Chapter 14Property held in trust
14.1The treatment of trusts in insolvency has ‘long been identified as an area for improvement with historical calls for reform’ including by the Harmer Report. However, reform in this area has been limited and no dedicated statutory regime has been enacted to regulate trusts. Despite this, company structure has increased in popularity and usage, making the complexities, inconsistencies and expense created by the absence of a dedicated statutory regime more obvious, particularly in the context of insolvency.
14.2Inquiry participants made clear that a broader regime of trust law reform is required, particularly in respect of insolvency, which could be the subject of consideration in a comprehensive review. However, the committee was informed that there may be certain issues that could be dealt with in the more immediate future.
14.3This chapter will outline the manner in which trusts currently operate and are regulated in Australia, particularly in the context of corporate insolvency. It will then consider the various calls for reform and make recommendations about future steps.
Trusts in the Australian economy
14.4In the trust structure, ownership of any trust assets are split: the trustee retains the legal interest, which allows them to deal with trust property in accordance with the terms of the trust deed in the interests of the beneficiary/ies, who hold the beneficial or equitable interest. This structure delivers some asset protection and tax benefits, while installing a corporate entity in the position of trustee which confers the benefit of limited liability. The trust structure creates two distinct economic entities, being the trustee and the trust, but under the law, the trust itself does not have legal personality separate from that of the trustee.
14.5In 1988, the Harmer Review noted that trading trusts had ‘become a popular device for conducting trade and commerce in Australia’. More than 30 years later, the committee was told that trading trusts remain ‘a popular and ubiquitous feature of Australian commercial life, including as a useful alternative to the Corporations Act company’.
14.6Statistics presented to the committee illustrate the representation of trusts across the economy. The Australian Small Business and Family Enterprise Ombudsman (ASBFEO), for example, told the committee that of the 2.5 million actively trading enterprises in Australia, about 950,000 are incorporated, meaning that the vast majority of enterprises are alternatively structured, including through trading trusts. Dr Nuncio D’Angelo pointed to data from the Australian Taxation Office (ATO), Australian Securities and Investments Commission (ASIC) and the ASX that demonstrates the prevalence of trusts in Australia:
…the ATO's most recent published annual figures—those for 2019-20—show that tax returns were lodged by over 927,000 trusts, having total assets of almost $2.2 trillion, total liabilities of over $1.4 trillion, and total annual business income of almost $400 billion. According to ASIC data, there are some 3,650 registered managed investment schemes, many if not most of which will be structured as unit trusts with a corporate trustee. This does not include the many commercial unit trusts that are not required to be registered with ASIC. Finally, turning to the ASX, at the end of last year the market capitalisation of listed real estate investment trusts was $137 billion, and of listed infrastructure trusts just over $62 billion.
Previous consideration of trusts in insolvency law
The Harmer Report
14.7In 1988, the Harmer Report identified a need for clarification in the existing law to provide more certainty in relation to corporate trading trusts in insolvencies and made 10 recommendations in this respect. These recommendations relate to the following broad themes:
administration of the business and affairs of an insolvent corporate trustee;
power to deal with property;
limitations on the right to indemnity;
removal of the company as trustee;
exercise of the right of indemnity;
distribution of proceeds among trust creditors; and
extended application of the trust provisions.
14.8The Harmer Report emphasised that ‘the principles for winding up an insolvent non-trustee company should apply to an insolvent corporate trustee yet at the same time maintain consistency with the general principles of trust law’.
14.9Evidence to the committee (as discussed further below) suggests that some thirty-five years later, the Harmer Report’s recommendations in respect of insolvent corporate trustees have not been implemented. No clear reasoning for this inaction was provided to the committee.
Treasury consultation – October 2021
14.10Clarifying the treatment of trusts in insolvency law was the subject of a Department of the Treasury (Treasury) consultation process in 2021. A consultation paper was published on 15October 2021, which called for submissions by 10 December 2021 to consider:
whether the treatment of corporate trusts in insolvency law required clarification;
the benefits of such reform; and
the most appropriate way to extend Australia’s statutory insolvency regime to these entities.
14.11Table 14.1 below sets out the 14 consultation questions that were put forward for discussion in the consultation paper.
