cannot have any different character; as property of the company but constrained in nature and character. His Honour concluded in a detailed review of the authorities (discussed below) that the obligation of the liquidator is to pay the funds only to creditors of the trust (at [95]).

The Chief Justice found two alternate roads to reach his conclusion that the scheme of priority applies. The first was that this is the proper effect of the Corporations Actapplying to the liquidation of companies who were trustees of trading trusts. The second was that, alternatively, Equity should mould itself to apply in a parallel way to the statutory scheme, on the distribution of trust assets to trust creditors upon the liquidation of the trustee company. Farrell J took the view that she was bound to follow Amerind and agree with the first road, preferred the second: that Equity should follow the scheme of priorities, with exceptions.

(1) Proper application of the Corporations Act – Allsop CJ’s first road

The Chief Justice observed that none of ss 501, 555, 556, 560 and 561 purport to change the nature and character of the property that falls under the control of the liquidator, whether as property of the company itself, or as proceeds of the exercise of that property (see [98]). In his Honour’s view, there is no reason why their plain terms should not be read in the context of an understanding by Parliament that companies can act from time to time as trustees of one or more trading trusts ([99]).

The Chief Justice agreed with the reasoning of King CJ in In re Suco Gold where it was held the statutory order of priorities applies to trust assets under the liquidator’s control. In that case, the insolvent company had been trustee of more than one trust, but had not traded on its own account. All debts were trust debts of one or other of the trusts. The only assets of the company itself were the various rights of exoneration against the property of each trust (see [100]). King CJ observed that;  To the extent that each priority debt has been incurred in the performance of a particular trust that priority creditor should have recourse to the property of that trust for the purpose of payment of that trust debt.” Allsop CJ agreed with King CJ. The statute applies to the funds produced from execution of the right/s of exoneration.

The Chief Justice took the view that the Corporations Act should not be restricted in its application to only some types of property of the company. Nor should it be construed as intended to change the nature of property of the company (at [101]).

His Honour observed that rights, duties and proprietary characteristics by operation of fundamental principles should be accommodated in the operation and working of the statute. Those rights, duties and characteristics are part of the legal groundwork and foundations against which one reads and applies the statute; the equitable principles and norms in which the statute was intended to operate (at [101]). I pause here to note that in my opinion, respectfully, this makes eminently reasonable sense. However, to the extent that this means the Corporations Act purports to modify trust law, not all commentators will agree with Allsop CJ here. There may be a range of arguable opinions here, but one of them runs along these lines: Briefly, trust law is generally treated as a matter for the state legislatures. On one view, section 51 of the Constitutiondid not confer power to legislate as to trust law upon the Federal Parliament. Hence if Allsop CJ’s remarks as to the Corporations Act operating in the context of trading trusts boils down to the Act purporting to vary the law of trusts, there may be a constitutional issue here requiring a referral of power from the states to resolve nationally. On my reading of it, the referral of power ahead of the 2001 enactment may not have been broad enough to achieve this.

Allsop CJ goes on to say that s 556 applies so that the property of the company – including the right of exoneration and the funds obtained from its exercise – are to be distributed in accordance with the statutory command of ss 501 and 556 (see [102]).

Farrell J falls into line with Allsop CJ and the application of the Corporations Act to the distribution of trust assets by exercise of the right of exoneration, albeit with some apparent relucance. At [200] Farrell J notes her acceptance that the Victorian Court of Appeal’s decision in Amerind is binding on this bench (which is not exercising appellate jurisdiction) and supports Allsop CJ’s conclusions at [101]-[102]. That is where his Honour refers to ss 501 and 556 and concludes that at least where the company has only ever acted as corporate trustee for one trust, the words of the statute are to be applied to direct the distribution of the property of the company. The balance of her Honour’s judgment reveals her own view that the proper basis for the scheme of priority (or part of it) applying is by operation of Equity.

Allsop CJ goes on to say that each provision of s 556 must be examined for its meaning (at [104]).

As to the costs of winding up, his Honour considered s 556(1)(b) (the costs of the winding up application). He noted the question may arise as to which fund should bear those costs – the relevant trust in respect of which the obligation was undertaken, the general assets of the trustee company, or the trusts and general assets rateably. Unfortunately, his Honour declined to answer the question, it not arising in that case (at [104]).

