Clarifying the treatment of trusts under insolvency law

Written by Rohan Balani

Low hanging fruit ripe for reform but a holistic approach is still required

On 15 October 2021, Treasury released a consultation paper titled ‘Clarifying the treatment of trusts under insolvency law’. The consultation is aimed at reforming Australia’s insolvency law as it relates to trusts, particularly those with corporate trustees.

Whilst we by no means discourage reform, as we have said in the past, a piecemeal approach to reform is not the best method.

We think the holistic approach, as conducted in the 1998 Harmer Report, should be adopted in another review of Australia’s insolvency and restructuring procedures (“Harmer II”). Such a wholesale review would also help avoid piecemeal reform such as ipso facto which in our opinion, failed to achieve its objectives. Such a review should consider the interests of creditors, shareholders, employees, customers/clients, directors of companies and even the interests of society.

Our submission targeted the following issues, which you can view using the following click-throughs:

1. Initial hurdles to reform
2. ‘Low hanging fruit’ reform

A full copy of KWM’s submission can be found here.

1. Initial hurdles to reform

Whilst our submission focused on a number of discrete, practical issues, we identified a number of issues associated with any wholesale reform to the law of trusts as it relates to insolvency.

First, it is unclear to what extent any reform can even occur at a Commonwealth level.¹ As it currently exists, trust law is regulated at a state level.² As such, any suggested changes to the regulation of corporate trusts in insolvency must maintain coherence with the general law and state regulation. There is no utility in wholesale change to insolvency law at the Commonwealth level if the end result is increased incoherence in the regulation of trusts generally.

Second, care must be taken in any reform not to change fundamental principles of trust law including the trustee’s duty to beneficiaries. Any insolvency reform which shifts the duty of a corporate trustee to creditors, for example, risks fundamentally undermining the institution of the trust. Whilst the use of trusts as a corporate form cannot be ignored, it ought not to become the focus where the effects of reform which will flow to non-corporate trusts.

Last, there are limits to the extent of codification of law in this area. Attempts to codify trust law have been limited ³ and typically focused on specific types of trusts such as superannuation trusts.⁴ As such, whether insolvency reform can be codified in the context of trusts remains unclear.

2. ‘Low hanging fruit’ reform

2.1 Simplifying the Insolvency Practitioner’s Power of Sale

A review of recent decisions relating to applications by insolvency practitioners to exercise their power of sale over trust assets shows their formulaic and ‘unremarkable’⁵ nature.

In our submission, facilitating a power of sale to be exercised by insolvency practitioners should be streamlined. Amendments to legislation which provide for an insolvency practitioner to administer trust assets is a sensible change to the current position. Similarly, allowing the same insolvency practitioner to administer both the assets and liabilities of the company and the assets and liabilities attributable to any trusts for which the company is trustee, with appropriate separate accounting, is a pragmatic response and reflects the reality of insolvencies of corporate trustees. 

2.2 Clarifying Asset Distribution in Winding up of a Trust

In our submission, there is no need to introduce a statutory order of priority in the winding up of a trust. This is because much of the ambiguity around distribution of assets in the winding up of a corporate trust has been clarified in recent case law.⁶

The principles arising from the case law can be summarised as below:

• The trustee’s right of exoneration is not held on trust for the beneficiary. Instead, it is held legally and beneficially for the trustee;
• The trustee’s right of exoneration takes priority over the proprietary rights of the beneficiary;
• The distribution of assets upon a sale of trust property follows the principles in Re Suco Gold Pty Ltd (in liq) (1983) 33 SASR 99, that is, where there are multiple trusts which share a common trustee which goes insolvent, the assets from a trust can only be used to discharge liabilities for that trust;
• The distribution of trust property where the trustee is a corporate trustee is to follow the priority regime in the Corporations Act 2001 (Cth) – including by prioritising the rights of insolvency practitioners to remuneration and reimbursement⁷; and
• Liquidators of an insolvent corporate trustee cannot access the trust property without an order from the Court (albeit our view is that this should change so far as it concerns the power of sale).

Further, the position established in the case law reflects a normatively sound position and as such, no change is needed by way of statutory intervention. The High Court’s stance on the justification for applying the statutory waterfall for priorities can be traced to the public policy need for consistency.⁸ In our submission, this position is correct. Particularly in the Australian landscape in which so many businesses operate using a trust structure, in the absence of a statutory register of trusts as exists for personal property securities, it is extremely difficult for lay-persons, including employees, to appreciate the differences and consequences arising from this corporate structure. Importantly, this is not to say that the priority regime in the Corporations Act 2001 (Cth) is without flaw but rather that any flaws that Parliament or the Courts wish to fix should be changes for all corporate structures. 

References

¹ Whilst the Commonwealth retains their power under section 51(xvii) to make laws with respect to bankruptcy and insolvency, the jurisdictional issues that will inevitably arise in the regulation of insolvency of corporate trusts must be considered

² See eg, Trustee Act 1925 (NSW).

³ New Zealand’s limited attempt being one example.

⁴ See eg, the Commonwealth superannuation legislation, Superannuation Act 1922 (Cth); Superannuation Act 1976 (Cth); Superannuation Act 1990 (Cth); Superannuation Act 2005 (Cth).  

⁵ Re Garrows Close Pty Ltd (in liq) [2021] FCA 505, [4] (Beach J).

⁶ Carter Holt Harvey Woodproducts Australia Pty Ltd v Commonwealth (2019) 268 CLR 524; Jones v Matrix Partners Pty Ltd (2018) 260 FCR 310.

⁷ Carter Holt Harvey Woodproducts Australia Pty Ltd v Commonwealth (2019) 268 CLR 524, 551 [56] (Kiefel CJ, Keane and Edelman JJ), 568 [96] (Bell, Gageler and Nettle JJ), 584 [153] – [154] (Gordon J).

⁸ Carter Holt Harvey Woodproducts Australia Pty Ltd v Commonwealth (2019) 268 CLR 524, 553 [58] (Bell, Gageler and Nettle JJ).