Insolvent Corporate Trustees – how directors and liquidators are impacted

Are trust assets protected from a liquidator when the trust’s corporate trustee becomes insolvent? Maybe not!

A common misconception is that assets held in trust can only be realised for the trust beneficiaries. Some believe an automatic change of trustee upon liquidation would put the matter beyond doubt, but liquidators will not hesitate to secure and realise trust assets whenever the law allows.

Given the abundance of corporate trustees and the great variation in trust deeds, all those involved with a ‘trading trust’ either as advisors, directors or beneficiaries, should appreciate that trust assets can be at risk and should understand the rights, and the limitations of liquidators to access those assets.

An insolvent corporate trustee creates many unique situations. Both a director and liquidator need to understand their rights and what is or is not protected in the situation that a trustee is wound up. This hypothetical case study highlights the key issues stemming from case law and previous examples for an insolvent corporate trustee.

1. Key Facts

People often look to how best protect and manage their assets, for the benefit of others. It becomes particularly relevant when starting a business.

A company director will often set up a family discretionary trust to own assets (which include a trading business). This trust structure nominates the beneficiaries (usually family members and the director himself) and the director will appoint a company to act as trustee over the discretionary trust.

A trust is a legal relationship whereby property is held by one party (trustee) for the benefit of another (trust).

The trust’s beneficiaries are the director and family members.

The business assets and the business itself are owned by the trust.

Directors’ and beneficiaries’, trustee’s perspective

The director and trust beneficiaries’ wants to employ a tax effective structure for the business and sets up a trust structure.

The director will often take action to ensure that in the event of liquidation control of the trust assets is maintained through the trust deed’s terms, which clearly sets out the trustee’s right of indemnity over the trust assets and that in the case that an insolvency practitioner is appointed—the trustee’s role is automatically terminated.

Liquidator’s perspective

No impact—but the liquidator’s rights are borne out of the trust deed’s terms at inception.

2. Key Facts

Business commences trading and all revenue and expenses are incurred and paid by the trustee (on behalf of the trust and its assets).

Although the trustee is the property’s legal owner, the trustee must use it for the trust beneficiaries’ benefit. The trustee is entitled to repay itself for costs and expenses incurred in administering the trust.

Directors’ and beneficiaries’, trustee’s perspective

Normal trading—director must ensure all dealings with creditors/suppliers etc. are set up on behalf of the trust.

The trustee will want to be covered (indemnified) for the risk and cost of managing the trust/trading the business.

Liquidator’s perspective

No impact.

3. Key Facts

A new trustee is appointed over the trust. The new trustee must be aware of the liquidator’s right of indemnity and equitable lien over the trust assets resulting from the winding up of the trustee. If a new trustee was not appointed, the insolvent trustee would continue as a ‘bare trustee’ over the trust.

Directors’ and beneficiaries’, trustee’s perspective

The director must be aware that the liquidator of the insolvent trustee company continues to have a right of indemnity through an equitable lien over the trust assets.

Liquidator’s perspective

Under common law (and possibly a contractual right under the trust deed) a liquidator can seek a right of indemnity under its equitable lien over the trust’s assets. This indemnity applies to the liabilities the trust incurred during the period the old trustee was responsible for the trust debts.

4. Key Facts

The trustee company does not beneficially own any assets and creditors are owed $500k as a result of trading the business and its assets.

Directors’ and beneficiaries’, trustee’s perspective

The director must comply with their obligations to assist the liquidator.

This can include:

  • Completing a ‘Report as to Affairs’ (i.e. statement of assets and liabilities) of the trustee company.
  • Providing the trustee company’s books and records with a copy of the trust deed.
  • Cooperating with the liquidator to determine a smooth interaction between the insolvent trustee company and the new trustee company.

Liquidator’s perspective

The liquidator must assess its powers to recover/realise assets for the benefit of creditors.

This can include:

  • Closely reviewing the powers and terms of the trust deed.
  • Understanding of what assets are beneficially owned by the trust.
  • Calculating the total creditors owed that relate to the trust assets.
  • Ensuring their role is not in breach as personal liability applies for any loss incurred from a breach.

5. Key Facts

The trust under its new trustee wants to continue trading the business.

Directors’ and beneficiaries’, trustee’s perspective

The director/beneficiaries must be aware of the liquidator’s right to seek court directions to be appointed as receiver and manager under the liquidator’s equitable lien.

The director/beneficiaries and the new trustee may consider a settlement with the liquidator in order to avoid significant disruption (and possibly a closure of the business or realisation of assets within the trust) to protect the going concern of the business.

Liquidator’s perspective

Usually, liquidators have an automatic right of indemnity through an equitable lien to indemnify itself relating to the liabilities incurred by the trustee on behalf of the trust assets.

Current judicial authority suggests that a liquidator should seek the directions of the court by appointing themselves as receiver and manager over the trust’s assets to realise their equitable interest in those trust assets.

6. Key Facts

The business falls into financial distress and the company is wound up.

Directors’ and beneficiaries’, trustee’s perspective

Director is obligated to assist the liquidator in realising the company’s assets and provide information about the trustee company’s role over the trust.

Liquidator’s perspective

A liquidator takes control of the insolvent trustee company and learns that it was automatically terminated from the trust.