The Chief Justice noted that in In re Suco Gold, King CJ had concluded that the liquidator’s costs were payable out of the trustee’s right of indemnity (at [105]). King CJ’s reasoning had been:

It is part of the duty of the trustee company to incur debts for the purposes of the trust businesses and, of course, to pay those debts. Upon winding up those debts can only be paid in accordance with the provisions of the Companies Act….As the company’s obligation as trustee to pay the debts incurred in carrying out the trust cannot be performed unless the liquidation proceeds, it seems to me to be reasonable to regard the expenses mentioned above as debts of the company incurred in discharging the duties imposed by the trust and as covered by the trustee’s right of indemnity.

Allsop CJ endorsed this at [106]. At [107] his Honour explained:

I do not see equitable principle or any of the provisions of the Corporations Act as preventing the approach identified by King CJ, based as it is upon the limited nature of the proprietary interest of the insolvent trustee – to exonerate itself for a purpose out of trust property. Indeed, I see the legislation being given full effect, but harmoniously with fundamental equitable principle that otherwise governs and dictates the fair and proper administration of trusts, and into the framework and operation of which the statute was placed.

The Chief Justice at [108] then considered the priorities afforded in ss 556(1)(e), (f), (g) and (h) of the Corporations Act to employee entitlements. His Honour saw no reason why they should not apply. He observed that they reflect, as do the balance of s 556, important public policy considerations of the legislature. Trading trusts were in use long before the 2001 Corporations Act was enacted. Parliament did not see fit to make any particular clarification of the position of insolvent companies that acted as trustees of trading trusts. He draws from this the following conclusion at [108]:

Where the corporation has only ever acted as a trustee of one trust and that has been the totality of its affairs, there is no reason either in principle or by reference to context or text why the words of the statute setting the order of priorities should not be followed. Complexities may arise in circumstances of multiple trusts or of trust and activity on the corporation’s own account. Considerations of, or akin to, marshalling or hotchhpot may be relevant as to the payment of debts dealt with in the statutory order. But these complexities will be resolved by application of principle and the text of the legislation, in a manner reflected by the approach of King CJ in In re Suco Gold.

(2) Proper application of equity and trust law – protects priority of at least employee entitlements and liquidators’ costs

This is an interesting argument. It essentially concludes that Equity ought to modify itself its application in the insolvency context. I will set out this out in some detail here so that practitioners may see the flow of reasoning.

Allsop CJ: At [111] the Chief Justice notes that after having read the reasons of Farrell J, if he is wrong as to the meaning and operation of the Corporations Act, and if the distribution of the funds that are the product of the exercise of the right of exoneration is to be in accordance with equitable principle, then there is a sound basis to conclude that Equity would follow the statute by providing for the priority of employees (rather than pari passu). His Honour’s reasoning was as follows – at [112] –

The protection of employees in the aftermath of the failing of a business is a matter of high public policy. It has been consistently addressed in terms of priority in access to funds and latterly by a qualification to the reach and operation of securities over the assets of the business enterprise. This has been a Parliamentary response informed by considerations of at the protection of the vulnerable and of fairness in the operation of the insolvency regime. “Such considerations are basal to the very nature and operation of Equity as a body of principle (including, but not limited to, rules.”

Then at [113] – his Honour explained this view, which essentially means not that the Corporations Law has modified Equity, but that Equity has and should modify itself to agree with the statute in this context –

The order of priorities to limited funds in any given situation is based on legal policy, especially justice and fairness. That a pari passu approach is generally applied is a reflection of Equity’s insistence on fairness and justice, through equality. Equality is Equity. But that maxim is not to be divorced from its informing source or values. The application of Equity by its adjustment of the maxim in the context of a statute of high public policy can be seen as the accomodation of equitable principles to the circumstances of the case to vindicate its fundamental norms of fairness, justice and equality, influenced by the recognition of a statute that reflects the cognate norm of the protection of the vulnerable.

He notes at [114] that by way of analogous comparison, the law of priorities of lien holders in Admirality is subject to a degree of flexibility dictated by the imperative to do justice.

