FEDERAL COURT OF AUSTRALIA

Lane (Trustee), in the matter of Lee (Bankrupt) v Deputy Commissioner of Taxation [2017] FCA 953

ORDERS

SUBJECT TO RECEIVING FURTHER SUBMISSIONS WITHIN SEVEN (7) DAYS AS TO THE PRECISE WORDING, THE ORDERS OF THE COURT WILL BE AS FOLLOWS:

1.    That the name of the Respondent be amended to “Deputy Commissioner of Taxation” and that the matter shall continue as if the action were started against that office holder.

2.    The Applicants are entitled to the following directions:

(a)    That, subject to order 4 hereof, the sum of $599,782.02 being the proceeds of sale of assets of the Warwick Lee Family Trust (“the Funds”) are subject to Mr Lee’s right of exoneration out of the trust assets and, subject to the following orders herein, are available to be distributed to trust creditors to the exclusion of non-trust creditors.

(b)    The Applicants are entitled to distribute the Funds prior to the payment of any dividend from the bankrupt’s estate.

(c)    The Australian Taxation Office is not entitled to priority out of the Funds pursuant to s 109(1)(e) of the Bankruptcy Act 1966 (Cth).

(d)    The provisions of ss 108 and 109 of the Bankruptcy Act 1966 (Cth) do not apply in relation to the distribution of the Funds which are to be paid to the trust creditors pari passu.

(e)    In the distribution of the personal estate of the bankrupt amongst all creditors, the trust creditors must bring into “hotchpot” the amount which they have received from the Funds as trust creditors.

(f)    The Applicants are entitled to paid from the Funds (prior to any payment to any creditors) the amount of $89,326.56 (being 46.76% of $191,032) for their costs, expenses and remuneration relating to work undertaken in respect of causing the trust creditors to be paid by the application of the trustee’s right of exoneration.

3.    It is declared that, pursuant to s 76 of the Trusts Act 1973 (Qld) that the Applicants, in their capacity as trustees in bankruptcy of the estate of Mr Warwick Gordon Lee, acted honestly and reasonably and ought fairly be excused for any breaches, failures or omissions relating to the administration of the bankrupt estate, arising from the payment of $139,137.04 for their remuneration from the right of indemnity funds.

4.    The parties have liberty to relist the remainder of the Application for further hearing in relation to the question of the characterisation of the proceeds received by the Bankruptcy Trustees from the Australian Taxation Office as an unfair preference.

5.    Liberty to apply.

6.    The Bankruptcy Trustees’ costs being their costs in the administration.

7.    Otherwise the question of the costs of any other party is reserved.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

DERRINGTON J:

Introduction

1    The application before the Court is for directions and relief pursuant to ss 90-15(1) and 90-20(1)(a) of the Insolvency Practice Schedule (Bankruptcy) (Schedule 2 of the Bankruptcy Act 1966 (Cth) (the Act)) in relation to the administration of the bankrupt estate of Mr Warwick Gordon Lee (Mr Lee). The directions and forms of relief sought by Mr Lee’s trustees in bankruptcy in this application are numerous and traverse a wide range of significant and complex issues. Central to many of the questions raised is the issue of whether Mr Lee’s right of indemnity out of certain assets which were held by him on trust can be utilised for the purposes of meeting the claims of “non-trust” creditors or the claims of the trustees in bankruptcy for their costs, expenses and remuneration of the administration of the estate. Other questions arise as to the entitlement of the Australian Taxation Office (ATO) to priority over other “trust creditors” in respect of an asserted Superannuation Guarantee Charge and as to the proportions in which funds may be distributed amongst the creditors.

Nomenclatures used in these reasons

2    It is important to keep steadily in mind that each debt incurred by Mr Lee in his capacity as trustee was one for which he was personally liable. The “trust” is not a legal entity which has rights or to which duties and obligations are owed (Agricultural Land Management Limited v Jackson (No. 2) (2014) 48 WAR 1 at 58; [302]). It is merely the label given to that bundle of rights and obligations, both personal and proprietary, which constitute the relationship between a beneficiary and a trustee (Kelly v Mina [2014] NSWCA 9 at [103]). As a trust has no separate existence, so far as third parties are concerned the trustee’s obligations to those parties are not limited in any way by reference to the assets of the trust, save in the case of an express agreement (Elders Trustee and Executor Company Limited v EG Reeves Pty Ltd (1987) 78 ALR 193 at 253). In the context of the Bankruptcy Act, any of the trustee’s creditors were entitled to make the application for the sequestration order regardless of whether the debt to them was incurred in the course of the administration of the trust or otherwise.

3    Despite the above, and although it is legally inaccurate to imply that a trust has some independent existence apart from the trustee in whom the trust obligations are reposed, in these reasons the creditors of Mr Lee whose debts arose in the proper performance by him of his obligations as trustee are referred to by the short-hand expression “trust creditors”. The debts owing to “trust creditors” are referred to as “trust debts”. Conversely, the creditors whose debts arose in the course of Mr Lee’s personal dealings are identified as “non-trust creditors” and their debts are referred to as “non-trust debts”.

4    Throughout these reasons the expression ‘insolvent trustee’ shall be used to distinguish that trustee from the trustee administering the insolvent trustee’s estate, which is referred to as a ‘bankruptcy trustee’.

Summary of principles regarding the use of a trustee’s right of exoneration in a bankruptcy

5    As a result of the large number of directions which the Bankruptcy Trustees have sought in this application and the uncertain state of the law in relation to the matters under consideration, the reasons for judgment in this matter are necessarily extensive. That being so, it is appropriate to attempt to succinctly identify some general principles which ought to guide a bankruptcy trustee when dealing with a bankrupt trustee’s right of indemnity out of trust assets.

(1)    A trustee has, amongst other rights of indemnity, a right to indemnification from the assets of the trust in respect of trust debts which have been properly incurred and for any tortious liability which has been not-improperly incurred.

(2)    The right of indemnity from the trust assets falls into two discrete parts. A right of recoupment (being the right to recoup money from the trust assets in respect of liabilities which the trustee has previously discharged from their own funds) and a right of exoneration (being a right to discharge trust liabilities directly from the assets of the trust).

(3)    The value of the trustee’s right of indemnity can only be fully ascertained upon the taking of the accounts of the trust, which includes the application of the “clear accounts rule”. In general terms, the value of the indemnity is equal to the extent to which the balance of the accounts favours the trustee regardless of the quantum of trust debts owing.

(4)    The trustee has an equitable lien which supports their rights of indemnity (both exoneration and recoupment). The consequence of the existence of the right of indemnity and lien is that the trustee has a beneficial interest in the assets held upon the terms of the trust and, to that extent, the beneficiaries’ interest in the trust property is diminished.

(5)    On the occasion of the trustee’s insolvency all existing trust creditors are equally entitled to be subrogated to the trustee’s right of exoneration and supporting lien although not to the right of recoupment.

(6)    Both the right of recoupment and the right of exoneration will form part of the personal property of the insolvent trustee which will pass to the bankruptcy trustee as “property of the bankrupt divisible amongst creditors”. Neither is trust property. The benefit of the supporting equitable lien will also pass to the bankruptcy trustee. It also is not trust property.

(7)    The exercise of the right of recoupment by a bankruptcy trustee will result in trust funds being transferred beneficially to the estate of the bankrupt which are then available to meet the claims of both trust and non-trust creditors. The distribution of such funds accords with the usual distribution of the proceeds of the bankrupt’s property pursuant to the priority regime in the Bankruptcy Act 1966 (Cth) (the Act).

(8)    The right of exoneration is much more limited. Its exercise by the bankruptcy trustee will only result in the transfer of trust funds directly to the trust creditors in payment of their debts. The exercise of the right does not result in the beneficial receipt of funds by the bankrupt’s estate which might be used to meet the claims of non-trust creditors.

(9)    Whilst the right of exoneration is property of the bankrupt, it is not capable of being realised so as to create “proceeds” which might be applied pursuant to ss 108 and 109 of the Act. It is merely a limited right to use trust funds to discharge trust debts and that is the only manner in which a bankruptcy trustee may exercise it in the course of the administration of the bankrupt’s estate.

(10)    As all trust creditors have equal rights of subrogation to the right of exoneration and supporting lien, it follows that the payments to them consequent upon the exercise of the right of exoneration occurs pari passu.

(11)    In the distribution of the proceeds of the bankrupt’s property under ss 108 and 109, the “hotchpot” principle applies such that the trust creditors must bring into account the amounts which they have received by the application of the right of exoneration, prior to participating in the distribution.

(12)    The limited nature of the right of exoneration has the consequence that it is not capable of being used to pay the costs, expenses and remuneration of the bankruptcy trustees. However, the principles in Re United Distributing and Berkeley Applegate provide a justification for allowing payment to the bankruptcy trustees of certain amounts from the pool of funds generated by their work before the right of exoneration is exercised.

(13)    The costs, expenses and remuneration which might be paid to the bankruptcy trustees pursuant to the principles in Re United Distributing and Berkeley Applegate are limited to that relating to the performance of work necessary for exercising the right of exoneration. However, where the sole business of the bankrupt was acting as trustee, it is likely that a substantial proportion of the costs, expenses and remuneration of the administration of the estate will be chargeable out of the pool of funds produced by the bankruptcy trustees.

(14)    Whether the amount of the bankruptcy trustee’s entitlement can be debited against the interest of the trust’s beneficiaries as opposed to the interest of the trust creditors in the pool of funds created need not be determined in this case as no “trust assets” remained.

Background facts

6    The Warwick Lee Family Trust was established by a deed dated 11 March 1998. The trustees initially appointed under that deed were Mr Lee and his wife, Wendy Ellen Lee. By the time of his bankruptcy in February 2013, Mr Lee was the sole trustee. The trust was a discretionary trust of which, inter alia, Mr Lee, Mrs Lee and Mr Lee’s children were “beneficiaries” in the sense that they were objects of the exercise of the trustee’s discretionary power to distribute income and in whom the corpus of the trust vested on the Vesting Day.

7    Prior to his bankruptcy, Mr Lee, as trustee, operated the business of a Subway franchise located in the suburb of Brassall in the State of Queensland. In the course of the operation of that “fast-food” business, Mr Lee employed a number of staff and incurred a number of significant liabilities. Importantly, for the claims of the Deputy Commissioner of Taxation in this matter, he did not employ anyone in his private capacity. Apparently, the Subway business was not a financial success. It was advertised for sale and a contract for its purchase by an unrelated third party was entered into on 18 December 2012. Settlement took place on 19 February 2013. Three days later, on 22 February 2013, Mr Lee was made bankrupt on a debtor’s petition. Mr Rajendra Kumar Khatri and Mr Morgan Gerard James Lane were appointed as the trustees in bankruptcy of Mr Lee’s estate. For convenience, and to distinguish them from the trustee of the Lee Family Trust, they are referred to herein as the “Bankruptcy Trustees”.

8    On the day prior to the execution of the contract of sale of the Subway business, being 17 December 2012, the trust deed of the Warwick Lee Family Trust was amended to remove a provision which would have disqualified Mr Lee from continuing to act as trustee in the event of his bankruptcy. No explanation has been proffered as to why that occurred. Nevertheless at all material times he has remained as the trustee of the Warwick Lee Family Trust.

9    From the material filed by the Bankruptcy Trustees, it is apparent that the operation of the trust was somewhat disorganised and unsophisticated. This has little relevance to the core issues to be determined, but it does have some significance with respect to the quantum of remuneration sought by the applicants. In any event, after a not-inconsiderable amount of work, the Bankruptcy Trustees have ascertained the nature and scope of Mr Lee’s personal estate. Necessarily, that required that they also ascertain the nature and scope of the trust estate.

10    The net proceeds of the sale of the Subway franchise, in the sum of $448,659.49, were received by the Bankruptcy Trustees in the period from 20 March 2013 to 28 May 2013. The evidence shows that monies were received “in response to a demand being made by the Trustees in Bankruptcy pursuant to Mr Lee’s right of indemnity”. By way of a letter dated 26 February 2013 to Mr Graham Roberts of Cooper Grace Ward, who was then Mr Lee’s solicitor, the Bankruptcy Trustees asserted that the trustee’s right of indemnity under the Warwick Lee Family Trust vested in them and, on that basis, they requested the transfer to them of the sale proceeds. Prior to any such transfer of the funds pursuant to that request, Mr Roberts held them for his client, Mr Lee, who, in turn, held them as trustee of the Warwick Lee Family Trust. It seems, therefore, that the funds which were then held in trust (and which were subject to the equitable lien protecting the trustee’s right of indemnity) were paid out of the trust and to the Bankruptcy Trustees in a purported realisation of the trustee’s personal right of indemnity. However, the Bankruptcy Trustees have indicated that they have kept these funds separate from the personal estate of Mr Lee and they are prepared to deal with the funds in the manner in which the Court directs. It is presumed that, by this the Bankruptcy Trustees accept that if the funds ought not to have been paid to them by Mr Lee’s solicitors consequent upon their demand, they will deal with the funds as they ought to have been dealt with in the first instance.

11    In the course of the administration of Mr Lee’s estate, the Bankruptcy Trustees recovered an unfair preference payment of $322,447.58 from the ATO which had been paid by Mr Lee in discharge of taxation liabilities arising from the operation of the Subway franchise. On the return of the money from the ATO it was apportioned between the trust on the one hand and Mr Lee’s personal estate on the other. The rationalisation for this was that Mr Lee had used an amount of $171,659.00 of his own funds to pay part of the tax debt such that it was appropriate to return an equal amount to his estate on the transaction being rendered void. The Deputy Commissioner has asserted that the whole of the funds should form part of the personal estate of Mr Lee so as to be available for all creditors. This was a submission made in writing well after the oral hearing had been concluded and it is dealt with at the end of these reasons.

12    In their written submissions the Bankruptcy Trustees identified that at the date of the filing of this application the creditors of Mr Lee in his capacity as trustee were the following:

(a)    ATO (superannuation liability in respect of the Subway employees) in the amount of $128,574.88;

(b)    ATO (trust tax liability) in the amount of $1,037,171.40;

(c)    Bevmont Pty Ltd as trustee for the Lee Family Trust in the amount of $330,000; and

(d)    Janet May Lee in the amount of $73,727.37.