Table 14.1Questions arising out of Treasury consultation paper on trusts, 15 October 2021
Question 1: Should the corporate insolvency framework be amended so that it expressly provides for the external administration of insolvent trusts with a corporate trustee? If so, what external administration processes should the amendments apply to? Question 2: What benefits would a legislative framework deliver? Question 3: Is there potential for detrimental or unforeseen impacts if the statutory regime is extended? Question 4: Should legislation expressly set out when a trust is deemed to be insolvent? Question 5: What is the most appropriate way to prescribe when a trust is taken to be insolvent? Question 6: Should the power of an insolvency practitioner to administer the trust assets and liabilities be expressly provided for in legislation? Question 7: Should the law provide that, subject to a contrary order by a court, the same insolvency practitioner may administer both the company, and the assets and liabilities attributable to any trusts for which the company is trustee? Question 8: Should the affairs of a trustee company and each trust it administers be resolved separately in external administration? Question 9: Should there be a statutory order of priority in the winding up of a trust? Question 10: Should a statutory order of priority replicate the regime for companies? Do additional factors need to be considered where a corporate trust structure is involved? Question 11: Should there be additional limits on the enforceability of ejection clauses and/or clauses that seek to limit a trustee’s right to indemnity, in situations involving insolvency or external administration? Question 12: What would be the impacts of any such limits? Question 13: Are there any other issues that need to be considered in light of the questions above? Question 14: What is the most appropriate model by which a statutory regime could be expressed in the legislation? |
Source: Treasury, Clarifying the treatment of trusts under insolvency law, 15 October 2021, pp.5–7.
14.12The consultation process received 29 submissions, including four confidential submissions. To the committee’s knowledge, no further public discussion took place in relation to this consultation prior to the end of the 46th Parliament. Treasury told the committee that the government is currently awaiting the outcome of this inquiry before taking any further action.
Regulation of trusts in insolvency
14.13The absence of clarity around the regulation of trusts, particularly in the context of insolvency, was raised as an ongoing issue and a cause of time inefficiency, complexity, and expense.
14.14Doctor’s Garry Hamilton and David Morrison highlighted the impact of the failure to adopt the recommendations of the Harmer Review. They stated:
More than three decades have now passed since the Harmer Report and the inattention to the matters originally raised by it has resulted in the continuing problems confronting practitioners and the courts. It is important that amendments are made because the problem is ongoing, and it is imposing unnecessary costs.
14.15A number of inquiry participants, including Professor Harris and Mr Murray and the Society of Corporate Law Academics (SCoLA) endorsed the recommendations of the Harmer Review with respect to insolvency in trusts. The Business Law Section of the Law Council of Australia (BLS LCA) and the Australian Restructuring Insolvency and Turnaround Association (ARITA) shared this view, endorsing the recommendations with a few amendments to address intervening events.
14.16As to trusts generally, Dr Nuncio D’Angelo told the committee that despite the prevalence of trusts across the economy, ‘the law does not fully recognise them as commercial entities and does not properly protect people who invest in or do business with them’. Dr D’Angelo said that ‘nowhere is this [absence of regulation] more obvious than when it comes to insolvency’.
14.17Dr D’Angelo explained that there is no dedicated statutory regime that protects stakeholders’ rights or informs the allocation of assets when trusts become insolvent. In the absence of such a regime, insolvent trusts must be dealt with through the insolvency of the trustee, be it through the Bankruptcy Act 1966 for natural persons or the Corporations Act 2001 (Corporations Act) for companies. Dr D’Angelo said that provisions in both regimes are being applied to trust insolvencies despite the fact that they were never designed to deal with trusts:
As a result, insolvency officials have to apply an overlay of trust law principles to work out parties' rights and the appropriate allocation of assets and losses. This is a somewhat slippery and perilous task. Those principles are mostly case law rather than statutory and are quite ancient, developed by the courts at a time when trusts did not engage in commerce or become insolvent as they do today.
14.18Dr D’Angelo said that ‘trust law itself can be quite complex, arcane and opaque’, leading to ‘copious litigation’ which has ‘forced the courts to fill the statutory vacuum by developing, in the usual stuttering, piecemeal fashion, a sort of common law of insolvency for trusts'. Dr D’Angelo added that the process by which a body of common law is developed ‘is slow and painstaking, and occasionally misfires’. He explained that ‘it is not a directed process and is not necessarily policy-based…it is essentially backward-looking and conservative’.
