New article – Full Federal Court in COT v Lane – bankrupt trading trustees and statutory priorities, the principle of ‘hotchpot’, and the treatment of preference recoveries of payments of trust money

I have added a new article to my website reviewing an important decision of the Full Federal Court handed down in November 2020, addressing 3 key questions that arose at the intersection of trust law and bankruptcy law – Commissioner of Taxation v Lane [2020] FCAFC 184 (COT v Lane). Some were similar to those which arise in the context of corporate insolvency law, and were addressed in recent years by the High Court in Carter Holt/Amerind and the Full Federal Court in Jones/Killarnee. The full article can be accessed here.

Bankrupt trustees – High Court pronounces on what “property of the bankrupt” vests in the trustee in bankruptcy where property had been held on trust

In a last Amerind-tinged gift before Christmas, the High Court has today handed down another judgment on an issue which lies at the intersection between insolvency law and trust law, although this time in the bankruptcy context. It is the latest in a string of unfolding legal developments at this intersection, including the High Court’s decision in June in Amerind and the Full Federal Court’s decision last year in Killarnee. (For more in relation to those decisions see here (Amerind) and here (Killarnee).)

In this case the High Court unanimously dismissed an appeal from the Full  Federal Court concerning whether property held by a bankrupt on trust for another vests in the bankrupt’s trustee in bankruptcy under s 58 of the Bankruptcy Act 1966 (Cth). The decision – which stems from a bankruptcy which has been before the Courts more than once – is Boensch v Pascoe [2019] HCA 49.

The case arose from a claim by the bankrupt Mr Boensch for compensation under s 74P(1) of the Real Property Act 1900 (NSW) on the basis that his trustee in bankruptcy Mr Scott Pascoe had lodged, and later refused or failed to withdraw, a caveat without reasonable cause. Mr Boensch’s claim for compensation was unsuccessful at each stage.

To give you a snapshot of the principles and reasoning on the key issue –

  1. Upon a person becoming bankrupt, section 58 of the Bankruptcy Act vests “property of the bankrupt” in the trustee of the estate of the bankrupt.
  2. The “property of the bankrupt” includes real or personal property and any estate or interest in real or personal property belonging to the person at the time of bankruptcy and divisible among the bankrupt’s creditors:  s 5(1) of the Bankruptcy Act (definitions of “property” and “the property of the bankrupt”).
  3. Excluded from the “property of the bankrupt” which vests in the trustee in bankruptcy is property held in trust by the bankrupt for another person: s 116(2)(a) of the Bankruptcy Act.
  4. It was settled in Octavo that where a person who is a trustee becomes bankrupt, and he/she has incurred liabilities in the performance of the trust, that person’s right to be indemnified out of trust property gives rise to an equitable interest in the property held on trust. This takes that property outside the exclusion in s 116(2)(a), on the basis that the exclusion is limited to property held by the bankrupt solely in trust for another person:  [2] per Kiefel CJ, Gageler and Keane JJ.
  5. The bankrupt’s entitlement in equity to be indemnified out of the trust property, giving rise to the equitable interest in the property, is property belonging to the bankrupt that is divisible among the bankrupt’s creditors. The right of indemnity is therefore property that vests in the trustee in bankruptcy:  [2] per Kiefel CJ, Gageler and Keane JJ.
  6. Octavo left open the question of whether the legal estate in the property held on trust by the bankrupt also vests in the bankruptcy trustee, where the bankrupt as trustee held a right of indemnity. This is part of the more general question of whether the legal estate in property held on trust by a bankrupt in which the bankrupt has an equitable interest vests in the bankruptcy trustee: [3] per Kiefel CJ, Gageler and Keane JJ.
  7. The more general question was substantially answered in Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth (Amerind):  [3] per Kiefel CJ, Gageler and Keane JJ.
  8. The short answer is yes it does. Under the Bankruptcy Act, where a trustee has no beneficial interest, the legal estate does not pass; but where he has, it does pass: [4] per Kiefel CJ, Gageler and Keane JJ, quoting with approval from Sir George Jessel MR in Morgan v Swansea Urban Sanitary Authority (1878) 9 Ch D 582 at 585. (However note that where, as here, the trust property is real estate, then pending registration on title, what is vested in the bankruptcy trustee by s 58(2) is the equitable estate: [5] per Kiefel CJ, Gageler and Keane JJ; [94] per Bell, Nettle, Gordon and Edelman JJ.)
  9. This answer is informed by a recognition of two things: (1) the fundamental nature of an equitable interest as something that “is not carved out of a legal estate but impressed upon it“; and (2) consistency with the objects of the Bankruptcy Act that the bankruptcy trustee automatically obtains the legal estate in property held by the bankrupt in which the bankrupt has an equitable interest in order better to secure the realisation of that equitable interest for the benefit of creditors: [4] per Kiefel CJ, Gageler and Keane JJ.

