Victorian Court of Appeal Provides Guidance on Whether the Corporations Act Priority Scheme Applies to Insolvent Corporate Trustees

Kate McFarlane

In the recent decision of Commonwealth of Australia v Byrnes and Hewitt [2018] VSCA 41 (Commonwealth v Byrnes), the Victorian Court of Appeal provided guidance on the contentious question of whether a corporate trustee’s right of indemnity from trust assets constitutes property to which the statutory priority scheme in the Corporations Act 2001 (Cth) (Corporations Act) applies.

In the usual course, a trustee is personally liable for any debts incurred in its capacity as trustee and has a corresponding right of indemnity over trust assets. The indemnity is secured by an equitable lien over the trust assets and may take the form of reimbursement for trust debts paid by the trustee, or exoneration for debts not yet paid.

Whilst these principles are well-established, there has been a divergence of opinion amongst the judiciary as to how this right of indemnity should be treated on the winding up of a corporate trustee. Should it be distributed according to the priorities listed in the Corporations Act, or should creditors be paid out pari passu? The Court of Appeal’s decision in Commonwealth v Byrnes addresses the conflicting authorities on this issue and concludes that the trustee’s right of indemnity should be characterised as ‘property of the company’ for the purposes of the statutory priority regime set out in ss 433, 556 and 560 of the Corporations Act, and therefore the statutory priority regime applies.

Facts

Amerind Pty Ltd (Amerind) carried on business solely in its capacity as trustee of a trading trust and maintained a number of secured facilities with the Bendigo and Adelaide Bank (the bank). The bank sent a demand for repayment and termination of these facilities, which led to the appointment of administrators and the bank’s appointment of receivers over Amerind. The company was eventually would up, with the administrators appointed as liquidators.

The receivers had continued to trade after their appointment and realised assets that Amerind had held in its capacity as trustee. The bank’s liability was repaid through realisation of its securities and, after estimating their own remuneration, the receivers held a net surplus of $1,619,018. Amerind had a right as trustee to be indemnified from this surplus for liabilities incurred on behalf of the trust.

During this period however, the Commonwealth of Australia had made payments to Amerind’s former employees for unpaid wages and entitlements. Under the statutory priority regime in the Corporations Act, the Commonwealth of Australia would enjoy a priority status to be reimbursed for these payments from the company before payment of other creditors.

The receivers applied to the Court for directions on the distribution.

Issues

The main issue for determination before the Court of Appeal was whether the Commonwealth of Australia could recover the employee payments as a priority creditor under the Corporations Act. The Commonwealth relied on s 433, which provides that a receiver who takes possession or assumes control over ‘property of the company’ secured by a ‘circulating security interest’ must pay debts out of that property in accordance with the statutory priorities set out in ss 556 and 560.

The issue has previously been subject to conflicting judicial opinion. On the one hand, the Victorian Court of Appeal in Re Enhill Pty Ltd [1983] 1 VR 561 (Re Enhill) and the South Australian Court of Appeal in Re Suco Gold Pty Ltd (In Liq) (1983) 33 SASR 99 (Re Suco Gold) characterised the trustee’s right of indemnity as property of the company which was divisible amongst creditors subject to statutory priority rules. More recently, however, Brereton J of the New South Wales Supreme Court departed from this approach in Re Independent Contractor Services (Aust) Pty Ltd (in liq) (No 2) (2016) 305 FLR 222 (Re Independent), taking the view that the Corporations Act priority scheme is only concerned with the distribution of assets beneficially owned by a company and available for division amongst its general creditors.

Conclusions of the Court of Appeal

In a unanimous decision, the Court of Appeal concluded (a) that the trustee’s right to indemnification from the surplus was property of the company; and (b) that the Corporations Act priority scheme applied to that surplus insofar as those assets were circulating assets at the relevant time. Accordingly, the statutory priority regime applied, and the Commonwealth was to be treated as a priority creditor in respect of the surplus.

The Right of Indemnity was Property of the Company

The Court of Appeal considered that Robson J’s conclusion at first instance that the trustee’s right of indemnity by way of exoneration was not property of the company was contrary to long-standing High Court authority.

In particular, the Court of Appeal referred to Octavo Investments Pty Ltd v Knight (1979) 144 CLR 360 (Octavo) and subsequent High Court authority in which the High Court had held that an insolvent corporate trustee’s right of indemnity against trust property for liabilities properly incurred in the performance of the trust confers a proprietary interest in the trust property. This interest passes to the liquidator upon the insolvency of the trustee and is an asset to which the liquidator has access for the benefit of the trustee’s creditors.

In light of this Line of Authority, the Court of Appeal commented (at [124]) that:

[T]he High Court has made it clear that the trustee’s right of indemnity, both in relation to recoupment and exoneration, constitutes a proprietary interest in the trust assets which is, in the corporate insolvency context, ‘property of the company’. The statutory provisions governing corporate insolvency have changed over time, but none of those changes have relevantly altered or affected this position.

In concluding on this issue, the Court of Appeal firmly stated that “it cannot be seriously doubted that the right of indemnity by way of exoneration is property of the insolvent trustee company” (at [273]).

The Distribution was Governed by the Corporations Act

The Court of Appeal held that Re Enhill and Re Suco Gold were correct insofar as the Courts applied the relevant insolvency legislation to the disposition of property — “[o]nce it is accepted that the right of indemnity is property of the insolvent, the insolvency legislation must apply” (at [276]). Any other conclusion would be inconsistent with High Court authority.

The Position of Non-Trust Creditors

One matter which was left open by the Court of Appeal was whether the distribution of property is confined to trust creditors or distributable amongst the trustee’s creditors generally. Re Enhill and Re Suco Gold diverge on this question.

Unfortunately, given that Amerind only had trust creditors, the Court of Appeal did not resolve this conflict. However their Honours indicated that, in the absence of subsequent appellate authority, the law articulated in Re Enhill is binding on lower courts in Victoria. This leaves the state of law in this respect in a state of uncertainty, particularly given that the Full Federal Court has since expressed the view in In the matter of Killarnee Civil & Concrete Contractors Pty Ltd (in liq) [2018] FCAFC 40 that Re Suco Gold is the correct decision.

Consequences of the Decision

The Court of Appeal’s decision provides welcome clarification for insolvency practitioners on the appropriate distribution of assets when dealing with insolvent trustee companies, in circumstances where the use of trading trusts is becoming increasingly common.

The decision also prevents the inconsistent application of the Corporations Act insolvency scheme, by not denying entitlements due to priority creditors solely because the insolvent company traded as a trust. As acknowledged by the Court of Appeal, the decision at first instance had potentially serious consequences insofar as it purported to remove the administration of insolvent corporate trustees from the comprehensive statutory insolvency scheme which governs, amongst other things, proofs of debt, equitable distribution and voidance of antecedent transactions.

The decision has subsequently been applied by other Courts, but no doubt this is a question that will most likely need to be determined by the High Court (at the time of writing an application for special leave to appeal has been lodged).

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