14.19Dr D’Angelo said that as a result of the absence of a statutory framework with respect to trusts in insolvency, outcomes have arisen ‘that are baffling and inconsistent with what would have been the result of the insolvent entity being a company’. He submitted that this has also led to inconsistent decisions in different jurisdictions as ‘[c]ourts across the nation, at both state and federal level, have handed down conflicting decisions on various questions’. As a result, Dr D’Angelo explained, ‘[t]he market is left in a state of ongoing uncertaintyand concluded that ‘it is simply not appropriate to leave the resolution of the many complex issues in the insolvency of trusts to a process that is so slow, random and uncertain’.
14.20A similar sentiment was expressed by Drs Hamilton and Morrison who posited that legislative intervention is necessary to establish the framework to address existing issues: no one case is likely to touch on all issues to allow for judicial interpretation and thus the creation of a comprehensive body of law to deal with the issues that arise.
14.21The Hon Reginald Barrett AO provided the committee with his submission to the 2021 Treasury consultation process. Judge Barrett identified that the High Court’s decision in Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth(Carter Holt) ‘resolved some important issues about cases in which an insolvent company’s activities are confined to trusteeship of a single trading trust’, however, ‘other uncertainties remain’. One such uncertainty, which Judge Barrett noted was raised in the Carter Holt decision itself, is in relation to ‘complications that may arise in cases where a corporate trustee has carried on business as trustee of more than one trust or as trustee of a trust and on its own account’. He explained:
At [56] [of the Court’s judgment in Carter Holt] it is noted that questions might arise about the correct order of priority between trust creditors after payment of the priority debts or about the marshalling of claims where a creditor has access to more than one fund…
14.22Echoing the sentiment expressed by Drs D’Angelo, Hamilton and Morrison, Judge Barrett asserted that ‘[s]uch difficulties and doubts cannot be left to random and piecemeal resolution as particular controversies are litigated at final appeal level’. He added:
Inconsistent views often emerge in court decisions. Two generations of lawyers pored over the uncertainty generated by the fundamentally conflicting 1983 decisions of intermediate appellate courts in Re Enhill Pty Ltd [1983] 1 VR 561 and Re Suco Gold Pty Ltd (1983) 33 SASR 99 until the matter was taken in hand by the High Court in Carter Holt.
Nor is it satisfactory that passing observations of judges not central to courts’ decisions should be the source of necessarily speculative views as to what the law might be.
Because the trading trust structure, with a company as trustee, has long been entrenched in Australian commercial life, liquidators, creditors, and others interested in the orderly administration of insolvent corporate trustees should be given by legislation the certainty and confidence that the current legal environment denies them.
14.23It was noted during the inquiry that at present, the power to legislate with respect to trusts is vested in the states. Therefore, in order to enact legislation in this space, the Commonwealth may need to seek a referral of the relevant powers from the States. Dr D’Angelo identified that the Corporations Act, which includes provisions that regulate managed investment schemes (which are configured as trusts with a corporate trustee), ‘was enacted and operates with the benefit of State referrals of power’.
14.24Dr D’Angelo told the committee that in his view, a great deal of the market and the profession supports legislative reform that would see trusts treated as companies. He explained:
The premise here is you have two entities that behave in the same way, do all the same things and put people at risk in the same way. There's no policy reason why those risks should be addressed any differently, simply because the parties have chosen one vehicle over another. The only reason we have that difference is a historical overhang—that is, parliament hasn't caught up to the fact that these entities are being used as if they were companies…there's no sensible, at least in my mind, policy reason why investors and creditors of companies should be treated any differently to trusts, when they both engage in the same risk-taking, profit-making activities.
Proposals for legislative reform
14.25Dr D’Angelo put to the committee that ‘the overwhelming preponderance of opinion’ appears to support legislative reform to address these issues by modifying the Corporations Act. He observed that there is no support for a standalone ‘Insolvency of Trusts Act’ nor a shorthand ‘deeming’ of trusts to be companies.
14.26Dr D’Angelo supported amendments to the Corporations Act that would seek to ensure that:
…in insolvency, commercial trusts and their stakeholders are dealt with in a manner that reflects the treatment of companies and their stakeholders, insofar as legally possible given their legal and structural differences.
