Many businesses in Australia are run by a trust.
A trust is a legal relationship between one person (called the trustee) and another person or group of people (called the beneficiaries of the trust).
Often, the trustee is a company (called a “corporate trustee”), and the beneficiaries are a group of family members. The result is that the relationship is described as “Smith Family Pty Ltd as trustee for the Smith Family Trust”. This is usually documented using a formal document called a Trust Deed.
A trust can be advantageous for tax reasons and for protection of your assets:
- Tax advantages. Income of the business can be provided between beneficiaries of the trust and accordingly split between family members in a tax effective way.
- Protection of the personal assets from the debts of the business. If your business fails, then (in most circumstances) the creditors of the business can only look to the trust to satisfy their claims, and not your personal assets.
So what happens when your business conducted by a trust fails, or is at risk of failure, and the trustee is placed into liquidation or administration?
In this scenario the liquidator or administrator will wish to access, and sell, assets of your trust to pay creditors. It is (usually) restricted to these assets and cannot look to your individual assets behind the trust, or your beneficiaries of the trust. But the fact that the company being administered or liquidated is a trustee causes some issues in selling and dealing with the property of the business:
- Technical practical difficulty in selling trust assets
If the Trust Deed contains a provision that removes the trustee from office automatically if the trustee is liquidated, the result is that the trustee no longer has those powers contained in the Trust Deed to sell the property of your trust. This also means the liquidator/administrator cannot automatically simply sell the trust’s assets.
The situation is rescued by the inherent legal right all trustees hold to use and reimburse from assets of the trust (known as the rights of exoneration and indemnity) to pay liabilities that the trustee itself pays or might have to pay. But it doesn’t give the right to sell.
The result is that if the Trust Deed automatically removes the trustee, the liquidator will need a Court Oder to sell trust property. This commonly occurs.
2. Priority payments to creditors
Once the assets are sold by the Liquidator, (whether it does so because the trustee was not removed, or by order of the court) the proceeds are then dealt with by the Liquidator.
A difficult question (answered for the most part in June 2019 by the High Court) has arisen as a result of the combination of these two complex issues.
- Legislation requires certain classes of creditors to be given higher priorities over others (For example, employees) when a liquidator distributes the trust property. This is a simple matter if the assets have been accessed by the Trustee because it still has the powers of the Trust Deed. All of the assets continue to be trust property.
- But what if the Trustee has had to rely upon a court order based upon its inherent powers only? In this case, because it is relying upon these rights only, it has not been clear that the property realised is thereby trust property that requires the priorities legislation to be applied.
The Court has now determined that these inherent rights of a trustee are trust property, and therefore, subject to the priorities legislation.
The key takeaways are:
- If a trust deed automatically removes a trustee from office upon the liquidation of the trustee, the liquidator or administrator will need to obtain an order of the court to sell the trust’s property to satisfy the debts of the trust; and
- Because the High Court has stated that trust property does extend to the inherent rights possessed by trustees, and not just those rights provided under the trust deed, priority of payments to certain creditors, such as employees, will apply to the property of the trust sold pursuant to that court order.
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