In a judgment delivered this week, the Federal Court of Australia has given directions to a court-appointed receiver touching on a series of priority questions arising out of an apparently insolvent discretionary trust.

In Francis (Trustee), in the matter of Fotios (Bankrupt) v Helios Corporation Pty Ltd [2022] FCA 199, Colvin J confirmed the broad power of the court to give directions to a receiver it has appointed over trust property, and proceeded to make observations about the appropriate priority arrangements between a number of competing parties.  The most interesting finding confirms that properly registered financiers with first-ranking security interests perfected by registration against a trust’s ABN and even a trustee’s ACN may nevertheless be subordinated by the claims to trust property of ordinary unsecured creditors of a former trustee.

Blackwall Legal acted for the successful receivers in obtaining the directions, and partner Chris Pearce appeared as counsel.

Background

The case concerns a family trust established in 1986.  An individual was trustee for some three decades until he was made bankrupt, triggering an ipso facto removal provision in the trust deed.  A company replaced him as trustee of the trust, and the trustees in bankruptcy of the bankrupt former trustee commenced action against the replacement trustee claiming an entitlement to trust property by reason of the bankrupt’s rights both of recoupment and exoneration.  The company entered voluntary administration, where it remains for the present time.  It remains the trustee of the family trust, but in any event, the voluntary administrators were appointed by the court (with the consent of the bankruptcy trustees of the former trustee) as court-appointed receivers of the family trust assets.

The receivers applied for directions as to the applicable priorities between competing interests to trust property, and answers to some specific questions about the characterisation of certain issues.  Notice was given to all relevant creditors, but only the trustees in bankruptcy for the former trustees appeared.

Jurisdiction

As court-appointed receivers lack the ability to utilise the directions power under s 424 of the Corporations Act 2001 (Cth), the application needed to establish alternative power for the court to make orders.  There were up to four potential sources of power for such jurisdiction:

• the power to make orders under s 90-15 of the Insolvency Practice Schedule (Corporations);
• the power to make orders under s 90-15 of the Insolvency Practice Schedule (Bankruptcy);
• the power to give directions to trustees under s 92 of the Trustees Act 1962 (WA); or
• the inherent jurisdiction of the Court.

Justice Colvin hinted that despite the extraordinary breadth of the modern statutory insolvency powers in the Insolvency Practice Schedules, there is a question whether an application by receivers relating to their own actions pursuant to court orders appointing them falls within those powers.  The Court found there was no need to consider that question in detail given the Court had power under its inherent jurisdiction to give directions to receivers it had appointed.

Priorities generally

The judgment summarises a priority waterfall in which the court recognised:

• the superior rights (under the Universal Distributing principle, though that case was not explicitly mentioned) of certain parties who had participated in the care, preservation and realisation of the trust assets – including court appointed experts, the receivers, and to a certain extent, the trustees in bankruptcy of the former trustee and the administrators of the replacement trustee;
• the priority entitlement of the rights against trust assets of the first-in-time former trustee (whose loss of office does not result in the loss of rights of indemnity) over the replacement trustee;
• the entitlement (referred to by the High Court in Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20 and by the Full Federal Court in Jones (Liquidator) v Matrix Partners Pty Ltd, in the matter of Killarnee Civil & Concrete Contractors Pty Ltd (in liq) [2018] FCAFC 40) of so-called “trust” creditors to subrogate to the claims of the former and replacement trustees under their rights of indemnity; and
• the consequence that in both the corporate insolvency and personal insolvency contexts, the proceeds become available in accordance with statutory priorities but only to so-called “trust” creditors of the insolvent bankrupt and company respectively.

The receivers also asked for directions in respect of certain specific questions arising from somewhat complicated factual scenarios.