Their Honours held here that by reason of his having an entitlement to indemnification out of the trust property, the bankrupt Mr Boensch had an equitable interest in the Rydalmere property which subsisted at the time of his bankruptcy. It followed that that equitable interest, and with it the equitable estate in the Rydalmere property, vested in Mr Pascoe as the trustee in bankruptcy of the estate of Mr Boensch. The equitable estate so vested in Mr Boensch was a caveatable interest:  [10]-[11] per Kiefel CJ, Gageler and Keane JJ.

Interestingly, the High Court decided this issue in the absence of a determination by the primary judge and the Full Court on the question of whether the bankrupt held a right of indemnity against the trust property, although the question was raised by the pleadings of the trustee in bankruptcy Mr Pascoe. Both judgments discuss this matter.

Takeaways

Broadly, where a bankrupt held property as a trustee and had a right of indemnity in the trust assets, the property will vest in the bankruptcy trustee, subject to the trust: [93] per Bell, Nettle, Gordon and Edelman JJ.

However where a bankrupt held property on trust for another but held no interest in the property at all, whether vested or contingent, and no matter how remote, that property will not vest in the bankruptcy’s trustee upon bankruptcy: [87] per Bell, Nettle, Gordon and Edelman JJ.

To put it this way, at [92] their Honours Bell, Nettle, Gordon and Edelman JJ quoted with approval from Farwell LJ in Governors of St Thomas’s Hospital v Richardson [1910] 1 KB 271 at 284 –

The property of the bankrupt does not include property held by the bankrupt on trust for any other person. But it does include property held by the bankrupt on any trust for his own benefit, and when … he holds property to secure his own right of indemnity in priority to all claims of any cestui que trust, and the retention of such property is necessary to give full effect to such right, it follows that the property, ie the legal estate, and right to possession vest in the trustee in bankruptcy to the extent to which they were vested in the bankrupt…

Latest decision of interest in this post-Amerind world dropped today

Just a note to alert readers that the latest decision of interest in this post-Amerind world dropped today in the Federal Court in Queensland. The liquidators of an insolvent corporate trustee successfully obtained orders appointing them receivers of the assets of two trusts to enforce the rights of exoneration and liens of the former trustee. The application was contested by the new trustee of the property trust, who sought to sell the key asset itself (a hotel – freehold title to the land). Note the orders made (order 6) as to recourse to the assets of the trusts for the receivers’ remuneration, costs and expenses regarding each trust and the winding up of the company generally.

The case was the decision of Derrington J in Connelly, in the matter of Gregorski Investments Pty Ltd (in liq) v 320 Nominees Pty Ltd as trustee of the Gregorski Property Trust [2019] FCA 1400. 

 

New article on the High Court in Amerind – statutory priorities apply on insolvency of trustee companies, employee entitlements protected, Re Enhill is no more

I have added a new article to my website reviewing last week’s important High Court decision in the Amerind appeal – Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20; 368 ALR 390 (Amerind). The full article can be accessed here.

 

Newsflash – the High Court’s judgment in Amerind is in

This morning the High Court has handed down judgment dismissing the appeal from the decision of the Victorian Court of Appeal in Commonwealth of Australia v Byrnes and Hewitt as receivers and managers of Amerind Pty Ltd (receivers and managers apptd)(in liq) [2018] VSCA 41; (2018) 54 VR 230, which itself was the appeal of the decision of Robson J in Re Amerind (receivers and managers apptd)(in liq) [2017] VSC 127; (2017) 320 FLR 118.

