Amending trust deeds pre-liquidation – a cautionary tale

Articles, Restructuring + Insolvency

The continuing saga of insolvent trustees: amending instruments immediately before liquidation

In the recent decision in Carrello, in the matter of Gembrook Investments Pty Ltd (in liquidation) [2019] FCA 1143, the Federal Court of Australia dealt with an application by a liquidator in relation to his remuneration as liquidator of an insolvent corporate trustee. The case provides interesting commentary on the amendment of trust instruments prior to an insolvency event.

Relevant background

Gembrook Investments Pty Ltd (in liquidation) (Gembrook) was the trustee of the Bailey Family Trust. As trustee, it traded a Hogs Breath Cafe in the northern suburbs of Perth. Gembrook had no other function. All of its assets were assets of the Trust and all liabilities incurred in the conduct of the Cafe business.

On 12 September 2017, Gembrook was wound up and a liquidator appointed. Immediately prior to the liquidator’s appointment the trust instrument was amended pursuant to a power of amendment. That amendment provided that where a liquidator was appointed the trustee of the Trust could not be removed and “all remuneration, fees, charges and expenses [of the liquidation] shall be expenses properly incurred by the Trustee in the administration of the Trust and payable from the Trust Fund”.

Following appointment, the liquidator realised the assets of the Trust and recovered a number of unfair preference claims. Relevantly, the liquidator did not apply to the Court to be appointed receiver of the Trust. There was ultimately insufficient funds from realisations / recoveries to pay out priority creditors with employee entitlement claims and ordinary unsecured creditors in full. The liquidator made an application to the Court seeking, amongst other things, orders that he would be justified in paying his costs and remuneration, and paying creditors in accordance with section 556 of the Corporations Act 2001 (Cth) (Act). That application was brought with notice to ASIC, creditors, and those beneficiaries of the Trust that could be clearly identified.

Key points

Whilst not having to decide the matter, there being no argument in support (or opposition), the Court did raise issue with the amendment to the trust deed. The Court referred to the decision in Mercanti v Mercanti [2016] WASCA 206; (2016) 50 WAR 495, where in the Court concluded that a power of amendment in a trust instrument could not be used for any extraneous or ulterior purpose.

The Court noted that the power of amendment was exercised at a time when Gembrook was clearly insolvent. In the Court’s opinion, the amendment power in the trust instrument was exercised in the interest of creditors as opposed to the beneficiaries of the Trust. The effect of the amendment was to apply in such a way to enable the liquidator to sell Trust assets and apply the proceeds by way of exoneration on the basis of Gembrook’s right of indemnity for liabilities to creditors. However the Court did not have to ultimately decide whether the amendment power had been exercised in circumstances that would amount to a fraud.

In addition to the above, the Court gave a useful summary of the recent authorities clarifying the position with respect to insolvent corporate trustees who do not perform any other functions as follows:

  1. Liquidators of an insolvent trustee can exercise the statutory powers to realise assets in the exercise of a lien or charge that secures the trustee’s right of indemnity. It is necessary however to apply to the court and seek appointment as receiver (seeJones (Liquidator) v Matrix Partners Pty Ltd, in the matter of Killarnee Civil & Concrete Contractors Pty Ltd (in liq) [2018] FCAFC 40).
  2. Those proceeds can then be appropriated by way of exoneration and applied in accordance with section 556 of the Act (see Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth[2019] HCA 20).
  3. A liquidator of an insolvent trustee with no other function is entitled to be paid their remuneration for their work in administering the trust fund and for winding up the affairs of the corporate trustee (see for example In the matter of AAA Financial Intelligence Ltd (in liquidation) ACN 093 616 445[2014] NSWSC 1004).

Takeaways

The decision is interesting for a number of reasons:

  1. First, when considering whether to amend a trust instrument prior to the appointment of an external administrator regard must be had to the form of the amendment power and its intended purpose.
  2. Secondly, whether the removal of an ipso factoclause providing for the automatic removal of a trustee on the occurrence of an insolvency event (a common clause in trust deeds) would be contrary to the power of amendment. Whilst ultimately to be determined on a construction of the particular amendment clause, it is an interesting proposition where the amendment is utilised to avoid the corporate entity continuing as bare trustee.
  3. Thirdly, irrespective of the size of the administration / available assets a liquidator is required to apply to the Court to deal with the assets of the trust as receiver of those assets.

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