A trustee's right of indemnity survives liquidation.
The purpose of setting up a trust is usually to protect those assets from either the bankruptcy of an individual or the insolvency of a company. A trust deed is the basis upon which a trust operates. A typical structure for a trust arrangement is to have a company act as a trustee.
At the time of establishing a trust structure little time is spent by advisers understanding the impact an insolvency of the corporate trustee (“insolvent”) would have on the trust structure and the assets it holds. Often trust deeds use standard clauses whereby the insolvency of the corporate trustee automatically disqualifies it from acting as trustee. This appears to protect the trust assets from the hands of a liquidator of the insolvent corporate trustee. However, the impact of the insolvency and a liquidator appointment as the controlling officer managing the wind down of the insolvent can present problems for the trust itself and for any incumbent trustee of the trust due to the insolvent’s right of indemnity, which is secured by an equitable lien over the trust assets.
This equitable lien over the trust's assets allows the liquidator to indemnify itself for any liabilities incurred by the insolvent on behalf of the trust assets. When the insolvent is wound up, the liquidator must determine and then seek out this right of indemnity from the trust's assets. The liquidator also needs to explore its power to sell trust assets under the equitable lien it holds over those assets. A liquidator often looks to its powers under section 477(2)(c) of the Corporations Act 2001 and/or directions from the court for guidance.
Recent judicial decisions on this right of indemnity have created uncertainty and conflict over the appropriate way this should be handled. At the very least, it is suggested a liquidator must apply to the court for directions on its ability to realise the trust assets.
To better understand the impact of an insolvent on trust assets, we explore the following:
- a liquidator’s right of indemnity secured by an equitable lien
- the conflicting judicial decisions
- solutions or enforcement options of this right of indemnity under both situations: when a new trustee replaced the insolvent or when the insolvent continues to act after insolvency has occurred (i.e. acted as a ‘bare’ trustee).
Background
A trust is a legal relationship whereby property is held by one party for the benefit of another. A trust is created by a settlor (often known as the creator) and is overseen by a trustee who administers certain property on behalf of the trust's beneficiaries.
Although the trustee is the property's legal owner, the trustee must use the property for the trust beneficiaries' benefit. The trustee is also entitled to repay itself for costs and expenses incurred in administering the trust. This is called the right of indemnity.
When a trust is established, it is important that any adviser fully considers the trust deed's key terms and those powers conferred upon the trustee. Key powers under a trust deed can include:
- dealing with the assets
- its right of indemnity
- the circumstances under which the trustee ceases to act as trustee.
Commonly a trust deed automatically disqualifies a corporate trustee from acting as the trustee upon the insolvency of the trustee. The result usually means that the insolvent continues to act as a ‘bare trustee’ or a replacement trustee is appointed to continue to administer the trust's affairs. Under both scenarios, the right of indemnity exists for the insolvent.
However, some trust deeds do not include a clause that automatically terminates the corporate trustee and in that situation, the insolvent continues to act as trustee under a liquidator's control.
Whether the insolvent has been automatically terminated in its role as trustee and is acting as a bare trustee or continues in its right as a trustee, the insolvent has certain rights with regards to indemnity and accessing the trust's assets.
The insolvent retains the following rights:
- Its right to indemnity out of the trust's assets, for liabilities incurred on behalf of the trust.
- An equitable lien or charge over the trust assets to secure this right of indemnity.
- The right to continue to deal with the trust assets, in accordance with the trust's terms, which includes the right to satisfy any liabilities in respect of which this right of indemnity exists.
- The liquidator's right to claim for its costs and expenses incurred in its own winding up.
A liquidator’s right of Indemnity and equitable lien
An insolvent’s right of indemnity being secured by an equitable lien has been the key element of many judicial decisions guiding liquidators. However, it is important for advisers to understand when establishing a trust for clients how these rights may impact trust assets.
As stated earlier, a trustee usually has a right to indemnify itself for costs and expenses in administering the trust and/or dealing with the trust assets for the beneficiaries' benefit. This right continues upon the corporate trustee's insolvency.
When a liquidator is appointed over a corporate trustee they should perform the following:
- Examine the trust deed's terms and powers to understand the insolvent’s powers.
- Understand what assets the trust beneficially owns.
- Calculate the total creditors relating to the trust assets.
- Examine the trustee's creditors to determine whether they are creditors relating to the trust and its assets.
