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Last Updated: 22 August 2023
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director
59
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director
Struan Scott*
Corporate trustees vary. At one end of the spectrum there are “trustee corporations”.1 Moving towards the other end of the spectrum there are those limited liability companies that act as trustees for a number of trusts.2 And, at the other end of the spectrum, there is the assetless limited liability company that was incorporated to act as the trustee of a single trust and the trust property is a business (or the trust property is actively engaged in a business). This last situation, in particular the use of a corporate trustee to act as the trustee of a trading trust, is the focus of this article.The use of an incorporated company as trustee is not new;3 nor is the carrying on of business by trustees. Originally developed to describe the general situation where a trustee carries on a business that is trust
* Professor of Law, Faculty of Law, University of Otago. I am grateful for the comments by the anonymous reviewer of this article.
within the meaning of the Trustee Companies Act 1967: Trusts Act 2019, s 9 (adopting the definition in the Protection of Personal and Property Rights Act 1988, s 2).
60 Otago Law Review (2021) Vol 17 No 1
property,4 the term trading trust5 has developed a specialised meaning in both Australia and New Zealand – referring to the situation where the trust business is operated by a limited liability company (the corporate trustee) as the sole trustee for named beneficiaries.6 Typically, the corporate trustee beneficially owns little property, so is effectively assetless,7 and is a one-person company, with its sole director being its sole or dominant shareholder (either directly or indirectly through related companies). Further, the beneficiaries are typically discretionary beneficiaries,8 comprising the director personally and members of their family (either directly or indirectly through the medium of other trusts).
Unless the context requires otherwise, in the balance of this article the term “corporate trustee” is distanced somewhat from that of “trading trust” and is used to refer to a limited liability company that displays the attributes mentioned in the last paragraph and acts as the trustee of a trading trust. As a consequence, the term “trading trust” reverts to its more generalised meaning, albeit the beneficiaries display the above- mentioned attributes.
One perceived advantage associated with the use of a corporate trustee is an ability to distance and insulate the director who makes the decisions (or supervises their making) regarding the administration of the trust from the personal liability associated with being a trustee.9 As a general rule, a director of a corporate trustee may avoid primary personal liability as a trustee.10 But a corporate trustee is still an incorporated company and its director – who is responsible for managing (or supervising the management) of the company’s business (which is to act as a trustee)11 –
(NZLC R130, 2013) at [2.8].
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 61
owes duties to the company regarding its conduct of that business. The end result is that the director may incur personal liability to the company for liability incurred by the company arising through its administration of the trust.12
The decision of the Court of Appeal in Arnerich v DHC Assets Ltd (Arnerich) confirms and illustrates a situation where a director of a corporate trustee may face personal liability for their company’s administration of a trust.13 That case involved a distribution of effectively all of the trust funds to the beneficiaries, which, in turn, adversely impacted upon one trust creditor. In that respect it was similar to the earlier case of Levin v Ikiua (Levin), which brought attention to the issues associated with the use of corporate trustees, trading trusts, and the distribution of trust property at the expense of creditors.14 Arnerich differs from Levin in that the Court’s focus was directly on the director’s statutory duties to the corporate trustee, in particular s 131 of the Companies Act 1993 (the Act).15
For reasons developed in this article, it is considered that s 131 is the duty that directors of corporate trustees of trading trusts (and the associated trust creditors) should be most aware of, especially when making distributions.16 Despite this focus, the message of this article – be mindful of director’s duties and liability – has general relevance to all directors of limited liability companies who act as a trustee.
The article starts with some important background. This involves a brief reminder of trustee liability. It then considers key (mis)perceptions regarding the corporate trustee and incorporated companies generally that hide a full appreciation of the risks a director of a corporate trustee assumes. This forms background to a consideration of Arnerich and some issues that it does not resolve.
extend to any “wrongful” act: Levin (HC), above n 7, at [99].
Commission, above n 3, at [7.65].