The Chief Justice concludes at [116] that in the context of the protection of employees, there is every reason for Equity to follow the statute in applying its principles of distribution concerning employees conformably with the public policy in the statute which conforms with all of the relevant underlying norms of Equity: fairness, justice, the protection of the vulnerable and, within that framework, equality. At [117] his Honour observes the approach might be seen as an example of consistent and clear legislative policy informing a change to judge-made law. His Honour appears to be suggesting not that the statute has changed the common law, but that the common law has changed itself in order to conform with the statute, informed by the same policy considerations.

In support of this view his Honour cites a long raft of higher court decisions in Australia, the UK and the USA, as well as a range of academic writings on the influence of statute upon the general law (see [119]). His Honour quotes from Lord Diplock in a 1979 decision of Even Warnink BV v J Tonsend & Sons (Hull) Ltd [1979] AC 731 at 743, where his Lordship observed:

Where over a period of years there can be discerned a steady trend in legislation which reflects the view of successive Parliaments as to what the public interest demands in a particular field of law, development of the common law in that part of the same field which has been left to it ought to proceed upon a parallel rather than a diverging course.

The Chief Justice draws his argument together in this way (at [120]) –

Here the consistent policy of Parliaments discussed in the reasons of Farrell J has been to protect employees. The techniques have become progressively stronger, brought about by an appreciation of inadequacy in some circumstances of an earlier regime. There is, however, clear and consistent policy now based in national legislation. Equitable principle should reveal consistency with, not divergence from, public policy of such strength and consistency, when it conforms so completely with all the norms that underlie Equity.

Farrell J: Her Honour takes the view at [201] that in this case a court of Equity should authorise the distribution of trust assets in paying the reasonable remuneration and costs of the liquidator in the priority provided by s 556(1) and employee related expenses in the orders out in s 556(1)(e) (f) (g) and (h). Farrell J does not, however accept that the costs of an application to wind up the corporate trustee constitute a trust debt (let alone be afforded priority of payment from the trust assets). Farrell J explains the selectiveness this way-

That is because of the breadth of the trustee’s authority and the indemnity under the trust deed in this case. I can envisage circumstances where the trustee’s indemnity might not cover some liabilities (for instance, for fines or penalties related to late payments) under the terms of the trust deed, where payments out of trust assets could not be made.

Farrell J agreed with Allsop CJ that each paragraph of s 556 must be interrogated for its meaning, and noted that not all debts which might fall within s 556 should properly be accorded priority in the distribution of trust assets (at [201]).

Farrell J explained her reasoning at [203]:

The priority regime and the definition of ‘property’ in s 9 of the Corporations Act are generalised. Whilst that may be appropriate for guiding the distribution of assets of an insolvent company which has only traded in its own right, it has proven inadequate to provide sufficient certainty for the resolution of issues that arise upon the insolvency of a corporate trustee which has operated one or more trading trusts.

As her Honour need, these issues have been arising and been the subject of comment since the late 1970’s, with conflicting judgments and academic views written (see [206]). They were addressed in the ALRC’s report in 1988. FEGS has complicated matters, as has legislation regarding payment of superannuation guarantee charges.

In [207], her Honour observes frankly that it is unfortunate that the legislature has not seen fit to make more explicit the extent to which the priority regime in the Corporations Act impacts on the interests of those involved with a trading trust. As her Honour observed at [207] –

There are good public policy reasons for a legislated priority regime which expressly encompasses an insolvent corporate trustee given the position that such trusts occupy in australia’s economy.

Farrell J observed that it would be appropriate for the legislature to make clear whether it prefers the policy approach reflected in Re Enhill, In re Suco Gold, Re Independent Contractors, or some other approach (at [208]). As her Honour noted, honest minds can differ about which approach is preferable, even in the relatively straightforward case of a trading trust carrying only one family business. The Victorian Court of Appeal did not attempt to resolve the question of whether the approach in Re Enhilll or In re Suco Goldwas to be preferred. Farrell J observed that the Full Court preferred the approach in In re Suco Gold because it is more consistent with principle and better accommodates more complex situations (at [208]).

At [214] Farrell J arrives at her view that a court of Equity should follow the statute in giving a receiver (or liquidator acting as receiver) directions as to how trust creditors (and only trust creditors) should be paid out of trust assets. There are many reasons for this –

First, the order in which payment must be made in such cases cannot be regarded as settled (at [215]).

