Chapter 8 - Beneficiaries, insolvent corporate trustees and definitions
Insolvent corporate trustees
There are several issues and areas of uncertainty regarding trading trusts in the context of insolvency. These include:
(a)whether a corporate trustee should be liquidated;
(b)the entitlement of the liquidator to fees and expenses from trust assets;
(c)the distribution of assets and priority of creditors on liquidation;
(d)the application of the insolvent transaction regime to trust creditors; and
(e)the removal and replacement of a corporate trustee on liquidation, which was addressed in Issues Paper 4.402
As indicated above, the Commission is interested in whether these are merely potential problems, or whether they have resulted in practical difficulties in New Zealand. The issues listed above will be described briefly in turn.
Liquidation of a corporate trustee
The issue of whether an insolvent corporate trustee should be liquidated has come under scrutiny by the courts on several occasions. It was also raised as requiring consideration by a submitter to an earlier Issues Paper.403 If a corporate trustee becomes insolvent, the company may be put into liquidation, either by a shareholder’s resolution or by the Court on the application of a creditor, in the same way as any company would ordinarily be put into liquidation.404 Particular problems are created when a company, set up by solicitors or accountants to provide trustee services, is the corporate trustee for multiple trusts, usually family trusts for clients of the practitioner. Such companies are commonly assetless.405 If the corporate trustee incurs liabilities (perhaps unknowingly), the question arises as to whether the corporate trustee should be liquidated, and this decision affects not just one but many trusts.
In Commissioner of Inland Revenue v Chester Trustee Services406 in 2002 the Court of Appeal considered whether an insolvent corporate trustee should be placed in liquidation. Chester was the corporate trustee of 35 trusts that had no assets other than its rights of indemnity. The Commissioner of Inland Revenue had issued a statutory demand against Chester in respect of GST liability incurred by two of the trusts. If Chester was put into liquidation it would have to resign in relation to all the other trusteeships, which would be very costly. The Court of Appeal decided that Chester should be liquidated nonetheless, as an insolvent company is generally unfit to act as a trustee, and the result was consistent with general company law policy and trustee law. This position was reflected in section 51(2) of the Trustee Act 1956.
The High Court case of Newmarket Trustees Ltd v Commissioner of Inland Revenue involved a corporate trustee that was acting as the trustee of 118 trusts, in addition to a trust that incurred GST and income tax liability. The Commissioner applied to liquidate Newmarket Trustees. Associate Judge Bell considered that there was a prima facie case for liquidation, as the corporate trustee had incurred liabilities and had failed to comply with a statutory demand. However, the Court decided to dismiss the application to liquidate the company. The impact of the liquidation on the other 118 trusts was a relevant consideration, along with the fact that the corporate trustee had no assets to realise for the benefit of creditors, so no benefit would arise from ordering the liquidation. The Commissioner has been granted an extension of time to appeal to the Court of Appeal against the decision in the High Court.407
The Public Issues Committee of the Auckland District Law Society Inc has released a public issues paper on the Newmarket Trustees case, encouraging practitioners operating trustee companies to ensure that “a corporate trustee is used only for the single trust for which it was established, or at most only for those trusts established for the same client.”408
The trusts involved in these cases are somewhat different in structure and purpose from trading trusts as referred to elsewhere in this Part. There may be a need for trusts legislation to provide more guidance on when a corporate trustee should be liquidated. These issues may be dealt with in more detail in Stage Three of the Commission’s review of trusts law, when the trustee companies legislation will be examined, but submitters’ preliminary views would be welcome.
