In a previous blog post we explained what a trust is, and what happens when a trust with a corporate trustee can’t pay its debts.

However, recent case law has highlighted gaps in the legislation that dictates how external administrators (such as Liquidators and Voluntary Administrators) can deal with and distribute the proceeds of an insolvent trust’s assets. And in some respects, the case law is contrary to how external administrator usually complete these tasks.

What happens when a Liquidator is appointed?

When a Liquidator is appointed to a corporate trustee, the trustee is sometimes removed from office. This removal may happen as soon as a Liquidator is appointed due to an ipso facto clause.

Note: This may change if proposed amendments to insolvency law come into effect in 2017.

Despite being appointed, a Liquidator may not necessarily have the powers to deal with the trust’s assets. In these circumstances, the Liquidator can choose one of four options:

  1. Transfer the assets to a new trustee, and have the trustee realise those assets and pay them the proceeds for distribution.
  2. Seek an order from the Court appointing them as Receiver of the trust’s assets.
  3. Seek an order for judicial sale of the assets.
  4. Retain the trust’s assets pursuant to rights under the trustee’s indemnity, and sell the trust’s assets pursuant to the Corporations Act.

Which option the Liquidator takes will depend on their professional judgement. However, a Court application is often necessary given:

  • the complexity of trust law
  • the often competing interests of various stakeholders in both the trust’s property and the winding up process
  • a Court may need to consider issues regarding the Liquidator’s remuneration (and the Receiver’s, if one is appointed by the Court) if creditors cannot approve these via the usual mechanisms under the Corporations Act.
Distributing trust assets to creditors

Once the Liquidator has realised all of the assets, they need to distribute the proceeds to creditors.

In a normal liquidation scenario, assets are distributed pursuant to the Corporations Act. Under this regime, employee entitlements (e.g. unpaid wages, superannuation, leave and retrenchment entitlements) are given priority in a distribution to creditors. This means employee entitlements must be paid in full before ordinary unsecured creditors (such as trade creditors and the ATO) receive anything.

But a recent decision made by Breteton J[1] held that all unsecured creditors, including employees, rank pari passu (equally) on distribution of trust assets.

Here are two scenarios to explain the difference.

Let’s say XYZ Pty Limited is placed into liquidation, and a Liquidator is appointed. The liquidation realises $100,000, which can now be distributed to creditors. Claims for employee entitlements total $100,000, while claims for ordinary unsecured creditors total $200,000.

Scenario 1 – There is no trust structure. XYZ Pty Limited traded in its own capacity, and the $100,000 available for distribution was realised from assets owned by XYZ Pty Limited.

Scenario 2 –XYZ Pty Limited operated as the trustee of the XYZ Family Trust. The company holds no other assets besides those it holds for the Trust, and the $100,000 available for distribution was realised from assets of the Trust.

Scenario 1
– Distribution of Company Property ($)
Scenario 2
– Distribution of Trust Property ($)
Amount available for distribution 100,000 100,000
Less: Employee claims ranking in priority to ordinary unsecured creditors (100,000)
Net amount available for distribution to ordinary unsecured creditors 100,000
Ordinary creditor claims (200,000) (300,000) (includes Employee claims)
Creditor shortfall (200,000) -200,000
Distributions paid by creditor class Amount ($) Percentage (%) Amount ($) Percentage (%)
Employees 100,000 100% 33,333 33.33%
Ordinary unsecured creditors 66,667 66.67%
Total distributions paid 100,000 100% 100,000 100%

 

This table highlights how distributions are made differently under the Corporations Act and the principles set out in the Independent Contractor case. In Scenario 2, ordinary unsecured creditors are the winners, as there would otherwise be insufficient assets to give them a return. This is at the expense of employees, who receive 66.67% less of a return.

With the possibility of needing Court intervention to liquidate a trustee company, Liquidators may be deterred from voluntarily accepting such appointments. The company may not have sufficient assets to cover the Liquidator’s legal costs—especially if it’s a small company.

[1] Independent Contractor Services (Aust) Pty Limited ACN 119 186 971 (in liquidation) (No 2) [2016] NSWSC 106