14.27Such legislative reform could either:
(a)amend relevant specific parts of the Corporations Act individually so that they have ‘dual operation’ with respect to companies and relevant trusts; or
(b)consolidate all the necessary provisions into a new Chapter (say, a new Chapter 5AA Dealings with Relevant Trusts and their External Administration) that contains all the provisions needed for dealing expressly with relevant trusts.
14.28Three possibilities for legislative reform were provided to the committee. Firstly, draft legislation was submitted by Drs Garry Hamilton and David Morrison which would be inserted into Chapter 5 of the Corporations Act. This proposal would legislate for (among other things):
the winding up of an insolvent corporate trustee that has traded in its trustee capacity only;
the winding up of an insolvent corporate trustee that has traded in capacities other than a trust of a single trading trust;
the administration of the affairs of a corporate trustee.
14.29Drs Hamilton and Morrison’s draft legislation also suggests provisions to be inserted in the relevant state and territory Acts that would provide for the conferral of the relevant powers to the Commonwealth.
14.30Secondly, Judge Barrett provided an indicative outline of core provisions of a legislative regime for dealing with trusts in insolvency. In Judge Barrett’s view, under such a statutory regime:
…the estate of the company in its own right and the estate (or estates) of the company as trustee are administered separately but concurrently by a single and adequately empowered liquidator, with the assets and liabilities applicable to each such estate being dealt with in the way contemplated by the Corporations Act (including as to order of application of assets) as if the separate estate were itself a company. The regime should be constructed around the basic principle that the company is liable for all debts, including those incurred as trustee, but with a right of indemnity out of trust property for the debts properly incurred as trustee, which debts are to be met out of the trust property until that property is exhausted and thereafter out of non-trust property.
14.31Thirdly, Dr D’Angelo recommended the insertion of a new Chapter 5AA into the Corporations Act entitled Dealings with Relevant Trusts and their External Administration and provided the committee with a framework. The primary objective of the framework is to:
equate or align, as far as legally possible, the legal risks and outcomes in insolvency faced by arm’s length parties who do business with trustees of commercial trusts, with those of parties who deal with Corporations Act companies acting in their own right, but without otherwise interfering with the essential nature of the trust or the many benefits that accrue to those who use and deal with them as business vehicles.
14.32Dr D’Angelo said that the overall objective of his proposed legislative reform is underpinned by the following themes:
(a)in Australia, trusts operate as unincorporated business entities and, in that form, can and do engage in the same commercial activities as Corporations Act companies, and on a very substantial scale across the economy;
(b)arm’s length parties who conduct business with trusts face all the same risks as those who deal with companies (including the risk of their insolvency), plus a range of additional legal risks unique to the trust form;
(c)legal and other risks faced by those dealing with companies, both at the frontend (ie at the time of dealing) and at the back-end (ie in insolvency), are managed and ordered by sophisticated legislation that reflects prevailing socioeconomic and political philosophies and policy positions, while risks faced by those dealing with trusts are not;
(d)there is no obvious policy reason why this should be so, and (to my knowledge) there has never been a deliberate executive or legislative determination that it should be so. The difference can only be explained by regulatory lag, an unintended consequence of the rapid growth in use of the trust as an unincorporated business vehicle in recent decades;
(e)in my view, the primary objective of any reform should be to equate or align, as far as legally possible, the legal risks and outcomes in insolvency faced by arm’s length parties who deal with trustees of commercial trusts with those of parties who deal with Corporations Act companies acting in their own right, but without otherwise interfering with the essential nature of the trust or the many benefits that accrue to those who use and deal with them as business vehicles.
14.33Dr D’Angelo identified two significant considerations that would need to be kept in mind in undertaking any regime of reform. The first relates to concerns from critics of such reform that argue that ‘trusts are different animals and shouldn’t be treated like companies’. In response to this Dr D’Angelo emphasised that in any legislative reform, the benefits of the trust structure should not be interfered with. Dr D’Angelo explained that trusts ‘have valuable benefits, and we don’t want to interfere with those…No one wants to annihilate the benefits that trusts deliver…particularly in structural flexibility.’
