Dominic Emmett, Peter Bowden, and Talia Lirosi, Gilbert + Tobin
For many years, Australian courts have been confronted with a question to which the answer was (until recently) unclear: do the statutory priorities afforded to employee creditors under the Corporations Act 2001 (Cth) (Corporations Act) apply to the distribution of trust property where a company has operated as a trustee? In other words, are employee creditors deprived of statutory priority if the company is the trustee of a trading trust, and is holding its assets on trust? The High Court of Australia, in its much-anticipated decision of Carter Holt Harvey Woodproducts Australia Pty Ltd v Commonwealth of Australia & Ors, has finally settled this question confirming that section 433 of the Corporations Act (in respect of a receivership) and sections 556, 560 and 561 of the Corporations Act (in respect of a liquidation) require priority employee claims that arise from trust liabilities to be paid from trust assets.
Amerind Pty Ltd (Amerind) was the trustee of the Panel Veneer Processes Trading Trust (Trust). Amerind carried on business and incurred liabilities solely in its capacity as trustee of the trust.
Bendigo and Adelaide Bank Ltd (Bank) provided various facilities to Amerind. The bank was the only secured creditor and held a registered security interest, pursuant to a general security deed. On 6 March 2014, the bank issued Amerind with a payment demand and terminated the banking facilities. This prompted the sole director of Amerind, on 11 March 2014, to appoint administrators to Amerind. On the same day, the bank appointed receivers and managers to Amerind. On 13 August 2014, Amerind’s creditors voted in favour of the company being placed into liquidation.
The receivers of Amerind opted to continue to trade the business following their appointment and realised various assets held by Amerind as trustee of the trust. Following repayment of the bank’s debt and accounting for their remuneration, the receivers estimated that there was a net surplus of approximately $1.6 million available to be distributed to creditors.
The Commonwealth Department of Employment (Commonwealth) had advanced approximately $3.8 million to Amerind’s former employees in satisfaction of outstanding wages and other entitlements pursuant to the Fair Entitlements Guarantee Scheme. The Commonwealth claimed that, pursuant to section 560 of the Corporations Act, it had a right to obtain the same priority position of Amerind’s former employees under sections 433 and 556 of the Corporations Act, in respect of the surplus realised from trust assets that were subject to a circulating security interest. Carter Holt Harvey Woodproducts Australia Pty Ltd (Carter Holt Harvey), an unsecured creditor and the appellant in the High Court decision, contended that such realisation should be distributed on a pari passu basis and that the statutory priority did not apply to the distribution of trust assets.
The question for the Court was whether the statutory priority waterfall (namely sections 433, 556 and 560 of the Corporations Act) applied in the distribution of Amerind’s assets in circumstances where it was trading as the trustee of a trust and was holding the assets on trust.
Section 433 of the Corporations Act sets out the priority of payment regime in a receivership. It provides that where a receiver is appointed under a circulating security interest, the receiver taking possession or assuming control of property of the company, must pay out of property coming into his or her hands, certain debts in priority to any claim for the principal or interest in respect of the debenture. The priority debts include debts subject to the priority regime in sections 556(1)(e), (g) or (h) or section 560 of the Corporations Act (which are provisions applicable to the liquidation priority regime). Put simply, the priority regime in section 433 of the Corporations Act draws from the priority regime applicable in a liquidation. Sections 556(1)(e), (g) and (h) and 560 of the Corporations Act relate to employee priority claims and the priority of creditors who have advanced funds to meet employee claims.
The Supreme Court of Victoria, the Court of Appeal and the High Court each refer to a divergent body of case law that provides different views on the contentious points of law. For ease of reference, the position of each of these decisions is briefly summarised below.
The receivers of Amerind sought directions from the Court as to whether they were required to apply the statutory priorities in section 433 of the Corporations Act in distributing the receivership surplus. The issue first came before Robson J in the Supreme Court of Victoria.
The Commonwealth contended that Amerind’s right of indemnity over the trust assets is property of the company and is able to be distributed amongst all creditors, citing Re Enhill in support of that contention. Carter Holt Harvey argued that the right of indemnity is not property of Amerind as corporate trustee, and that the Court was bound to follow the decision in Re Independent Contractor Services.
