Insolvency: Judicial Views on Trusts and Creditors

In March 2018, the Full Federal Court of Australia released its judgment in the case of Killarnee Civil & Concrete Contractors Pty Ltd, ruling that (among other things) trust assets should be applied first in paying employees and other statutory preferred creditors whilst trust assets could only go to trust creditors, not non-trust creditors.

By way of background, Killarnee was the trustee of a trading trust, that is, the trust carried on a business. Killarnee experienced financial difficulties and was subsequently put into administration and a liquidator appointed. On the appointment of the liquidator, the trust automatically terminated, resulting in the trustee company holding the trust assets as ‘bare trustee’. In winding up, the liquidator realised the remaining trust assets and also recovered from the Australian Taxation Office an amount paid as an unfair preference.

The liquidator applied to the court for directions and declarations regarding the proper approach to take in relation to the distribution of the proceeds.

The issues resolved by the Court in this case include:

• Liquidators of trustee companies cannot use their statutory powers to realise trust assets, if they do not have a power of sale as a trustee. Where the appointment of a liquidator automatically terminates a trust, the liquidator must apply to the court to be appointed receiver of the trust assets. In absence of court orders, the trustee would be open to a claim for breach of trust whilst also allowing creditors to exercise their right of subrogation.
• Where there are trust assets available under the trustee’s right of exoneration, they may be applied amongst trust creditors first as governed by the Corporations Act’s statutory priority regime, that is, payment of employee entitlements and liquidator’s expenses must be paid ahead of other trust creditors.
• The trustee’s right of indemnity (whether by way of exoneration (before a debt is paid) or recoupment/reimbursement (after a debt is paid)) does not apply to non-trust creditors.  That is, creditors do not, as a result of this conclusion, become beneficiaries of the trust; rather the right of indemnity remains property of the trustee but “its nature and character are that it is exercisable only to pay trust creditors.”

The issue with this last point is that there is now conflicting judicial authority on this matter, see the case of Commonwealth v Byrnes and Hewitt. In that case, the Victorian Full Court held that trust assets could be used to pay the trustee’s personal debts or debts as trustee of other trusts. This conflicts is obviously a concern for practitioners, receivers and liquidators as well as trust creditors, particularly in circumstances where trusts are trading across different States. Accordingly, until this matter is settled by the High Court of Australia, parties may want to tread with care when dealing in such cases.