14.34Secondly, Dr D’Angelo stressed that any reform would have to be cognisant of the two different types of trustees, being both natural persons and corporate trustees. Dr D’Angelo highlighted to the committee that while legislative reform concerning trusts with corporate trustees could be carried out by changes to the Corporations Act, such an action ‘would not be appropriate for trusts with a natural person as a trustee’.[58] Dr D’Angelo added, ‘[o]f course, if recommendations to merge the two regimes are adopted (with appropriate State referrals), the constitutional issues in the distinction would be dealt with in that process’.
14.35Other inquiry participants shared similar views. For example, ARITA advocated for a single insolvency law which addresses companies, partnerships, trusts and individuals. Deloitte opined that ‘[i]t would be short sighted…to provide a solution only for trading trusts with corporate trustees’.
Ejection of trustee in insolvency
14.36A frequent issue that was nominated as requiring reform arises where a trustee has a claim against trust assets to satisfy its right of indemnity or to satisfy liabilities incurred in the administration of the trust. The committee was told that at present, trust deeds frequently contain clauses which eject trustees from this position upon entering liquidation. Mr Richard Fisher, a consultant with Ashurst Australia and a Commissioner for the Harmer Review, explained that the effect of this is to deny trustees in liquidation the ‘continuing authority and ability to manage the trust assets, sell them and so forth’, the proceeds from which could be used to satisfy claims of creditors.
14.37In these circumstances, liquidators must apply to the court to be appointed as receiver of trust assets in order to be able to deal with them. The rationale for this arrangement, Mr Fisher explained, is that ‘because the administration involves the affairs of a trust, that administration should be subject to court supervision’.
14.38Inquiry participants told the committee that this arrangement causes unnecessary costs for liquidators and therefore detrimentally impacts returns to creditors. Professor Jason Harris described this issue as ‘the most pressing issue [in this] space’ and ‘an unnecessary cost on the system’. He explained:
What we know is a number of insolvency practitioners might be appointed over a company—let's say there's $30,000 worth of assets in the trust fund. All of that is going to be covered by their right of indemnity, so they are entitled to that amount, and yet they still have to go off to court and spend $15,000 or $20,000 to confirm that.
14.39Professor Harris explained that notionally, the rule exists to protect trust beneficiaries. However, in his view:
…in all of these cases we're talking about circumstances where the trustee company's right of indemnity is available and that, in most cases, will exhaust the funds regardless. The beneficiaries are not going to get anything out of this on either outcome.
14.40Legislative amendments were suggested to enable liquidators to deal with trust assets. Professor Harris expressed that this issue could be rectified by an amendment to the Corporations Act, as had been recommended by the Harmer Review, to express that, in circumstances where the right of indemnity is open, property of the company specifically includes property that is held on trust. Mr Fisher also suggested this amendment, which he described as follows:
All we're suggesting is that, where those liabilities have been incurred in the course of running the trust, the liquidator have direct access to the trust assets to satisfy the claims of the company corporate trustee in liquidation, in the way that the liquidator would have access to the company's assets which it owned in its own right to satisfy the claims of its creditors. The law says that the trust assets are charged with an obligation to satisfy the liabilities of the trustee incurred in its capacity as trustee.
14.41Submitters also noted that this issue could also be addressed by extending the ipso facto clause regime to prohibit such clauses. The BLS LCA stated that while such an approach may go some way to addressing this issue, gaps would remain, including ‘trust deeds which pre-date 1 July 2018 or corporate trustees which go straight into liquidation’.
14.42Mr Fisher told the committee that so far as he is aware:
…no objection is ever raised to the circumstance that the liquidator of a corporate trustee applies to a court for the liquidator’s appointment as received. So there is no objection, so far as the courts are concerned in their oversight of this regime, to the liquidator of the corporate trustee acting as received of the trust assets.
14.43The effect of this amendment, therefore is ‘to remove that additional step…of the liquidator as the corporate trustee having to go to court and spend the money associated with having the liquidator…appointed as receiver’. MrFisher advised that this proposal does not seek to change the benefits of using a corporate trust, but rather improve the administration of trusts in insolvency to make it more simple and less expensive.
14.44It was suggested to the committee that such reform could be described as ‘low hanging fruit’ and could be undertaken swiftly. The BLS LCA told the committee that on this issue, there appears to be broad consensus, and that this area could be one addressed in the short-term future without need for consideration by the comprehensive review.