The bench comprised Kiefel CJ, Bell, Gageler, Keane, Nettle, Gordon and Edelman JJ. Whilst the decision to dismiss the appeal was unanimous, three separate judgments were written: one by Kiefel CJ and Keane and Edelman JJ, another by Bell, Gageler and Nettle JJ and the third by Gordon J. The decision is: Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20.

My fuller review of the decision will follow. For now, some highlights –

  • The High Court unanimously held that s 433 of the Corporations Act applies in the exercise of the power of exoneration in the receivership of a trustee company. Slight points of difference in reasoning between the judgments, but the same result. Kiefel CJ, Keane and Edelman JJ expressly pointed out that the same reasoning applies to s 561, which is the provision cognate to s 433 but relevant to liquidators rather than receivers.
  • The High Court unanimously held that accordingly the statutory scheme of priority applies to distribution of the relevant trust property, being here the receivership surplus subject to the trustee’s right of indemnity. It follows from this that the Commonwealth’s claim to priority in the distribution of the receivership surplus by virtue of the payments it had made of employee entitlements under FEGS is vindicated.
  • The High Court went on unanimously to hold that trust assets may only be used to pay trust creditors on exercise of the power of exoneration in a receivership or in the liquidation of a trustee company, not also non-trust creditors. Re Enhill was wrongly decided.

More to follow.

Newsflash – High Court to hand down judgment in Amerind this Wednesday

The High Court of Australia will be handing down judgment in the Amerind appeal this Wednesday 19 June 2019. Watch this space.

In the meantime, for my review and analysis of the Victorian Court of Appeal decision in Amerind which is the subject of this appeal see here.

For my article considering the Full Federal Court decision in Killarnee and the landscape for liquidating corporate trustees of trading trusts in light of both Amerind and Killarnee see here.

For those who want more, the submissions that have been filed for each of the appellant (creditor Carter Holt Harvey Woodproducts Australia Pty Ltd), the first respondent (the Commonwealth of Australia, which advanced $3.8m for former employees of the company under FEGS) and the second respondent (the Receivers of Amerind Pty Ltd (Receivers & Managers appointed)(in liquidation)) may be read on the High Court website here.

For now, I note that the submissions for the appellant creditor identified the following three issues for consideration in the appeal –

  1. Whether the “property of the company” of a corporate trustee under s 433(3) of the Corporations Act 2001 (Cth) includes not only the trustee’s right of indemnity but also the underlying assets to which the trustee company can have recourse.
  2. The precise nature of, and the limitations upon, a trustee’s right of indemnity where the trustee seeks exoneration in respect of unmet trust liabilities, in particular in the context of the insolvency of the trustee.
  3. Whether a corporate trustee’s right of indemnity from trust assets is “property comprised in or subject to a circulating security interest” for the purposes of s 433(2) of the Corporations Act.

The appellant submitted, inter alia, that –

  • Properly understood, a trustee’s right of indemnity, especially the ‘exoneration arm’ of the right of indemnity, is no more than a right to have trust assets applied to meet trust debts. It confers upon the trustee no interest in the trust assets themselves, or the proceeds thereof.
  • A trustee’s right of indemnity is not subject to s 433(2) of the Corporations Act because it is not a “circulating asset” and hence is not property which is “comprised in or subject to a circulating security interest”.

The appellant submitted that if either of these challenges be upheld, the Court of Appeal’s decision cannot stand.

The Commonwealth identified two issues for consideration in the appeal –

  1. On the basis that the trustee’s right of indemnity gave it a beneficial interest in the assets of the trust – was that interest “property of the company” within the meaning of s 433(3)?
  2. On the basis that s 433(3) applies to property coming into the hands of a receiver who is appointed by a debenture holder ‘secured by a circulating security interest’ – was it necessary that the trustee’s right of indemnity itself be ‘property comprised in or subject to a circulating security interest’? If so, was the trustee’s right of indemnity such property?