13    Further, the Bankruptcy Trustees assert that Mr Lee’s personal creditors were as follows:

(a)    ATO (personal taxation liability) in the amount of approximately $295,291.71;

(b)    Janet May Lee in the amount of $27,000;

(c)    Westpac Bank in the amount of $26,363.26; and

(d)    the Lee Family trust in the amount of $399,720 (which appears to be a loan made to Mr Lee by the trust).

14    The ATO has given notification that its claim against Mr Lee of $128,574.88 is the subject of a Superannuation Guarantee Charge (SGC) with the result being that it is entitled to the payment of that amount as a priority pursuant to s 109(1)(e) of the Act. This superannuation liability arose in the course of conducting the Subway franchise and it is a liability of the trust. However, r 6.02 of the Bankruptcy Regulations 1996 (Cth) limits the amount of any such priority under s 109(1)(e) at a set amount per employee with the consequence that the ATO’s priority amount will be capped at $100,969.52. That leaves a shortfall to be recovered as a non-priority trust debt in the sum of $27,605.36.

15    The asset and liability position of the bankrupt’s estate and the trust are as follows:

(a)    Mr Lee’s estate has assets of $183,750.22 and creditors of $876,949.85; and

(b)    The trust creditors total $1,317,165.35 and the trust assets are said to be $599,782.02.

16    The Bankruptcy Trustees have now finalised all recovery actions, have ascertained all known unsecured creditors and are in a position to distribute the funds under their control. However, due to some legal uncertainties they seek directions as to the appropriate method of disposal. In that respect, at paragraph 20 of their written submissions (filed 22 May 2017) they submit:

A number of the issues the subject of the directions sought have no direct legal authority that has been located, and others are the subject of conflicting or inconsistent single judge and intermediate appellate decisions.

There is no doubt that there exists some not-insubstantial uncertainty and confusion in this area of the law as is evidenced by the numerous inconsistent authorities and commentaries which surround it. In that environment it is not surprising that the Bankruptcy Trustees made this application for directions and other relief. It appears from the material filed that all persons who have an interest in the outcome of this application have been served or notified of it. Only the Deputy Commissioner of Taxation has appeared to make submissions.

The making of an application for directions under the Bankruptcy Act

17    As mentioned, this application purports to be made by the Bankruptcy Trustees pursuant to ss 90-15(1) and 90-20(1)(a) of sch 2 of the Act which affords the Court power to make any orders it thinks fit in relation to the administration of a regulated debtor’s estate. By s 5-15 of that schedule, a “regulated debtor” includes a person who is bankrupt. Section 90-15(1) appears to have replaced, in part, the now repealed s 134(4) which had permitted a bankruptcy trustee to make an application to the court for directions.

18    For present purposes the relevant parts of s 90-15 provides:

90-15 Court may make orders in relation to estate administration

Court may make orders

(1)     The Court may make such orders as it thinks fit in relation to the administration of a regulated debtor’s estate.

…

Examples of orders that may be made

(3)     Without limiting subsection (1), those orders may include any one or more of the following:

(a)     an order determining any question arising in the administration of the estate;

…

(f)     an order in relation to remuneration, including an order requiring a person to repay to the estate of a regulated debtor, or the creditors of a regulated debtor, remuneration paid to the person as trustee.

19    The power conferred by this section is wide and obviously intended to facilitate the resolution of contentious matters as they arise in the course of the administration of a bankrupt’s estate. It is not limited to the making of directions as was the former s 134(4) which was encumbered with various inherent limitations (See Bufalo v Official Trustee in Bankruptcy [2011] FCAFC 111 and the cases cited therein). The power granted by s 90-15 is sufficiently wide to make the directions or give the relief which is sought in the Application.

Whether the funds are to be distributed to all creditors or only to “trust creditors”

20    The first question raised by the Bankruptcy Trustees in relation to the use of the funds held by them allegedly as proceeds of the right of indemnity is stated in the following terms:

Whether the $599,782.02 received by the applicants pursuant to Warwick Gordon Lee’s right of indemnity as trustee… be distributed amongst creditors of Mr Warwick Gordon Lee as trustee or amongst creditors of both Mr Warwick Gordon Lee as trustee and Mr Warwick Gordon Lee personally.

21    As posed, the question fails to acknowledge some of the more difficult issues surrounding the nature of a trustee’s right of indemnity and the manner in which it might be dealt with by those who administer the insolvency of a trustee and in whom such indemnity is vested. Much has been said in the recent authorities and commentaries concerning these issues and there is a danger that adding to that discussion might only serve to confuse rather than elucidate. However, whilst both of the parties before the Court acknowledged the acute difficulty of the issues raised, each asserted that their consideration was essential to the directions and the relief which the Court is asked to give.

The statutory regime pursuant to which the issue arises

22    In this matter it is the provisions of the Act which fall to be construed and applied. In many of the authorities to which reference was made in the course of argument, it was the cognate insolvency provisions of the relevant companies’ legislation which were the subject of consideration. Whilst, in some cases, differences in the various insolvency regimes may provide a legitimate ground for distinguishing certain decisions, the essential issue raised in cases of this ilk, concerns the manner in which a trustee’s right of indemnity can be utilised by those responsible for administering the estate or property of the insolvent trustee. Neither the nature of that right nor the manner in which it is held by a trustee, will alter depending upon whether the trustee is an individual or a corporation. On the other hand, the method by which the property of the insolvent trustee might be disposed of under the alternative insolvency regimes may provide some legitimate ground of differentiation. That being so, it is necessary to consider the legislative context in which the assets and rights of the bankrupt are to be administered under the Act.

23    Section 58 of the Act causes certain property to vest in the bankruptcy trustees on an individual’s bankruptcy. Relevantly, that section provides:

58 Vesting of property upon bankruptcy-general rule

(1)    Subject to this Act, where a debtor becomes a bankrupt:

(a)    the property of the bankrupt, not being after-acquired property, vests forthwith in the Official Trustee or, if, at the time when the debtor becomes a bankrupt, a registered trustee becomes the trustee of the estate of the bankrupt by virtue of section 156A, in that registered trustee; …

24    The expression “the property of the bankrupt” as it is used in s 58 is defined in s 5 of the Act, inter alia, as follows:

the property of the bankrupt, in relation to a bankrupt means:

(a)    Except in subsections 58(3) and (4):

(i)     the property divisible among the bankrupt’s creditors; and

(ii)     any rights and powers in relation to that property that would have been exercisable by the bankrupt if he or she had not become a bankrupt; …

25    The meaning of the phrase “property divisible among the bankrupt’s creditors”, is explained in s 116 of the Act in the following terms:

116 Property divisible among creditors

(1)    Subject to this Act:

(a)    all property that belonged to, or was vested in, a bankrupt at the commencement of the bankruptcy, or has been acquired or is acquired by him or her, or has devolved or devolves on him or her, after the commencement of the bankruptcy and before his or her discharge; and

(b)    the capacity to exercise, and to take proceedings for exercising all such powers in, over or in respect of property as might have been exercised by the bankrupt for his or her own benefit at the commencement of the bankruptcy or at any time after the commencement of the bankruptcy and before his or her discharge;

…

is property divisible amongst the creditors of the bankrupt.

(2)    Subsection (1) does not extend to the following property:

(a)    property held by the bankrupt in trust for another person.

26    In the interpretation of the expression “the property divisible among creditors”, consideration must also be given to the separate definition of “property” in s 5 which is:

“Property means real or personal property of every description, whether situate in Australia or elsewhere, and includes any estate, interest or profit, whether present or future, vested or contingent, arising out of or incident to any such real or personal property.”

27    Reference also needs to be made to the provisions empowering the bankruptcy trustees to pay the claims of the creditors. These provisions are contained in Division 2 of Part VI which is headed “Order of Payment of Debts”. In particular s 108 provides:

108     Debts proved to rank equally except as otherwise provided

Except as otherwise provided by this Act, all debts proved in a bankruptcy rank equally and, if the proceeds of the property of the bankrupt are insufficient to meet them in full, they shall be paid proportionately.

28    Section 109 of the Act imposes an order of priority in respect of the payment of debts from the “proceeds of the property of the bankrupt” and the chapeaux of s 109(1) provides:

109     Priority payments

(1)     Subject to this Act, the trustee must, before applying the proceeds of the property of the bankrupt in making any other payments, apply those proceeds in the following order:

Thereafter, the subparagraphs of subsection (1) establish the priority regime for payments from the proceeds which are realised from the bankrupt’s property.

29    The expression “proceeds” in the phrase “proceeds of the property” as used in ss 108 and 109, has the usual meaning of the “sum, amount, or value of land, investments, or goods, etc., sold, or converted into money” as defined in Jowitt’s Dictionary of English Law (4th ed), p 1920. Indeed, given the context, it is likely that it means the “net proceeds” of realisation after the expenses of sale are deducted. (See the definition of “proceeds” in Stroud’s Judicial Dictionary (9th ed)).

30    It can be immediately observed from this suite of provisions that the “property of the bankrupt” which vests in a bankruptcy trustee is not necessarily the property which is actually distributed to the creditors once the estate is otherwise fully administered. Whilst under s 58(1)(a) the bankruptcy trustee takes possession of all of the “property of the bankrupt” (ss 58 and 116), it is only from the “proceeds” of the realisation process that payments are made to the creditors under ss 108 and 109 (cf s 134(1)(ac)). Occasionally, some of the bankrupt’s property is not capable of being realised so as to produce “proceeds”. It may be of such a nature that possession of it results in additional expense to the holder. This may occur in the case of a lease or mortgaged land where the income or anticipated realisation to be derived is less than the cost of its retention and maintenance. In those circumstances the bankruptcy trustee has power to disclaim the onerous property (s 133 of the Act). Other property of the bankrupt, which may be in the nature of rights or powers, may be productive of little or no realisation due to their inherent limitations. Consequently, the “proceeds” which are to be used to meet the creditors’ claims in accordance with the priority provisions, are not equivalent to the “property of the bankrupt” which vests in the bankruptcy trustee on the making of the sequestration order.

31    It did not seem to be disputed before the Court that an insolvent trustee’s right of indemnity from trust assets might be within the description of “property” which vests in a bankruptcy trustee, although it was also acknowledged that there are a variety of inconsistent authorities on this issue. Generally, the authorities (albeit from a corporate insolvency context) which hold that the right of indemnity is not property which vests in the bankruptcy trustees, do so on the basis that the indemnity is effectively “trust property”, see for instance Re Independent Contractor Servicers (Aust) Pty Ltd (in liq) (2016) 305 FLR 222 and Re Amerind Pty Ltd (in liq) [2017] VSC 127.

32    Putting aside for one moment the impact of s 116(2)(a) of the Act, it can be readily accepted that an insolvent trustee’s equitable right to be indemnified in respect of liabilities incurred in the not-improper administration of a trust, would be within the concept of “property divisible amongst the creditors of the bankrupt”. The right to be indemnified out of trust assets is personal property, being a right to exercise power with respect to “property” within the meaning of s 116(1)(b) as informed by the definition of s 5. Not insignificantly, there are also a number of authorities which have held that a trustee’s right of indemnity is part of a trustee’s personal estate which will pass to a bankruptcy trustee in the event of the trustee’s insolvency. Some of the more significant are Savage & Whitelaw v Union Bank of Australasia Ltd (1906) 3 CLR 1170 at 1188 and 1196; Octavo Investments v Knight (1979) 144 CLR 360 at 367-368 (Octavo) and In re Suco Gold (1983) 33 SASR 99 at 102 (Re Suco Gold). On one view, the binding effect of these authorities might be thought of as foreclosing most of the issues concerning the first question asked of the Court on this application. However, as certain recent decisions have suggested that a trustee’s right of indemnity is actually property held “on trust” such that it falls within the meaning of s 116(2)(a) (or not property of the company in a corporate insolvency), the question requires further consideration. It is also appropriate to acknowledge that there exists an argument that the decision in Octavo did not expressly identify the scope of creditors whose claims may be met by the use of the right of indemnity. In that case all of the creditors were trust creditors and it has been said that the High Court did not expressly hold that the right of indemnity could not be utilised to meet the claims of non-trust creditors. This is also a matter which requires detailed consideration.

Nature of the trustee’s right of indemnity

33    In the course of submissions it was suggested that one explanation for the inconsistency amongst the authorities concerning the use of a trustee’s right of indemnity in an insolvency context, was a somewhat less than strict adherence to the doctrine of precedent in relation to certain High Court decisions, including Octavo. Whilst there is possibly some force in that submission, it is more likely that, properly analysed, conflicts between some of the authorities are more apparent than real and that the distinguishing of the various High Court authorities can be legitimately defended. However, it is true that it is not possible to reconcile all of the authorities, some of which are diametrically opposed.

34    It is apt to keep in mind in the consideration of the authorities that the rights of exoneration and recoupment from the trust assets which are considered in this matter, are only part of the protection afforded to a trustee in relation to liabilities not-improperly incurred in the performance of a trust. For example, in the absence of contrary provisions in the trust instrument, a trustee is also entitled to a personal indemnity from the beneficiaries who are all sui juris and absolutely entitled to the trust assets in relation to all debts and liabilities incurred in the performance of the trust; (Hardoon v Belilios [1901] AC 118; Balkin v Peck (1998) 43 NSWLR 706); a trustee has a right to retain the interest of a beneficiary who owes the trustee money (Re Akerman [1891] 3 Ch 212 at 219); trustees have a right to contribution and/or indemnity from any co-trustee in relation to the trust debts and liabilities; and a trustee can impound the interest of a beneficiary who has instigated or requested that the trustee act in a way which involves a breach of trust (Fletcher v Collis [1905] 2 Ch 24 at 30-32). The essential point is that the trustee has a number of rights which are inherent to their position and which operate to hold them harmless from liabilities incurred in the fulfilment of their duties. The entitlement to an indemnity from the trust assets is merely part of that suite of rights. Whilst these various rights have the effect of preventing or avoiding any diminution of the trustee’s personal estate, they do not all operate by way of replenishing the trustee’s estate once the trustee has personally incurred a debt or liability. Some of them operate by exonerating the trustee from liability by ensuring that a trustee is not required to discharge a trust liability in the first place.