Unpaid present entitlements

A report by court-appointed experts revealed some asserted claims (said to be between $5.1 million and $8.4 million) by beneficiaries of the trust to so-called “unpaid present entitlements” arising over a number of years by reason of a claim to distributions said to have arisen but not been paid out of trust assets.  There were at least the following issues which the Court was not asked to determine as they remained the subject of factual inquiries:

• Was the former trustee (the bankrupt) prohibited conceptually from giving rise to an unpaid present entitlement owing to himself personally by reason of the self-dealing rule (effectively preventing the former trustee from contracting with himself to create the entitlement even in a different capacity)?
• Had the unpaid present entitlements to the bankrupt and to other parties arisen on the facts in any event?

Separately from those questions was an issue about the characterisation of the entitlements.  Were they merely debts claimable against the trustee or did an entitlement give rise to some greater, even proprietary claim to the trust assets?  The issue had been considered in a different context by the Court of Appeal of Western Australia in Chianti Pty Ltd v Leume Pty Ltd [2007] WASCA 270.  In circumstances where the trust deed specified that upon declaration, such entitlements were to be set aside and held directly for the relevant beneficiary (but where in this case and in Chianti, that did not appear to have occurred) was there some greater claim to the trust assets than an entitlement to be paid the relevant amount?  In Chianti, Buss JA had concluded that the trustee held the distributed amounts on trust for the beneficiary absolutely.  Still, the beneficiary made (and was found to be entitled to make) personal claims against the trustee.

Justice Colvin considered Chianti and also the prospect that a beneficiary’s claim might be framed differently – for example a compensatory claim in equity arising from a breach of trust by the trustee in not holding property in a particular manner.  The difficulty arises that certain types of claims against the trustee might not be subrogated to the trust assets, if for example the trustee’s conduct was sufficiently vitiated to affect the right of indemnity.  Ultimately, the Court determined that there was nothing to indicate the beneficiaries held a vested interest in the trust property (as distinct from a right to call for the obligations in the trust deed to be performed).  Consequently, there was no reason to suspect that such beneficiaries held direct proprietary claims against trust assets which might affect priority, though the Court gave the various UPE creditors the right to apply to make further submissions on the point.

Sale of personal property to satisfy trust debt

The former trustee and his wife had mortgaged a property in support of a guarantee of a loan taken out by the bankrupt in his trust capacity.  That is, the primary borrower under the loan facility was the former trustee of the trust, but the bank had taken security over personal assets.  Upon the former trustee’s bankruptcy, the bankrupt’s joint tenancy with his wife was automatically severed at law.  The trustees in bankruptcy sold the property and applied the proceeds first to the bank in satisfaction of the guaranteed liability.  Half of that amount was effectively satisfied by the bankrupt’s wife giving rise to a right to subrogate to the bank’s unsecured claim against the former trustee, and to subrogate further to the former trustee’s right of exoneration against trust assets.  The bankrupt himself had satisfied a personal obligation and was (as former trustee) entitled to claim against the trust property under his lien.

Subordination of security interest

Of most note in the Court’s findings was a conclusion about the priorities to be afforded to a first-ranking security interest granted to the bankrupt’s wife by the replacement trustee and perfected by registration on the PPSR against both the ABN of the Trust and the ACN of the replacement trustee.

Section 73 of the Personal Property Securities Act 2009 (Cth) sets out a series of interests arising “by operation of general law” that will be afforded priority to interests perfected by registration.  Certain questions arise as to whether a trustee’s right of indemnity in a given case arise “by operation of general law” (Colvin J concluded that any right of indemnity arising from the trust deed did not exclude the equitable rights).  Applying the requirements of s 73(1), the former trustee’s rights of indemnity satisfy the requirements to be afforded priority even over subsequent security interests perfected by registration.

The upshot is that a financier taking security from a trustee must assume that any continuing trust debts of a former trustee (despite being unsecured) will nonetheless take priority over their security interests.  In our view, registering against the former trustee is unlikely to be sufficient – PPSR registrations merely notify of (and perfect) existing interests and no security has been granted by the former trustee.  Rather, to obtain certainty, the financier must obtain consensual security from the former trustee (either AllPAAP or at least covering all rights against trust assets).  The interest should be perfected by registration against both the trust (usually by its ABN) and the trustee.