Second, it is true that in most cases ‘equality is equity’ is the appropriate guiding principle (at [216]). The priority accorded to the liquidator and employees in legislation regulating the winding up of corporations is of long standing (at [217]). As noted in Amerind, priority was first given to wages and salaries of employees in bankruptcy legislation in the UK in 1825 and there was then a history of the giving of priority to employees, to protect the vulnerable (at [218]). It reflects the requirements of fairness (on which equitable prinipcles are also based) to address vulnerability of employees in relation to the insolvency of companies which employ them (at [219]). Her Honour then traced the history of this in Australia starting with WA company legislation in 1893 (at [220]). Since then, the priority position of employees in legislation dealing with the winding up of companies has only been enhanced and the position of liquidators for their reasonable remuneration costs and expenses has been preserved (at [221]).

Third, the cardinal principle of equity is that the remedy must be fashioned to fit the nature of the case and particular facts. It is difficult to see why the same order of priority as prescribed in the priority regime under the Corporations Act for companies trading in their own right should not be accorded to liquidators and employees (and those who stand in the employees shoes having paid them out) under equitable principles (at [222]).

Her Honour concludes that even if she did not feel bound to follow the decision in Amerind, in this case, Equity should follow the statute in the order of payment of liabilities to trust creditors properly in exercise of the right of exoneration. However, her Honour repeated her agreement with Allsop CJ that each paragraph of s 556 must be considered individually in light of the nature of the right of exoneration. It cannot be assumed that that right will provide access to trust assets under each paragraph. Farrell J expressly noted that she had formed her opinion in light of the prevalence of trading trusts, the legislative fous on protecting employee eneitltments for over a century, and the fact that equitable remedies should be shaped to fit the circumstances (at [223]).

(3) The dissent

As noted above Siopis J dissented from the views of Allsop CJ and Farrell J, taking the view that the statutory scheme of priorities does not apply to the distribution of monies derived from the sale of trust assets (at [150]).

However, it is important to note that his Honour did allow that it could be achieved: if a receiver is appointed to effect the sale of trust assets, the court could give directions to the receiver as to the distribution of the money to trust creditors, including the application of a regime other than pari passu, subject to the circumstances of the particular case (at [155]). Farrell J recognises this prospect also at [212] and [214].

Siopis J noted that the Liquidator held monies from the prior sale of trust assets that were the product of an unauthorised sale by the liquidators (there were several initially). On that ground alone, his Honour said, the priority regime in ss 555 and 556 had no application to trust monies which the current Liquidator held from those sales (at [151]). Siopis J accepted that if the liquidator were to apply (with the former liquidators), the Court would likely appoint them as receivers of the trust assets nuns pro tunc, as well as for the remaining trust assets and their future sale (just the liquidator) (at [152]).

From there, in his Honour’s view, the real question was whether it was open to this court exercising its equitable jurisdiction in supervising the court-appointed receiver’s sale of trust assets and the distribution of proceeds thereof, to direct that in distributing the monies to the trust creditors, the receiver is to apply a regime other than pari passu? (at [153]) Or, could the Court direct the court-appointed receivers to give a priority to employee trust creditors over trade and other trust creditors? (at [154])

Siopis J agreed for the reasons given by Allsop CJ and Farrell J at [111]-[120] and[214]-[222] that it would be open to the Court to give directions to do so (at [155]). Although his Honour did note that each case would need to be assessed according to its circumstances. However his Honour took the view that in this case, until the application is made for the liquidator to be appointed as receiver re the sale of unsold assets (and nunc pro tunc over already-sold trust assets), it would not be appropriate to give the liquidator a direction in those terms (at [156]).

Siopis J had another reason to oppose the application of the statutory priority regime to the payment of trust creditors from proceeds of sale of trust assets (from [160]-[191]). Put briefly, this was to do with his view that “property of the company” in s 501contemplates only property the surplus of which, after payment to creditors, is to be distributed to the owners of the company. Not property constrained to be disbursed only to trust creditors, with the surplus to go to trust beneficiaries.

7. Trust assets may go to pay only trust debts

It may be useful at this point to re-read the “preliminary points” section above, giving a brief general outline of the nature of trusts, and the differences between the two trustees’ rights of indemnity – the right of recoupment and the right of exoneration, before reading on.