Fees and expenses of liquidators
An area of some uncertainty relating to corporate trustees is whether a liquidator is entitled to recover their fees and expenses from trust assets.409 This was raised by a previous submitter410 and has also been the subject of a series of conflicting cases in Australia.411 The position in New Zealand appears to be that the liquidator’s expenses and remuneration can be paid from the trust assets.412 There is also the policy consideration that it would be difficult to find liquidators willing to act as such if their costs could not be recovered from trust assets.413 Without the actions of an insolvency administrator the trust beneficiaries would not receive a distribution.414
The expenses relating to the administration of the trust can be recovered from the trust assets, but the general expenses of administering the estate, unrelated to the administration of the trust, cannot come from trust assets, as they are private liabilities.415 Nonetheless, where the liquidator acts reasonably to identify which are trust assets and which are not, those costs are recoverable.416 The court has an inherent jurisdiction to allow remuneration and payment of expenses for the administration of trust property by a receiver or liquidator.417
In Australia the courts have taken a “very technical” approach, holding in some cases that the liquidator had no right to apply trust assets for any purpose except to administer the trust property and to discharge trust debts.418 Overall the position is less clear but is generally consistent with that in New Zealand.419 The Australian cases are based on the liquidator’s costs and expenses being recovered under the trustee’s right of indemnity; if there is no right of indemnity, then it may be that the liquidator cannot recover their costs and expenses from trust assets.420 Some time ago the Australian Law Reform Commission proposed extending the trustee’s right of indemnity to include not only trust debts and liabilities, but also the costs associated with the winding up of the company (where the assets of the company are not sufficient to cover those costs).421 However, this would not assist in clarifying whether the costs can be recovered when the indemnity is not available. The position of the liquidator in New Zealand does not seem to be similarly vulnerable: it has been held that the ability of a liquidator to recover costs comes from equity and is not related to the position of trustee, so the ability of the liquidator to recover costs will not be lost because of illegality or breach of trust by the trustee.422
No cases in New Zealand have yet addressed a corporate trustee which has as its only business the administration of a trust. In this situation in Australia the general expenses of winding up are able to be recovered from the trust assets, as they are necessarily related to the administration of the trust,423 and it is likely that the same approach would be taken in New Zealand.424
It may be useful to clarify in trusts legislation the position in New Zealand regarding who bears the costs of liquidation, to resolve uncertainty for liquidators about whether they will be able to have their expenses met from the trust assets; costs relating to general administration versus administration of the trust; the relevance of the trustee’s right to indemnity; and the situation regarding general expenses where a corporate trustee has the administration of a trust as its only business. Views on this are invited.
Distribution of assets and priority of creditors on liquidation
Further issues arise in the case of insolvency of a trading trust regarding the distribution of assets and priority of creditors. A corporate trustee of a trading trust may have both trust creditors and non-trust creditors. Trust assets cannot be used to satisfy private non-trust debts. There is a distinction to be drawn in different situations involving funds recovered using the trustee’s right of indemnity. When a trustee has personally paid a trust debt, they are entitled to recover the amount from the trust assets, through the right of recoupment. The recouped funds are the trustee’s own money and are therefore available to liquidators and non-trust creditors. However, when a trustee seeks to have liabilities paid directly out of the trust assets, through the right of exoneration, those funds can only be applied to trust liabilities.425
Where an insolvent trustee has insufficient assets to satisfy the claims of all creditors, the question arises as to the order and priority for payment of the claims. The general assets of the trustee (if any) will be distributed in accordance with the statutory preferential creditor regime in sections 312 to 313 and Schedule 7 of the Companies Act 1993. A key issue is whether the preferential creditor regime will apply to the distribution of the trust assets. The statutory regime does not apply to trust property of an individual trustee, which will be distributed according to equitable principles of the courts.426 When liquidating a corporate trustee, again trust property will not be subject to the statutory regime, but the liquidator may exercise the right to indemnity and divide the results of that among creditors.427 One view is that the preferential regime is likely to apply to assets recovered through the right of indemnity as they are assets of the company.428
The Supreme Courts of South Australia and New South Wales have held that the statutory preferential regime will apply to trust assets recovered via the right of indemnity on liquidation of a corporate trustee.429 The basis for these decisions is that liabilities incurred by a corporate trustee in trade are the corporate trustee’s liabilities, so creditors of the company are to be paid in the order of the statutory regime.430 This is subject to the principle described above that trust property (from the trustee’s right to indemnity) cannot be applied to satisfy the general debts of the company; they can only be applied to the payment of trust creditors.431
Not all agree that the statutory preferential regime should apply to trust assets. McPherson J (writing extrajudicially) has argued that it is incorrect for the Australian statutory regime to apply to division of trust assets among trust creditors in the winding up of a corporate trustee, and that the regime applies only to assets that are beneficially owned by a company and are available for division amongst the creditors generally.432 He argued that priorities should be fixed by the court; such an approach would traditionally mean that the trust creditors would be paid on a pari passu basis (ranking equally without preference) after the costs of realising the assets and the costs, charges and expenses of the trustee have been paid.433 A differing view is that trust creditors should be paid in the order in which their claims arose, based on the equitable principle that the prior in time is the better equity.434
Views are sought on whether the application of the preferential creditor regime (or an alternative regime) to corporate trustees should be provided for in legislation.