35    As the trustee is personally liable for the debts incurred in the conduct of a trust, it is a necessary incident of the office of trustee that they have an entitlement to indemnity out of the trust assets for all charges, expenses and liabilities appropriately incurred. That principle, which was stated by Lord Eldon LC in Worrall v Harford (1802) 8 Ves 4; 32 ER 250, it is now enshrined in most State legislation regulating trusts. For the purposes of the trust instrument before the Court the relevant legislative provision is s 72 of the Trusts Act 1973 (Qld) (Trusts Act) which provides:

72     Reimbursement of trustee out of trust property

A trustee may reimburse himself or herself for or pay or discharge out of the trust property all expenses reasonably incurred in or about the execution of the trusts or powers.

In this case, the trust instrument itself also makes provision for the trustee to have a right of indemnity from the assets of the trust in a similar manner. By clause 21 of the trust instrument it is provided that:

INDEMNITY OF TRUSTEES

21.    The Trustee shall be indemnified and held harmless out of the Trust Fund against all claims, costs, damages, losses, fees, expenses, taxes, duties and impositions which arise in connection with or in consequence of this Deed or the Trusts hereby created except to the extent that the same arises from the Trustee’s own dishonesty provided that the Trustee shall have not right of indemnity against any one or more of the Beneficiaries.

The right of indemnity in the trust instrument is wider than that which exists in equity or under the Trusts Act, in respect of the range of liabilities for which the trustee is indemnified. In equity, the trustee’s right of indemnity only extends to liabilities incurred by the trustee in the “proper performance of the trust” and to tortious liability where that liability has been incurred in the “not improper” performance of the trust (In re Blundell; Blundell v Blundell (1889) 40 Ch D 370 at 376-7; Re Suco Gold Pty Ltd (1983) 33 SASR 99 at 104 per King CJ). By comparison, the scope of the indemnity provided for in the trust deed in this case extends to any expense or liability arising in connection with the trust save to the extent to which it arises by the trustee’s own dishonesty. Otherwise, the expression “shall be indemnified and held harmless” in clause 21 connotes the same procedure for satisfying the indemnity as exists in equity; namely the reimbursement of expenses paid by the trustee or the direct payment of liabilities from the assets of the trust.

Two alternative rights of indemnity – recoupment and exoneration

36    As appears from the statement of the principle in s 72 of the Trusts Act, the right of a trustee to be indemnified from the assets of the trust falls into two distinct parts. First, where a trustee has discharged a trust debt out of their own funds, the trustee is entitled to reimbursement out of the trust funds in an equivalent amount. That occurs by money being transferred from the trust funds to the trustee who receives an absolute, beneficial interest in that money. That right in relation to satisfied trust liabilities is often referred to as the right of “recoupment”. Second, the trustee is entitled to meet unsatisfied trust debts directly from the trust assets by utilising the right of “exoneration”. Pursuant to this right, the trustee directly applies trust assets to discharge the indebtedness by paying trust funds directly to the trust creditor (Commissioner of Stamp Duties (NSW) v Buckle (1998) 192 CLR 226 at 245–246; Re Suco Gold Pty Ltd (1983) 33 SASR 99 at 105; Re Exhall Coal Company (Limited) (1866) 35 Beav 449 [55 ER 970] per Lord Romilly MR; see also the discussion of the right in H J A Ford, Trading Trusts and Creditors’ Rights, (1981) 13 Melb LR at 1, 3, 4, 14 – 19 and 26 and the discussion in Hon BH McPherson, “The Insolvent Trading Trust” in Finn PD (ed), Essays in Equity (Law Book Co, 1985), Chapter 8 at p 147). This process of “exoneration” does not involve the trustee obtaining any beneficial interest in the assets which are used to discharge the trust debts. The nature of the right has been identified by the learned authors of Ford & Lee: The Law of Trusts (Thomson Reuters Westlaw AU online version) at [13:030] in the following terms:

In a trust of any magnitude the trustees will necessarily incur administration expenses. They are entitled to, and for administrative reasons preferably should, meet those expenses directly from the trust fund. This inherent right of the trustee is articulated in trustee legislation

(Emphasis added)

37    The duality of the trustee’s right of indemnity out of trust assets appears in the statement of principle found in Halsbury’s Laws of England, Trusts and Powers (Vol 98, 2013, LexisNexis online edition) at [342]:

A trustee is entitled to be reimbursed from the trust funds, or may pay out of the trust funds, expenses properly incurred by him when acting on behalf of the trust… (Footnotes omitted)

As expressed in that passage, the right of the trustee is either to be reimbursed for expenses already paid by the use of his or her own funds, or to raise funds from the trust estate for the purposes of satisfying the liabilities which have been incurred. This position is recognized succinctly in the commentary to the American Third Restatement of the Law of Trusts (at § 88) p 256 in the following manner:

The trustee’s right of indemnification (§ 38(2)) entitles the trustee either to pay proper expenses directly from the trust estate (exoneration) or to obtain reimbursement from the trust when the trustee has personally paid those expenses.

That duality is also referred to by the learned authors of Scott and Ascher on Trusts (5th ed, Wolters Kluwer) at § 22.1.1, p 1627:

The trustee may use trust funds to pay expenses properly incurred in administering the trust. A trustee who properly incurs an obligation on behalf of the trust is entitled to discharge the obligation out of trust funds, though applicable law designates the obligation as the trustee’s own. A trustee has, in other words, not merely a right of reimbursement for trust expenses already paid out of the trustee’s own funds, but also a right of exoneration, i.e., the power to use trust funds to discharge obligations that have arisen out of trust administration.

(Footnotes omitted)

38    The important distinction between these two aspects of the trustee’s right of indemnity is usefully assayed in Ong D, Ong on Subrogation (The Federation Press, 2014), Chapter 2 and in Mitchel and Watterson, Subrogation, Law and Practice (Oxford University Press) at Chapter 12. In the former work (at pp 31 – 32) the learned author identifies that a trustee is restricted in the use of the right of exoneration to using it for the purpose of discharging his liability to the trust creditors and no other.

39    Lest it be thought that the distinction identified above is “hair-splitting”, it ought to be observed that the duality of the right of indemnity from trust assets reflects a similar attribute in the right of indemnity which the trustee has as against the beneficiary. In the latter case, a trustee is entitled to discharge the trust liabilities by use of their own funds and then seek to be reimbursed by the beneficiary, or obtain an order in equity requiring the beneficiary to pay the creditor once the debt falls due; Subrogation, Law and Practice at p 428; para [12.11]. The learned authors of Jacob’s Law of Trusts in Australia (8th ed, Butterworths, 2006) at [21-05], p 515 identify that the “usual order will be one requiring the beneficiary to pay the creditor or otherwise procure the release or discharge of the trustee”. Where the trustee has already paid the debt, the beneficiaries will be required to pay an equivalent amount to the trustee.

40    As the discussion below identifies, some of the authorities concerning the trustee’s right of indemnity from the trust assets do not always maintain this critical distinction between the right of “recoupment” or “reimbursement” on the one hand and the right of “exoneration” on the other. However, the distinction is fundamental. If what comes into the hands of a bankruptcy trustee is a trustee’s right of recoupment, it is a right to take money from the trust funds for the benefit of the insolvent trustee’s estate. It is, in effect, the payment of an amount owing to the trustee for the purposes of reimbursing the trustee’s personal estate. Such a payment is received by the bankruptcy trustee as part of the bankrupt’s personal estate and is available to meet the claims of both trust and non-trust creditors. However, the position is markedly different when what the bankruptcy trustee receives is merely a right or entitlement to have trust assets applied to discharge trust debts. That is a considerably more limited right.

41    The distinction between the right of recoupment (or reimbursement) on the one hand and the right of exoneration on the other was emphasised in In re Richardson [1911] 2 KB 705. That case concerned a bankruptcy trustee’s entitlement to the benefit of the insolvent trustee’s right of indemnity from a beneficiary. At 711, Cozens-Hardy MR, in effect, held that where the trustee has paid a trust debt out of his own money, the right of reimbursement is the trustee’s own property absolutely and, if the trustee is insolvent, any bankruptcy trustee might use that right of reimbursement for the benefit of all of the creditors of the trustee’s estate. However, the right of exoneration is merely a power which is exercisable by the trustee solely for the purposes of paying the expenses of the trust. That latter conclusion is in keeping with the remedy which would be awarded in an action to enforce the right; being that the beneficiary would be ordered to pay the creditor directly once the debt has become owing Mitchell and Watterson, Subrogation, Law and Practice (Oxford University Press, (Rev ed) 2007) at p 428; The Law of Contribution and Reimbursement (Oxford University Press, 2003, para [14.38]–[14-45]). Although in In Re Richardson the Master of the Rolls was dealing with a trustee’s right of indemnity from a sui juris beneficiary rather than any right of exoneration out of the trust assets, the relevant distinction between exoneration and recoupment necessarily appears from his Lordship’s reasons.

42    The decision of In re Richardson also supports the proposition that, whilst in a bankruptcy administration a right of exoneration might vest in the bankruptcy trustee, it does not change its character to become a right to use trust funds to pay non-trust creditors. If the right of exoneration is limited in the trustee’s hands, it is equally limited in the hands of the bankruptcy trustee. Neither the trustee nor, in his stead, the bankruptcy trustee, is entitled to use funds which are the subject of the right of exoneration to discharge non-trust liabilities (In re Richardson [1911] 2 KB 705 at 714, per Fletcher Moulton LJ). These principles hold true even though in In Re Richardson the right of exoneration from the beneficiary may have been wider in different circumstances.

43    The nature of the right of exoneration as a mere right or power to use trust funds to meet debts incurred in the operation of the trust, can also be detected in the origins of the rights of trust creditors to be subrogated to that right on the trustee’s insolvency. This right evolved as a remedy in an administration action where the creditors of the executors, were entitled to prove in the estate under the administration decree and, where their debts were accepted, they would be paid directly out of the estate. The trustee was not entitled to assume beneficial ownership of the funds for the purposes of discharging the trust debts (see the discussion by HJA Ford in Trading Trusts and Creditors’ Rights, (1981) 13 Melb LR 1, 18 – 19).

44    In the context of this consideration of the nature of the rights of recoupment and exoneration, it is important to observe that there is no “third entitlement” of a trustee to indemnification for trust expenses and liabilities out of the assets of the trust estate. Particularly, there is no right for the trustee to take from the trust a sum of money equivalent in amount to the existing trust debts and for the trustee to appropriate that money to themselves with the intention of paying the trust debts out of their own assets which have been swelled by the trust funds. Prima facie, that would constitute a breach of trust on the basis that the trustee would be profiting from his position by assuming beneficial ownership of trust property (In re Johnson (1880) 15 Ch D 548 at 552). There does not appear to be any express judicial authority for the existence of such a right save that the reasons of Lush J in Re Enhill Pty Ltd [1983] 1 VR 561 at 568, might be taken as inferentially supporting its existence. It is a view that was rejected by the reasoned observations of King CJ in Re Suco Gold at pp 105–106 who held that, if the trustee takes trust funds into his possession for the purposes of meeting trust debts, the funds do not lose their character as trust property (see also Re Matherson (1994) 49 FCR 454 at 466.) Despite that, it should be recognised that in Grime Carter & Co Pty Ltd v Whytes Furniture (Dubbo) Pty Ltd [1983] 1 NSWLR 158, McLelland J identified that this “third entitlement” of a trustee to appropriate funds beneficially to themselves was assumed to exist in the decision in Re Enhill. His Honour said (at p 161):

In the judgment of the Full Court of the Supreme Court of Victoria in Re Enhill Pty Ltd (1982) 7 ACLR 8, the existence of this third element in a trustee's entitlement to indemnity was certainly assumed, and must be taken as having been decided. In that case the court expressly declined to follow the decision of Needham J in Re Byrne Australia Pty Ltd and the Companies Act [1981] 1 NSWLR 394 (and see Byrne Australia Pty Ltd and the Companies Act (No 2) [1981] 2 NSWLR 364) in which it had been held that a trustee's entitlement to indemnity out of trust assets in respect of trust liabilities did not authorize appropriation of trust funds to the trustee's general estate free of any obligation to apply them in satisfaction of trust liabilities. In each case a specific question before the court was whether trust assets might be applied by the liquidator of a company which was a trading trustee, in satisfaction of the costs and expenses of the winding up, including the liquidator's remuneration. This question was decided in the negative in Re Byrne Australia Pty Ltd and in the affirmative in Re Enhill Pty Ltd.

45    The difficulty with his Honour’s approach was the acceptance of an implicit assumption of the existence of a hitherto unknown “third entitlement” as part of the trustee’s right of indemnity in the absence of any supporting authority or principled analysis justifying its existence. Whether that was a correct approach or not need not be considered further as the decision in Grime Carter & Co predated that of the South Australian Full Court decision in Re Suco Gold which eschewed the existence of any such entitlement. Indeed, subsequently in Re ADM Franchise Pty Ltd (1983) 7 ACLR 987, McLelland J recanted his earlier reliance on Enhill. Instead, he followed Re Suco Gold and accepted that no such third entitlement existed.

46    An accurate analysis of the nature and scope of the trustee’s right of exoneration as opposed to the right of recoupment, was undertaken by Farrell J in Woodgate, in the matters of Bell Hire Services Pty Ltd (in liq) [2016] FCA 1583 (Bell Hire Services). There, the liquidator of a corporate trustee applied for directions under both the Corporations Act 2011 (Cth) and the Trustee Act 1925 (NSW). The insolvent company’s sole undertaking had been that of conducting a business as trustee of a family trust. No replacement trustee had been appointed and the company retained possession of the trust assets. In dealing with an argument as to how the costs of the winding up were to be paid, Farrell J succinctly identified the distinction between the right of recoupment and the right of exoneration and the different ways in which they might be utilised by a liquidator. At [36] – [37] her Honour said:

[36]     The fact that the trustee enjoys an indemnity secured generally over trust property and that it is proprietary in nature does not automatically bring trust property within the general pool of creditors’ claims in a winding up or the statutory order of priority for payment. A trustee company is not entitled, in exercise of its indemnity, to appropriate trust property before payment of a trust debt so that the amounts appropriated become available to the company’s creditors generally in the liquidation. It is only if the creditors of the trust have been paid out of the trustee company’s own funds that the company’s general creditors are entitled to be paid out of trust assets appropriated to satisfy the trustee’s right of recoupment; the statutory order of priority for payment then applies. Unpaid trust creditors are entitled to stand in the shoes of the trustee and to obtain payment from the trust property; the right of subrogation must be exercised in their favour; trust property is therefore not property divisible among the trustee’s creditors generally and the statutory order priority does not apply.

