Trust me: Liquidators justified in using trust funds to investigate potential claims available to trustee - Financial Restructuring

This week's TGIF considers a recent decision in which the Court directed that liquidators would be justified in utilising trust funds to conduct further investigations to identify and pursue potential claims available to a trustee.

WHAT HAPPENED?

The plaintiffs were appointed as voluntary administrators of the trustee company (Trustee) and subsequently became its liquidators. The Trustee acted as responsible entity and trustee within a corporate group that funded property investment and development activities.

During the course of the plaintiffs' investigations, concerns were raised with respect to transactions between the Trustee and a third party (Third Party) and potential claims against the directors of the Trustee for breaches of duty in relation to those transactions. The transactions with the Third Party were already the subject of separate proceedings commenced against the Trustee.

On 30 September 2016, the plaintiffs sought directions under s 511 of the Corporations Act 2001 (Cth) (the Act) for directions as to whether they would be justified in expending trust funds to:

conduct public examinations and obtain orders for production under Part 5.9 of the Act; and
obtain counsel's opinion in respect of the transactions between the Trustee and Third Party and whether the separate proceedings should be defended and/or cross-claims brought.

Evidence was led by the plaintiffs that it was in the interests of creditors for the liquidators to undertake further investigations as it would be in a better position to assess the likelihood of certain outcomes if permitted to do so. However, this course of action was opposed by a creditor of the trust (Trust Creditor).

THE COMPETING ARGUMENTS

In simple terms, the Trust Creditor argued that, as the only trust creditor, the available trust funds should be used to meet its claim rather than used to defend the separate proceeding. The Trust Creditor asserted that the only party to benefit from a successful defence of the separate proceeding was the trust beneficiary, and if the defence was unsuccessful, the Trust Creditor would be disadvantaged (because the trust assets would have been depleted in defending the separate proceeding).

The plaintiffs responded that they could not simply disregard the interests of the beneficiary in determining whether to conduct examinations and, further, given the potential misconduct identified, it may not be appropriate for the plaintiffs not to defend the separate proceedings and allow judgment to be entered against the Trustee.

The plaintiffs also pointed out that, even if proceedings had not been commenced against the Trustee, they would not have accepted a proof of debt lodged by the Third Party. As such, the dispute was inevitable and therefore the action proposed did not place the Trust Creditor in a worse position.

THE APPLICABLE PRINCIPLES

A direction under s 511 of the Act provides a liquidator with a level of comfort that the conduct they intend to take is sanctioned by the Court and they will be free from personal liability for breach of duty.

However, there must be something more than the making of a commercial decision. There must be an issue of power, proprietary reasonableness or involve a legal issue of substance or procedure before the Court will give such direction.

THE COURT'S DECISION

His Honour was satisfied that there was a real controversy that confronted the liquidators and the advice sought was not in respect of a mere commercial decision.

With respect to the arguments raised by the Trust Creditor, the Court was not convinced, on the evidence, that the Trust Creditor would be paid in full in the immediate future or that the beneficiary would be the only party that benefits from the defence of the separate proceedings.

His Honour accepted the plaintiffs' submission that they should at least be cautious in not pursuing a meritorious defence, simply because that may be to the commercial disadvantage of a creditor of the trust.

Further, the Court rejected the notion that a liquidator must not pursue examinations, obtain counsel's advice or conduct proceedings, where the advantage of doing so would flow to both higher and lower ranking creditors but the costs of doing so would potentially be borne by lower ranking creditors if those proceedings were unsuccessful.

His Honour noted that the funding of the liquidators' actions, if properly undertaken, is by recourse to the assets of the trust, with the ultimate economic impact to be determined in accordance with the relevant trust documents.

COMMENT

With the increasing use of corporate trustees as a vehicle to conduct commercial enterprise, liquidators continue to confront complex factual and legal scenarios when winding up such entities in the face of competing demands from beneficiaries and trust creditors.

A prudent insolvency practitioner should seek the Court's direction when faced with matters which involve questions of reasonableness or a legal issue of substance. This is particularly so when embarking on a course of action that will incur costs to be reimbursed from trust assets.

If that course of action involves legal proceedings, the Court will consider what is in the best interests of creditors and sanction conduct which may ultimately be of advantage to the liquidation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.