Robson J considered the decisions in Re Suco Gold and Re Enhill, where it was held that the priority regime in the Corporations Act applies where assets of a company are held on trust. Robson J, however, favoured the view in Re Independent Contractor Services and held that section 556 of the Corporations Act does not apply to trust assets as it only applies to “property of the company”. Robson J also held the following:
Robson J concluded that distributions of trust property are not subject to employee priorities because such property is not “property of the company” (as required by section 433 of the Corporations Act). The Commonwealth’s claim was rejected, with the consequence being that employees were not afforded with a preferred priority position, but ranked equally with other unsecured creditors.
The Commonwealth successfully appealed the decision at first instance. The Court of Appeal held that Amerind’s right of indemnity out of trust assets was “property of the company” and sections 433 and 556 of the Corporations Act would therefore apply.
The Court first acknowledged the long-standing principle that a trustee holds a right of indemnity in respect of liabilities properly incurred in operating the trust and that such a right is maintained by a charge or lien over the trust assets. In reviewing a body of case law dealing with the nature of the trustee’s right of indemnity, the Court cited the High Court decision of Octavo Investments Pty Ltd v Knight, which is authority for the proposition that a trustee’s right of indemnity (through exoneration) for liabilities incurred in its capacity as trustee of a trust is a proprietary interest which passes to a liquidator, and the relevant statutory priority regime will therefore apply. The Court rejected Robson J’s finding that the trustee’s right of indemnity was not property of the company based on the reasoning of the High Court in Octavo.
The Court also considered the previous decisions of Re Enhill, Re Suco Gold and Re Independent Contractor Services in forming its view on whether the right of indemnity is property of the company and in deciding whether the priority waterfall applied to the trustee’s right of indemnity. The Court favoured the approach of King CJ in Re Suco Gold and Re Enhill, finding that the right of exoneration was property of the company for the purpose of section 433 of the Corporations Act.
The Court also held that because the general security deed created a circulating security interest in the proceeds of the inventory sold by the receivers, the Court was not required to determine whether the general security deed created a circulating security interest in Amerind’s right of indemnity. It was of paramount importance that the assets that underlie the right of indemnity (not the right of indemnity itself) were subject to a circulating security interest.
Their Honours did not make any finding on whether the right of exoneration may be exercised to discharge the debts of creditors generally or the trust creditors only, citing the difficulty of doing so given the conflicting interests and divergent authorities, and noting that in the present case it was unnecessary to decide (as Amerind only traded as a trustee and had no general creditors). The Court did, however, state that, until the issue was determined by a higher court, Victorian trial judges should follow the decision in Re Enhill (which held that proceeds of realisation can be distributed to all creditors and not simply trust creditors).
Carter Holt Harvey appealed the Court of Appeal decision on the grounds that the Court erred in finding that the receivership surplus was proceeds of the company’s right of indemnity as trustee (and available for distribution to creditors in accordance with section 433 of the Corporations Act). The High Court granted special leave to Carter Holt Harvey on 17 August 2018.
The High Court unanimously dismissed the appeal, upholding the Court of Appeal’s decision.
The High Court made the following key findings:
Although the findings were unanimous, there are, however, three separate judgments within the decision as summarised below.
It should be noted that the existence of the receivership surplus itself was not determinative of whether priority would be afforded to creditors; such priority will be afforded when realising circulating assets irrespective of whether a secured creditor is paid in full.
Their Honours opined on the nature of the trustee’s right of indemnity (particularly, the power of exoneration). The Court reasoned that the power of exoneration is “part and parcel of the ‘trust’ rights in a broad sense”; the trustee’s right of indemnity is not property of the company but a right that takes priority over the equitable rights of the beneficiaries of the trust.
The Court considered Re Enhill, noting Young CJ’s finding that a trustee’s power of exoneration enabled a liquidator to pay costs and expenses of the winding-up providing that following such payment of priority debts the trust assets were available to non-trust creditors. Their Honours disagreed with this proposition, noting that a trustee’s right of exoneration was to exonerate the business of the trust; liabilities incurred while operating the trust. Their Honours then turned to King CJ’s decision in Re Suco Gold where it was held that the Re Enhill decision (ie, that trust assets were available to non-trust creditors) was “in conflict with fundamental principles of the law of trusts”. Their Honours agreed with King CJ and noted that unlike the power of reimbursement which would be available to creditors generally, where a trustee exercises its right of exoneration in relation to liabilities incurred in operating the trust, any property realised is available only to trust creditors.