[37]     It has been observed that careful attention must be paid to whether the trustee’s indemnity is being asserted as a right of recoupment or exoneration. Where it is exoneration, the trustee may resort to trust property only for the purpose of discharging trust liabilities. “Company law ends and trust law takes over” at a point earlier than where the right being exercised is the right of recoupment: see the useful discussion in D’Angelo, N “Commercial trusts in practice: the trust as a surrogate company” (Paper presented at the Annual Commercial and Corporate Law Conference, Supreme Court of New South Wales, 15 November 2016) and in his book Commercial Trusts (LexisNexis Butterworths, 2014), particularly at 5.124–5.127 under the heading “The true nature of the exoneration limb: a power to apply assets for the benefit of creditors”. I endorse that view. It is inconsistent with principle to apply the statutory order of priority for payment of the company’s debts out of its own property to the order of distribution of trust property. That this might result is two regimes (for trust property and property of the company) is unfortunate, but it is something which courts have had to accommodate.

47    Her Honour’s exhortation to precision when identifying the nature of the trustee’s right of indemnity is most appropriate and, when an issue arises concerning the manner in which the right of exoneration might be dealt with, it is necessary to constantly keep in mind her Honour’s adept description of the very limited nature of that right being that “the trustee may resort to trust property only for the purpose of discharging trust liabilities”.

The equitable lien which supports the rights of exoneration or recoupment

48    The trustee’s right of indemnity (whether it be the right of “recoupment” or “exoneration”) is protected by an equitable lien or charge which, subject to any term in the trust deed to the contrary, entitles the trustee to retain possession of the trust assets against the beneficiaries (or possibly new trustees; as to which see Rothmore Farms Pty Ltd v Belgravia Pty Ltd (1999) 2 I.T.E.L.R. 159, referred to in Hayton D, Matthews P and Mitchell C, Law of Trusts and Trustees (18th ed) (Butterworths: LexisNexis, 2010), para [81-33]) until the trustee’s liabilities have been discharged. The lien is enforceable against the trust assets even after they have passed from the original trustee’s possession and have vested in a new trustee. It also has the effect of conferring a priority in the administration of the trust in favour of the trustee over the beneficiaries (Commissioner of Stamp Duties (NSW) v Buckle (1998) 192 CLR 226 (Buckle) at 245 – 246; Re Exhall Coal Company (Limited) (1866) 35 Beav 449 [55 ER 970]).

49    The impact of the existence of the right of indemnity and associated lien on the trust assets is far from clear. In Buckle it was suggested that, despite the existence of the trustee’s indemnity and lien, the beneficial interest of the beneficiaries in the assets of the trust remains “unencumbered”, although the proprietary rights in respect of those assets were ordered in such a way that the trustee’s interest prevailed. It was explained that, the assets which were held upon the terms of the trust were not “trust assets” to the extent to which they were subject to the trustee’s right of indemnity because the “trustee’s right to exoneration or recoupment ‘takes priority over the rights in or in reference to the assets of beneficiaries or others who stand in that situation’” (at 247). That said, the High Court also accepted that the trustee’s interest was a “beneficial interest” in the trust assets to the extent of the value of the right of indemnity and that a court would authorise the sale of trust assets to satisfy the right to recoupment or exoneration. In substance that is effectively an equitable charge over the “trust assets” which protects the trustee’s rights. However, the Court was clear that the trustee’s interest in the trust assets did not amount to a security interest or right (at 247). Similar views were expressed in Octavo (at 367) where it was held that the effect of the indemnity and lien is that the trust assets are subject to the beneficial interests of the trustee in priority to that of the beneficiaries. The consequence of this was (at 370) that the trustee’s interest in the trust property amounted to a “proprietary interest” and was not property held in trust for another person for the purposes of s 116(2) of the Bankruptcy Act. In Re Suco Gold Pty Ltd (1983) 33 SASR 99 at 104 King CJ identified the “beneficial interest” as only consisting of the right of indemnity and a supporting lien.

50    After a careful analysis of these issues by Robson J in Re Amerind Pty Ltd (in liq) [2017] VSC 127 at [96] (Amerind), his Honour reached the contrary conclusion, namely that the right of indemnity itself was “trust property” and not a personal asset of the trustee. As such, it was a right which could only be used to meet trust debts rather than the personal debts of the trustee. In part, his Honour reached this conclusion on the basis that the lien which supported the right of indemnity gave the trustee (and the creditors by subrogation) an interest in the trust assets and any money arising from the enforcement of the lien would necessarily be trust money (see Amerind at [51], [53] and [256]). With respect to the learned Judge, that reasoning tends to elevate the equitable lien above the right of exoneration which the lien exists to protect. Additionally, the lien merely impacts upon the beneficiaries’ beneficial ownership of the trust assets by affecting those rights to the extent to which the lien will be enforced by the Court at the suit of the trustee. As was said in Buckle, “to the extent that the trust assets held by the trustee are subject to their application to reimburse or exonerate the trustee, they are not “trust assets” or “trust property” in the sense that they are held solely upon trusts imposing fiduciary duties which bind the trustee in favour of the beneficiaries.” (at 246; [48]). The comments in the unanimous decision of the High Court in CTP Custodian Pty Ltd v Commissioner of State Revenue (Vic) (2005) 224 CLR 98, 120-121; [50]-[51] are to a similar effect. There the High Court identified that the assets of the trust could not be identified until the rights of reimbursement and exoneration were satisfied. In other words, the trust assets were those assets which were held by the trustees less the amount of value of the trustee’s right of indemnity. In this respect Robson J’s view that the trustee’s right of indemnity is “trust property” does not seem to be entirely consistent with the views of the High Court as expressed in the two cases mentioned above.

51    The nature of the trustee’s right in the assets held on trust arising from the right of indemnity has, historically, been regarded as a “right” over the assets which are held on trust and, as such, when ascertaining the trust assets, the value of the trustee’s charge is to be deducted from the trust property as a whole (Re Exhall Coal Company (Limited) (1866) 35 Beav 449 [55 ER 970]). The concept of the “trust property as a whole” is different to that of the “property belonging to the beneficiaries”. The latter can only be ascertained after the value of the trustee’s charge is deducted from the former as the property which is held upon trust is subject to the incidents of the trustee’s office in priority to the rights of the beneficiaries. One of those incidents is the right of indemnity which applies indifferently across all of the assets held on trust. In this respect the interest of the trustee in the assets held on trust is more aptly identified as being a paramount beneficial interest in the assets of the trust rather than a security interest or part of the “trust property” (Buckle at 247; Octavo at 367; Ong D, Ong on Subrogation, The Federation Press, 2014 at p 17).

52    Additionally, as the lien which protects the right of exoneration is merely an equitable lien, it is only enforceable by judicial sale or by the appointment of a receiver and the making of an order by the Court that the trustee is to be reimbursed or exonerated. A trustee has no further “ownership rights” which, necessarily, would need to exist before a trustee would be entitled to the remedy of foreclosure or sale out of Court (Lemery Holdings Pty Ltd v Reliance Financial Services Pty Ltd (2008) 74 NSWLR 550 at 553-554 at [18]; Melbourne Tramways Trust v Melbourne Tramway & Omnibus Company Ltd (1887) 13 VLR 487 at 490; Re Pumfrey (1882) 22 Ch D 255 at 262; In Re Stucley [1906] 1 Ch 67). Given the above, it is difficult to ascertain how these limited rights in the trustee could be described as amounting to “trust property” which is legally owned by the trustee but which beneficially belongs to the beneficiaries and which is only to be used for their benefit.

53    The fluctuating and fluid nature of the right of indemnity and supporting lien is reflected in its characteristic that it is not limited to the assets in the trust at the time when the trust liability was incurred, but applies over all assets of the trust under the control of the trustee (Dowse v Gorton [1891] AC 190 at 206; Re Amerind Pty Ltd (in liq) [2017] VSC 127 at [102]). Additionally, it is not limited temporally or in relation to any specific asset of the trust and it does not apply differentially to particular assets of the trust (Octavo at 367).

54    The right of exoneration is also subject to the state of accounts as between the trustee and the beneficiaries. If that is in favour of the beneficiaries, there is nothing to which any creditor might be subrogated. This was identified by Jessel MR in In re Johnson (1880) 15 Ch D 548 at 552 – 3 where his Lordship said:

But if the trustee has wronged the trust estate, that is, if he has taken money out of the assets more than sufficient to pay the debts, and instead of applying them to the payment of the debts has put them in his own pocket, then it appears to me there is no such equity, because the cestuis que trust are not taking the benefit. The trustee having pocketed the money, the title of the creditor, so to speak, to be put in the place of the trustee, is a title to get nothing, because nothing is due to the trustee. It does not appear to me that in the case the creditor, who has never contracted for anything who has only got the benefit of this equity, if I may say so, by means of the trustee, through the lucky accident of there being a trust, ought to be put in a better position than any other creditor.

This passage highlights that a trustee’s entitlement to indemnity is subject to the rule in Cherry v Boultbee (1839) 4 Myl & Cr 442; 41 ER 171 which is sometimes mistakenly referred to as the “clear accounts rule”. The effect of that rule is that a trustee’s right of indemnity might be limited by any “offsetting” liability which the trustee owes to the trust estate. The extent of the right of indemnity is the net value of the expenses properly incurred less any amount which is owed by the trustee to the estate.

55    During the course of submissions, it was suggested that the “clear accounts rule” only applied to tortious wrongs which were committed by the trustee and that there were no allegations in this case of any such wrongdoing which would operate to limit the trustee’s right of exoneration. That submission understates the limits of the “clear accounts rule” or, at least, the more general rule of which the “clear accounts rule” is but an example. There is no doubt that the general principle operates in circumstances where the trustee has engaged in a breach of trust which has resulted in loss to the trust, such that no right of indemnity exists until the trustee remedies his default (RWG Management Ltd v Commissioner for Corporate Affairs [1985] VR 385 at 397 per Brooking J; Australian Securities and Investment Commission v Letten (No. 17) (2011) 286 ALR 346 at 353 [20] per Gordon J). However, the rule also extends to any occasion where the trustee is otherwise indebted to the “trust”. The following passage from Jacobs’ Law of Trusts (8th ed) at 514 identifies the rule as extending to debts as well as tortious liabilities:

The trustee does not always have a right of indemnity. In the first place, it is submitted that where the trustee is a debtor to the trust (which can occur without any breach of trust), the indemnity cannot be exercised without the debt first being repaid by the trustee (unless the trust instrument provides to the contrary): this follows from the rule in Cherry v Boultbee. Hence, if there is any doubt about the matter, both the indemnity and the lien protecting it may be suspended pending investigation of the trustee’s accounts.

56    The reference in that quote to the rule in Cherry v Boultbee might well be taken as being a reference to a more general rule that “a person cannot share in a fund in relation to which he is also a debtor without first contributing to the whole by paying his debt” (In re Akerman [1891] 3 Ch 212 at 219 (per Kekewich J) and recently, In re Kaupthing Singer & Friedlander Ltd (No 2) [2012] 1 AC 804 at 815. This wider rule applies to all debts regardless of whether they are ascertained or ascertainable at the relevant time. In Re Rhodesia Goldfields Ltd [1910] 1 Ch 239, Swinfen Eady J refused to allow a right of indemnity to be enforced until a claim that the trustee was indebted to the trust had been resolved. His Honour said at 247:

In my judgment the rule is of general application that where an estate is being administered by the Court, or where a fund is being distributed, a party cannot take anything out of the fund until he has made good what he owes to the fund. It is immaterial whether the amount is actually ascertained or not. If it is not actually ascertained it must be ascertained in order that the rights of the parties may be adjusted, and it would be a strange travesty of equity to hold that in distributing the fund Partridge was entitled to be paid at once all that was due to him out of the company’s money, and subsequently to find, after it had been established that he owed money to the fund, that the amount could not be recovered from him.

57    This passage was cited with approval by Ungoed-Thomas J in Selangor United Rubber v Cradock (No 4) [1969] 1 WLR 1773 at 1778, and, more recently, by the House of Lords in In re Kaupthing Singer & Friedlander Ltd (No 2) [2012] 1 AC 804 at [18]. However, a contrary view as to the extent to which any claim against the trustee had to be ascertained was suggested in the New South Wales Supreme Court (Gatsios Holdings Pty Ltd v Nick Kritharas Holdings Pty Ltd (in liq) [2002] NSWCA 29). Despite these interesting authorities, ultimately, there does not appear to be any dispute as to what liabilities will be taken into account when considering the balance of account between the trustee and the beneficiary (Mitchell and Watterson, Subrogation, Law and Practice, Oxford University Press, (Rev ed), 2007, p 432).

58    In the present matter, the evidence discloses that the trust debts total $1,569,473.65 and, it is presumed that they were all incurred in the proper, or at least not-improper, performance of the trust. In the ordinary course, that would result in Mr Lee being entitled to exoneration from the trust assets in that amount. However, it is said that Mr Lee is indebted to the trust in an amount of $399,720. The impact of that is to reduce the quantum of the right of indemnity (exoneration) to $1,169,753.65 although in a pragmatic sense, that does not actually impact upon the worth of the indemnity as the value of the trust assets is only $599,782.02. Consequently, whilst there remain assets which are held upon the terms of the trust, there no longer exists any “trust assets” in the sense of assets held only for the beneficiaries and subject to the fiduciary duties of the trustees. The trustee’s right of exoneration has completely overwhelmed the rights of the beneficiaries.

59    This side excursion into the scope of the clear accounts rule has a particular relevance in the context of the insolvency administration of a trustee. The foregoing brief discussion discloses that the ascertainment of the scope of an insolvent trustee’s right of exoneration or recoupment may be no simple matter. It will often require a consideration and understanding of the state of the accounts of the trust and of the personal accounts of the trustee as well as an examination of the stewardship of the trust by the trustee. These actions will necessitate expense and effort and, where the insolvent trustee’s accounts are not well maintained, that may be a lengthy and expensive exercise. This is a pertinent consideration when a Court is asked to give directions about the extent to which an insolvency administrator might be entitled to receive benefits from any fund generated by them for the purposes of utilising the right of exoneration to meet the claims of creditors.

