The status of the trustee’s right of indemnity in the winding up of insolvent trustees – the latest

Overview

In the recent Federal Course case of Lane (Trustee), in the matter of Lee (Bankrupt) v Deputy Commissioner of Taxation [2017] FCA 953 (Lane v DCT), Justice Derrington provided an in-depth analysis of the principles relating to an insolvent trustee’s right of indemnity over trust assets. The pervasive use of trading trusts in Australian commerce means that this question continues to feature prominently in matters of greatest concern to insolvency practitioners in everyday practice.

Lane v DCT is an important review of a line of recent authorities to the effect that the trustee’s right of indemnity (in particular, the right of exoneration) is “trust property” available only for distribution among trust creditors.¹

The decision is a timely discussion of an issue which remains a source of significant uncertainty for insolvency practitioners (in particular, the basis for their right to priority of payment of their costs and remuneration) and which is currently the subject of consideration by the Full Courts of both the Federal Court and the Supreme Court of Victoria. The currently pending decision before the Full Court of the Victorian Supreme Court is an appeal against the Amerind decision. A link to our March 2017 article regarding the Amerind decision appears here.

Key takeaways

Derrington J’s decision in Lane v DCT is a significant departure from the approach taken by Robson J in Re Amerindinsofar that Lane v DCT stands as authority for the conclusion that the trustee’s right of indemnity is not trust property but is instead property of the insolvent trustee. This in turn could support an argument that the statutory priority rules in s 556 (including the priority claims of liquidators for their remuneration) should apply to the distribution of the assets of an insolvent trading trust. 

However, in the absence of further judicial consideration of this issue, Lane v DCT highlights the increasing importance for insolvency practitioners of pragmatic judicial application of equitable principles (rather than statutory priority rules) in seeking priority payment of their costs and remuneration out of trust assets. This is particularly evident given the ubiquity of corporate trading trusts in modern commercial life and the consequent frequency with which insolvency practitioners will be called upon to administer the winding up of a commercial trust.

Background

By the time of his bankruptcy in February 2013, Mr Lee was the sole trustee of the Warwick Lee Family Trust. The trust was a discretionary trust of which Mr Lee’s children were beneficiaries. When Mr Lee became bankrupt, Messrs Khatri and Lane (the Bankruptcy Trustees) were appointed as trustees of Mr Lee’s bankrupt estate. Shortly prior to his bankruptcy, Mr Lee sold a Subway franchise he operated as trustee.

The Bankruptcy Trustees asserted that Mr Lee’s right of indemnity as trustee vested in them and sought the Court’s directions under the Bankruptcy Act 1966 (Cth) regarding the application of that indemnity and its accompanying lien in the distribution of the sale proceeds among Mr Lee’s “trust creditors”, as distinct from Mr Lee’s personal (non-trust) creditors.

Consideration of the trustee’s right of indemnity

Justice Derrington made the following key findings regarding the trustee’s right of indemnity:

• His Honour expressed disagreement with the characterisation by Robson J in Amerind of the indemnity and accompanying lien as “trust property”, noting that such a view was inconsistent with prior statements from the High Court to the effect that a trustee’s right of indemnity forms part of a trustee’s personal estate which passes to the bankruptcy trustee or liquidator in the event of the trustee’s insolvency. Derrington J also noted that trust creditors’ entitlements of subrogation to the trustee’s indemnity and accompanying lien were consistent with the view that the indemnity was held solely for the benefit of beneficiaries and therefore was a “trust asset”.
• Derrington J noted that Robson J’s treatment of the trustee’s indemnity and lien as trust property was also inconsistent with the High Court’s findings in Chief Commissioner of Stamp Duties (NSW) v Buckle² and CPT Custodian Pty Ltd v Commissioner of State Revenue (Vic)³ to the effect that “trust property” is confined to those assets remaining after discharge of liabilities properly incurred by the trustee for which the trustee is entitled to be indemnified.

Having concluded that the trustee’s indemnity and lien form part of the “property of the bankrupt” within the meaning of s 116 of the Bankruptcy Act, his Honour then considered the question of whether that indemnity and lien can be used to meet the claims of non-trust creditors and prioritise payment of the Bankruptcy Trustees’ costs and remuneration, particularly in circumstances where the right being exercised is the right of exoneration (being the trustee’s entitlement to apply trust assets in payment of unsatisfied trust debts). His Honour held that the right of exoneration is merely a limited right to use trust funds to discharge trust debts, a right whose character is unaffected by the vesting of that right in a bankruptcy trustee or liquidator. It followed that the trust funds to be applied in discharging trust debts were not “proceeds” of the right of indemnity and therefore did not fall within the ambit of the “proceeds of property of the bankrupt” referred to in s 109 of the Bankruptcy Act (the equivalent “waterfall” priority provision to s 556 of the Corporations Act).

In reaching this conclusion, his Honour acknowledged that unlike s 109 of the Bankruptcy Act, ss 555 and 556 of the Corporations Act do not expressly identify “proceeds” of the company’s property (as distinct from the property itself) as the focus of those provisions. However, in obiter comments, his Honour stated that insofar that the right of exoneration is property incapable of being realised in monetary form, it would not fall within the scope of ss 555 and 556, thereby resulting in a pari passu distribution of the trust assets among trust creditors. In this context, Derrington J expressed the view that insofar that a liquidator’s costs and remuneration are regarded as a trust debt, the most rational and justifiable basis in principle for according priority to payment of that debt ahead of other trust debts lies in the equitable principle of “salvage”, which operates to compensate the liquidator for his/her efforts in administering the trust through his/her identification, protection and realisation of trust assets on behalf of those persons beneficially entitled to them.⁴

¹ In the matter of Independent Contractor Services (Aust) Pty Limited ACN 119 186 971 (in liquidation) (No 2) [2016] NSWSC 106; Re Amerind [2017] VSC 127; Kite v Mooney, in the matter of Mooney’s Contractors Pty Ltd (in liq) (No 2) [2017] FCA 653.

² (1998) 192 CLR 226.

³ (2005) 224 CLR 98.

⁴ Citing Re Universal Distributing Co (in liq) (1933) 48 CLR 171 and Re Berkeley Applegate (Investment Consultants) Ltd (in liq) [1989] Ch 32.