The High Court unanimously dismissed an appeal from the Victorian Court of Appeal in relation whether the assets of an insolvent corporate trustee should be distributed to employees or trade creditors. It held that the priority regime contained in s 433 of the Corporations Act 2001 (Cth) applied to the trustee of a trading trust, and thus employees had priority.

Facts and history

Amerind Pty Ltd (“Amerind”) was the trustee for a trading trust, the Panel Veneer Processes Trading Trust, and traded solely in that capacity. The Bendigo and Adelaide Bank (“the Bank”) appointed receivers (“the Receivers”) after Amerind defaulted on bank facilities on the same day that the sole director of Amerind appointed Administrators. The Bank were the holders of a “circulating security interest” registered under the Personal Property Securities Act.

After the creditors resolved that Amerind be wound up in insolvency, the Administrators were appointed as joint and several liquidators of Amerind. By this time, the Receivers had realised most of Amerind’s assets and were in a position to retire. After all of the Bank’s secured debt had been discharged, the Receivers had a receivership surplus of $1,619,018. Two competing parties sought to access that surplus before the High Court:

1. Carter Holt Harvey Woodproducts Australia Pty Ltd (“Carter Holt”), a trade creditor; and
2. The Commonwealth of Australia (in the shoes of employees).

The entitlement to the surplus depended on the application of s 433 of the Corporations Act. That section holds as follows:

(2)  This section applies where:

(a)  a receiver is appointed on behalf of the holders of any debentures of a company or registered body that are secured by a circulating security interest, or possession is taken or control is assumed, by or on behalf of the holders of any debentures of a company or registered body, of any property comprised in or subject to a circulating security interest; and

(b)  at the date of the appointment or of the taking of possession or assumption of control (in this section called the ‘relevant date’):

(i)  the company or registered body has not commenced to be wound up voluntarily; and

(ii)  the company or registered body has not been ordered to be wound up by the Court.

(3)  In the case of a company, the receiver or other person taking possession or assuming control of property of the company must pay, out of the property coming into his, her or its hands, the following debts or amounts in priority to any claim for principal or interest in respect of the debentures:

(a)  first, any amount that in a winding up is payable in priority to unsecured debts pursuant to section 562;

(b)  next, if an auditor of the company had applied to ASIC under subsection 329(6) for consent to his, her or its resignation as auditor and ASIC had refused that consent before the relevant date–the reasonable fees and expenses of the auditor incurred during the period beginning on the day of the refusal and ending on the relevant date;

(c)  subject to subsections (6) and (7), next, any debt or amount that in a winding up is payable in priority to other unsecured debts pursuant to paragraph 556(1)(e), (g) or (h) or section 560.

…

Carter Holt (the appellant) submitted that s 433 of the Corporations Act did not afford priority to the Commonwealth, and that it had priority because of Amerind was a trading trust.

The Commonwealth (the first respondent) had paid $3.8 million in accrued wages and entitlements to former employees of Amerind, under a statutory scheme known as the Fair Entitlements Guarantee Scheme. Pursuant to s 560 of the Corporations Act, it argued that it had the same priority as those employees, and that those employees were entitled to payment as a priority under ss 433 and 556 of the Corporations Act.

The difficulty was that the company held no assets on its own behalf. It only held trust assets for beneficiaries. However, as the trustee of a trading trust, the trustee had the right of indemnity (or right to be covered in relation to liabilities undertaken on the part of the trust). This right of indemnity had two aspects:

• A right of exoneration: a right on the part of the trustee to discharge trust liabilities directly from the assets of the trust; and
• A right of reimbursement: a right on the part of the trustee to use trust assets to cover those liabilities which it has already incurred on its own behalf by fulfilling the terms of the trust.

It was the right of exoneration aspect of the the right of indemnity which was at issue in this case.

The trial judge held that s 433 of the Corporations Act did not apply because Amerind had no assets of its own, only a right of indemnity, which was neither “property of the company” nor “comprised in or subject to a circulating security interest” within the meaning of the section.

The Court of Appeal allowed the Commonwealth’s appeal, and held that Amerind’s right of indemnity was “property of the company”, and that ss 433, 555 and 556 applied to the distribution of the surplus. Moreover, it held that the proceeds of realisation of the inventory were property of Amerind subject to a circulating security interest, and the receivers had taken possession or assumed control of those proceeds of realisation of the inventory. Thus, s 433(3) required the receivers to pay the claims in s 556(1)(e) in priority out of those proceeds. Because all of Amerind’s creditors were trust creditors, it was unnecessary to decide whether the proceeds of realisation were distributable among creditors generally, as was held in Re Enhill Pty Ltd [1983] 1 VR 561, or only as between trust creditors, as was held in In re Suco Gold Pty Ltd (In liq) (1983) 33 SASR 99, but that trial judges in Victoria should continue to follow Re Enhill until the High Court of Australia decided otherwise.