Creditors’ rights to subrogation

60    Some authorities which have examined the manner in which a trustee’s right of indemnity might be dealt with on insolvency have identified that the trust creditors’ right of subrogation to the indemnity is important in ascertaining whether the indemnity can be used to meet the claims of non-trust creditors. There is, no doubt, a clear tension between the existence of the trust creditors’ right to subrogate themselves to the right of exoneration and the proposition that it is available to be used to meet the claims of all creditors. Prima facie, if bankruptcy trustees are entitled to use the right of exoneration to meet the claims of all creditors, the trust creditors’ right to subrogation would be inutile.

61    One matter which requires emphasis at this point is that the trust creditors’ right of subrogation only arises in relation to the trustee’s right of exoneration. It does not, and cannot, arise in relation to the trustee’s right of recoupment. By definition, the trustee’s indebtedness to the trust creditors will have been discharged to the extent to which the payment by the trustee of trust debts out his or her own funds has given rise to the right of recoupment.

62    It is also of particular importance that the trust creditors’ rights of subrogation to the trustee’s right of exoneration only crystallise when the trustee is insolvent or it is otherwise reasonable to assume that obtaining a judgment against the trustee would be pointless (Owen v Delamere (1871) LR 15 Eq 134 at 139–140 per Sir James Bacon VC; Re Pumfrey (1882) 22 Ch D 255 at 263 where Kay J identified that before the right of subrogation arose, it had to be shown that the trustee could not pay and that every reasonable means of making him pay had been exhausted). Prior to the insolvency of the trustee or to the inability of the trustee to pay, trust creditors have no right to execute against the trust assets. Their only right is to pursue the trustee in an action for “debt”. However, in the event of the trustee’s insolvency, they become entitled to be subrogated to the trustee’s beneficial interest created by the right of indemnity (Vacuum Oil Pty Ltd v Wiltshire (1945) 72 CLR 319). A modern statement of those principles was succinctly expressed by Wilson J in Zen Ridgeway Pty Ltd v Adams [2009] 2 Qd R 298 at [12] – [13]:

[12] … The creditor's right is derivative of the trustee’s, and cannot exceed the extent of the trustee's legitimate claim on the trust estate. Further, it is subject to whatever interests in the trust assets the trustee has lawfully created in favour of third parties.

[13] However, the right of access to the trust assets by way of subrogation is inchoate unless the trustee is insolvent or it is otherwise reasonable to assume that obtaining a judgment against the trustee would be pointless. The following passage from Deancrest Nominees Pty Ltd v Nixon is apposite to this case:

‘… it has been held that a creditor does not have a right of subrogation simply by virtue of the existence of a debt owed to it by a trustee, but it must reasonably appear, at least, that any attempt to recover the debt from the trustee would be fruitless. That is, the right of subrogation does not exist simply as an alternative means by which a creditor may recover a debt owed by a trustee. In the present case, there is nothing to suggest that the debt could not reasonably be recovered by Deancrest from the trustees concerned.’

(Footnotes omitted)

63    It was this principle, that the trust creditor’s right of subrogation only arises on the trustee’s insolvency, that was particularly important to the conclusion of King CJ in Re Suco Gold at p 108 that the right of exoneration could not be used to meet the claims of all creditors. There is much force in his Honour’s reasoning and, indeed, it complements the precise identification of the right of exoneration as being merely a right to meet the claim of trust creditors out of the assets of the fund. Prior to insolvency that is the only purpose for which the trustee could have used the right and, when insolvency intervenes, the creditors are entitled to seek an order that the right be exercised for their benefit. There is nothing which suggests that the intervention of bankruptcy changes the nature of the right. That being so, it is difficult to see how the right might be used to meet the claims of non-trust creditors.

64    The above analysis is also consistent with the nature of the remedy to which a trust creditor is entitled when seeking to enforce the right of subrogation. The remedy is not for payment of a money sum from the trustee, but for a judicial sale of trust assets and the discharging of their debts with the proceeds (Re Raybould; Raybould v Turner [1900] 1 Ch 199, 201-202).

Some authorities in more detail

65    Given the variety of conclusions which have been reached in the competing authorities as to whether, on insolvency, a trustee’s right of exoneration can be utilised to meet the trustee’s personal creditors, it is necessary to consider some of those decisions in greater detail. Before doing so, however, it is worth observing that, although, some authorities have sought to distinguish Octavo on the basis that it did not deal with an insolvency under the present iteration of the companies’ legislation (as opposed to the previous regime where certain provisions of the Bankruptcy Act were incorporated), the substantive point of differentiation has not always been clearly identified. Under s 116 of the Act the issue is whether the right of indemnity is “property of the bankrupt” and so divisible among the general creditors. Under the Corporations Act the question is whether it is property of the company pursuant to s 555 and s 556. It is difficult to discern that the relatively minor differences in these regimes for administering personal bankruptcies and corporate insolvencies, or differences in the sequential iterations of company legislation, generate any sufficient rationale for recasting the nature of a trustee’s right of indemnity. Whether the right vests in a bankruptcy trustee or remains in a company under the control of a liquidator does not seem to relevantly impact on its nature nor the manner in which it is able to be used. At the very least, there has been no sufficient explanation as to why that would be the case.

66    Counsel for the Bankruptcy Trustees relied upon the decision of Clyne J in Re Doyle (1943) 13 ABC 128 as supporting the proposition that the right of exoneration might be applied to meet the claims of non-trust creditors. That decision, however, proceeded upon the basis of some incorrect assumptions. First, at p 132 it was thought that the beneficiaries would have a continuing interest in seeing that any indemnity provided by them would be applied in payment of the trust creditors as those creditors had a right of subrogation to the trustee’s indemnity from the trust assets. However, once a beneficiary has paid the trust creditor or paid to the trustee an amount equivalent to the trust debt (assuming that is how the indemnity operates), the trustee’s right of exoneration from the trust assets no longer exists and the trust creditors have no rights of subrogation. Second, also at p 132, it was said that the trust creditors’ rights of subrogation to the trust assets comes to an end if the beneficiary assigns their interest in the trust. Clyne J relied upon Ashburner’s Principles of Equity (2nd ed) at p 161 in support of that proposition. However, such a proposition is not consistent with the nature of the right of exoneration and the entitlements of the trust creditors, and it is not a proposition which appears at p 161 of the text cited or otherwise in that text. The decision is not of assistance in relation to the right of exoneration from the trust assets.

67    In Octavo the insolvent trustee company, Coastline Distributors Pty Ltd, whose only business was as trustee of a trust, had made payments to Octavo Investment Limited within the six month period prior to its winding up. It was asserted by the appellant that the payments were not voidable preferences because they were made out of “trust funds” in the course of the trust business and not from Coastline’s “own money”, such that the transaction was beyond the scope of s 122 of the Bankruptcy Act as applied by s 293 of the Companies Act 1961 (Qld). That was rejected by the High Court which identified (at pp 367–368) that the beneficial interest which the trust creditors have by way of subrogation in the assets held by the insolvent trustee forms part of the property of the bankrupt which is divisible amongst the creditors. It held that in order for the payment to be void as against the bankruptcy trustee, it did not need to be a payment from the bankrupt’s own money. Alternatively, it held that a payment out of trust assets in respect of which a bankrupt had the legal estate and a beneficial interest by reason of the right of indemnity, may well have been a payment out of the bankrupt’s own money (at p 368). In this latter respect the majority said (at 369):

Even if we are mistaken in this conclusion, the words “from his own money” may well be satisfied if a trustee makes payments to a creditor out of trust assets in respect of which he has not only the legal estate but also a beneficial interest to secure his right to an indemnity.

68    In rejecting the argument that, what the liquidator was seeking to do by the action was to render void the surrender of the right of indemnity and associated lien, the plurality said at p 369:

Section 122 applies, amongst other transactions, to a payment made by a prospective bankrupt to a creditor which has the effect of giving that creditor a preference, priority or advantage over other creditors. If the present payments had not been made by Coastline to Octavo then the liquidator of Coastline would have had access to the charge over those moneys for the benefit of all its creditors. The payments therefore were to the prejudice of the creditors generally and it is those payments which attract s 122.

Those comments might be taken as suggesting that the right of indemnity was available to be used to meet the claims of trust creditors and non-trust creditors alike. However, it is far more probable that the comments were intended only to apply to the trust creditors given that the trustee, Coastline Pty Ltd, only operated as a trust and had no non-trust creditors.

69    The Court then turned its attention to whether the money paid to Octavo Pty Ltd was “trust property” and, therefore, was not property divisible amongst Coastline’s creditors. It identified that the trustee’s right to be indemnified from the trust assets together with the associated lien meant that the trustee’s interest was a proprietary interest in the assets held on trust but was not, itself, trust property. The fact that the assets over which the trustee’s right existed were trust assets did not render the trustee’s right of indemnity a “trust asset” as well. At p 370, their Honours said:

The fact that the trust property itself cannot be taken in execution by the creditors of the trustee is not to the point. Those creditors are nevertheless subrogated to the rights of the trustee in relation to that property, and in the event of the trustee becoming bankrupt, it is those rights which are to be realized in their favour.

70    That conclusion was sufficient to allow the Court to hold (in the case of a personal bankruptcy) that a trustee in bankruptcy becomes vested of the insolvent trustee’s beneficial interest in the trust estate such that any previous payments by the trustee to trust creditors using the right of indemnity attracts the operation of s 122 of the Bankruptcy Act. It also held that the payment by the trustee to a trust creditor out of the assets of the trust in reliance upon the right of exoneration was a payment which was apt to be rendered void by s 122 because it was a use of the trustee’s beneficial interest in the assets held on trust rather than the trust assets themselves. The plurality said at p 371:

We take the view that the passing to the trustee in bankruptcy of the trustee’s beneficial interest in the trust estate, even if that is all that passes, is sufficient to attract the operation of s 122 of the Bankruptcy Act. Once it is recognized that a trustee may enjoy a right of indemnity over trust property in respect of liabilities incurred by him in the administration of the trust, it follows that the creditors of a trust business may have resort to the assets of the trust to the extent of the liabilities incurred by the trustee. Section 122 is apt in the case of an individual trading trustee to render void as against the trustee in bankruptcy a payment out of the trust property in circumstances which have the effect of giving the payee a preference, priority or advantage over other creditors.

71    It is apparent from the reasons of the plurality, that, although the right of exoneration was a right over the assets held on trust, the right itself was not trust property. It is also apparent that the Court held that the right of exoneration was capable of being used by the trustee in bankruptcy to meet the claims of the trust creditors who were otherwise entitled to be subrogated to that right. This was certainly the view of Needham J in Re Byrne Australia Pty Ltd [1981] 1 NSWLR 394 at 398, who correctly identified that there was no suggestion in Octavo that there were any creditors other than the creditors of the trust business and no suggestion that the proprietary interest which the trustee had in the trust fund was property divisible among creditors other than those who had a right to be subrogated to the trustee’s right of indemnity.

72    When considered in the above light, there is nothing unusual or unorthodox in the High Court’s reasoning, nor is it inconsistent with the limited nature of the right of exoneration which is only a right to apply trust property to meet trust debts. The High Court merely identified that the bankrupt trustee’s right to exoneration in respect of trust debts is property of the bankrupt which vests in the trustee in bankruptcy and which is available to meet the claims of those who might otherwise have been subrogated to that right; namely the trust creditors.

73    The authorities which shortly followed Octavo were concerned with the manner in which the right of indemnity might be used in a winding up and, in particular, whether it might be used to meet the costs, expenses and remuneration incurred by a liquidator of corporate trustees.

74    The first was the decision in Re Byrne Australia Pty Ltd [1981] 1 NSWLR 394, where Needham J at 398 correctly identified that Octavo was not authority “for the proposition that, where a trustee company carries on business with a trust fund and incurs liabilities and then is wound up, the whole of the trust fund is property divisible amongst all the company’s creditors, whether trust creditors or not.” His Honour accurately identified that the indemnity right (being the right of exoneration) was inexorably linked to the existence of trust creditors who had a right of subrogation to the trust assets for the purposes of having their debts paid. That being so, his Honour concluded that the right of indemnity could only be used to meet the liabilities of the trust creditors. As the liquidator, at least at that point in time, could not be said to be a “trust creditor”, he was not entitled to be paid his costs and remuneration out of the proceeds of the right of indemnity. That position was subsequently confirmed in Re Byrne Australia Pty Ltd (No.2) [1981] 2 NSWLR 364.

75    The decision of the Full Court of the Supreme Court of Victoria in Re Enhill Pty Ltd [1983] VR 561 soon followed but, there, the Court adopted a significantly different approach. In that case directions were sought concerning the entitlement of the liquidator of an insolvent corporate trustee to be paid his costs, expenses and remuneration of winding up out of the proceeds of the sale of trust assets and in priority to all creditors. The trustee company had only carried on business as a trustee and all of its debts were incurred in that capacity. In his reasons, Young CJ held that the majority in Octavo did not impose any limitation on the use to which the trustee in bankruptcy or liquidator could apply the proceeds of the right of indemnity. Some may argue that such a view overlooks the indication by the High Court that the right of exoneration was to be applied to those entitled to be subrogated to it; namely trust creditors. The Chief Justice determined that the right of indemnity could be put to a much wider use. He said (at p564):

In these circumstances to hold that a trustee in bankruptcy could only apply the proceeds of the right of indemnity towards some only of the bankrupt’s creditors, viz. creditors of the trust business, would deny the very purpose of the right to indemnity which is to exonerate the trustee’s personal estate. In a case like the present therefore the proceeds of the trustee’s lien are available for division among the bankrupt’s creditors generally, not only among creditors of the trust business, and in the case of a company in liquidation are subject to the control of the liquidator under s292.

It should be observed that the learned Chief Justice did not explain how it was that the lien might be converted into “proceeds” which were divisible amongst creditors. As identified above, the lien merely existed such that the trustee might enforce the right of exoneration by obtaining an order for sale and the discharging of the claims of the trust creditors. However, that process would not result in funds coming into the possession of the trust company for distribution amongst creditors. That said, in Enhill there was no clear indication whether the right of indemnity being considered was the right of exoneration or the right of recoupment. Were it the latter, the observations of the learned Chief Justice would be appropriate. That said, the facts set out in the reasons of the Chief Justice at p 562 would suggest that all that was in issue was the right of exoneration. On that basis, there is an absence in the learned Chief Justice’s reasons of any explanation of how the right to apply the assets of the trust to discharge the trust liabilities might be converted into money in which the trustee has a beneficial interest so as to be used to discharge the debts of all creditors.