The sources of the trustee’s right of indemnity are threefold: equitable principle, the terms of the trust, and statute (the various state Trusts and Trustee Acts) (Allsop CJ at [37] and [40]). In equitable principle, the right and its characteristics arise from its place in the trust relationship (at [38]). These shape it. The right of indemnity has priority over the claims of the beneficiaries of the trust, and is secured by a lien over trust assets, subject to the terms of the trust (at [35]).

The Chief Justice observed that if the trustee uses its own funds to pay the debt, giving rise to the right of recoupment, then the trustees’ entitlement of access to the trust assets to recoup its expenditure is a personal asset of the trustee, unattended by equitable obligation arising from the trust. If it happens to be insolvent, it is available for all creditors, not only trust creditors (at [45]).

As noted above, if the trustee has not yet paid the debt, it has a right of exoneration from the trust assets. This is a right to use the trust assets to pay the trust debt directly. In his careful analysis of the authorities, the Chief Justice observed that neither Octavo Investments nor Vacuum Oil examined the precise character of the interest in question, save for its beneficial proprietary character and its inuring for the benefit of the estate of the trustee (at [42]).

Simply because the trustee’s right is a proprietary interest, does not conclude the enquiry as to its nature. It does not mean it is unconstrained or connotes general ownership (at [50]). As Allsop CJ explained, the right of exoneration is not an unconstrained beneficial interest. The obligation of the trustee to the creditors and the nature of the trust relationships are the source of the trustee’s right and interest and of the purpose of the right (to pay creditors from the trust funds), and these inform the shape and content of the right of exoneration (Allsop CJ at [48], drawing this from the authorities there cited). As his Honour put another way, the right of the trustee to reach into the trust assets is not a personal right devoid of connection with the purposes and working of the trust; it inheres in, and arises out of, the trust relationship that exists for a purpose – to pay the creditors and thus to exonerate the trustee. It is without a doubt a right of the trustee (and in that sense personal), but one that is constrained in its content by its purpose  – the payment of trust creditors.

As Allsop CJ observed, at least in Anglo-Australian law, there is no direct access by the creditors to the assets of a trust, but in equity the creditors may be subrogated to the rights of the trustee against the trust assets (see [34] and the authority there cited). The obligation of the trustee to use the trust assets to pay trust creditors is reflected by, and provides the foundation for, the creditors’ right of subrogation (at [49]). The entitlement of the creditors to be subrogated to the trustee’s right of exoneration out of the trust assets is derivative through the trustee. It does not give the creditors an interest as secured creditors or to a right of execution against the trust assets. Nor does the trustee hold the right of indemnity on trust for the creditors (at [68]).

If a company or person is trustee of more than one trust, or owns property in its own right as well as as trustee, the trust assets – property impressed with a particular trust – can only be used for the purposes of that trust (at [51]).

The trustee is subject to a fiduciary duty to use the funds of the trust for trust purposes and for the purpose which gave rise to the entitlement to apply the assets – the payment of the creditor to whom the trustee was indebted. To use proceeds from the exercise of the right of exoneration to benefit itself personally would be to advantage itself at the expense of the trust. To use proceeds from the exercise of the right of exoneration over assets of trust A, to pay the creditor of trust B, would be to use an asset impressed with one trust for the benefit of another trust. (all at [51])

The Chief Justice noted that the correctness of the proposition that the trustee is obliged by fiduciary duty to use the right of exoneration only to pay the trust creditors is at the heart of this application (In re Suco Gold and Re Byrne supports this, Re Enhill denies) (at [52]).

His Honour discussed Re Enhill, and observed that to say that the right of exoneration is property of the trustee does not answer the question whether it can be used for the benefit of all creditors (at [75]). Allsop CJ at [76] endorsed what was said by King CJ in In re Suco Gold at 105 (central to King CJ’s disagreement with Re Enhill) –

A trustee, however, has no legal right to use or apply the trust property other than for the authorised purposes of the trust…[the trustee] has no legal right to apply the trust property for his own benefit or for the benefit of third parties: Keech v Sandford….if a trustee [or its liquidator or trustee in bankruptcy] is permitted to use trust property, not for the discharge exclusively of liabilities incurred in the performance of the trust, but in the discharge of other liabilities as well. the money is being used for an unauthorised purpose and is being used, moreover, for the benefit of the trustee, and of third parties, namely the non-trust creditors.