Carter Holt appealed to the High Court. It argued:

• Amerind’s right of indemnity was not “property comprised in or subject to a circulating security interest” within the meaning of s 433(2)(a); and
• The funds obtained from the sale of trust assets were trust property which was not subject to the Receivers’ duty to pay creditors of Amerind “out of the property coming into his, her or its hands” in accordance with s 433(3) of the Corporations Act.

Kiefel CJ, Keane and Edelman JJ:

Kiefel CJ, Keane and Edelman JJ said at [24] that the trust is not a separate entity and does not have a separate solvency status from the trustee. A trustee is personally liable for debts incurred as trustee, regardless of whether or not the creditors knew of the existence of the trust. They said that “trust assets” meant “the rights held on trust by the trustee” and “trust creditors” meant “those creditors of the trustee whose debts were properly incurred with authority in the course of trust business.” They noted that generally trust property did not form part of the estate available for distribution to creditors ([25] – [27]) but  at [28] noted that there was an exception where a trustee is permitted to derive any benefit from the rights held on trust, including by means of the trustee’s “right of indemnity”. To the extent of the power, the trust rights are no longer property held solely in the interests of the beneficiaries of the trust.

It was said that where a right of indemnity operates, trust assets are subject to two competing proprietary rights: the trustee’s and the beneficiaries’. The trustee’s rights take priority over those of the beneficiaries to the extent of the trustee’s powers of indemnity. An analogy was drawn between the trustee’s rights and the constructive trust which arises upon entry into a specifically enforceable contract of sale of land. When a trust is in the hands of a liquidator or trustee in bankruptcy, the power of exoneration can only be used to pay trust creditors: the liquidator or trustee in bankruptcy has the same rights as the trustee did (at [34] – [36]). Insofar as the Commonwealth suggested that proceeds from the sale of trust assets should be used after payment of priority creditors for the discharge of all other debts, not merely trust creditors, this was wrong (at [37] – [44]).

The Receivers were held to have been appointed on behalf of the holders of debentures secured by a circulating security interest (namely the Bank). Thus, there was no need to imply a further condition  limiting the operation of the priority provision in s 433(3) so that the priority was given only over circulating assets that are the property of the company. The existing preconditions in s 433(2)(a) prevent creditors such as employees, being given priority over the holders of fixed, or non-circulating, security rights. However, even if this was so, as noted above, the indemnity rights gave Amerind a right to use the trust assets for its own benefit and were thus “property of the company in any case” (at [45] – [49]).

It was held to be incorrect to treat rights held on trust by a company as if they existed independently of the power of exoneration. Amerind’s power of exoneration was the means by which its trust rights could be used for its personal benefit as trustee. It was meaningless to ask whether Amerind’s power of exoneration was subject to the circulating security interest independently of the legal rights to the trust assets to which the power relates. The point was that Amerind’s legal rights to the trust assets, to the extent that it has power to use them for its own benefit, were themselves circulating assets and were “property of the company” within s 433 (at [50] – [52]).

The payment was held to be out of property coming into the receiver’s hands, and thus subject to the duty to pay creditors in accordance with the priorities set out in s 433. “Out of the property” was held to include payments made “by the use of the property”. Hence, if the trustee could exercise its rights in relation to the trust assets, including its power of indemnity, to sell the assets for the purpose of exoneration, then a payment of a trust creditor directly from the trust assets by use of the power of exoneration was a payment made “out of” the trustee’s rights in relation to the trust assets. And it followed that a payment by the Receivers of trust creditors by use of Amerind’s power of exoneration must be a payment “out of the property” in the Receivers’ hands ([at [53] – [55]).

Finally, Kiefel CJ, Keane and Edelman JJ held that there were strong public policy reasons why trading trusts should be subject to the priorities contained in s 433. The conclusion fit with the underlying purpose of ss 433 and 561. Also it would be perverse if employee creditors were denied priority over the holders of a circulating security interest solely for the reason that the company which employed them was trading as a trustee. And at the time s 433 was enacted, it was generally believed that liquidators and others could have recourse to trust funds pursuant to Re Suco Gold (1983) 33 SASR 99 (at [56] – [59]).

