Chapter 6 - Introduction to trading trusts

Previous Law Commission review of trading trusts

Trading trusts were addressed briefly by the Law Commission in 2002 in Preliminary Paper 48: Some Problems in the Law of Trusts.218 This paper identified risks to unsecured creditors and risks to beneficiaries as the main concerns.219 It also noted that it is probably the case that the trustee’s right to indemnity out of trust assets may not be limited or excluded by the trust assets, but considered it preferable to put this beyond doubt.220

In its Report later in 2002, the Law Commission recommended that the following section be inserted into the Trustee Act:221

Trading Trusts

(1) In this section “trading trust” means a corporation (not being a trustee corporation or a Board incorporated under Part II of the Charitable Trusts Act 1957) which in the capacity of trustee of a trust carries on any trade or business; and “distribution” has the same meaning as is provided by the Companies Act 1993 section 2(1).

(2) The directors of a trading trust will have the same obligation to the beneficiaries of the trust as they would have had if they and not the corporation had been the trustees of such trust.

(3) No contract or arrangement purporting to reduce or remove the entitlement of the trading trust to be indemnified out of the assets of the trust shall be of any effect.

(4) A trading trust may make a distribution to a beneficiary of the trust only if the same requirements as are prescribed by the Companies Act 1993 section 52 (relating to the solvency test) have been satisfied, and in the event of a breach of this provision, the directors and officers of the trading trust will be under the same criminal liability and the same personal liability to make repayment as are directors of a company under the Companies Act 1993 sections 52(5) and 56.

The following section discusses some of the reaction to the Commission’s proposals. Some submitters responded to the Preliminary Paper stating that trading trusts were not in widespread use or causing problems.222 The Commission put forward its recommendations in the Report nonetheless, it stated, in order “to prevent the occurrence in New Zealand of difficulties of the type that have been encountered in Australia before they actually happen.”223 In 2007, an external reviewer engaged by the Ministry of Justice to review the Commission’s proposed changes to the Trustee Act considered that since the 2002 Report the use of trading trusts had become more common in New Zealand. However, the reviewer too was unaware of any significant difficulties resulting from their use.224

On the proposal to treat the directors as having the same obligations to beneficiaries as if they were the trustee, in (2) of paragraph [6.21] above, submitters were divided but some saw merit in such a provision.225 Others who were against the proposal commented that it would be a very significant change that would disregard legal form and blur the distinctions between trustees and directors.226 Some considered that the law already adequately protects beneficiaries, in that directors may be liable for dishonest assistance in a breach of trust or knowing receipt of trust funds, and no case had been made out that there was a need to extend the liability of directors any further.227 Hart considered that the potential exposure for directors would be too great under the proposed provision, in light of the obligations already owed including their fiduciary obligations, and those under the Companies Act.228 The change could discourage people from acting as directors of a corporate trustee carrying on business.229

All of those who submitted on the issue supported the proposal to put beyond doubt that a trustee’s entitlement to indemnity may not be excluded by the trust instrument, in (3) of [6.21] above.230 Many commented that this was likely already to be the law in New Zealand.231

Submitters who commented were generally not in favour of the proposal to apply the solvency test in section 52 of the Companies Act to distributions by a trading trust to its beneficiaries, in (4) of [6.21] above. There were concerns that the requirement would put too great a burden on trustees. Hart considered this proposal to be “not unreasonable” as it prevented the trustee from reducing its assets to such an extent that it was incapable of meeting its commercial obligations.232 However, he noted that the personal liability for directors would be harsher under the proposed provision than under section 56(1) of the Companies Act, which provides the ability to recover the distribution from the shareholder. The external reviewer was concerned that the proposed restriction on distributions would impose significant transaction costs on trustee companies such as trustees of unit trusts, and also considered that the “very brief cross-reference technique” created uncertainty about how the rules relating to distributions would apply.233

 

Two additional proposals referred to in the Preliminary Paper were not included in the final Report:

  • Providing in statute that no corporation aggregate with limited liability may be appointed as an express trustee other than a trustee corporation. This was described in the paper as maybe “too big a sledgehammer”.234 Several submitters disagreed with the proposal.235 Some were of the view that the corporate structure was appropriate to manage personal risks and no objections could be made to the company acting as a trustee;236 thin capitalisation concerns could be raised in respect of many corporates in New Zealand, irrespective of any trust involvement.237
  • Requiring disclosure by a company that was a trustee that this was its status. The Commission considered this was perhaps insufficient to put potential unsecured creditors on guard.238 Most submitters did not comment on this point, although one did note the importance of notifying creditors that they were dealing with a trust. The submitter suggested that there could be a positive obligation on trustees to put any contracting party on notice that they are dealing with a trust, so that contract negotiations could proceed on a transparent basis.239

Ultimately, as a result of the concerns raised by the external reviewer, no provisions on trading trusts were included in the Trustee Amendment Bill 2007. In any case the Bill itself did not progress and the Law Commission subsequently received a much broader reference on the law of trusts, so trading trusts fall to be considered again under the current review. Due to the brevity of the discussion in the 2002 Preliminary Paper and Report, this chapter has looked afresh at the issues and possible options, but does refer back to the 2002 options and submissions received where relevant.

Law Commission Some Problems in the Law of Trusts (NZLC PP48, 2002) at [23]–[25].

Ibid, at [23]–[24].

Ibid, at [25].

Law Commission Some Problems in the Law of Trusts (NZLC R79, 2002) at [29].

See Law Commission Some Problems in the Law of Trusts (NZLC R79, 2002) at [29]; submission of Chris Kelly, Public Trust on Preliminary Paper 48: Some Problems in the Law of Trusts (submission dated 15 March 2002) at 5.

Ibid, at [28]. 

David Goddard QC “NZLC 79 – 'Some Problems in the Law of Trusts' – Implementation” (Draft Memorandum prepared for Ministry of Justice, 6 May 2007) at 2.

Submission of the Institute of Chartered Accountants of New Zealand (ICANZ) on Preliminary Paper 48: Some Problems in the Law of Trusts (submission dated 21 March 2002), at 10.

Submission of Pravir Tesiram on Preliminary Paper 48: Some Problems in the Law of Trusts (submission dated 21 March 2002) at 3.

Goddard, above n 224, at 2–3 and ibid, at 3. See further discussion in paragraphs [8.2]–[8.5]. 

John Hart “Trading Trusts” (paper presented to New Zealand Law Society Trusts Conference, 2003) at 158.

Ibid.

Submission of Chris Kelly, above n 222; ICANZ, above n 225; and Tesiram, above n 226

Submission of Tesiram, above n 226, at 4.

Hart, above n 228 at 160; also mentioned by Goddard, above n 223, at 5.

Goddard, above n 224, at 5.

Law Commission Some Problems in the Law of Trusts (NZLC PP48, 2002) at [25].

Submission of the New Zealand Trustees Association on Preliminary Paper 48: Some Problems in the Law of Trusts (submission dated 15 March 2002).

Submission of the Property Law Section, New Zealand Law Society on Preliminary Paper 48: Some Problems in the Law of Trusts (submission dated 12 March 2002) at 3.

Submission of ICANZ, above n 225, at 9.

Law Commission Some Problems in the Law of Trusts (NZLC PP48, 2002) at [25].

Submission of ICANZ, above n 225, at 9.