On the Case: Issue 13

How Are Creditors Of A Trust When A Trustee Company is In Liquidation to be Paid?

In this edition of On the Case Adjunct Professor Philip Stern, who taught Insolvency Law at The University of Notre Dame Australia, School of Law, Sydney, last year, discusses a recent decision which has significant ramifications for secured creditors¹.

In Brief

This case is authority to the effect that trust law principles apply to distribution of trust assets on the liquidation of a corporate trustee of a trust. In particular creditors of the trust rank equally in the distribution of the trust’s assets and the scheme of priority payments normally applicable in a liquidation pursuant to the Corporations Act 2001 does not apply. Further, the liquidator’s remuneration and expenditure are subject to Court approval whereas in a liquidation of a company which owns assets beneficially, creditors or a committee of inspection can approve liquidator remuneration.

Brief Facts

A corporate trustee was in liquidation .The company’s only function was to act as trustee of a trust. It owned no assets in its own right, there was a significant deficiency in available trust assets compared to the claims of creditors /beneficiaries (being, under the trust deed, persons who provided services to the trust), and there was a very substantial claim by the Australian Taxation Office arising out of a superannuation guarantee charge for unpaid superannuation contributions, interest and administrative charges .

Relevant legislation

The Superannuation Guarantee (Administration) Act, 1992 (Cth) (SGAA) deems persons who work under a contract, that is wholly or principally for the labour of a person, to be employees of the other party, for the purposes of that legislation². Generally in the liquidation of a company, an unpaid superannuation guarantee charge is afforded priority in payment over general creditors, who otherwise rank equally in distributions³ (see s556 (1)(e) Corporations Act 2001 (Cth)(Corporations Act). An “employee” is defined in s556 (2) Corporations Act as a person “who has been or is an employee of the company, whether remunerated by salary, wages, commission or otherwise”.

Application

The liquidator sought, inter alia, a direction from the Court that he would be justified in distributing the available trust funds, after payment of his fees and expenses, to the ATO for the unpaid superannuation guarantee charge, or alternatively, to the contractors who provided services.⁴

The basic law

Brereton J reiterated the basic trust law as follows:

1. a trustee is entitled to apply trust assets to discharge liabilities incurred in the authorised conduct of the trust,
2. that right of indemnity is secured by an equitable lien over the trust assets, which is a security interest and has priority over beneficiary claims,
3. upon bankruptcy or liquidation of a trustee, its right of indemnity and lien vest in its trustee in bankruptcy or liquidator, and
4. a trust creditor is entitled to be subrogated to the trustee’s right and lien.

Issues and decision

1. Were the liabilities of the company to its creditors, particularly the ATO, covered by the trustee indemnity?
   As the liabilities of the company, including the superannuation guarantee charge, were incurred in the course of its acting as a trustee the company (now through its liquidator ), was entitled to be indemnified from the trust assets in priority to the interests of beneficiaries⁶.

2. Is the superannuation guarantee charge entitled to priority and, if not, how are the liabilities to rank? The answer depends upon whether the company’s liability falls within s556(1)(e) Corporations Act, and, if so, does s556 apply to the rights of trust creditors over trust property?
   Brereton J had previously found that the contractors were not employees⁷. He held that the expanded definition of “employee” in s12 SGAA was for the purposes of that Act only and had no application to the Corporations Act, other than in respect of employees as defined in s556⁸. A South Australian appellate decision⁹ which applied the statutory priorities in the previous legislation to trust liabilities payable from trust property, was “virtually universally accepted to be incorrect”¹⁰. That is because s556 is concerned only with the distribution of assets beneficially (i.e. absolutely) owned by a company and available for division between its general creditors¹¹. There were two alternatives then as to how the trust assets were to be distributed as the equities between creditors are equal. The first is that trust creditors have priority in accordance with the order in which their claims arose (as each claim arose it brought with it an interest, via subrogation, in the trustees lien over the trust assets). Or second, the trust creditors rank pari passu (i.e. equally and rateably between themselves)¹². His Honour found that all creditors were entitled to be subrogated to the liquidator’s lien pari passu and share equally in the trusts assets after the costs of administration¹³. The trustee’s lien does not attach to any particular asset, nor secure any particular liability, but is in the nature of a floating charge over all the trust assets. Multiple creditors share the right to be subrogated to the trustee’s indemnity¹⁴.

Conclusion

As all the company’s liabilities were incurred in its trustee capacity all its creditors, including the ATO in respect of the superannuation guarantee charge, are entitled to be subrogated to the liquidator’s lien over trust assets and share pari passu in the trust assets (after the costs of administration). Section 556 Corporations Act does not apply to trust assets, and even if it did, the expanded definition of “employee “ in the SGAA has no application to the Corporations Act so as to deem contractors “employees “for the purposes of Corporations Act priority payment in a liquidation.”¹⁵

A further issue – liquidator’s remuneration

Brereton J also held that standard Corporations Act procedures for approval of liquidator fees (being by creditor, or committee of inspection, approvals) had no application for liquidator remuneration when the company carried on business as a trustee. The liquidator requires Court approval for his/her fees and expenses, pursuant to the Court’s general equitable jurisdiction¹⁶. The Court has a wide discretion in fixing the level and basis of remuneration¹⁷. Relevant factors include the proportion of recoveries compared to the fees claimed, the degree of risk and responsibility involved (here diminished by delegation of some tasks to a debt collection agency and to lawyers), and the complexity and size of the administration¹⁸.

Implications of this Case

The case essentially recognises separate regimes for corporate liquidations-one when a company owns assets beneficially which is governed by the Corporations Act, and one when it holds assets on trust which is governed by trust law. This has serious implications for liquidators, creditors and beneficiaries because of differing returns, complexities and costs depending on which regime applies. All creditors are to be treated equally in dividend returns in the liquidation of a corporate trustee of trust assets.

This article was originally published by Woodgate & Co, Level 8, 6-10 O’Connell Street, Sydney and their willingness to permit its republication is gratefully acknowledged.

¹ In the matter of Independent Contractor Services (Aust) Pty Ltd (in liquidation)(No2) [2016] NSWSC 106 (ICS)
² SGAA s12
³ ICS [6]
⁴ ICS [11]
⁵ICS [19]
⁶ ICS
⁷ ICS [21]
⁸ ICS [22]
⁹ Re Suco Gold Pty Ltd (1993) 33 SASR 99
¹⁰ ICS [23]
¹¹ ICS [23]
¹² ICS[23]
¹³ ICS [24]
¹⁴ ICS [25]
¹⁵ ICS [52]
¹⁶ ICS [28],[31] and [32]
¹⁷ ICS [32]
¹⁸ ICS [32] ,[33],[39] and [40]