Bell, Gageler and Nettle JJ: 

Bell, Gageler and Nettle JJ said at [80] – [84] that a corporate trustee’s right to be indemnified out of the assets of the trust confers “property” for the purposes of the Corporations Act. At [84], they said:

Possibly, the trustee’s right of indemnity could be as well described as conferring a personal power (as Professor Ford argued it should be) as a proprietary interest. But the choice of description should conform to, rather than dictate, the application of fundamental principles to “solving a concrete legal problem”. The trustee’s right to apply trust assets in satisfaction of trust liabilities is proprietary in that it may be exercised in priority to the beneficial interests of the beneficiaries. To describe it as constituting a beneficial interest in the trust assets, and so as property, thus acknowledges the characteristic blending of personal rights and obligations with proprietary interests which is the “genius” of the trust institution. Such a beneficial interest falls naturally and ordinarily within the definition of “property” in s 9 of the Corporations Act.

At [85] – [87] they said that while the trustee has a beneficial interest in the trust assets via the right of indemnity, it was important to be clear about the precise nature of that interest. The right of indemnity and the trust assets are separate property interests, although the former confers a proprietary interest in the latter. A failure to understand this lead to the misconception that because Amerind’s right of indemnity was not property that was subject to a circulating security interest, s 433 did not apply. While Amerind held the inventory on trust in accordance with the terms of the trust deed, that did not mean that it could not be “property of the company” for the purposes of s 433. As legal owner of the inventory, Amerind had the power under the trust deed to subject the inventory to a circulating security interest in favour of the Bank. Upon default, the receivers were able to take possession or assume control of the inventory pursuant to that circulating security interest. And Amerind had a right of indemnity out of the whole of the inventory of which the receivers took possession or assumed control.

The policy of the forerunners of s 433 was said to be to ensure creditor who accepts a floating charge of a company’s business assets will not be permitted to displace the legislative priorities, including the remuneration of employees. This policy was held to flow through to the current section. Therefore, in the winding up of a corporate trustee, the “property of the company” available for the payment of creditors includes those trust assets to which the trustee company is entitled to apply in satisfaction of the claims of trust creditors pursuant to a right of indemnity (at [88] – [90]).

At [91] – [97], it was held that an insolvent corporate trustee’s right to be indemnified out of trust assets constituted property of the company that may be applied only in payment of trust creditor liabilities as was held in In re Suco Gold Pty Ltd (In liq) (1983) 33 SASR 99. Insofar as Re Enhill Pty Ltd [1983] 1 VR 561 held that the insolvent corporate trustee’s right to be indemnified out of trust assets constituted property of the company available for distribution among creditors generally, it was incorrect. Thus, the trial judge was right to hold that the proceeds from an exercise of a corporate trustee’s right of exoneration in respect of trust liabilities may be applied only in satisfaction of the trust liabilities to which that right relates. The trial judge was incorrect to hold that it therefore followed that the statutory order of priority for the payment of debts was inapplicable. Although it has often been stated that bankruptcy legislation has no application to trust assets, this is misleading. From the earliest days of bankruptcy legislation, principles of equity and statutory priorities have worked in tandem. There was no reason in principle or by reference to the legislation why the statutory order of priorities should not be followed in the distribution of the proceeds of the trustee’s right of indemnity among trust creditors. Like Kiefel CJ, Keane and Edelman JJ, they noted that s 566 had been enacted in a context where Re Suco Gold was held to be correct. Thus it should apply to such corporations and their property of all kinds.

Bell, Gageler and Nettle JJ concluded at [98] that Amerind’s right of indemnity as such was not “property comprised in or subject to a circulating security interest”. It could not be so, because it was not a “circulating asset” within the meaning of s 340 of the Personal Properties Security Act 2009 (Cth) and thus any security over it was not a “circulating security interest” as defined in s 51C of the Corporations Act. The inventory itself, however, was property of the company, being property “comprised in or subject to a circulating security interest” created by Amerind in favour of the Bank. It was property of Amerind of which the receivers took possession or assumed control pursuant to the Bank’s circulating security interest over the inventory. That property yielded proceeds of realisation from which the receivers were entitled to discharge trust liabilities. In the event of a winding up, those proceeds would have been property of Amerind available for the payment of creditors in accordance with s 556(1)(e) of the Corporations Act. Accordingly, s 433 applied.

Gordon J:

At [116], Gordon J said that she agreed with Bell, Gageler and Nettle JJ’s judgment, but had written separately to explain why, at a level of principle and practice, the appeal should be dismissed with costs.

