FCA: Unfair preferences recovered from trust property must benefit creditors

The Federal Court has held that payment from trust property recovered as an unfair preference must be applied by trustee in bankruptcy for the benefit of creditors of the trust.

Lane (Trustee), in the matter of Lee (Bankrupt) v Commissioner of Taxation (No 3) [2018] FCA 1572

Background

Mr Lee was the sole trustee of the Warwick Lee Family Trust (the Trust).  Prior to his bankruptcy, Mr Lee paid the sum of $322,447.58 to the Commissioner of Taxation (the Commissioner) in discharge of taxation liabilities arising from the operation of a Subway franchise operated by the Trust.  Mr Lee had funded that payment by using $171,659.00 of his own funds and $150,788.58 funds of the Trust, in doing so he exercised his right of exoneration as trustee[1].  The right of exoneration is the right of the Trustee to discharge obligations incurred in their capacity as trustee directly from the assets of the Trust.

After the bankruptcy of Mr Lee, the Commissioner agreed to return the sum of $322,447.58 to the trustee in bankruptcy in response to an assertion that the payment to the Commissioner constituted an unfair preference under section 122 of the Bankruptcy Act 1966 (Bankruptcy Act).

The issue for determination by Derrington J was whether, upon the recovery of the funds from the Commissioner, the trustee in bankruptcy held all funds for the benefit of all creditors of the estate of Mr Lee (both in his personal capacity and in his capacity as trustee of the Trust) or whether the trustee in bankruptcy held the sum of $150,788.58 (representing the amount initially paid by Mr Lee from funds of the Trust) for the benefit of Trust creditors only[2].

The Commissioner contended that the former view prevailed, whereas the trustee in bankruptcy contended that the latter view prevailed[3].

Decision

In reaching his determination, his Honour noted that section 122 of the Bankruptcy Act operated without the need for an order of the Court; that is, the payment is avoided upon the making of a sequestration order if the provision is applicable[4].

His Honour noted that as a matter of practical reality, however, that although the effect of the provision is to void a transfer to which it applies, transfers in effect remain effectual until a trustee in bankruptcy takes steps to avoid it[5].  Significantly, his Honour also noted that if a trustee in bankruptcy’s action to establish that a transfer was avoided by virtue of section 122 was successful, the “title in the property is to be regarded as not ever having passed”[6].

After undertaking an analysis of the basis of the trustee in bankruptcy’s entitlement to recover the preferential payment pursuant to section 122 of the Bankruptcy Act, his Honour concluded that:

Mr Lee’s entitlement to use trust funds only arose by reason of his position as trustee and because the debt arose from the administration of the trust.  Outside of his office as trustee, he was not entitled to pay the funds to the Commissioner nor did he have any entitlement to recover them when the payment was found to be void.  It necessarily follows that the right to recover the payments from a transaction which was avoided was a right which was held for the benefit of the trust[7].

After careful analysis of the Commissioner’s contention that any repayment by the Commissioner of an equivalent amount to that paid to it by Mr Lee utilising the right of exoneration from the Trust would be held by the trustee in bankruptcy free of all trust obligations and could be used to discharge debts to non-trust creditors, his Honour concluded that:

If a trustee acquires a chose in action as a consequence of the operation of a trust, that chose in action is held pursuant to the trustee’s rights and obligations, no less than other trust property.  In this case, the taxation liability which was discharged by the payment of trust funds to the Commissioner arose as a result of the operation of the trust and Mr Lee paid the amount of $150,788.58 out of the trust funds to discharge that liability and, pro tanto, it reduced the trustee’s equitable lien over the trust assets.  He was only entitled to use that money by reason of his position as trustee and the rights and entitlements he acquired as a result.  When the transaction was avoided by reason of the making of the sequestration order, the right to recover the payment only existed because of Mr Lee’s position as trustee.  His right to recover the amount paid is subject to the trust obligation to use the trust funds for the purposes of the trust.  It is not possible to hive off from the other rights and obligations of a trustee, the right to recover payments made for the purposes of the trust which have been avoided.  The right is necessarily a constituent element of the bundle of rights and obligations of the trustee and no principle was referred to which suggests that a trustee might exercise such rights independently of the other trust obligations [8]. [underlining added]

Conclusion

The decision is of assistance given that the issue in contention was not the subject of any direct Australian authority[9].

It now stands as authority for the proposition that when funds paid by a trustee in exercising their right of exoneration from trust assets are recovered as an unfair preference pursuant to section 122 of the Bankruptcy Act, the repaid funds are themselves “subject to the obligation to use them in the manner required of the original funds, being for the purposes of discharging trust debts”[10].

It should be noted, however, that his Honour’s conclusions arise as a result of his analysis of the terms and effect of the particular recovery provisions in the Bankruptcy Act and for that reason, caution ought be exercised before seeking to use the decision in the context of the broadly equivalent provisions of the Corporations Act 2001.

It should also be noted that at present, the decision of the Full Bench of the Supreme Court of Victoria in Commonwealth v Byrnes (as joint and several receivers and managers of Amerind Pty Ltd) (recs and mgrs apptd) (in liq) (2018) 354 ALR 789 is subject to appeal in the High Court of Australia.  The High Court’s decision on the nature of a trustee’s right of exoneration may well alter the position further.

 

Adrian Robins
Adrian Robins (Director)
About the Author

Adrian Robins is a Director at James Conomos Lawyers, where he practices in the areas of commercial litigation, insolvency, bankruptcy and legal costs disputes. Adrian is committed to achieving positive outcomes for his clients and is celebrated for his prompt and practical legal advice.

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[1] Lane (Trustee), in the matter of Lee (Bankrupt) v Commissioner of Taxation (No 3) [2018] FCA 1572 (Lane No 3 Decision) at [6] & [7].

[2] Lane No 3 Decision at [7].

[3] Lane No 3 Decision at [8].

[4] Lane No 3 Decision at [13].

[5] Ibid.

[6] Lane No 3 Decision at [14] citing Westpac Banking Corporation v Bell Group Ltd (No 3) (2012) 44 WAR 1.

[7] Lane No 3 Decision at [19].

[8] Lane No 3 Decision at [27].

[9] Lane No 3 Decision at [4].

[10] Lane No 3 Decision at [32].