The Chief Justice concluded that –

• The right of indemnification passes to the insolvent estate of the trustee. If payment has already been made, the right of recoupment is a generally available asset. If not, the right of exoneration is an asset available for trust creditors only, unless a different conclusion is a result of statute (at [78]).
• The right of exoneration is a proprietary interest attended by inhering equitable obligations. Its nature and character are that it is exercisable only to pay trust creditors (at [79]).
• The Chief Justice disagreed with the reasoning in Re Enhill and approved that in In re Suco Gold.

Farrell J agreed at [211] with what Allsop CJ had said at [69] and would emphasise it:  trust assets are not property of the company, but the trustee’s right of exoneration supported by the lien in the character of a property interest is. It is, however, property of a particular character, with its content and shape determined by the purpose for which it came into existence – the payment of creditors the liability to whom was incurred in executing the trust. Derrington J’s reasoning in Lane is consistent with this, and Farrell J preferred this to that of the Victorian Court of Appeal in Amerind (at [247]-[281]). The reasoning is about the nature of the trustee’s right of exoneration and the creditor’s right of subrogation.

In Farrell J’s view, at [211] – the exercise of the right of exoneration is incapable of producing “proceeds”. It is the act of payment to trust creditors from trust assets which produces the exoneration, and that is the reason why trust assets are not available to creditors who are not trust creditors. This is what gives effect to the trust creditors’ right to be subrogated to the trustee’s right of indemnity.

Her Honour noted that the Victorian Court of Appeal in Amerind did not attempt to resolve the question of whether the approach in Re Enhill or In re Suco Gold is to be preferred, and observed –

This bench prefers the approach in In re Suco Gold because it is more consistent with principle and better accommodates more complex situations.

Conclusion

So where does this leave us?

In Victoria, on the last question (the availability of trust assets to be applied in exercise of the trustee’s right of exoneration to pay non-trust creditors), we are in a bind. On the one hand, we have our Victorian Court of Appeal acknowledging some doubt but maintaining that unless and until a subsequent appellate decision decides otherwise, trial judges in this State must apply Re Enhill (see Amerind at [286]; see also my article discussing the Amerind appeal decision here).

On the other hand, we have the Full Court of the Federal Court exercising original (not appellate) jurisdiction, disavowing Re Enhill and approving In re Suco Gold, and making clear their view that trust assets may only be used to pay trust creditors. (Note that Killarnee was not an appellate decision. Rather, the questions raised by the Liquidator’s application had been referred up for determination by the Full Court sitting in the Federal Court’s original jurisdiction (see s 20(1A) of the Federal Court of Australia Act 1976 (Cth).)

We have confirmation by the Full Court majority in Killarnee that the right of exoneration and its supporting lien is property of the trustee company, not of the trust. In Amerindthis was enough for the Victorian Court of Appeal to conclude at [276] and [281] that the priority regime must apply –

Once it is accepted that the right of indemnity is property of the insolvent, the insolvency legislation must apply.

However in Killarnee, this did not so clearly follow. Allsop CJ agreed that it did. Farrell J did so reluctantly, and it seems only because of Amerind. Farrell J’s preferred approach was not that the insolvency legislation applied, but that Equity should bend itself to apply to the distribution of trust assets in such a way as to echo the scheme of priority. Allsop CJ adopted this as his second, alternate road to the same end. Siopis J disagreed that the priority scheme could apply at all (by operation of the Corporations Act or of Equity), but both Siopis J and Farrell J noted that a similar result could be achieved by a court exercising its equitable jurisdiction in directing a court-appointed receiver over the trust assets as to their distribution.

However both Allsop CJ and Farrell J warned that not all debts accorded priority in the scheme of s 556 will be afforded priority in every case; indeed Farrell J flagged that in some cases some such debts might not qualify for access to trust assets by the right of exoneration at all (at [223]). Their Honours both took the view that each element of the scheme of priority (each sub-paragraph of s 556) must be “interrogated for its meaning”.

Plus, after Killarnee it more clearly emerges that there are problems of power for liquidators of trustee companies, which the Full Court made clear it expected would need to be resolved by court order in each case.

In the end, it seems we do not yet have a happy relationship with clear paths to follow, at this interface of insolvency law and trust law. Given the prevalence of the use of trading trusts in commercial life in Australia, the insolvency industry as well as the business community at large would be well-served by the achieving of greater certainty as to how insolvency laws are to apply in Australia on the liquidation of trustee companies.