62 Otago Law Review (2021) Vol 17 No 1
II Background
(a) Trustee Liability
An adjective that is commonly used to describe the default loyalty duties imposed upon an express trustee is “onerous”. But these duties are just the start. Another default liability, and the one most readily encountered when the trust is involved in commercial activity, is the personal liability that a trustee assumes to others in their interactions with the trust.17 The end result is the imposition of potentially “ruinous responsibilities” upon trustees.18Some individuals still may become a trustee “from kindness to others” and with little “contemplation” of the responsibilities they are assuming19 but not all. The rigour of equity’s default duties can be tempered in a number of ways, for example through their express alteration in the trust deed; through the inclusion of express clauses purporting to limit or to exclude liability for breach of those duties in the trust deed;20 through judicial discretion to remove or lessen liability for some breaches of trust;21 and through well-drawn contracts in which the amount of the trustee’s liability for performance of the contract is limited to the trust assets.22 But risks remain.
(b) The Corporate Trustee Solution
Perhaps influenced by developments in Australia,23 since the 1980s, some have seen the use of a corporate trustee as an attractive solution to lessen the risks assumed by trustees. Its attractiveness is that the use of the corporate trustee responds to the risks visited upon trustees by attempting to lessen the consequences of liability, once imposed. It does so by providing a (very) limited fund against which creditors and
19 At 373.
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 63
beneficiaries can seek redress.24 Associated with this, the company’s primary liability appears to act as a shield from personal liability for the director(s) who determine (or supervise) the company’s actions regarding the administration of the trust. In so doing the corporate trustee is simply displaying attributes that are inherent in incorporated companies – separate legal identity and limited liability.
The use of a corporate trustee, especially in the context of a trading trust has raised concerns. Indeed, its use has been described as “counterintuitive”25 and contrary to the assumption that “a responsible person is needed to manage assets held on behalf of another”.26 In turn, issues associated with the protection of trust creditors and beneficiaries have been explored and recommendations made.27 While recognised (and commented upon),28 the ability of creditors to pursue claims against the director of a corporate trustee for that company’s acts and omissions regarding the administration of the trust has remained largely unexplored.29
The assumption, that the corporate trustee’s separate legal personality provides some sort of protection for the director who determines the company’s actions regarding the administration of the trust, overlooks both equity’s traditional recognition of an incorporated company’s
at ch 7 (creditors) and ch 8 (beneficiaries).
64 Otago Law Review (2021) Vol 17 No 1
vulnerability to self-interested behaviour by its directors30 (this is of particular relevance for trading trusts) and the recognition (by both the courts and Parliament) of the need for, and imposition of, wider duties upon directors. The days of director’s actions (and inaction) being evaluated by standards of “honesty” and “gross or culpable negligence in a business sense”31 are well over. Indeed, some would say that both company directors and trustees are subject to onerous duties, albeit that they are different duties. Directorial duties, of course, apply to directors of corporate trustees. “A company is a company is a company” and “[a] director is a director is a director”.32
III Some (Mis)perceptions Associated with the Corporate Trustee
(a) The Limited Assets Available to the Corporate Trustee’s Creditors
Because of their very nature and role, a corporate trustee of a trading trust will be effectively assetless.33 This is both a correct and misleading statement. It is correct in that the corporate trustee will have been incorporated with a nominal share capital and will have generated few, if any, profits, let alone retained them. It is also correct in that the trust assets that the corporate trustee legally owns are not its beneficial property and, as such, are unavailable to pay its personal debts. But, by failing to take into account the rights of indemnity that equity has conferred upon trustees, this statement is misleading. A corporate trustee is a trustee is a trustee!At common law the trustee is the principal through whom, either personally or by their agent(s), all contracts involving the trust are made and all tortious acts are committed and, as such, is personally liable. Equity, however, confers upon the trustee a right of indemnity against the trust fund so as to ensure that the trust fund bares ultimate responsibility for the discharge of these debts.34 As summarised in Heath and Whale: Insolvency Law in New Zealand:35
The indemnity operates practically in four ways. First, the trustee is entitled to spend the trustee’s own funds and then be reimbursed from the trust fund; known as right of reimbursement [or recoupment]. Second, the trustee may meet the trustee’s liabilities qua the trustee direct from the trust fund. This is known as the right of exoneration. These entitlements
J.
