On 23 February 2016, Justice Brereton in the New South Wales Supreme Court handed down the decision in the matter of Independent Contractor Services (Aust) Pty Ltd ACN 119 186 971 (in liquidation) (No 2) [2016] NSWSC 106.

This is an important judgment, with significant consequences for the insolvency community.

The decision deals with two fundamental aspects of insolvency law, being:

  1. How a liquidator should distribute surplus funds to creditors whose proofs of debt have been admitted to proof where the company in liquidation is the trustee of a trading trust; and
  2. How a liquidator’s remuneration should be calculated when winding up such a trust, particularly when the pool of available funds is relatively small.

Brevity dictates I only deal with the first of these issues at this point in time. However, both are of considerable importance to insolvency practitioners in their everyday practices. This is a decision that all Australian liquidators and the lawyers who deal with them should know of and understand.

Virtually nothing about the facts of the case was in any way remarkable. The liquidator was tasked with responsibility for winding up a proprietary company (ICS) that carried on a small business as the trustee of a discretionary family trust. The liquidator had originally been appointed as the voluntary administrator of the company, but became the liquidator by reason of the vote of creditors at the second meeting. The funds available to the liquidator were (it appears) derived from the collection of debtors, monies in an existing bank account and the receipt of a GST refund. The liquidator had paid himself his approved remuneration and expenses for the administration, as well as his expenses incurred throughout the liquidation, leaving the princely sum of $130,980.00 in the liquidation bank account.

Quite simple so far, you must be thinking. It sounds a lot like the sort of “bread and butter” liquidation that insolvency practitioners deal with on an everyday basis. You would be right on both counts. Liquidators frequently encounter companies that have carried on their businesses as the trustee of a family trust or a unit trust. It is an orthodox asset-protection structure that has been adopted by business owners since Abraham and his sons set up shop in Canaan.

Creditors of ICS had lodged proofs of debt with the liquidator in amounts far exceeding the funds available to him. There were 21 trade creditors who claimed $232,368.84 between them and a proof of debt from the ATO in a sum approaching $12 million. Of this, over $2 million related to unpaid employee superannuation payments.

For as long as I can remember, in these circumstances liquidators have applied the scale of priorities set out in section 556 when paying dividends to creditors. To my mind, the fact that the company is a trustee does not of itself preclude the operation of that provision. After all, the trustee is still a company and it is still a winding up conducted under the Corporations Act. At least that is how I understood the law of this land to apply. Well, having read His Honour’s decision I now realise that I could not have been more wrong.

Brereton J has made it clear that such reasoning is completely flawed. Section 556 does not apply to the winding up of a trust at all. Indeed, his Honour observed that a previous decision of the South Australian Full Court which had held this to be so (Re Suco Gold Pty Ltd (1993) 7 ACSR 873) was “virtually universally acknowledged” to be incorrect at law.

The correct approach, according to His Honour, is to look to the law of trusts, not the law of insolvency – and according to the law of trusts the claims of all unsecured trust creditors rank pari passu. There are no priorities between classes of unsecured creditors. They share a right of indemnity, which is itself a derivative right to look to the trust assets. The identity of the trust creditors, the amounts they are owed and the trust assets over which they have a right of indemnity are things that will all fluctuate from time to time.

The clear losers from this decision are employee creditors and the Department of Employment in respect of FEG payments. Secured creditors would still have recourse to their securities granted over trust assets. The liquidator would still enjoy a lien for his or her remuneration and expenses.

I for one am not convinced that Brereton J’s logic is sound. Nor am I convinced that it necessarily follows that future Courts will apply His Honour’s analysis in preference to that employed by the Full Court of South Australia in Suco Gold. Indeed, a Judge in a Queensland Court (for example) would be placed in the invidious position of choosing between two interstate decisions (one by a single judge, the other by an appellate Court) that are diametrically opposed.

Doubtless we shall see the point discussed, debated, and hopefully clarified, by the Courts over the coming months and years. It is indeed desirable for another appellate Court to now consider the law in this area and definitively decide which of these competing methodologies practitioners should adopt in their day to day practices.

There is, of course, a quicker, clearer and better long term solution to this – statutory reform. That should now be a priority on the insolvency law reform agenda.

In the meantime, liquidators are well advised to protect themselves by bringing an application to the Court for directions before making any distributions to creditors of a company acting as trustee.