- Analyse its books and records to understand if the insolvent’s only role is to be a corporate trustee for that one trust.
- Ensure they do not breach their duty to act responsibly as the liquidator may be held personally liable for any loss incurred because of that breach.
Uncertainty has surrounded a liquidator's rights and powers (particularly in selling trust assets) over an insolvent because judicial cases have varied in its responses in how an equitable lien should be enforced.
Conflicting judicial decisions
The cases Apostolou v VA Corporation of Australia Pty Ltd (2010) 77 ACSR 84, Re Bacchus Distillery Pty Ltd (Administrators Appointed) (2014) 98 ACSR 539 and Re Kitay [2014] FCA 670 (“Kitay”) made it clear that an administrator or a liquidator of an insolvent had the power to sell trust assets under the provisions of section 437A(1)(c) (for an administrator) and section 477(2)(c) of the Corporations Act (for a liquidator).
In particular, Kitay established the following position:
- A trustee has a right of indemnity out of trust assets for costs and expenses incurred and a right of exoneration from liability.
- A trustee is entitled to the benefit of an equitable lien over the trust assets in order to enforce its right of indemnity/exoneration.
- When a liquidator is appointed over an insolvent, the liquidator acquires these same rights.
- That right of indemnity exists whether the trustee is automatically removed as trustee because of the insolvency or not.
- This equitable lien, which secures the insolvent’s right of indemnity and exoneration, does not give it a right of power of sale but rather a security that is enforceable by the insolvent through a judicial sale or appointment of receiver.
The key point of contention was with regard to point five above that addressed the issue related to the liquidator’s right of power of sale and how a liquidator should enforce this power. Section 477(2) of the Corporations Act sets out the powers upon which a liquidator can act in this role. Sub-section C relates specifically to the power of sale for a liquidator.
In Kitay, the Judge was satisfied that it made good commercial sense to recognise that the power of sale in section 477(2)(c) of the Corporations Act gave a liquidator of an insolvent a relevant power of sale, which enabled the liquidators to make an approach to court for directions each time they sought approval for selling trust assets.
The Kitay case seemed to establish good guidance on how to commercially deal with trust assets by using its power of sale under section 477 (2)(c) of the Corporations Act and to avoid unnecessary costs by applying to court for directions relating to realising trust assets.
However, in the most recent decision dealing with this issue, Stansfield DIY Wealth Pty Ltd (in liquidation) [2014] NSW SC 1484 considered the power of sale and how a liquidator should adopt section 477 (2)(c) of the Corporations Act when realising trust assets.
The Judge considered the powers under section 477(2)(c) of the Corporations Act and stated that while recognising a corporate trustee may have legal title to those trust assets, unless the assets are beneficially the company's property, a liquidator could not be entitled to those assets as it prejudiced the trust assets' beneficiaries. Therefore, the Judge found that a liquidator did not have an inherent power to sell trust assets under the power construed in section 477(2)(c) of the Corporations Act.
To assist liquidators with the position, the Judge stated that a liquidator would be justified in applying to court to be appointed as receiver and manager of the trust assets to realise its equitable interest (in the assets) as the precedent that a trustee has an equitable lien over the assets remained. And that a liquidator is entitled to recover the costs of the receivership from the trust asset's sale.
Solutions around enforcing this right of indemnity
In considering these judicial decisions, advisers should consider the following impact insolvency has on trust assets and the trustee.
- Whether there is an automatic right in the trust deed to disqualify a trustee from its role as trustee if it is wound up.
- Liquidators will always have a right of indemnity secured by an equitable lien to the trust assets irrespective of whether the insolvent remains as trustee or not following the winding up of the insolvent.
- A liquidator and the insolvent only has a right of indemnity for costs, expenses and liabilities relating to the trust assets, administering the trust and the winding up costs.
- Liquidators should seek the direction of the court when applying this power of sale over the trust assets. This is in the form of appointing a receiver and manager over the trust assets through its equitable lien over the assets.
- Liquidators should always seek legal advice and are likely to make a court application to seek directions with realising trust assets under its right of indemnity and equitable lien.
In conclusion, it does not matter whether the automatic right to disqualify an insolvent from acting as trustee exists, or even if a replacement trustee is subsequently appointed—a right of indemnity secured by an equitable lien remains and the above considerations apply to either scenario.