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 65
to an indemnity allow the trustee to retain an appropriate amount of trust assets until the trustee’s claim for reimbursement or exoneration is satisfied.
Thirdly, the trustee may retain trust assets for income until the trustee’s indemnity is met. This applies both to current liabilities and future liabilities. The value of assets retained for these contingent liabilities is to a level to meet the worst outcome but not one based on fanciful assumptions. The fourth incident of the trustee’s indemnity right is the right of realisation. Thus, the trustee is not necessarily required to wait until it is convenient for assets to be realised to meet the trustee’s costs. The trustee may proceed to realise assets, or perhaps preferably apply to the Court for an order for sale.
Of course, equity recognises conditions that qualify when the right of indemnity is available, for example it applies only to those liabilities that had been “properly incurred”36 (ie authorised by the trust) and the amount recoverable could be reduced by the amount required to remedy any loss caused to the trust fund by breach of trust.37 The trustee’s right of indemnity is expressly recognised in the Trusts Act 2019.38
On liquidation of a corporate trustee, in the absence of the appointment
of a new trustee, the company will remain as the trustee of the trust but, of course, the company comes under the liquidator’s control, who must administer the trust assets “in accordance with the equitable obligations which govern the trust”.39 It will be recalled that the right of indemnity comprises a right of reimbursement (or recoupment) from the trust fund for trust debts personally paid by the trustee. This right “creates an equitable interest in both the capital and income of the trust”;40 it is, therefore, an asset of the trustee and, in the case of a corporate trustee in liquidation, an asset available to the liquidator to pay both trust debts and the corporate trustee’s personal debts.41
The right of indemnity also comprises a right of exoneration – the right to pay trust debts directly from trust funds. The position with respect to this right is more complicated. Equity recognised that a trust creditor whose debt the trustee has a right of exoneration in respect of
66 Otago Law Review (2021) Vol 17 No 1
could be subrogated to that right.42 In the classic discussion of this right of subrogation, Sir George Jessel MR expressly refers to a mischief this right is addressing – this is “set[ting] up a trustee who may be a man of straw, and make him a bankrupt to avoid the responsibility of the [trust] assets for carrying on the trade”.43 Associated with this is the “injustice caused by a beneficiary receiving assets, as a result of credit provided to the trustee that has not been repaid”.44 The end result is that the right of exoneration is an asset that is available to the liquidator for the benefit of trust creditors, rather than all creditors.45 Moreover the relevant trust creditors themselves can be subrogated to this right.46 At equity, the creditor’s right of subrogation, however, is derivative, and therefore dependent upon the right of the trustee to be exonerated for that debt and can be reduced by claims the beneficiaries have against the trustee.
Significantly, s 86 of the Trusts Act 2019 confers upon creditors a direct claim against the trust. The trustee must still47 have had a right to be indemnified but, provided the creditor has given value, the trust has received a benefit from the transaction between the trustee and the creditor, and the creditor has acted in good faith, the creditor’s claim is not adversely affected by some other act of the trustee that at equity would disqualify the trustee from being indemnified or fully indemnified.48 The example given in the Act is disqualification arising because the trustee incurred the liability in breach of trust.
For sake of completeness it should also be noted that in certain
situations a trustee enjoys a right of indemnity against a beneficiary.49
Despite some uncertainty over the distribution of trust funds that the corporate trustee is entitled to through the right of indemnity, in particular the right of exoneration, it is clear that the right of indemnity is an asset of the trustee and one that should not be overlooked when determining just how assetless a corporate trustee is.
MR.
may be exercised by a liquidator: at [26.4(c)].