The Commonwealth submitted inter alia that –

  • Sections 433, 556 and 561 of the Corporations Act give statutory priority to employees’ claims in insolvency. Insolvency law is statutory and primacy must be given to the relevant statutory text. That statutory priority has been recognised since 1883 in the case of corporate insolvency. The compelling reasons for the statutory priority of employees claims is well known. It is a strong thing to deprive employee creditors of their statutory priority merely because their employer had acted as a trustee.
  • There are no non-trust creditors. There is only one trust. This case does not give rise to the question of whether creditors of the company who are not ‘trust creditors’ may be paid from the proceeds of realisation of trust assets.
  • A trustee’s right of indemnity (whether by way of reimbursement or exoneration) confers on the trustee an interest in the trust assets which is a proprietary, beneficial interest, and takes priority to the interests of the beneficiaries of the trust. This submission relies on several previous High Court decisions, including Octavo Investments Pty Ltd v Knight (1979) 144 CLR 360 and Chief Commissioner of Stamp Duties (NSW) v Buckle (1998) 192 CLR 226.
  • What matters in the Personal Property Securities Act‘s interaction with the Corporations Act is the nature of the security held by the secured party, not the nature of the interest in the personal property held by the grantor. Even if it was necessary to characterise the trustee’s right of indemnity as an asset subject to a circulating security interest, it was such an asset.
  • It follows that, as the Court of Appeal held, s 433(3) was engaged. The Court of Appeal’s decision should be upheld.

We await Wednesday’s judgment with interest.

Big few days next week – not just the banking RC report, but the hearing of the High Court Amerind appeal

The first few days of next week are shaping up to be pretty big. As has been well covered in the press, the final report by of the Banking Royal Commission has now been handed to the Governor-General and will be publicly released on Monday afternoon 4 February 2019 at 4.10pm, coinciding with the sharemarket close. Reportedly Commissioner Kenneth Hayne’s final report stretches to more than 1000 pages.

Then on Tuesday 5 and Wednesday 6 February 2019 is the hearing of the High Court appeal in Amerind, set down for 2 days. To refresh your memories, for my review and analysis of the Victorian Court of Appeal decision in Amerind see here, and for my article considering the Full Federal Court decision in Killarnee and the landscape for liquidating corporate trustees of trading trusts in light of both Amerind and Killarnee see here.

For those who want more, the submissions that have been filed for each of the appellant (creditor Carter Hold Harvey Woodproducts Australia Pty Ltd), the first respondent (the Commonwealth of Australia, which advanced $3.8m for former employees of the company under FEGS) and the second respondent (the Receivers of Amerind Pty Ltd (Receivers & Managers appointed)(in liquidation) may be read on the High Court website.

 

Newsflash – Amerind High Court appeal listed for hearing

The Amerind appeal to the High Court of Australia has reportedly been listed for a 2-day hearing on 5 and 6 February 2019. Watch this space.

In the meantime, for my review and analysis of the Victorian Court of Appeal decision in Amerind see here, and for my article considering the Full Federal Court decision in Killarnee and the landscape for liquidating corporate trustees of trading trusts in light of both Amerind and Killarnee see here.

For those who want more, the submissions that have been filed for each of the appellant (creditor Carter Holt Harvey Woodproducts Australia Pty Ltd), the first respondent (the Commonwealth of Australia, which advanced $3.8m for former employees of the company under FEGS) and the second respondent (the Receivers of Amerind Pty Ltd (Receivers & Managers appointed)(in liquidation)) may be read on the High Court website.

When a payment of trust money is recovered as an unfair preference, does it become trust money once again?

Last Friday Derrington J in the Federal Court in Queensland tackled this question which remains unresolved in Australia, in  Lane (Trustee), in the matter of Lee (Bankrupt) v Commissioner of Taxation (No 3) [2018] FCA 1572. That is, when a payment is recovered as an unfair preference, and the original payment out was of trust moneys applied in payment of trust debt/s, does the recovered money become impressed with the trusts once again, or does it form part of the bankrupt’s general estate? (Or, on a liquidation, the company’s?) As a fungible, of course the funds recovered are not the same funds as those paid to discharge the debt.

Facts

Mr Lee was the sole trustee of the Warwick Lee Family Trust. Prior to his bankruptcy, Mr Lee operated the business of a Subway franchise in the suburb of Brassall in Queensland on behalf of the trust. In his capacity as trustee he employed a  number of staff and incurred a number of significant liabilities. In the course of the administration of Mr Lee’s bankrupt estate, the Bankruptcy Trustees recovered an unfair preference payment of $322,447.58 from the ATO, which had been paid by Mr Lee in discharge of tax liabilities arising from the operation of the Subway franchise. Of this sum, $171,659 had been paid using Mr Lee’s own money to pay this tax debt, and the balance of $150,778.58 had been paid from funds of the trust. The Bankruptcy Trustees had apportioned the unfair preference recovery accordingly between Mr Lee’s personal estate on the one hand and the trust on the other.