14.45Associate Professor Hargovan, with whom Associate Professor Wellard agreed, expressing the view that a carve-out of the nature suggested could exist for a ‘plain vanilla trust’, otherwise known as a single trading trust where the company has acted as trustee for one trust only.
Register of trusts
14.46The committee was told that a major issue in dealing with trusts is the lack of transparency involved. It heard that while sophisticated investors may be able to ascertain that the entity they are dealing with is a trust, many do not, and therefore do not realise that the assets of those entity do not, in a beneficial sense, belong to that company.
14.47One solution proffered is the establishment of a publicly available register of trusts. Associate Professor Hargovan suggested that such a register would ‘be enormously helpful’ for those who engage with trusts. It would increase ‘awareness of the entities they are dealing with and what the possible implications are... There would be a benefit in creating transparency’.
14.48The repository for such a register was also discussed. Dr D’Angelo, for instance, expressed the view that the register should sit within ASIC. For ASIC’s part, Mr Warren Day, Chief Operating Officer of ASIC, stated that it was for government, Treasury and the parliament to consider whether trusts should be registered and searchable in the same way as companies. He explained:
There are some functional things, though, that go with that. Obviously, there would need to be a separate register set up for them, and that would have to be through, I would expect, Australian Business Registry Services, which, as members of this committee would know, is connected into this modernisation of business registers.
14.49Mr Day pointed to the ongoing review of the Modernising Business Registers program, which is being led by Mr Damon Rees and is due to report to government by 30 June 2023. Mr Day suggested that the establishment of such a register would have to follow the modernisation of the current registers of companies and business names. He expressed the view that he could not ‘see how you would find time to then push in another register of those things’.
Committee view
14.50Between the Treasury consultation process and evidence provided to this inquiry, a significant body of evidence has developed which supports timely and substantial legislative reform to protect stakeholders who undertake or engage in business with trusts. It is clear that the status quo, wherein corporate trust insolvency is a matter largely determined by common law precedence rather than legislation, drives up rates of litigation and thus expense.
14.51The committee acknowledges that the issues related to trust law are complex and require rigorous examination. However, the Harmer Report recognised that legislative reform was necessary to clarify the treatment of trusts in insolvency law more than 30 years ago, and proposed solutions to address this. The inattention that has persisted since has resulted in continuing uncertainty, inefficiency and expense for stakeholders in this space. Ensuring that stakeholders who engage in business with trusts receive the same protections as those who engage with Corporations Act companies is a matter both of fairness and economic advantage.
14.52The committee acknowledges and supports calls for reform to address the absence of a dedicated statutory regime for dealing with insolvency in the trust environment. The committee is of the view that the following considerations should be taken into account in this process:
(a)In order for broader reform to be enacted, the Commonwealth may need to seek a referral of powers from the State governments. The government should seek the views of the State governments on this matter and establish a path forward.
(b)The committee has heard that the current body of law in respect of trusts has developed in a piecemeal way, leading to inconsistencies and inefficiencies. The government should seek to achieve cohesive legislative reform to end this cycle.
(c)The committee supports the views of inquiry participants who favour the implementation of the Harmer Report recommendations and is of the view that the government should analyse and update the recommendations where necessary to ensure that they reflect contemporary circumstances.
(d)The committee finds favour with the proposition that reforms in this space should not fundamentally undermine the core tenets of the trust structure. It encourages the government to consider proposals for legislative reform, such as those put to this inquiry and the Clarifying the treatment of trusts in insolvency Treasury consultation, while maintaining the inherent benefits of this structure.
14.53The committee notes the near universal support for the implementation of an amendment to the Corporations Act to allow liquidators appointed to an insolvent corporate trustee to deal with trust assets. The committee supports such an amendment for single trading trusts but is of the view that further consultation may be necessary (noting the consultation already undertaken by Treasury), before extending this to trustees of multiple trusts.
14.54The committee supports the establishment of a register to increase the transparency of trading trusts. The committee notes the ongoing work of the Modernising Business Registers program, but is of the view that the government should consider options for establishing such a register at a reasonable time.
14.55The committee recommends that the government amends the Corporations Act 2001 to expressly clarify the treatment of trusts with corporate trustees during insolvency.
Senator Deborah O'Neill
Chair