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Issues in liquidation where a trustee serves more than one function

07 Sep 2010

The supreme court decision of Re Dalewon Pty Ltd (In Liquidation) [2010] QSC 311 has highlighted the need for lawyers, creditors and liquidators to exercise caution when dealing with or acting in relation to companies that are trustees, particularly when a company acts as corporate trustee of multiple trusts.

Basic principles relating to trustees

The basic principles relating to trustees are that:

  1. a trustee is personally liable for the debts and expenses it incurs in the course of carrying on business on behalf of a trust; but
  2. the trustee has a right of indemnity against the assets of the trust in respect of those debts and expenses (except assets which, pursuant to the terms of the trust deed, it was not authorised to use for the purposes of carrying on the business);
  3. the trustee‘s right of indemnity is secured by an equitable charge or lien over the trust assets;
  4. the trustee‘s right of indemnity takes priority over the trust‘s beneficiaries‘ interests in the assets of the trust;
  5. creditors of the trustee have a right of subrogation in respect of the trustee‘s right of indemnity (ie a right to ’stand in the shoes of the trustee‘) and thereby have their debts satisfied from the assets of the trust;
  6. the trustee‘s right of indemnity survives a change of trustee; and
  7. if a trustee enters liquidation, the liquidator‘s fees and expenses are seen to be costs of administering the trust (or alternatively the cost of realising the assets of the trust for the benefit of creditors) and are therefore covered by the trustee‘s right of indemnity against the trust assets and paid in priority to other claims.

In cases where a company solely carries on business as trustee of a single trust, these principles are fairly straight forward, and for all and intents and purposes the trust assets will be treated as if they are assets of the company.

Difficulties where trustee serves more than one function

Often, a company will be a trustee for more than one trust, or will carry on business as trustee of a trust as well as in its own capacity.

In those situations, the rationale behind the basic principles set out above become significant, and the circumstances in which various debts, expenses or claims were incurred will determine whether or not they can be satisfied from trust assets.

That is because a trustee‘s right of indemnity against a trust‘s assets only applies to debts and expenses it incurs or in the course of carrying on business as trustee of that trust.

Accordingly, if a company is the trustee of more than one trust, the debts and expenses incurred in the administration of one trust cannot be paid from the assets of the other. Likewise, the debts and expenses incurred by a company carrying on business in its own right (ie not as trustee) cannot be satisfied from trust assets.

By extension, a liquidator‘s fees and expenses can only be satisfied from the assets of a trust if the fees and expenses relate to the administration of that trust. For example, if a liquidator incurs fees and expenses in recovering property to which one trust is entitled, those fees and expenses cannot be satisfied from the assets of another trust.

The decision last week in Re Dalewon Pty Ltd highlights the issues which can arise in cases of a corporate trustee of multiple trusts.

Re Dalewon Pty Ltd

The case arose out of the Brisconnections saga. This involved the issuing of partly paid shares (some were on market at about $00.1) on terms where the owners of the shares were liable to make two installments to fully pay for the shares.

The facts

  1. Dalewon Pty Ltd was the trustee of two trusts, the ’Investing Trust‘ and the ’Superannuation Trust‘ - Dalewon as trustee of the Superannuation Trust held the shares.
  2. Dalewon could not pay for an installment and following Brisconnections serving a creditor‘s statutory demand, was liquidated.
  3. The debt on which the winding up proceedings were based was the debt arising from the unpaid installment, and therefore a debt owed by Dalewon as trustee of the Superannuation Trust.
  4. During the liquidation, Dalewon‘s directors brought proceedings against Dalewon and Brisconnections asserting that Dalewon did not owe a debt to Brisconnections, that Dalewon was always solvent and should never have been wound up, and seeking the termination of the liquidation.
  5. The liquidators incurred fees and expenses of around $200,000 in conducting the liquidation, approximately 65% of which (including around $100,000 in legal fees) related to the proceedings brought by Dalewon‘s directors (with the balance relating to the general administration of the liquidation).
  6. The liquidators sought a declaration that they were entitled to be indemnified from the assets of both trusts to satisfy those fees and expenses.

The decision

The court held that:

  1. the liquidators‘ fees and expenses incurred in relation to the legal proceedings brought by the directors were costs of administrating the Superannuation Trust only (as the debt pursuant to which Dalewon was wound up was allegedly owed by that trust, and the proceedings involved a dispute in relation to that debt);
  2. by extension, the liquidators‘ fees and expenses relating to the legal proceedings were not the costs of administering the Investment Trust (the assets and liabilities of which were not in dispute);
  3. the assets of one trust could not be applied in payment of the costs of administrating the other - consequently, the assets of the Investment Trust could not be used to satisfy the fees and expenses incurred in relation to the legal proceedings; and
  4. the liquidators had failed to provide sufficient detail to show what portions of their fees and expenses related to the administration of which trust.

The court therefore dismissed the liquidators‘ application for declarations that the assets of both trusts be applied in payment of their fees and expenses.

The lesson for liquidators

In situations where a company is carrying on business in more than one capacity (either as trustee for more than one trust, or as trustee of a trust and in its own right), it is critical for liquidators to be able to identify which portions of their fees and expenses relate to the administration of the company in each of its capacities (including in relation to the liquidation generally).

Although the courts have recognised the practical difficulty of distinguishing between the different types of costs in liquidations (particularly in relation to the winding up in administering trust assets and the costs of winding up generally), it is necessary for liquidators to establish some nexus between the fees and expenses claimed, and the administration of the trust from which the liquidator seeks to have those fees and expenses paid.

There will be other circumstances where a liquidator will be required to distinguish between the different purposes for which its fees and expenses were incurred. For example, a liquidator may not be entitled to the fees and expenses it incurs in relation to legal proceedings which are found to have been improperly brought, but still be entitled to its fees and expenses in relation to the general administration of the liquidation. Alternatively, a liquidator may have a priority entitlement to the fees and expenses it incurs in relation to legal proceedings, but a secondary priority in relation to its fees and expenses in relation to the general administration of the liquidation.

In those situations, and others, the more detail the liquidator can provide as to what work its fees and expenses relate, the easier it will be to obtain fee approval.

The lesson for creditors

A creditor dealing with a trustee of a trust cannot assume that all of the trustee‘s assets will be available to satisfy the creditor‘s debts.

It is only the assets of the trustee in their own right and the assets of the trust on whose behalf the debt was incurred that will be available to satisfy the debt, and not the assets of any other trust of which the company was a trustee.

A debt can only be satisfied from the assets of the trust if the debt was incurred by the trustee as trustee. No recourse to the trust assets will be available if a debt is incurred by a company in the course of it carrying on business in its own right (notwithstanding that it may also be a trustee of one or more trusts), or if the trustee did not have the authority to incur the debt on behalf of the trust under the terms of the trust deed.

Conclusion

With the increased use of trading trusts, the issue of enforceability of debts against trust assets has and continues to attract quite a deal of judicial scrutiny and is in some respects, a developing area of the law. Hynes Legal have been involved in many recent cases and can assist in dealing with the complex issues that can arise.