When a trading trust goes bust: the aftermath of the Killarnee decision

Many modern businesses are carried on through a “trading trust”, with a private company serving as trustee. However, while this type of arrangement is not uncommon, there is still a great deal of uncertainty about correct protocol when a corporate trustee becomes insolvent. Questions arise such as:

• What happens with the corporate trustee is wound up?
• Can the liquidators just go ahead and sell the property?
• If/when the property is sold; do the liquidators distribute the proceeds to creditors of the company, or creditors of the trust?
• How is priority determined between those creditors?

Over the years these issues have been considered by various Courts in a number of different jurisdictions. Nonetheless, the recent decision of the Full Court of the Federal Court of Australia in Killarnee,[1] demonstrates that there remains a lack of judicial consensus with respect to many of the abovementioned issues.

The facts

• Killarnee Civil & Concrete Contractors Pty Ltd (Killarnee) carried on a concrete and construction business as trustee of the Thompson Family Trust;
• Administrators were appointed to Killarnee in September 2014, then Liquidators were eventually appointed in December 2014;
• Clause 21 of the trust deed disqualified the trustee from holding office if it entered into liquidation, hence Killarnee ceased to be trustee in December 2014;
• Various trust assets were sold by the Administrators/Liquidators during the relevant period.

Selling the trust property

Section 477 of the Corporations Act 2001 (Cth) (the Corporations Act) allows a liquidator of a company to sell and distribute property of the company. Because, strictly speaking, trust property is not property of the company,[2] the Court held that this section does not give liquidators power to sell trust property.[3]

However, that does not mean liquidators cannot sell the trust property at all, and indeed the Court was cautious to emphasise that, although there is no statutory power to sell trust property, the power may (and will most likely) be granted by a court exercising equitable jurisdiction.[4]

The basis for a Court exercising equitable jurisdiction to allow the sale of trust property is the right of indemnification, which allows trustees to have recourse to trust assets to discharge debts properly incurred as trustee. This right is considered to be company property and vests in liquidators upon a company entering into liquidation.[5]

Availability of the proceeds to certain creditors

As a trustee’s right of indemnification takes priority over the rights of beneficiaries,[6] beneficiaries will almost inevitably miss out on a piece of the pie. The more pressing and controversial issue is: should the funds realised from the sale of trust assets be distributed to creditors of the company, or creditors of the trust only?

The Court differentiated between two components of the right of indemnification:

1. The right of recoupment, which allows trustees to recoup moneys already outlaid; and
2. The right of exoneration, which allows trustees to be indemnified for debts/liabilities incurred.

Chief Justice Allsop, who delivered the lead judgment in this case, held that if payment has already been made, the right of recoupment is “a generally available asset”, whereas if payment has not already been made, the right of exoneration due to its nature and character (it being that a right over, or in respect of, trust property to be used for trust purposes) “is an asset available for trust creditors” (as distinct from company creditors).[7]

It is telling that this conclusion is contrary to the conclusion reached by the Victorian Supreme Court of Appeal some months prior in Amerind.[8]

Distributing the proceeds

As trust assets are not sold pursuant to the Corporations Act, the Court considered whether the regime governing distributions set out under the Corporations Act was applicable.

On this point, Chief Justice Allsop and Justice Farrell held that proceeds from the realisation of trust assets should be applied in accordance with the priorities regime,[9] whereas Justice Siopis dissented because he thought the scenario was not one contemplated by the legislation.[10]

The majority’s conclusion supports a similar conclusion reached in Amerind, but notably diverges from other recent decisions.[11]

Key takeaway

Killarnee supports the view that funds realised from a liquidator’s sale of trust property should be available to trust creditors (as distinct from company creditors generally) and should be distributed so that liquidators’ costs/remuneration and employee entitlements have priority over claims of other trust creditors.

Although Killarnee remains the most current authoritative decision on these matters, it is safe to say that the law remains in a state of flux. This uncertainty recently resulted in the Supreme Court of New South Wales agreeing to adjourn the balance of an application for three months to allow the High Court (if special leave was granted) to authoritatively resolve the controversies arising from Amerind and Killarnee.[12]

Thankfully, on 17 August 2018 the High Court granted an applicant special leave to appeal the Amerind decision. It can therefore be expected that the above issues will be unequivocally determined by the High Court in the near future. Until then, it would be prudent to approach the Killarnee decision with caution.

[1] Jones (Liquidator) v Matrix Partners Pty Ltd, in the matter of Killarnee Civil & Concrete Contractors Pty Ltd (in liq) [2018] FCAFC 40 per Allsop CJ, Siopis J and Farrell J.
[2] Although trustees are generally the legal owners of trust property, they cannot use trust property for their own commercial benefit; trust property must be held on trust for the benefit of the beneficiaries.  As such, when a corporate trustee is wound up the trust property is not taken to be property of the company for the purposes of the liquidation.
[3] As previously mentioned, assets had already been sold by the Liquidators prior to the Court’s decision.  Hence, the funds that were realised were said to have been the product of an unauthorised sale: per Siopis J at [140] at [151].
[4] See Allsop CJ’s remarks at [91] and Siopis J’s remarks at [139].
[5] Octavo Investments Pty Limited v Knight (1979) 144 CLR 360.
[6] Per Allsop CJ at [68].
[7] Per Allsop CJ at [78].
[8] Allsop CJ stated at [30] (and Farrell J agreed at [197]) that the decision in Re Enhill Pty Ltd [1983] 1 VR 561 was “wrong in its view as to the availability of the proceeds of the right of exoneration generally to all creditors”, whereas in Commonwealth of Australia v Byrnes and Hewitt [2018] VSCA 41 (“Amerind”) the Victorian Supreme Court of Appeal stated at [286] that Re Enhill should continue to be followed by Victorian trial judges.
[9] Per Allsop CJ at [120] and per Farrell J at [214] and [222] – [223].[10]
Though he noted at [155] and [158] that it would be open for a court to direct payments otherwise than pari passu.
[11] For example, in Independent Contractor Services (Aust) Pty Limited ACN 119 186 971(in liquidation) (No 2) [2016] NSWSC 106, Brereton J concluded at [52]: “The statutory priority referred to in the Corporations Act, s 556, does not apply in respect of trust assets, and the creditors share pari passu in the trust assets, after providing for the costs of administration, including the Liquidator’s remuneration and expenses.”  See also Bell Hire Services Pty Ltd (in liq) [2016] FCA 1583.
[12] MJM(WA) Enterprises Pty Ltd (in liq) [2018] NSWSC 944.

Authored by: 
Guy Edgecombe, Partner
Mitchell Byram, Associate