It was noted at that employees have had priority over claims secured by a floating charge, now referred to as a circulating security interest, for over one hundred years, despite some question as to why employees have priority over claims secured by a circulating security interest, but do not have priority in relation to property secured by a fixed charge. Although this case dealt with a receiver, it was observed that the principles also applied to liquidators, and other cases where the statutory order of priority fixed by the Corporations Act intersects with assets realised through an insolvent corporate trustee’s right of exoneration (at [110] – [111]).

The definition of “property” in s 9 of the Corporations Act was:

“any legal or equitable estate or interest (whether present or future and whether vested or contingent) in real or personal property of any description and includes a thing in action …”

This definition is wide. Where a receiver takes possession of property of the company, the receiver must pay out of the property debts or amounts in priority to any claim for principal or interest in respect of the debentures. The reference to “debentures” in s 433(3) is important; they are the same debentures referred to in s 433(2) and provide the basis for the application of the section. Moreover, the debentures are debentures of a company that are secured by a circulating security interest. Section 433(3) is concerned with the distribution of circulating assets, not any other property of the company, and requires payment of three categories of claims in priority to all other claims when distributing those circulating assets (in this case, the third category, employees, is at issue) (at [116] – [117]).

Thus Gordon J said at [121]:

The intended effect of ss 433(3)(c) and 561(a) is that where a company is in receivership or in liquidation, employees’ claims will enjoy priority over the claim of a party secured by a circulating security interest, and will be paid out of the property comprised in or subject to the circulating security interest in priority to the secured creditor. The intention of ss 433(3)(c) and 561(a) is to ensure that, as has been the case historically, employees rank before creditors secured by a circulating security interest in relation to property subject to the circulating security interest, whether a company is in receivership, or is being wound up.

Gordon J then went on to consider each of Carter Holt’s grounds of appeal in detail.

Gordon J on the first ground: whether Amerind’s right of exoneration, and proceeds from the exercise of that right, are “property of the company” within the meaning of s 433

Gordon J noted that if Amerind had been conducting the business in its own right, Amerind’s employees would be priority creditors under s 433(3)(c). She noted that the fundamental question in the appeal was whether the position was different because Amerind conducted the business as a trustee and had a right of indemnity out of the assets of the trust to pay the employees (at [122]). The nature of the trustee’s right of indemnity was pivotal to the resolution of this question, and the Commonwealth’s submissions should be accepted in preference to Carter Holt’s (at [123] – [127]).

At [133] – [134], Gordon J accepted Allsop CJ’s description of the trustee’s right of indemnity in the form of exoneration in the recent decision of the Full Federal Court of Australia in Jones v Matrix Partners Pty Ltd:

“[T]he right (in a sense personal in that it was distinct from and superior to the interests of cestuis que trust) of the trustee to use trust assets to exonerate itself arises to meet a trust liability, and can be exercised only for that purpose. The property in the hands of the trustee remains trust property, but subject to the trustee’s proprietary interest that exists for the purpose of paying the creditors. The property is not held on trust for the beneficiaries alone; the proprietary interest of the trustee is preferential to the interests of the beneficiaries, but that interest of the trustee is shaped by its purpose and origins in the trust relationship – to pay trust creditors in order to exonerate itself from those debts. The character and limits of the interest are shaped by its purpose and origins. The obligation of the trustee to use the trust assets to pay trust creditors is reflected by, and provides the foundation for, the creditors’ right of subrogation.” (emphasis added)

She noted that this description was consisted with prior High Court Authority (at [133] – [138]), and said that this description was also consistent with the nature of the trustee’s interest in the fund as a security interest in the form of an equitable lien. Such an interest is  “proprietary” in character not because it gave rise to rights amounting to full ownership, but in the sense that it gave rise to rights against a thing, not merely against a person.

It was said that it was incorrect to call the right of exoneration a proprietary interest. Rather, the right of exoneration generated a proprietary interest in the trust assets. And given the broad definition of “property” in the Corporations Act, this proprietary interest was clearly covered (at [140] – [141]). The principles did not change simply because the trustee company was insolvent (at [142] – [145]).

Gordon J also found it necessary to deal in obiter with four other matters which were not directly raised by the facts of the appeal at [146] – [148]:

1. Whether creditors generally could be paid out of the trustee’s interest in the fund or whether only trust creditors could be paid out, and whether uncertainty regarding this was a reason to reject the Commonwealth’s construction of s 433;
2. How s 433 would operate on a trustee of multiple trusts;
3. How costs of administration, which have priority in a winding up pursuant to s 556(1)(a) of the Corporations Act, should be distributed where there is a corporate trustee of multiple trusts; and
4. Whether there was an inconsistency between the approach adopted in relation to an insolvent corporate trustee, and the position of a bankrupt trustee.