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 67
(b) Protection Offered by Shareholder Primacy
The perceived wisdom is that key company law concepts involving a company’s separate legal identity and shareholder limited liability will operate to insulate the director of a corporate trustee from their decisions.This seems to be the assumption in the 1970s and 1980s when most of the then commentary concentrated upon the scope of the trustee’s indemnity and its availability for trust creditors. Encouraging this assumption was the equation of the interests of the company with those of its shareholders and shareholder ability to ratify breaches of duty. Moreover, directors’ duties were largely focused upon the traditional fiduciary loyalty concerns, for example those of self-dealing and other self-interested acts.
With the benefit of hindsight, the Act can be seen as building upon developments that were then occurring in our conception of a company and expectations of directorial behaviour. As indicated at the outset by its title, the Act was designated a “reform” Act; one identified area being “to define the relationships between companies and their directors, shareholders, and creditors”.50 As identified by the Supreme Court in Madsen-Reis v Cooper, s 131 of the Act enacts a key duty of directors – this is “to act in the best interests of the company”.51 While the Supreme Court did not resolve “competing” views as to whose interests (for example the shareholders as a whole, stakeholders, or the company itself) are to be equated with those of the company,52 the Court did confirm that “maintaining solvency is vital”.53 Indeed, prior to the Act, Cooke J in Nicholson v Permakraft (NZ) Ltd recognised that a company’s “insolven[cy], ... near-insolven[cy], or ... doubtful solvency” were crucial times in determining whose interests the directors were to consider.54 Cooke J observed:55
The duties of directors are owed to the company. On the facts of particular cases this may require the directors to consider inter alia the interests of creditors. For instance creditors are entitled to consideration, in my opinion, if the company is insolvent, or near-insolvent, or of doubtful solvency, or if a contemplated payment or other course of action would jeopardise its solvency.
51 Madsen-Reis v Cooper [2020] NZSC 100, (2020) 29 NZTC 24-088.
52 At [31].
53 At [32].
54 Nicholson v Permakraft (NZ) Ltd, above n 15, at 249. 55 At 249.
68 Otago Law Review (2021) Vol 17 No 1
In turn, building upon Sojourner v Robb,56 Madsen-Reis v Cooper confirms that for the purposes of s 131, once a company ceases to be solvent its directors must consider the interests of its creditors. Sojourner also confirms that the company’s solvency impacts the shareholders’ ability to assent to and to ratify the acts of the directors.57
The end result – a director of a corporate trustee must consider the interests of its creditors, at least when it is insolvent or proposed acts will make it insolvent. Given that the main asset of a corporate trustee is its right of indemnity against the trust fund, the s 131 duty (at the very least) must be engaged should the corporate trustee do anything to imperil that right or attract liability that cannot be reimbursed from the trust assets. In turn, on the appointment of a liquidator,58 both s 301 of the Act and the liquidator’s ability to sue in the name of the company59 provide the means of enforcement and recovery from the director.
The circumstances giving rise to the s 131 claim in Arnerich are now considered.
IV Arnerich
(a) FactsBoth the facts and procedural history of this case are relatively complicated. In essence, the case arose out of a property development undertaken though the medium of a discretionary trading trust.60 The trust was the Vaco Investments (Lincoln Road) Trust (Vaco Trust). Its “discretionary beneficiaries ... were (ultimately, via other trusts) Mr Arnerich and members of his family”.61 The trustee of the Vaco Trust was Vaco Investments (Lincoln Road) Ltd (Vaco).62 Mr Arnerich was Vaco’s sole director63 and a related company (of which Mr Arnerich was also the sole director and shareholder64) was Vaco’s sole shareholder.65
56 Sojourner v Robb [2007] NZCA 493, [2008] 1 NZLR 751 [Sojourner (CA)]. 57 At [25].
the property was undertaken by Vaco in its capacity as trustee of, and
for the benefit of, the Vaco Trust”).