The question was whether they were right to do so. The debate centred on the recovery of payment of trust money, and whether the Bankruptcy Trustees were correct in their treatment of the $150,778.58 as becoming trust money “once again” upon its recovery.

Submissions

In broad terms, the Bankruptcy Trustees submitted that the funds recovered by them were impressed with the terms of the trust such that they (in the shoes of Mr Lee) would only be entitled to use them to discharge liabilities owing to trust creditors. His Honour noted the Trustees also seemed to submit that the trust creditors would be entitled to be subrogated to the equitable lien which attached to those funds in support of the trustee’s right of exoneration (at [7]).

The Commissioner generally submitted that the monies repaid by him were not subject to the terms of the trust and was available to be used by the Bankruptcy Trustees to meet the claims of all creditors (at [7]). The Commissioner submitted that although the trust funds were paid to him by Mr Lee as trustee utilising the right of exoneration, when an equivalent amount was repaid, the money was held free of all trust obligations and could be used to discharge the debts of non-trust creditors (at [20]).

Decision

As Derrington J observed at [25] that to date there is no sufficiently authoritative statement on this topic.

His Honour’s key reasoning is at [19]. He observes that attention needs to be focused on the entitlement to recover the sum paid from trust funds pursuant to Mr Lee’s entitlement to exonerate himself in respect of debts incurred in his capacity as trustee. Mr Lee’s entitlement to use trust funds only arose by reason of his position as trustee and because the debt arose from the administration of the trust. He concludes that the right to recover the payments of trust money from a transaction which was avoided was a right which was held for the benefit of the trust. Hence that right of recovery would be trust property vested in the trustee in that capacity and not in his / her /its personal capacity. “Rights which accrue from the performance of trust obligations tend to be trust property”, he adds.

At [24] his Honour concludes: “It would appear to be axiomatic that the right to receive repayment from the Commissioner consequent upon the avoidance of the preference payment was a right which vested in Mr Lee qua trustee such that the right is property of the trust, albeit one in which Mr Lee also had a beneficial interest.” He takes the view that at the very least, the right to receive the funds would be subject to the fiduciary duty that Mr Lee is not to profit from his position as trustee (at [28]).

Derrington J’s conclusion meant that the Trustee’s of Mr Lee’s bankrupt estate were correct to apportion the unfair preference recovery between the trust and Mr Lee’s general estate, in accordance with the source of the original payments that had been avoided. That is, the impugned payments of trust monies recovered as unfair preferences were to be treated as held for the benefit of trust creditors only (see [32]).

Conclusion

This should provide some guidance to bankruptcy trustees where the bankrupt had been a trustee who made preferential payments prior to bankruptcy.

However the question is more likely to arise in the corporate context, and will be particularly acute where a company was trustee of more than one trust, or also acted at times in its own capacity. The difficulty here is that some of his Honour’s reasoning was particular to the bankruptcy context (see [12]-[15]), and it is unclear if it would apply in the same way in the corporate context. Once again, because the Corporations Act fails to grapple explicitly with the liquidation of trustee companies and the issues which arise where trusts are involved, we are left with the question unresolved. Directions may need to be sought.

His Honour observes at [15] that the Bankruptcy Act confers no right of recovery or cause of action on the Bankruptcy Trustee (s 122 simply operates to avoid the preferential payments). It follows from this, his Honour says, that the Bankruptcy Trustee’s claim to recover the money is derivative upon a general law right acquired from the bankrupt. His Honour goes on to conclude that this right of the bankrupt is trust property which vests in the Bankruptcy Trustee by virtue of s 58 of the Bankruptcy Act (at [24]).

However unlike the Bankruptcy Act, s 588FF of the Corporations Act does provide a right of recovery and to seek other orders. For unrelated reasons , pursuant to s 588FF the right to bring the application is that of the liquidator, but the Court’s power is inter alia to order payment to the company . It is unclear whether the Courts would take the view where the impugned payment out had been a payment of trust money, that the rights of recovery under s 588FF are themselves trust property. And whether it would follow that any unfair preference recoveries received by a liquidator which had originally been payments out of trust moneys, were themselves subject to the obligation to use them in the manner required of the original funds, being for the purposes of discharging trust debts only, rather than available to the company in liquidation’s creditors generally.