76    With respect to the first sentence of the passage from the reasons of the Chief Justice quoted above, the rationale relied on does not appear to support the conclusion. The Chief Justice suggests that the right of indemnity would not exonerate the trustee’s personal estate if it could not be applied to the discharge of all of the trustee’s creditors. However, the indemnity being considered was to exonerate the trustee from trust debts and not from the trustee’s personal debts. If the right of exoneration were used to satisfy non-trust debts, it would necessarily leave the trust debts unpaid or partly unpaid. If that were so, the right of exoneration would not have achieved its purpose.

77    Nevertheless, Young CJ determined that the effect of the occurrence of the bankruptcy was to “separate” the bankrupt’s estate from the trust estate and, it would appear, that necessarily defeated the trust creditors’ right of subrogation (at 564 – 565). One might speculate that the learned Chief Justice assumed that the lien was much like any other security for indebtedness which might be separately enforced so as to enable the recovery of funds. In fact, all that the lien protected was the right to have the trust funds applied to meet the trustee’s personal liability to trust creditors.

78    The other substantive judgment in that case was delivered by Lush J who founded his conclusion upon the footing that the trustee’s right of exoneration was the right to take funds from the assets of the trust and hold them beneficially for the purposes of meeting the liabilities of the trust (see pages 567 – 568). If that were correct, a trustee would be entitled to take proceeds out of the trust and appropriate them to herself or himself at which point they would become the absolute beneficial owner of them. His Honour seemed to rely upon certain comments in Re Johnson for this proposition, however, in that case Lord Jessel MR did not identify any right of a trustee to remove money from the trust and appropriate it to themselves. On the contrary, his Lordship seemingly identified that such conduct would be a breach of trust which would, by the operation of the “clear accounts rule”, thereby impinge upon any future right of indemnity. Additionally, the identification of the trustee’s right by Lush J, appears to be at odds with the trust creditors’ right of subrogation on the insolvency of the trustee; Owen v Delamere (1871) LR 15 Eq 134 at 139 – 140; per Sir James Bacon VC. None of the authorities cited by Lush J appear to support the notion that trustees have a right to pay themselves out of the assets of the trust for the purposes of on-payment to the trust creditors. It would appear from the passage at p 569 (lines 39–48) of Lush J’s reasons that his Honour fell into error by equating the trustee’s right of exoneration with the much wider entitlements in relation to the right of recoupment. Whilst the trustee’s right of recoupment is a wholly personal right of the trustee to be used for replenishing the trustee’s estate after the trustee has personally discharged the trust liabilities, the same cannot be said of the right of exoneration.

79    As a result of the approach adopted by Lush J, his Honour determined that the trustee’s right of indemnity, whether that be recoupment or exoneration, was the trustee’s “personal property” which was a chose-in-action capable of passing to a liquidator or a bankruptcy trustee. His Honour further concluded that the right of indemnity or its proceeds would be available to meet the claims of both trust and non-trust creditors. However, somewhat inconsistently, his Honour held that the trust creditors had a right to be subrogated to the trustee’s lien in respect of the trust liabilities in the case of insolvency or even prior to insolvency in some cases (Re Raybould [1900] 1 Ch 199). That would seem to negate the suggestion that the right could be utilised to meet the claims of all creditors. It was also unusual that his Honour relied upon the decision of the Court of Appeal (UK) in Jennings v Mather [1902] 1 KB 1 in support of his conclusion as that case supports the proposition that, on the insolvency of the trustee, the right of indemnity is to be used only to meet the debts of the trust creditors (see, in particular, the discussion of Stirling J at p 7).

80    Despite the undoubted eminence of the members of the Court in Re Enhill, the decision has not been widely supported since it was delivered. Its essential difficulty lies in its conflation of the right of recoupment with the right of exoneration which leads to the erroneous assumption that a trustee has a right to appropriate funds to themselves beneficially for the intended purposes of meeting trust debts. As has been previously identified, McLelland J in Re ADM Franchise Pty Ltd (1983) 7 ACLR 987, rejected that suggestion and there is an absence of authority or principle to support it.

81    In the line of significant authority on this topic, the next relevant decision is that of the Full Court of the Supreme Court of South Australia in Re Suco Gold Pty Ltd (1983) 33 SASR 99. That decision is discussed elsewhere in these reasons and it not necessary to consider it in detail here. However, the following conclusions can be taken from the various judgments of the Court:

(a)    First (at p 104), the beneficial interest of the trustee in the right of indemnity and the supporting lien passed to the liquidator and was property divisible among the company’s creditors.

(b)    Second (at p 105), that the right of indemnity out of the trust assets has the twin aspects of the right of recoupment and the right of exoneration, with the latter being the right to use trust assets to discharge the trust liabilities.

(c)    Third (at p 105), that a trustee has no right to transfer trust property to itself in an amount which is sufficient to meet unsatisfied trust debts.

(d)    Fourth (at p 108), where a trustee takes money out of a trust into his own possession for the purposes of paying trust debts, that money retains its character as trust property such that it may only be used for the purposes of meeting the debts of the trust.

(e)    Fifth (at p 108), on insolvency the right of exoneration is not available to meet the claims of non-trust creditors.

(f)    Sixth (at p 109), that the liquidator is bound to apply the priority provisions of the company’s legislation to the payment of trust debts by use of the right of exoneration (this proposition has been rejected by a number of subsequent authorities).

(g)    Seventh (at p 110), the costs, expenses and remuneration of a liquidator arise from the carrying on of the business of the trust and, as such, that they are to be “regarded” as trust debts payable out of the trust assets or right of exoneration. It seems that the payment of the costs, expenses and remuneration of the trustee were to have priority over the claims of other trust creditors because they were subject to the priority regime of the Companies Act. This conclusion is a little unusual given that, if the liquidator’s expenses and remuneration were treated as trust debts, it is not easy to see how they would not rank pari passu with the other trust creditors.

82    The relatively recent decision of Brereton J in Re Independent Contractor Services (Aust) Pty Ltd (in liq) (No 2) (2016) 305 FLR 222 is important in the present context. That case involved the liquidation of a corporate trustee which operated a trust business of making persons (called “contractors”) available to third party customers such that the “contractors” would perform services for those customers. The asserted beneficiaries of the trust were the various contractors (or entities controlled by those persons) who provided the services to the third parties on behalf of the trustee company. The trustee company received payments in respect of the work of the contractors and purportedly held those funds on trust. It made regular payments from the trust funds to the contractors as beneficiaries, presumably in proportion to the work undertaken by them. The trustee company had operated upon the presumption that the contractors were not its “employees” and, consequently, it made no deduction for superannuation contributions in respect of those persons. Its conclusions in that respect were wrong. It did have an obligation to make superannuation contributions and, having failed to do so, became liable to a superannuation guarantee charge to the Australian Tax Office (ATO). The company was placed into liquidation. The ATO lodged a proof of debt which, in part, related to the superannuation guarantee charge. The contractors also lodged claims for amounts which they asserted belonged to them as beneficiaries. The liquidator applied to the Court for directions that he would be justified in distributing the balance of the trust assets to the ATO in partial satisfaction of the superannuation guarantee charge or, alternatively, to the contractors who had provided services on behalf of the company. This necessitated a consideration by the Court of the nature of the trustee’s right of indemnity and, further, of the applicability of the statutory priority regime in s 556 of the Corporations Act to the exercise of the right of exoneration.

83    In a relatively brief judgment on this topic, Brereton J held that the liability of the trustee to pay the superannuation guarantee charge was a debt or liability incurred in the operation of the trust for which the trustee was entitled to indemnification. That being so, the first question which arose was whether that ATO debt or liability was entitled to priority in accordance with s 556(1)(e) of the Corporations Act. Brereton J identified that a subsidiary question was whether “s 556 applied to the rights of trust creditors in respect of trust property” (at p 229 [20]). In answering that subsidiary question his Honour considered the decision of the Full Court in Re Suco Gold Pty Ltd. He observed that the conclusion of King CJ that liabilities were to be paid from the trust property in the order laid down in the priority provisions of the relevant company legislation was “virtually universally accepted to be incorrect”. His Honour held that s 556 was only concerned with the distribution of assets “beneficially owned by a company and available for division between its general creditors”. Apparently, his Honour did not regard the trustee’s right of exoneration to be property owned by the company and divisible between the general creditors. In his view the company in liquidation, as trustee, had a right of indemnity from, and lien over, the trust assets for liabilities it incurred in acting as trustee and that those rights had priority to the interests of the beneficiaries (at p 231 [25]). He further held that, as all the company liabilities were incurred by the company in its capacity as trustee, all creditors were to be subrogated to the liquidator’s lien such that the statutory priority did not apply in respect of the trust assets and the creditors participated pari passu after providing for the costs of administration including the liquidator’s remuneration and expenses (pp 231- 232; [25]).

84    In essence, Brereton J rejected the notion that the trustee’s right of indemnity was property of the company which might be utilised in the winding up and in accordance with the priority provisions. He determined that the right of indemnity (exoneration) was a “trust asset” which was to be shared between the trust creditors. From one perspective that might be said to be at odds with the views reached by the High Court in Savage and Octavo. That aside, it is important that Brereton J characterised the right of indemnity (exoneration) as the trustee’s entitlement to “resort to and apply trust assets for the discharge of liabilities incurred in the authorised conduct of the trust” (at p 227 [11]). In that sense, his Honour accurately observed that the use of the right by the liquidator was limited to discharging the liabilities owed to trust creditors. For that reason, the result of his Honour’s reasoning on this point is consistent with the result reached in Octavo.

85    Although the decision in Bell Hire Services has been referred to earlier in these reasons, it is appropriate to consider it in slightly more detail. That case concerned an application for directions by the liquidator of a company whose only business had been to act as trustee of a family trust. In the course of so acting it carried on a business and incurred substantial debts. As mentioned earlier, Farrell J identified the nature of the right of exoneration as being the entitlement of the trustee to resort to trust property only for the purpose of discharging trust liabilities. Her Honour determined, albeit not without some doubt, that Re Suco Gold should be followed such that the costs of the winding up application and the remuneration of the liquidator were payable out of the trust estate as a “trust debt”. However, it was correctly observed that if the costs of the winding up were, in fact, an incident of the trust business, they would rank pari passu with the other trust creditors and s 556 of the Corporations Act would not apply. Her Honour accepted that this was contrary to the result in Re Suco Gold but was “consistent with the otherwise orthodox principles discussed by King CJ” in that case. In this latter respect, her Honour indicated that she preferred the approach of Brereton J in Independent Contract Services. Of course, here, her Honour was only referring to the application of the priority provisions in s 556 in relation to the right of exoneration. From her reasons it is apparent that her Honour followed Re Suco Gold to the extent that it held the right of exoneration was not trust property, and not the contrary view of Brereton J in Independent Contract Services. As between the costs of the winding up application and the liquidator’s remuneration, her Honour was of the view that the latter had priority.

86    An extensive review of the authorities was undertaken by Robson J in Re Amerind Pty Ltd (in liq) [2017] VSC 127, where his Honour reached the conclusion, in relation to the provisions of the Corporations Act, that an insolvent trustee’s right of indemnity from trust assets is not property of the company for the purposes of s 433(3) and s 556 of the Corporations Act. Again, that appears to be contrary to the conclusions of the High Court in Savage and Octavo although it must be said that Robson J sought to distinguish the latter decision on a number of different grounds, not in the least being that the decision in Octavo applied a different statutory regime to the one which his Honour was considering. However, whilst it may be correct that different statutory schemes were being considered, it is not particularly easy to ascertain how those differences alter the nature of the right of exoneration as a trustee’s own property.

87    The facts in Amerind were not complex. The company acted solely in its capacity as the trustee of the “Panel Veneer Processes Trading Trust” which manufactured and distributed decorative and architectural finishes. After experiencing financial difficulties, the company was placed into administration, a secured creditor appointed receivers and, subsequently, the company’s creditors resolved that it be wound up. After the realisation of the secured assets and the repayment of the security holders, the receivers retained a surplus of funds and sought directions as to its appropriate distribution. An initial question was whether the surplus in the hands of the receivers was “trust property”? On this issue his Honour preferred the approach of Brereton J in Independent Contractor Services and observed that the trustee’s right of indemnity and related lien do not become property of the company so as to be available to meet non-trust liabilities of the company. It was only available to satisfy the liabilities incurred on behalf of the trust (see paras [53], [79], [94]). At that latter paragraph his Honour said:

[94]    In my opinion for the reasons discussed below, the proper course for me is to adopt the reasoning of Brereton J in Re Independent, being that s 556 of the Corporations Act only applies to property of the company and does not apply to trust assets, that the trustee’s right of indemnity is not property of the company, and that where there are multiple creditors of the trust, the creditors share pari passu in the right to be subrogated to the trustee’s equitable lien to enforce the trustee’s indemnity. Similar reasoning also applies to s 433.

88    Robson J undertook a lengthy and considered analysis of the relevant authorities and his conclusions can be found in his observations in paragraph [96] of his reasons:

[96]    For the following reasons, I do not accept that the corporate trustee’s right of indemnity (and lien) is not property held in trust, but that it is the corporate trustee’s own beneficial ‘personal property.’ The right of indemnity is over trust assets. The indemnity must be used to meet trust liabilities. The indemnity is not an exclusive right of the trustee. It may be exercised by the trust creditors through the right of subrogation. The indemnity is a right to be indemnified against claims by trust creditors. That requires that the indemnity be used to meet trust liabilities. The indemnity is not a personal asset of the trustee. It is trust property.

89    In the course of his judgment, his Honour identified four lines of reasoning which led him to conclude that the trustee’s right of indemnity over trust assets was trust property which was only available to meet trust liabilities. They were:

(a)    (At [100]) That it is always in the interests of the trust that trust assets be used to meet trust liabilities and that is particularly so where a trading trust has goodwill which needs to be protected or enhanced. This reasoning is analogous to that of Salmond J in Official Assignee v Jarvis [1923] NZLR 1009 which concerned the situation where an indemnifying party has an interest in the extinction of the liability to which the indemnity relates (see also Re Richardson).

