When will a court impose a trust relationship in commercial agreements such as franchises?

In Re Stay in Bed Milk & Bread Pty Ltd (In Liquidation) ACN 115 166 982 [2019] VSC 181, the Court considered whether monies paid into a marketing fund by franchisees gave rise to a trust relationship.

Background and the parties’ arguments

Stay in Bed Milk & Bread Pty Ltd (the Company) was the franchisor of the “Aussie Farmers Direct” franchise. In March 2018, the Company was placed into voluntary administration and eventually went into liquidation. The liquidators of the Company sought declarations and directions from the Court as to how funds paid to the Company as a “marketing levy” by its franchisees, pursuant to a number of franchise agreements, were to be distributed. The liquidators argued that the monies were held on trust by the Company for the benefit of the franchisees, either as an express trust or a Quistclose trust.

Conversely, the Department of Jobs and Small Business, as the responsible entity for administering the Fair Entitlements Guarantee (FEG) scheme, intervened in the proceedings. It argued that these funds were not subject to a trust and should be distributed in accordance with sections 501, 555 and 556 of the Corporations Act 2001 (Cth). FEG would be the ultimate beneficiary of the funds if the Court ruled in its favour.

Pursuant to the terms of its franchise agreement, the franchisees were required to pay a marketing levy to the Company’s marketing fund. From 1 January 2015, due to changes to the Franchise Code, the Company was required to hold the funds paid in to the marketing fund in a separate account. Prior to that, the funds had been intermingled into the Company’s general account.

The liquidators argued that the funds were the subject of either:

1. an express trust; or
2. a Quistclose trust,

for the benefit of the franchisees.

If the Court declared the funds were the subject of such a trust, then the monies would be returned to the franchisees, rather than being a circulating asset available for payment to FEG (who had paid money to employees of the Company to cover unpaid employee entitlements) and the Company’s other creditors.

The Court’s decision

Ultimately, the Court found that there was neither an express trust, nor did a Quistclose trust arise. Accordingly, the marketing fund was an asset of the Company and available for distribution among the creditors.

Were the funds held on an express trust?

No. The Court considered whether there was an intention to create a trust over the marketing funds, which is to be examined by reference to the “language of the parties construed in its context, including the matrix of the circumstances” (per Randall As J at [32]).

In particular, the Court found that:

1. under the Franchise Agreement, the Company retained the discretion to expend the Marketing Fund and, critically, this discretion did not have to be exercised for the benefit of a particular franchisee;
2. the language of the franchise agreements, the statutory framework and the conduct of the parties did not suggest that there was a mutual intention that the marketing funds were held on trust;
3. the Company was not obligated to apply the marketing fund monies to the businesses run by the franchisees, despite the franchisees being the contributors to the marketing fund;
4. the franchisees did not have any recognised interest and any right to the monies held in the marketing fund; and
5. there was no need to overlay a trust relationship on top of the contractual relationship which obligated the application of the levy towards meeting the cost of marketing.

Did a Quistclose trust arise regarding the funds?

A Quistclose trust will be imputed in circumstances where money has been paid for a specific purpose and the purpose for which the monies were paid fails. In considering whether a Quistclose trust arose, the Court examined whether:

1. there a specific purpose tantamount to a condition; and
2. there was an intention that the Marketing Fund become an asset of the Company.

The Court found that that while it was the parties’ intention that the monies were paid to the Company for the exclusive purpose of the Marketing Fund and that purpose had failed due to the insolvency of the Company, it could not impose a trust relationship on the parties. The Court determined this by examining the terms of the franchise agreement and the Company’s obligations pursuant to the Franchise Code. The Court found that it was clear that the parties intended the funds to be an asset of the Company.

Key takeaway

The Court’s decision provides helpful insights for insolvency practitioners, particularly those appointed to franchisors, in assessing whether funds paid to the franchisor company are to be held on trust. As is demonstrated in this case, courts are generally reluctant to impose a trust relationship in commercial arrangements, particularly where there is no express reference to such a trust.