Application of insolvent transaction regime to trust creditors
A further question is whether the insolvent transaction provisions apply to transactions made with trust creditors. These provisions are “designed to enable the liquidator to set aside transactions into which the company entered before liquidation so that money is restored to the company to ensure all creditors are treated equitably.”435 The particular focus is on sections 292 (insolvent transactions) and 298 (transactions for excessive or inadequate consideration) of the Companies Act. Sections 293 (voidable charges), 297 (transactions at undervalue) and section 348 of the Property Law Act 2007 (dispositions of property made with intent to prejudice a creditor) are also relevant.
In Octavo the High Court of Australia held that the voidable preference provisions in Australian legislation did apply to dispositions of trust property, so payments made by the corporate trustee prior to liquidation could be recovered from recipients and made available to the liquidator for distribution.436 This was based on the view that the trustee’s right of indemnity out of trust property was a proprietary right that could be exercised by the liquidator on behalf of the company’s creditors. Ford has criticised this proprietary view of the right of indemnity as incorrect;437 he considers the right of indemnity to be merely a “power over the trust property” that is a “fiduciary power”.438
This issue has not yet been determined in a court in New Zealand. In Levin Heath J left open the question of whether Octavo439 would apply in this country. However, he held that section 298, involving transactions for excessive or inadequate consideration, did not apply to property held on trust. Section 298 was directed at company assets, not distribution of trust property to its beneficial owners; the Court of Appeal accepted, however, that there was a proprietary interest in the property distributed to beneficiaries to the extent of the trustee’s right of indemnity.440 When directors of a corporate trustee distribute trust property to beneficiaries knowing that trust debts would remain unpaid, the creditors’ protection is that the directors are liable for any loss resulting.441 In contrast, section 292 could be used to reclaim property that was held on trust, but has been disposed of to give a preference to one trust creditor over others.442 If money had been paid out to a beneficiary under the insolvent circumstances referred to in section 292, the property could be reclaimed for distribution to trust creditors (but not to non-trust creditors, until trust creditors had been paid in full).443
Another view is that the voidable transaction regime will not apply to payments made to beneficiaries unless the payment was made to the beneficiary as a creditor. For instance, if a trustee has credited an amount to a beneficiary’s account with the trust, payments debiting the beneficiary’s account would constitute a payment to the beneficiary as a creditor, this transaction would be very likely to be caught under the regime.444
The Commission would like to know whether submitters agree that some or all of the insolvent transaction provisions apply to corporate trustees and trust creditors, and whether it would be useful to clarify this in legislation.
Public Issues Committee, Auckland District Law Society Inc “Independent Trustees, Corporate Trustee Companies and the Need for Good Governance – the Newmarket Trustees Lesson” (Public Issues Paper, 1 August 2011) at 4–5.
Kalev J Crossland “Unsecured creditors and the ‘Uncorporation’: issues with trading trusts post Global Financial Crisis” (2011) 17 Trusts and Trustees 185 at 210. Heath and Whale on Insolvency, above n 404, at [46.5(e)].
Re National Pacific Securities Ltd (In Rec and In Liq) (1991) 5 NZCLC 67,332 at 67,340. Compare some saying the entitlement to recover is because the liquidator is performing the duties of the trustee: see Crossland, above n 412, at 210.