(b)    (At [101]) that trust assets ought not to be available to meet liabilities to non-trust creditors because the right of indemnity to which the trustee is entitled is that the trust assets are only to be used for authorised purposes; namely, the extinguishment of trust debts. Were it otherwise, the trustee would be utilising trust property for their own benefit or the benefit of third parties. Moreover, because the trust creditors are entitled to be subrogated to the trustee’s rights of indemnity, the indemnity cannot be regarded solely as a personal asset of the trustee but is subject to the equitable rights of the trust creditors. This reasoning effectively adopts some of the reasoning of King CJ in Re Suco Gold although it is not harmonious with the conclusion that the right of exoneration is a trust asset.

(c)    (At [102]) That the trust property is subject to the trustees’ indemnity and supporting lien and the creditors of the trust have a similar charge over the trust assets under their right of subrogation. Those rights of the trust creditors were proprietary rights in the assets such that the right of indemnity cannot be property of the trustee which might be used to pay its personal creditors. This effectively applies to the reasoning of Brereton J in Re Independent Contractor Services.

(d)    (At [103]) That the trustee’s right is one of “indemnity” which required the trustee to become free of the claim of the trust creditor. That could not occur if the right of indemnity was used in part, to discharge the liabilities owed to non-trust creditors.

90    His Honour subsequently concluded:

[255]    In my opinion, all four grounds of reasoning support the proposition that the right of indemnity that an insolvent trustee has over trust assets that arises through its incurring debts on behalf of the trust, constitutes a charge in favour of the trustee over all the assets of the trust that may also be exercised and enforced by the unpaid creditors of the trustee, where the liability to the creditors by the trustee caused the emergence of the indemnity. All four grounds lead to the conclusion that where an insolvent trustee has a right of exoneration from the trust assets that right does not form part of his personal estate but must be exercised and applied for the benefit of the trust to reduce the proprietary right of creditors over the assets of the trust estate and to achieve a true indemnification of the trustee from claims of the trust creditors.

91    In the result, his Honour held that the right of exoneration was not the property of the insolvent company for the purposes of being used to meet the claims of the non-trust creditors, but was trust property. The fact that trust creditors were entitled to be subrogated to the trustee’s indemnity necessarily precluded the right of indemnity from being properly described as the property of the trustee. It might be observed, however, that the fact that the trust creditors had a proprietary interest in the right, tends to negate the suggestion that the right was, itself, trust property.

92    The prima facie inconsistency between the ratio in Octavo, to the effect that the right of indemnity of a trustee was not trust property but property of the trustee which was capable of passing to an external insolvency administrator, and the conclusions reached in Re Independent Contractor Services and Re Amerind is patent. Although that apparent inconsistency is ameliorated somewhat by the various grounds on which Octavo was sought to be distinguished by Robson J in Re Amerind, it is not necessary to consider those grounds further in these reasons.

93    Since the hearing of argument in this matter, her Honour Markovic J, has delivered judgment in Kite v Mooney; In the matter of Mooney’s Contractors Pty Ltd (in liq) (No.2) [2017] FCA 653 (Kite v Mooney). That case also concerned an application by liquidators of a corporate trustee for directions as to the manner in which they might deal with the trustee’s right of exoneration. In her reasons, (at [70] – [137]) her Honour undertook an exhaustive and careful analysis of the authorities on the question of whether or not the priorities regime in the Corporations Act applied to the exercise of the trustee’s right of exoneration. At para [140] Markovic J indicated her preference for the approach of Brereton J in Independent Contractor Services as followed by Robson J in Re Amerind, to the effect that the right of exoneration was trust property such that the priority provisions did not apply to the manner in which it was exercised. Having reached that conclusion her Honour relied upon the “salvage principle” established by the decision in Re Universal Distributing Co (in liq) (1933) 48 CLR 171 (Re Universal Distributing) and, perhaps, the decision of Re Berkeley Applegate (Investment Consultants) Ltd (in liq) [1989] Ch 32 (Berkeley Applegate) to order that the liquidator’s costs, expenses and remuneration were a first charge on the assets of the trust (to the extent to which they were incurred in the administration of the trust).

Conclusion with respect to the ability to use the right of exoneration for meeting non-trust creditor’s claims

94    It is possible to detect in the various authorities, some of which are considered above, that the courts have struggled to deal with two diverging considerations. On the one hand, the right of exoneration is essentially a power associated with the administration of the trust relationship, with its main objective being the discharge of liabilities which the trustee has incurred on behalf of the beneficiaries. In form, and in substance, it is a power to use funds for a singular purpose and the creditors of the trust have a corresponding entitlement to be subrogated to that power. On the other hand, as a number of authorities including Octavo have found, the power or right rather clearly falls within the wide description of “property of the bankrupt” or “property of the company” as those phrases are used in the Act and the Corporations Act. That conclusion would seem to necessitate the use of that property for division amongst all of the creditors of the trustee and in accordance with the relevant priority regimes. The contradiction which arises is that the right of exoneration is property which can only be used for the purposes of meeting the claims of trust creditors (whom themselves have an entitlement of subrogation to the right) but the various insolvency regimes appear to include it with the definition of property of the insolvent trustee which might then be divided amongst all creditors. Given that conundrum, the conclusion that the right of exoneration remains trust property and, therefore, only capable of being used to meet the claims of trust creditors, becomes palatable. Indeed, were it not for the decisions in Savage and Octavo and the force of the authorities which have followed Octavo, that is a conclusion which a court might readily reach.

95    However, the conundrum identified above may be more apparent than real. If the precise nature of the right of exoneration is kept steadily in mind, its singular purpose, to be used to meet only the claims of trust creditors, can be reconciled with its characterisation as property of the bankrupt or company within the context of the relevant insolvency regimes. In essence, the right of exoneration is a right of a limited nature and, even when it passes to the bankruptcy trustee, it cannot be exercised other than by causing trust funds to be applied to meet trust debts. In the course of any insolvency administration the external administrator is entitled to exercise the powers of the insolvent trustee to the extent to which they will benefit the estate. That will include the realisation of property where that is possible. The right of exoneration however is not capable of being realised, although it can be used in the administration to cause or require the payment of the debts of the trust creditors. In this respect, the distinction between the concepts in the bankruptcy legislation of “property of the bankrupt which is divisible among the creditors” and of the “proceeds” of the property has to be maintained. It is the “proceeds” of the realisation process which are applied proportionately as required by the operation of s 108 or in the priority dictated by s 109. There is nothing in Division 4 of Part VI, “Realisation of Property”, which would prevent a bankruptcy trustee from exercising a power of the bankrupt which had the effect of directly benefiting some creditors over others, albeit with indirect benefits flowing to the remaining creditors.

96    The decision of the High Court in Octavo in relation to the provisions of the Bankruptcy Act (albeit in a corporate insolvency context) is binding on this Court. That decision concerned whether or not the trustee’s right of indemnity was “property divisible amongst the creditors” within the meaning of s 116(1)(a) of the Act. It cannot be seriously doubted that the High Court concluded that the right of indemnity was not a trust asset and was, therefore, property “divisible amongst the creditors”. However, the High Court did not suggest that the right of exoneration amounted to “proceeds of property of the bankrupt” which were to be applied as required by ss 108 and 109. In fact, the Court was clear that the right of exoneration was only to be used to meet the claims of the trust creditors who were entitled to be subrogated to the right. That conclusion is entirely consistent with the recognition of the right as a limited right or power of the trustee to apply trust funds only for the purpose of discharging trust liabilities. That is so whether it is exercised by the trustee prior to bankruptcy or by the bankruptcy trustees subsequent to a sequestration order being made. The bankrupt, as trustee, had no power, pursuant to that right, to appropriate funds in an amount equal to the liabilities which had been incurred as trustee so as then to be in a position to use them to meet the claims of all creditors. Further, there is nothing in the Bankruptcy Act which, upon the making of the sequestration order, transmogrified the right of exoneration into such a right.

97    It is instructive to consider what the position would be if, shortly prior to bankruptcy, the original trustee was replaced and the new trustee was in possession of the trust assets when the sequestration order was made. In those circumstances the bankruptcy trustees would be required to apply to the court for an order that the trust assets be applied in payment of the trust debts or an order that the new trustee indemnify the former trustee from liability for those debts. If necessary, an order for the judicial sale of some of the trust assets could be made along with an order appointing receivers to carry out the sale. The Bankruptcy Trustees would not be entitled to the payment of an amount of money (see Lemery Holdings (2008) 74 NSWLR 550 at [18]). In Re Pumfrey (1881) 22 Ch D 255 it was held that the trustee who seeks to enforce the lien is required to apply to the court for an order to that effect (at 262) (see also Hewett v Court (1983) 149 CLR 639, 663). The equitable lien which arises does not exist to enforce the payment of money to the erstwhile trustee, but to secure the right to have the trust funds applied in discharge of the trust debts. In addition, the trust creditors themselves might seek an order, relying upon their right of subrogation, for payment to them out of the trust assets. That is not something which the Bankruptcy Trustees could oppose.

98    It follows that even though the right of exoneration is the “property of the bankrupt” of which the bankruptcy trustees took possession, the only use to which it can be put in the course of the administration of the bankruptcy is to discharge liabilities owing to trust creditors. It is not capable of being used to meet the claims of non-trust creditors although they will benefit by having the claims on the remaining property of the bankrupt reduced.

99    When the right of exoneration is identified in this manner, the authorities to which reference has been made are capable of greater reconciliation in outcome if not also reasoning. This approach is concordant with the High Court’s decision in Octavo and consistent with the outcomes in Re Suco Gold Pty Ltd (in liq) and Re Amerind Pty Ltd (in liq).

100    The above reasoning coheres with the existence of the trust creditor’s rights of subrogation. When the limited nature of the right of exoneration is fully appreciated, full respect is accorded to the established “favoured” position of trust creditors on a trustee’s insolvency. In the course of submissions the Bankruptcy Trustees submitted that the trust creditors obtained this benefit by “mere happenstance” or it being a “lucky incidence” of doing business with a person who happened to be a trustee. They relied upon that as a substantiation for the conclusion that the right of exoneration should be available to all creditors. There are a number of answers to this proposition. First, if, as a matter of law, it is the case that the special rights of trust creditors to be subrogated to the trustee’s right of indemnity afford them an advantage in the insolvency context, there is no reason to deny them that right on some perceived notion of general “fairness”. Second, it is not apparent that those who traded with Mr Lee’s Subway franchise were not aware that he was conducting business as a trustee. The trading trust has become a ubiquitous part of modern commerce such that it may well be that the trust creditors, or some of them, knew of their rights and entitlements. Even though the franchisor was not a creditor in the administration of Mr Lee’s estate, given the size of its business around Australia, it is most likely that it was acutely aware of the nature of its rights arising from trading with its franchisee, Mr Lee, who operated his business as a trustee. Third, the “favoured position” of trust creditors is now so well established that it is not appropriate for a Court at first instance to ignore it. If any reform is required in this area it is clearly a matter for the legislature. Fourth, it is simply not possible to use a power to pay trust creditors out of trust funds, to meet the claim of non-trust creditors.

101    The above analysis is also coherent with the manner in which other forms of property of the trustee might be dealt with in insolvency. For example, in Re Richardson shows that a trustee’s right of indemnity from a beneficiary might be treated in a similar fashion to the right of exoneration out of trust assets even though its enforcement will only directly benefit a particular trust creditor. A similar result would occur if a right of contribution from a co-trustee in respect of trust debts or liabilities was sought to be enforced by a bankruptcy trustee. In that scenario, the co-trustee would be entitled to pay the trust creditors directly to discharge the trust debts. The bankruptcy trustee could not beneficially receive funds from the co-trustee and disburse them among all of the insolvent trustee’s creditors. That would leave the co-trustee remaining partially liable to the trust creditors despite having paid the full amount of his or her contribution.

102    It follows that the right of indemnity from a beneficiary and the right of contribution from a co-trustee have similar characteristics to the right of exoneration out of the trust assets in that they will be enforced by the bankruptcy trustees even though they will only result in payments being received by trust creditors. They are all “rights” or “powers” with respect to property albeit of a limited nature with the result being that they cannot be realised or turned into “proceeds” which might be distributed amongst all creditors.

A possible parallel with s 117 of the Act

103    The manner in which the bankruptcy trustees must deal with the right of exoneration in the course of the administration of the bankrupt’s estate is also not dissimilar to the manner in which they would deal with a right of indemnity under a policy of insurance which is within the scope of s 117 of the Act. That section provides:

(1)    Where:

(a)    a bankrupt is or was insured under a contract of insurance against liabilities to third parties; and

(b)    a liability against which he or she is or was so insured has been incurred (whether before or after he or she became a bankrupt);

the right of the bankrupt to indemnity under the policy vests in the trustee and any amount received by the trustee from the insurer under the policy in respect of the liability shall, if the liability has not already been satisfied, be paid in full forthwith to the third party to whom it has been incurred.

…

104    In s 117(1) the right of the bankrupt to indemnity under the policy vests in the bankruptcy trustee which is consistent with s 116(1) in that the bankrupt’s rights to be indemnified in respect of third party claims fall within the concept of “property of the bankrupt”. Putting aside for one moment the effect of s 117, most contractual rights of a bankrupt under policies of insurance and their coextensive choses in action would pass to the trustee in bankruptcy as part of the general assets divisible amongst creditors (see Re Harrington Motor Co Ltd; Ex parte Chaplin [1928] 1 Ch 105; Hood’s Trustees v Southern Union General Insurance Co of Australasia Ltd [1928] 1 Ch 793). In most cases, those rights or choses in action would be capable of being turned into money which would then form part of the “proceeds of the property of the bankrupt” and be available for apportioning amongst the creditors. It follows that, but for the operation of s 117, any money received by a bankruptcy trustee under a policy of liability insurance would be divided amongst all the creditors including the third party in respect of whose liability the bankrupt was insured. The major impact of s 117 is that it imposes limits on the use to which certain property of the bankrupt can be put and requires that money received under the policy be paid forthwith only to the party, the liability to whom was indemnified.

105    In the course of the administration of a bankrupt’s estate, a bankruptcy trustee would be obliged to enforce against the bankrupt’s insurer any claim under a policy which might meet the claim of a third party against the estate. Whilst the right of indemnity under the policy may only result in one creditor’s claim being satisfied, it would nevertheless be the duty of the bankruptcy trustee to ensure that occurred. Necessarily, the meeting of that creditor’s claim by use of the insurance funds will reduce the totality of the claims upon the remainder of the bankrupt’s estate and, to that extent, this operates to the benefit of all creditors. A liquidator of an insolvent corporation has similar obligations under s 562 of the Corporations Act.

