Insolvent Trading Trusts - one point of certainty

There are increasing numbers of trading trusts in Australia.  These trusts are often family discretionary trusts, with a range of discretionary beneficiaries, and a business operating under the corporate trustee’s name. Anyone dealing with the business would assume that it is owned by the trustee, not an undisclosed trust. There is concern that the law concerning some aspects of trading trusts is very unclear.  Such trusts have few of the legal protections which are afforded to companies.  One eminent commentator has described trading trusts as “jurisprudential hermaphrodites”.

The problems with trading trusts are most frequently shown when a trading trust becomes insolvent – when its liabilities exceed its assets.  If that occurs, the law which protects insolvent companies does not apply to insolvent trusts.  In NSW, even the Trustee Act 1925 affords little protection or guidance.

We now have one ray of clarity shining upon the operation of trading trusts.  The High Court in its recent judgement in Carter Holt Harvey Woodproducts Australia Pty Ltd  v The Commonwealth [2019] 8CA 20 has laid down that employee rights of priority in relation to a receivership or a liquidation will apply also when the receivership or liquidation concerns that of a trustee company of a trading trust.

In that case, Amerind Pty Ltd was the trustee of the trading trust which had granted a security interest to Bendigo and Adelaide Bank, to secure a bank facility.  When the trust went into default, the Bank appointed a receiver who proceeded to pay out all the secured debt, after which a significant surplus remained.  In the meantime, the Commonwealth had, pursuant to the Fair Entitlements Guarantee Scheme, paid out all the employee entitlements, and therefore stood in the place of the employees, and claimed the employees’ priority entitlements from the remaining surplus.

Central to the case was the operation of s.433 of the Corporations Act, which provides that where a receiver is appointed on behalf of holders of a circulating security interest, the priority given to employee entitlements pursuant to s.556 of the Corporations Act will apply. 

One of the unsecured creditors of the trust, Carter Holt Harvey Woodproducts Australia, commenced proceedings in the Victorian Supreme Court claiming that s.433 of the Corporations Act did not afford priority to the Commonwealth in respect of the earlier employee entitlements.  After succeeding in the Victorian Supreme Court, the plaintiff lost both in the Victorian Court of Appeal and in the High Court. 

In a unanimous decision of the High Court (albeit one delivered by the seven judges over three judgements) it was found that because, of the nature of a trustee’s right of indemnity against trust assets, being its rights of “exoneration”,  the trustee’s legal right to trust assets, to the extent that it has power to use them for its own benefit, is itself a circulating asset, and is  “property of the company” for the purposes of s.433.  From that property, the receiver must pay various debts, including debts for employee entitlements, in priority.  The three judgements considered that this outcome fitted in with the underlying purpose of sections 433 and 561 of the Corporations Act

The consequence of this important decision is that there is now at least one area of greater certainty with regard to insolvent trading trusts.  The receivers or liquidators of a  trustee company will now be required to pay out the employee entitlements in priority, almost as if the trustee company had been trading in business on its own behalf.  This protection of employee entitlements will probably not be afforded where the trustee is an individual rather than a company.

It is to be hoped that other areas of operation by trading trusts in will future be accorded similar certainty by the courts.

Author: Chris McCaffery