Derrington J’s view expressed more than once was that neither a trustee, nor anyone claiming through it, has an entitlement to profit from their position as trustee and recover funds that had been a payment of trust moneys for their personal use (see eg at [31]). Perhaps this will inform the approach the Courts take to this difficult question.

Current state of uncertainty in the liquidation of trustee companies and the bankruptcy of individual trustees

Given that this case decides a question which leads to a conclusion as to whether unfair preference recoveries are available to all creditors or only trust creditors, one more point should be  noted. This is a Federal Court bankruptcy decision (in Queensland). For most of Australia, on the liquidation of a trustee company, proceeds of the trustee’s right of exoneration and supporting lien are not generally available for distribution to non-trust creditors. They may only be used to pay trust creditors. This was confirmed by the Full Federal Court in March of this year in Killarnee – Jones (Liquidator) v Matrix Partners Pty Ltd; Re Killarnee Civil and Concrete Contractors Pty Ltd (in liq) [2018] FCAFC 40; (2018) 354 ALR 436 (Killarnee). See my distillation of the propositions for which Killarnee stands as authority here, and my article reviewing the judgment and considering each of those propositions in more detail here.

In Victoria, however, a five member bench of the Court of Appeal in February of this year in Amerind concluded on this issue that until a subsequent appellate decision decides otherwise, Re Enhill continues to apply in Victoria and should continue to be followed by trial judges here, and the proceeds of the trustee’s lien on a bankruptcy or liquidation are available for division amongst the company’s creditors generally, not only among trust creditors –  Commonwealth of Australia v Byrnes and Hewitt as receivers and managers of Amerind Pty Ltd (receivers and managers apptd)(in liq) [2018] VSCA 41; (2018) 354 ALR 789 (Amerind). See my article reviewing that judgment here. Derrington J’s disapproval of this position can perhaps be seen in his observation at [9] that:  “In general terms, the decision in Amerind concluded that a corporate trustee’s right of exoneration, being the entitlement to use trust funds to pay trust debts, transmogrifies on insolvency into a right to use trust funds for the [trustee company’s] non-trust debts.”

Of course Amerind dealt with other issues as well, principally whether a trustee’s right of indemnity is property of the company, and whether upon the liquidation of a trustee company the distribution of property is governed by the statutory priority regime. Special leave to appeal to the High Court in Amerind has been sought and in August 2018 was granted, although the appeal has not yet been heard.  **Update: The High Court appeal was heard on 5 February 2019. As at the date of writing this update (15 Feb 19) the HCA decision is pending.

I note too that Derrington J’s earlier decision in the bankruptcy of Mr Lee dealing with whether trust assets can be used to pay all creditors or only trust creditors, and whether the scheme of priority in s 109 of the Bankruptcy Act applies to trust assets / proceeds of the trustee’s right of indemnity and lien –  Lane v Deputy Commissioner of Taxation [2017] FCA 953; (2017) 253 FCR 46 – has been appealed by the Commissioner. However given the granting of leave to appeal to the High Court in Amerind the Lane appeal it is not presently being progressed (see [9]).

 

Newsflash – Special leave granted in Amerind

Earlier this morning special leave to appeal to the High Court was granted from the Victorian Court of Appeal’s decision in Amerind.  The bench comprised their Honours Gageler, Edelman and Nettle JJ. The transcript is not yet available on Austlii. Their Honours did not need to hear from counsel for Carter Holt Harvey Wood Products Pty Ltd, the creditor who had applied for special leave to appeal.

The five-member Victorian Court of Appeal decision from which special leave to appeal was granted can be read here: Commonwealth of Australia v Byrnes and Hewitt as receivers and managers of Amerind Pty Ltd (receivers and managers apptd)(in liq) [2018] VSCA 41 (Amerind).

My review and analysis of that decision can be read here. For my article considering the Full Federal Court decision in Killarnee and the landscape for liquidating corporate trustees of trading trusts in light of both decisions see here.