In relation to the first matter, whether creditors generally could be paid out of the trustee’s interest in the fund, at [149] – [154], Gordon J held that assets were only available to be applied by the receivers to meet trust debts, and only in accordance with the priority rules mandated by s 433 (and in relation to liquidators, s 561) consistently with In re Suco Gold Pty Ltd (In liq). It was not correct to say that creditors generally could be paid out of the trustee’s interest in the trust fund. Where the right of reimbursement was exercised, at [155], Gordon J said that the trust assets which are subject to it are the trustee’s personal assets, and will be divisible among creditors of the trustee generally according to the statutory rules of priority fixed by the Corporations Act. However, at [156] – [158], Gordon J said that in the case of a right of exoneration, the proprietary interest of the trustee in the trust fund is shaped by its purpose and origins, namely – to pay trust creditors in order for the trustee to exonerate itself from those debts. Thus, circulating assets which are the subject of the right of exoneration can only be applied to satisfy trust debts and are not available for distribution to creditors generally. However, that limitation does not preclude the application of the relevant statutory priority rules − here, s 433 − for two reasons. First, s 433 of the Corporations Act does not change the nature and character of property that falls under control of the receiver as property of the company. Secondly, any different conclusion would require the priority regime in s 433 of the Corporations Act to alter the relationship between a trustee and beneficiaries such that the proceeds of a trustee’s right of exoneration could be used to satisfy the personal liabilities of the trustee, potentially leaving trust debts unsatisfied, but there is nothing in the Act to support this. Moreover,  in equity, creditors cannot directly get at trust assets, but instead have to be subrogated to the trustee’s right of exoneration.

In relation to the second matter, how s 433 would operate on a trustee of multiple trusts, at [159] – [166], Gordon J said that the attributes of the trustee’s proprietary interests require that s 433 be applied separately to each fund because s 433 does not alter the nature of the assets such that the funds can be mixed and applied to meet the claims of non-trust creditors. This may lead to practical difficulties and expense, but administrators and liquidators can use equity and various discretions under the Act, including by marshalling or hotchpotch. They can seek the directions of the court.

In relation to the third matter, whether there was an inconsistency between the approach adopted in relation to an insolvent corporate trustee and the position of a bankrupt trustee, Gordon J said at [167] – [172], it was said that the relevant authority can be treated as a trust creditor on the same basis as King CJ dealt with a liquidator’s expenses in In re Suco Gold such that that costs and expenses of winding up be paid in priority to all other unsecured debts. Moreover, expenses should be apportioned between trusts, except where this is not possible, in which case the principle that applies should be that equality is equity. If apportionment is difficult, the relevant authority (liquidator, provisional liquidator or administrator) should apply to the court for directions in relation to their costs.

In relation to the fourth matter, it was argued that because trust property could not be applied to meet the debts of a bankrupt, then the same approach should apply in relation to a corporate trustee. Gordon J said at [173] – [174] that that contention should not be accepted. The right of exoneration and the proprietary interest generated in the fund means that the “trust property” in which the trustee has an interest ceases to be aptly described as property “held on trust” but instead is property of the trustee subject to limitations as to use. Thus,  there is no apparent inconsistency between the corporate insolvency priority regime and s 116(2)(a) of the Bankruptcy Act 1966 (Cth), which provides that property held by a bankrupt in trust for another person is not property divisible amongst the creditors of the bankrupt. 

Gordon J on the second ground: whether an insolvent corporate trustee’s right of indemnity is comprised in or subject to a “circulating security interest” within the meaning of s 433

At [176] – [187], Gordon J said that it was not correct to say that an insolvent corporate trustee’s right of indemnity falls outside the ambit of property secured by a “circulating security interest” or “comprised in or subject to a circulating security interest” under s 433(2)(a). To say otherwise proceeded on a misconstruction of s 433(3).

Gordon J said there was no provision requiring the trustee’s right of exoneration itself to constitute a circulating asset and the right itself is not a circulating asset; it is a fixed asset. Moreover, the text of s 433 does not require, and provides no basis to find, that the “gateway” to reach the circulating assets – the right of exoneration – must itself be a circulating asset. The two questions to be answered were simply whether s 433(2) applied (which it did) and, if so, did the receivers hold circulating assets to which s 433(3) required the application of certain priority rules (which they did).

Conclusion

In conclusion, the High Court’s judgment provides welcome clarity to the question of whether the assets of an insolvent corporate trustee should be distributed to employees or trade creditors. It is now established that the priority regime contained in s 433 of the Corporations Act 2001 (Cth) applies to the trustee of a trading trust, and thus employees have priority, which increases the coherence of the overall regime.