Their Honours then considered the applicability of section 433(3) of the Corporations Act. The Court again noted that the power of exoneration was not property of Amerind but the means by which its trust rights could be used for its personal benefit as trustee. The Court agreed with the reasoning of the Court of Appeal that there is no requirement in section 433 that the “right of indemnity by means of which the receiver could have recourse to the trust property must itself be subject to a circulating security interest”. It was held that what is important is that Amerind’s legal rights to the trust assets are themselves circulating assets and are “property of the company”.
More practically, their Honours commented that it would be unreasonable if the Corporations Act denied employees priority over the holders of circulating security interest just because their employer was the trustee of a trust (in many cases unbeknown to the employees).
Their Honours also held that the same reasoning applies to section 561 of the Corporations Act, which as above, is the provision similar to section 433 but applicable in a liquidation.
Their Honours first considered the question as to whether Amerind’s right to be indemnified out of trust assets was “property of the company” pursuant to section 433(3) of the Corporations Act. Their Honours held that the property coming into the hands of the receiver did not include the “right of indemnity” itself. While the right of indemnity was not “property comprised in or subject to [the] circulating security interest” (as required by section 433 of the Corporations Act), the underlying inventory was, and it comprised the circulating asset. Therefore, the statutory priorities were applicable.
The Court then considered the conflicting decisions of Re Enhill and Re Suco Gold in respect of whether an insolvent corporate trustee’s right of indemnity constitutes property that may be applied to creditors generally or only as against trust liabilities. Their Honours favoured the view in Re Suco Gold and that of the primary judge that any proceeds obtained from the corporate trustee exercising its right of exoneration may only be applied towards the satisfaction of trust liabilities.
Importantly, their Honours conceded that this may create practical complications by requiring external administrators of insolvent trustees to maintain separate trust funds in complex scenarios (ie, where a trustee operates multiple trusts). However, their Honours concluded:
The solution proposed by King CJ – of construing section 556 in such circumstances as if the liquidator of the corporate trustee held separate funds, each for a different group of creditors – coheres to the law of trusts and has common sense to commend it.
Gordon J agreed with the judgment of Bell, Gageler and Nettle JJ while also providing further reasons. Her Honour first considered the basic principles governing Amerind’s right of indemnity and noted that a trustee has an equitable charge or lien over trust property which gives it the right to retain or sell it until the right of indemnity is satisfied. Her Honour then cited Jones v Matrix Partners Pty Ltd; Re Killarnee Civil & Concrete Contractors Pty Ltd (In Liq) and Octavo to note that the trustee’s right of indemnity provides the trustee with a proprietary interest in the trust assets. Her Honour stated:
The proprietary interest generated by the trustee’s right of exoneration is not the right of exoneration itself. Rather the right of exoneration generates a proprietary interest in the trust assets.
As such the proprietary interest in the underlying trust assets (which is generated by the right of exoneration) was considered “property of the company” for the purposes of section 433 of the Corporations Act. In dismissing Carter Holt Harvey’s assertion that the trust assets were not property of the company (and as such the statutory priorities did not apply to them), her Honour also noted that the Court should be “slow to attribute an intention to Parliament to create two classes of employees in insolvency: those employed by a company and those employed by a corporate trustee”.
In considering whether the trust assets could be applied against creditors generally (or whether applications were restricted to trust creditors), Gordon J accepted the Commonwealth’s contention that section 433 of the Corporations Act operates on Amerind’s interest in the receivership surplus but did not alter the limits of that interest; the assets were available to meet only the trust liabilities in accordance with the priority waterfall. Her Honour acknowledged that while it may lead to practical difficulties and expense, the proper approach of a liquidator or receiver acting as trustee for multiple trusts is to apply the statutory priorities to each separate trust fund, and seek directions where such difficulties are problematic to the external administration. Gordon J also found that the right of exoneration itself is not a circulating asset (and in any event is not required to be a circulating asset). What is important is that the underlying property, being the receivership surplus, was a circulating asset.
The High Court’s decision provides greater certainty for insolvency practitioners in dealing with an insolvent corporate trustee that has incurred liabilities only in that capacity. The decision has settled decades of divergent case law and is a satisfying result from a policy perspective because it safeguards the priority position of employees in external administrations.
Despite this, practitioners may have some concerns, as the High Court seems to have advocated for what will likely be an expensive, time-consuming best practice: that receivers and liquidators should manage separate trust funds and groups of creditors where the company is an insolvent corporate trustee of multiple trusts. While the High Court decision does provide some level of judicial guidance, receivers and liquidators are well advised to seek directions from the Court where there is any uncertainty.