Can You Trust A Trust?

A trust is a relationship where a person (the trustee) is under an obligation to hold property for the benefit of other persons (the beneficiaries/unit holders). The terms of the obligation are defined by the terms of the trust deed entered into between the trustee and the settlor.

Generally, Australian law recognises as legal entities:

• individuals

• companies

• governments and statutory corporations.

However, a trust has no separate legal entity. A person must contract with the trustee as the trustee is the legal owner of the trust property. The beneficiaries of the trust hold the beneficial interest in the trust property.

A lender cannot directly provide financing to a trust. Instead, when a transaction involves a trust the lenders will be providing the finance to the trustee as borrower.

The description of the borrower should not contain any reference to the capacity in which the trustee is acting. For example, the borrower would be described as ABC Limited, as that is the legal entity borrowing.

However, to make it clear that the lender will have access to the trust assets, a clause should be included in the loan contract to acknowledge that the trustee is liable in its own right and in its capacity as trustee of the relevant trust.

Three Key Issues to Consider When Lending to a Trustee

The Trustee's Right of Indemnity

A trustee is personally liable for its obligations incurred as trustee of a trust. However, the trustee will usually have a right to be indemnified from the trust assets. The trustee's right to be indemnified from the trust assets is usually explicitly set out in the trust deed. It is usual to provide that the trustee will be entitled to be indemnified except to the extent that a loss is caused by the fraud, negligence or wilful default of the trustee.

A lender to a trust will only have recourse to the assets of the trust to satisfy its obligations under the loan agreement through the trustee's right of indemnity.

It is therefore very important to ensure that the trustee has all necessary power under the terms of the trust to do what the trustee intends to do. The powers to act will usually be contained in the trust deed. If the trustee does not have the power then it will not have the right to be indemnified out of the assets of the trust. For a lender, this could mean that it will only have recourse against the trustee personally and not to the assets of the trust, which may see the lender being an unsecured creditor of the trustee - an unintended and undesirable position to be in.

ABN vs ACN

Australian Company Numbers or ACNs were introduced to the Corporations Act many years ago. The purpose was to give a unique identifier number to each company.

Australian Business Numbers or ABNs came along with the introduction of GST on 1 July 2000. The ABN for most companies is the ACN plus a two digit prefix.

A single company can have more than one ABN. A separate ABN may be held in respect of the enterprises it conducts in its capacity as trustee of a trust.

Many pro forma legal documents now provide the option for inserting the ABN or the ACN. However, the use of an ABN could unintentionally reduce or limit the operation of a legal agreement.

Consider the following example:

Company X has an ABN for itself and also for the discretionary trust under which its main business is conducted.

If Company X is described in a loan agreement using the ABN for the company, arguments could arise as to whether the lender will have any recourse to the trust assets. This would be so despite a general clause saying that Company X enters the agreement in its own right and as trustee of any trust. The argument could arise because the specific use of a specific ABN may override general catch all provisions.

An even more awkward situation could arise if the ABN for the discretionary trust was used. As trusts do not comprise a separate legal entity, arguments could arise as to whether the trustee is a party to the transaction. This could jeopardise the validity of the entire loan arrangement.

One would hope that in the ordinary course, courts will prevent parties avoiding commercial obligations by use of this type of argument. However, a party could gain valuable time while arguing the point, particularly when it is a novel point which has not previously been considered by the courts.

Therefore, it is preferable whenever preparing a legal contract (whether it takes the form of formal deed, an agreement, or an exchange of letters) to use ACNs and not ABNs. However, ABNs are required on tax invoices.

Removal of a trustee

The removal of a trustee is regulated by the trust deed. Trust deeds frequently provide for the automatic removal of the trustee without the appointment of a replacement trustee in the following circumstances:

• if the trustee being an individual is found to be of unsound mind or becomes bankrupt

• if the trustee is a company, enters into liquidation (whether compulsory or voluntary), is placed in receivership or under official management by order of any court.

Lenders do not want the trustee to be automatically dismissed because if the lender enforces its security against the trust assets, the act of appointing a receiver will immediately terminate the office of the trustee. It may then be necessary to apply to court for the appointment of a replacement trustee, which will cause delay and cost.

It is recommended that any trust deed, which provides for the automatic removal of the trustee without a replacement trustee being appointed be amended prior to settlement.

• always ensure that the trust has power to enter into the transaction. Always ensure the borrower is bound in both capacities – personal and as trustee

• when preparing a legal contract, use ACNs and not ABNs

• ensure the trust deed does not provide for the automatic removal of the trustee without a replacement trustee being appointed.

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.