Several times throughout my years of legal experience, I’ve had to consider whether some legal right constituted property. Was this a proprietary interest or just a personal right (the in rem/in personam divide)? Thus, I found rather fascinating the High Court of Australia’s recent decisions in Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20.
The case dealt with an insolvent company trading as the trustee of a trading trust and whether s 433 of the Corporations Act 2001 (Cth) gave priority to employees of the company over other creditors just as it would if the company was not a trustee. Section 433 applies if a receiver is appointed on behalf of the holders of any debentures of a company that are secured by a circulating security interest. In this case, the company had various debt facilities with a bank secured by a range of securities including, it was found, a circulating security interest. Section 433 provides that a receiver of an insolvent company must pay “out of the property coming into his, her or its hands… in priority to any claim for principal or interest in respect of the debentures…” claims by employees.
The first issue was whether s 433 gave priority to the employee entitlements if the assets were held on trust by the company. The popular understanding was that property held in trust was not “property” of the company for insolvency purposes. The second argument put forth by the appellant was that s 433 could not apply because the company’s right of indemnity was a fixed asset rather than a circulating asset and, therefore, not capable of being subject to a circulating security interest for the purposes of s 433.
The nature of the trustee’s right of indemnity was at the core of the case. The interesting aspect of the case for me was how the High Court, in each of the three judgments, dealt with the trustee’s right of indemnity. In deciding whether employee entitlements had priority, the Court of Appeal of Victoria had rejected the claim by the appellants that the right of indemnity was the only “asset” that constituted property of the company and that s 433 didn’t apply because the right of indemnity was fixed not circulating. I found it curious that the actual right of indemnity was considered an asset, in and of itself.
The right of indemnity which arose in favour of the trustee in this case was the right of exoneration. This is, the right to be reimbursed out of the assets of the trust for liabilities properly incurred by the trustee in the course of trust business. So even though the trustee had only bare legal title to the trust assets, it had the benefit of those assets to the extent of its indemnity. Therefore, creditors of the trustee had access to the assets of the trust through the trustee’s right of indemnity.
All three of the High Court’s judgments dismissed the appeal and found that employee entitlements could be paid in priority pursuant to s 433. However, they differed in their approach to the nature of the trustee’s right of indemnity.
The judgment of Kiefel CJ, Keane and Edelman JJ characterised the right of indemnity as conferring upon the trustee a “proprietary interest” in the trust assets, and that the “legal title held by the trustee has thus been described as subject to an equitable charge or lien in favour of the trustee to secure the powers of indemnity.” [32] The property interest of the trustee, therefore, would seem to be the interest in the trust assets created by the right of indemnity rather than the right of indemnity itself. These judges found that it was incorrect to treat the rights held on trust by the trustee as if they existed separately and independently from its power of exoneration. [50] Although they did not come right out and say that the power of exoneration was merely a personal right, they found it was not necessary for the right of indemnity to be subject to a circulating security interest but that s 433 was satisfied as long as the trust assets (to which the right of exoneration extended for the benefit of the trustee) were circulating assets. In this case, those assets were inventory which are circulating assets subject to the bank’s circulating security interest. Thus, s 433 was satisfied and employee claims had priority.
Similarly, the judgment of Bell, Gageler and Nettle JJ stated that the trustee is entitled to be indemnified out of the trust assets and, therefore, enjoys a beneficial interest in those assets. [80] This judgment referred to Professor Ford’s argument as misplaced, an argument which I thought made much sense by proposing that the trustee’s right of exoneration is properly characterised as conferring a personal power. It is not property nor does it create a beneficial interest in the trust assets.[1] The judges stated that this position distracted attention from the practical relationship between the trustee’s equitable right of indemnity and legal powers of ownership. They found that the trustee has an equitable charge or lien over the trust assets but with a distinction that sent me straight to my online dictionary:
It is not, however, a charge or lien comparable to a synallagmatic security interest over property of another. It arises endogenously as an incident of the office of trustee in respect of the trust assets. [83]
The judgment acknowledged that the trustee’s right of indemnity could as well be described as conferring a personal power, but the trustee’s right to apply trust assets in satisfaction of trust liabilities is proprietary in that it may be exercised in priority to the beneficial interests of the beneficiaries. The judgment made another useful distinction by stating that the “property constituted of the right of indemnity as such and the property constituted of trust assets themselves are separate and distinct, albeit that the former confers a proprietary interest in the latter.” [85] It was noted that the right of indemnity itself was not “property [of the company] comprised in or subject to a circulating security interest”. Rather, it was the inventory held in trust by the trustee that was subject to a circulating security interest for the purposes of the s 433.
In her judgment, Gordon J agreed that the trustee’s interest in the funds held by the receiver for distribution was generated by its right of exoneration. Gordon J stated at the beginning of her judgment that the right of exoneration is a fixed asset [108], but this didn’t preclude the operation of s 433 because the funds held by the receivers for distribution were proceeds of assets that had been circulating assets. She acknowledged that the trustee has an equitable charge or lien on trust property to satisfy its right of indemnity. But she also recognised that a number of previous cases adopted imprecise language in referring to the right of exoneration itself as the proprietary interest. She emphasised that the right of exoneration generates a proprietary interest in the trust assets. The proprietary interest in not the right of exoneration itself. This is a very helpful clarification. However, she concludes by saying that the right of exoneration is not a circulating asset, but a fixed asset which suggests that the right of exoneration itself is a proprietary interest. I am left to ponder whether something can be an asset but not a proprietary interest?
As stated in the introductory paragraph to the judgment of Kiefel CJ, Keane and Edelman JJ, the Australian Law Reform Commission observed in 1988 that companies legislation makes little or no provision for corporate trustees that become insolvent and this remains true today. Nevertheless, as far as the application of s 433 to insolvent corporate trustees, the High Court of Australia has now spoken.
[1]“Trading Trusts and Creditors’ Rights” (1981) 13 Melbourne University Law Review 1 at 4-5, 14, 17.