106    This reference to the operation of s 117 is not to suggest that a trustee’s right of exoneration is the equivalent of a bankrupt’s right of indemnity under a policy of liability insurance, even though there are parallels. It is merely to identify that there are occasions where the bankruptcy trustee is required to deal with property of a limited nature which enures for the benefit of a single creditor.

The “property of the bankrupt”

107    It is apparent from the above discussion that this Court must accept that the right of exoneration is a right which falls within the scope of the expression “property of the bankrupt” as it is used in s 58(1)(a) of the Act. If there is any difference, it is also property which falls within the expression “property divisible among creditors” within the meaning of s 116(1)(a) and (b) (see Rogers v Asset Loan Co (2006) 4 ABC(NS) 293 at [37] citing Cummings v Claremont Petroleum NL (1986) 185 CLR 124 and Cirillo v Citicorp Australia Ltd [2004] SASC 293 at [75]–[79]). A trustee’s right to use the trust funds to meet trust debts incurred in the performance of a trust is, at least, a capacity to exercise power “in, over or in respect of property” which might have been exercised for the bankrupt’s own benefit within the meaning of s 116(1)(b). That conclusion is in accordance with the decision in Octavo to the extent that it held that a trustee’s right of indemnity was property of the bankrupt within the meaning of ss 58 and 116 of the Act.

108    Even if Octavo was not binding, as a matter of principle it is difficult to accede to the proposition that a right in respect of the trust assets which could be exercised by the bankrupt for the purposes of discharging his or her personal liabilities would be “trust property” and hence not within the scope of ss 58 and 116(1). The mere fact that the use of the right might be limited by reference to specific debts, does not support the conclusion that the right is not “property of the bankrupt”. Moreover, the fact that the trust creditors have entitlements of subrogation to the right and a corresponding lien to enforce it, makes it less likely that it could be regarded as being held solely for the benefit of the beneficiaries and therefore a “trust asset” or part of the trust.

109    It should also be remembered that the bankruptcy trustee takes the property of the bankrupt subject to any equities affecting it (Sonenoco (No.77) Pty Ltd v Silva (1989) 24 FCR 105 at 124-5). In the case of the right of exoneration, that includes the rights of the trust creditors to be subrogated to the rights of the trustee including the ability to exercise the equitable lien. Again, that tends to negate any suggestion that the right is trust property or that it can be used to the detriment of the trust creditors’ rights of subrogation.     

110    Nor does the fact that the right is secured by an equitable lien over the trust assets take the right beyond the scope of ss 58 and 116 and render it an asset of the trust as suggested in Re Amerind. The equitable lien merely secures the ability of the trustee to exercise the right whenever the trust assets are removed from the trustee’s possession or where the beneficiaries demand payment of their entitlements without making provision for discharging the trustee’s liabilities.

111    It follows that the right of exoneration is a right which is “property of the bankrupt” and which is, prima facie, divisible among the creditors of the bankrupt within the meaning of s 116(1)(b). That is so, regardless of the fact that it is not capable of being realised and that it can only be exercised in a limited way by requiring that the trust assets be used to discharge the claims of the trust creditors. It is not “trust property” within s 116(2)(a).

Did bankruptcy change the nature of the right of exoneration?

112    In the course of oral argument, Counsel for the Deputy Commissioner of Taxation submitted that the operation of the bankruptcy regime altered the nature of the right of exoneration in the hands of the Bankruptcy Trustees, such that it became available for “distribution” amongst all creditors. It was submitted that, in their hands, the right of exoneration could be used to obtain payment of money out of the trust funds in an amount equal to the claims of the trust creditors and those funds might then be used to meet the claims of all creditors. This, it was submitted, arose either as a result of the insolvency regime “cutting through” otherwise established rights, or that the “overarching theme” of the insolvency regime had the effect of rendering the rights in the hands of the bankruptcy trustee wider than they were in the hands of the bankrupt. No specific provision of the Act was identified as having this transformative effect upon the bankrupt’s property and rights as they vested in the Bankruptcy Trustees. The Deputy Commissioner’s submission was supported, to some extent, by Counsel for the Bankruptcy Trustees although on slightly different grounds. Mr Eade submitted that the position in relation to the right of exoneration was similar to the position of a contractual right of indemnity where the person to be indemnified has become insolvent. In such circumstances, so the argument went, the bankrupt’s contractual right of indemnity in relation to a particular debt can be applied for the benefit of all creditors unless the indemnifier had an interest in seeing that the indemnified debt was discharged. Reliance was placed on the decision of the Court of Appeal in Re Law Guarantee Trust and Accident Society Ltd: Liverpool Mortgage Insurance Co’s Case [1914] 2 Ch 617. That case concerned the construction of a re-insurance contract and, it is noted, Buckley LJ identified that the particular issue turned upon the construction of the language of the contract. After discussing the construction of that language, at 633, his Lordship considered the position in relation to equitable obligations to indemnify and said:

The equitable doctrine is that the party to be indemnified can call upon the party bound to indemnify him specifically to perform his obligation, and to pay him the full amount which the creditor is entitled to receive, and that whether having received it he applies it in payment of that creditor or not is a matter with which the party giving the indemnity is not concerned. ... The case is otherwise where the party giving the indemnity is concerned with the application of the money which he pays. This was the case in Re Richardson. The wife who was bound to indemnify was there concerned in seeing that the money which she paid went to the lessor so as to relieve the property of which she was beneficial owner from the consequences of non-payment of rent and damages for breach of covenant.

(Footnotes omitted).

Kennedy LJ agreed that there was nothing in the reinsurance contract which required the payment of the indemnity to the debenture holders and that was especially so given that they were not parties to the contract of indemnity and the indemnifier had no interest in seeing how the indemnity moneys were applied.

113    In the present matter there is no “contract” of indemnity. The subject matter under discussion is the right of exoneration. There is only one method by which the right can be exercised and that is by the application of trust funds to paying the claims of trust creditors. It is not a contract which can be construed to require payment to the person indemnified of an amount of money equal to that needed to meet the liability to a third party. That is a critical difference between the present situation and that which arose in the Liverpool Mortgage Insurance Co’s Case [1914] 2 Ch 617.

114    Additionally, the trust creditors have a right of subrogation to the right of exoneration and accompanying lien. In effect, that means that they have a right to be subrogated to the proprietary interest of the trustee in the assets of the trust. They are entitled to orders that their debt be paid directly out of the trust funds without those monies passing through the hands of the trustee (Re Evans, Evans v Evans [1887] 34 Ch D 397). There is nothing in the authorities to suggest that the equitable right of subrogation dissipates upon the trustee’s insolvency. The contrary is true. Those rights of subrogation are inchoate until insolvency or the trustee is otherwise unable to pay the trust debts. The crystallisation of those equitable rights upon the trustee’s insolvency is not consistent with the notion that the trustee’s right to have the trust assets applied in discharge of the trust debts is abrogated by the trustee’s insolvency. Were the Commissioner’s submission to be accepted, the insolvency of the trustee would be both the occasion for the crystallising of the right of subrogation and the reason for its destruction.

115    The Deputy Commissioner’s submission also overlooks the fact that any property received by a bankruptcy trustee is subject to all of the liabilities and equitable interests existing prior to the bankruptcy (Re Clarke; Ex parte Beardmore [1894] 2 QB 393; Whyte v Williams (1903) 29 VLR 69; 9 ALR 98). In relation to the right of exoneration, one of those equitable interests is the trust creditors’ entitlement to be subrogated to it. In accordance with the well-established authorities, that interest is not diminished by the trustee’s bankruptcy.

116    No other authority was cited to the Court and none has been located which supports the contention that, on the bankruptcy or winding up of a trustee, the right of exoneration evolves into a broader right from which the trustee or company liquidator can obtain a direct payment of an amount equal to the debts in respect of which the right of exoneration exists. Such a notion is inconsistent with the various decisions concerning the right of indemnity given that, if such a principle existed, the contentious matters in those authorities would not have arisen. It was also specifically rejected by McLelland J in Re ADM Franchise Pty Ltd (1983) 7 ACLR 987 at 988-989.

117    It follows that the submission that a trustee’s right of exoneration is broadened by the bankruptcy of the trustee should be rejected. In the hands of the Bankruptcy Trustees the right remained as it was in the trustee’s hands, namely a right to apply trust funds in discharge of trust debts.

The use to which the right of exoneration may be put under the Bankruptcy Act

118    Pursuant to s 58(1) of the Act, upon the debtor becoming bankrupt, the property of the bankrupt vests in the bankruptcy trustee or, if the trustee is appointed by the creditors, the property vests on the date of that appointment (s 132(1)). Once the bankruptcy trustee has possession of the property or it is otherwise vested in them, they are required to administer the estate. Division 4 of Part VI of the Act affords a bankruptcy trustee powers for undertaking that task. By s 134 numerous specific powers are granted to enable the bankruptcy trustee to deal with the property, including the power to generate funds in various ways such as by leasing, carrying on a business, and charging or mortgaging any property. It is worth observing that, whilst s 116(1)(b) specifically includes within the description “property divisible amongst the creditors of the trustee”, the “capacity…to exercise powers in, over or in respect of property”, there is no specific power granted by s 134 authorising the exercise of those powers for the purposes of generating funds. It may be that the entitlement to exercise the bankrupt’s powers in the administration of the bankrupt’s estate arises from the more general authorisations in s 134(1)(n) to “superintend the management of the whole, or part, of the property of bankrupt” or in s 134(1)(o) to “administer the property of the bankrupt in any other way”. It is also relevant that s 134(3) affords the bankruptcy trustee a wide discretion as to the manner in which the estate is administered by providing, “Subject to this Act, the trustee may use his or her own discretion in the administration of the estate.”

119    In the administration of the estate, a bankruptcy trustee is bound to deal with the assets that come into their hands with a view to achieving the maximum return from them so as to best satisfy the claims of the creditors (see Adsett v Berlouis (1992) 37 FCR 201 at 209 citing with approval the observations of Smithers J in Mannigel v Aitken (1983) 77 FLR 406 at 408 – 409). In the present matter, the relevant subject matter of the bankrupt’s estate is a right to use trust funds (not otherwise available for use in the bankruptcy) for the purposes of meeting the claims of the bankrupt’s trust’s creditors and that is all that the Bankruptcy Trustees might do with it. That is not undertaking a sale of the right nor its conversion into funds. Put simply, the right is not one which is capable of being “realised” so as to produce a monetary return. Quite rightly, no argument was made to this Court that the money to be paid from the trust assets to trust creditors could be characterised as “proceeds” within the scope of the expression “proceeds of the property of the bankrupt” as it is used in s 108 and s 109(1) of the Act.

120    This approach to the orderly administration of the bankrupt’s estate is consistent with the approach which would be taken in relation to other forms of restricted or limited property. It would be the approach adopted by a bankruptcy trustee in relation to an entitlement to claim on a policy of insurance which is subject to the limitations imposed by s 117 of the Act. It is also the approach which would be adopted if the bankrupt trustee had a right of indemnity against a beneficiary such as that which arose in Re Richardson. The right would need to be enforced against the beneficiary for the benefit of the single trust creditor with the non-trust creditors only deriving the indirect benefit of a reduction of the total quantum of claims against the trustee’s personal estate. Yet a similar situation would arise where the bankrupt trustee’s right was one for contribution from a co-trustee in relation to trust debts. In the course of the administration that right of indemnity would be enforced only for the direct benefit of the trust creditors.

121    For the purposes of s 108 of the Act it is the “proceeds of the property of the bankrupt” which are to be used to pay the creditors and, if they are insufficient, the creditors are to be paid proportionately. From what has been identified above, no “proceeds” can be derived from the right of exoneration. The consequence is that the right is not subject to either the provisions concerning distribution of proceeds under s 108, nor the priority provisions of s 109. In the context of the provisions of the Act, the right can only be used to meet the claims of trust creditors.

Whether the right of exoneration ought to be exhausted before dividends are paid?

122    A further matter on which the Bankruptcy Trustees seek directions is whether the right of exoneration should be exhausted before dividends are paid to creditors from the proceeds of property under s 108. It was submitted that the right of exoneration should first be used to discharge the claims of trust creditors, prior to any distribution of the “proceeds” of the bankrupt’s property. If that occurs, the “trust creditors” will, at best, only participate in the bankrupt’s personal estate for the remaining amount of their debt.

123    The administration of the bankrupt’s estate will necessitate the exercising of the right of exoneration by the Bankruptcy Trustees and the realisation of property capable of being turned into money. Once those tasks are completed the Bankruptcy Trustees will be in a position to ascertain the value of the estate which is available for distribution. Until that stage is reached, it is impossible for the bankruptcy trustees to make the priority payments required by s 109 or to declare a dividend under s 140. Therefore, it logically follows that the right of exoneration must be exercised before any consideration is given to making a distribution to creditors under s 109.

124    Although it has been held that the trust creditors’ rights of subrogation to the right of exoneration does not make them “secured creditors” (Buckle at 247), they are certainly akin to secured creditors in some respects. In a very real sense, the amount which remains owing to the trust creditors by the insolvent trustee is the total amount of their debt less the value of their subrogated right of indemnity. In the context of legislation where the creditors are to be treated equally, it would be an unusual situation were the trust creditors to be able to assert the full amount of their claim so as to participate in the proceeds of the property of the bankrupt, only to be entitled to turn around and seek an additional payment from the trust assets.

125    In addition, significant administrative difficulty would arise if the trust creditors were able to receive dividends from the personal estate of the bankrupt prior to receiving the benefit of their right of subrogation. Were that to occur, it would follow that a right of “recoupment” to the extent of the amount paid to the trust creditors from the personal estate would arise or vest in the bankrupt’s estate. The bankruptcy trustees would then be required to realise that right of recoupment which would lead to the establishing of a further fund for distribution amongst all of the creditors, including the trust creditors. That, in turn, would lead to a further right of recoupment arising and the scenario would continue almost ad infinitum. It is not likely that the legislature would have intended such an absurd result.

126    Consequently, the administration of the estate should occur by the trust creditors’ claims being paid out of the right of exoneration prior to their participation in the receipt of any dividends under s 108 and s 109 from the assets of Mr Lee’s personal estate. Although not founded upon the same reasoning, this was the approach adopted by King CJ in Re Suco Gold (at 109 – 110).