Presented by Jones Partners

The term “insolvent trust” is a term commonly misunderstood. Trusts cannot technically become “insolvent”, as they are not a separate legal entity. Trusts are better described as a relationship, outlining powers and obligations, owed by a trustee to a beneficiary. A trustee is solely responsible for the operation of the trust and can be a natural person or a corporate entity.

Historically, trusts have been a mechanism for a natural person to legally own property for the benefit of another. Today, trusts have evolved into commercial entities, becoming tools of business to minimise tax liability, manage finances with discretion and privacy, and limit liability in the event of insolvency. This final point (unsurprisingly) creates tension, as the law struggles to correctly regulate this often-duplicitous legal relationship.

When a trust becomes unable to pay its debts, the trustee becomes liable for the debts incurred, and the subject of any recourse. The trust deed will usually outline indemnity for the trustee, which (frustratingly), is funded using trust assets. This tension between creditor and trustee interests often results in litigation and application to the court, which has contributed to a series of unpredictable, inconsistent, and commercially unviable common law decisions. Extensive court appearances only diminish the final return to creditors, fundamentally undermining the primary objective of insolvency procedures. Many professionals believe that trust law principles have no place in a modern context.

Implementing reform to trust law to clarify obligations and powers during insolvency is a tricky business. The natures of trust and insolvency law are in many ways diametrically opposed, and it is important that changes do not undermine the fundamental purpose of a trust. Nevertheless, the current system is in need of overhaul.

The recent parliamentary inquiry into corporate insolvency law outlined several recommendations and amendments to the way in which trusts are handled. This included amendments to the power to deal with trust property by a liquidator, limitations on the right of indemnity and changes to the exercise of the trustee’s right of indemnity, just to name a few. The recommendations were sensible, achievable, and similar to findings from the Harmer Inquiry into insolvency in 1988. Nevertheless, it is somewhat frustrating three decades on, no actual progress has been made to implement these recommendations.

Only time will tell how the government intends to proceed with amendments to the Corporations Act to clarify the management of insolvent trustees. There are clear issues with the operation of trust law within Australia, that need to be addressed using a holistic, pragmatic approach.

For more reading, see our blog on the Parliamentary Inquiry into Corporate Insolvency Law

Insolvent Trust