61 At [14].
62 At [14].
63 At [1].
64 At [12].
65 At [13].
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 69
As trustee, Vaco purchased a property at Lincoln Road from the related company66 and then entered into a fixed price contract with DHC Assets Ltd (DHC) to design and to build a commercial building on that property.67 That contract conferred limited rights upon DHC to make claims for additional payments and established procedures to be followed. This included submitting claims to the engineer appointed under the contract for evaluation and then approval or rejection. During the build Vaco made a number of claims for additional payments; some were accepted or partially accepted but others were not. Mr Arnerich was aware of these claims and made comments upon them to the engineer.68 DHC disagreed with the decision to reject some of its claims, leading, not-surprisingly, to disagreements between it and Vaco. The building was completed and, without DHC’s knowledge, sold;69 settlement was on 3 April 2013.70
As an aside, at this stage it should be noted that the effect of the sale was to change the nature of the trust property from the land (and fixtures associated with the new building) to cash. From the trust funds71 Vaco repaid the mortgage and associated costs. On 8 and 9 April 2013 Vaco then paid about $2.3 million to Mr Arnerich, his family members, and to related business interests.72 This left about $500,000, which was retained to cover retentions and outstanding costs.73 By mid-September 2013 (or thereabouts) most of the retained funds had been dissipated, with payments to creditors and further payments to Mr Arnerich’s family members and business interests.74 On 4 October 2013 Vaco ceased trading;75 at that time its “remaining asset” (presumably the remaining trust funds) was a credit balance of $6,440.25.76 On 1 July 2014 Mr Arnerich (in his role as shareholder) appointed a liquidator for Vaco.77
During this time DHC was corresponding with Vaco regarding its claims.78 On 2 July 2014 DHC was advised that Vaco was in liquidation;79
66 At [12].
67 At [17].
68 At [29], [33], [39], [40], [43], and [47]–[48] as examples.
69 At [52].
70 At [54].
71 At [137].
72 At [56].
73 At [53].
74 At [58]–[59].
75 At [76].
76 At [76].
77 At [78]. Presumably the remaining funds were enough to cover the
expected liquidation costs.
78 At [77].
79 At [79].
70 Otago Law Review (2021) Vol 17 No 1
a few days later it lodged a proof of debt, claiming a sum slightly in
excess of $700,000.80 This claim was rejected.81
In February 2016 the High Court granted leave to DHC to commence adjudication proceedings against Vaco (in liquidation) regarding the claims rejected by the engineer.82 The Adjudicator determined that Vaco was liable for some of the claims but not others (the disallowed claims); the end result being that Vaco was required to pay DHC a sum slightly in excess of $300,000 plus interest.83 DHC then obtained both a High Court order that the disallowed claims be referred to arbitration (one of the mechanisms provided for the contract for disputed claims) and a District Court order that the Adjudicator’s determination of liability be entered as a judgment (this was for $367,768.12).84
Rather than proceeding with the arbitration to determine Vaco’s liability for the disallowed claims, DHC brought proceedings against Mr Arnerich pursuant to s 301 of the Act,85 arguing a breach of s 131. As summarised by the Court of Appeal, the High Court86 found that Mr Arnerich had breached s 131 (for reasons considered in the next section) and ordered him to pay DHC directly the $367,768 awarded against Vaco.87 The High Court declined, however, to determine Vaco’s liability for the disallowed claims on the basis that the contract required these to be determined by other mechanisms and they had been referred to arbitration.88
Mr Arnerich unsuccessfully appealed, arguing that there was no breach of s 131. DHC cross-appealed seeking orders that the High Court could determine the disallowed claims and, on so doing, could order Mr Arnerich to pay the amount or any additional sums to it under s 301. DHC’s cross-appeal was successful.89
80 At [80].
81 At [83].
82 At [86].
83 At [92].
84 At [97].
abide the decision of the Court regarding Vaco’s liability to DHC.
89 The Court of Appeal concluded that the High Court did have jurisdiction to determine the amount of any further claim DHC might have against Vaco and this aspect of the case was remitted back to the High Court to determine: at [191]. An application by Mr Americh for leave to appeal was dismissed by the Supreme Court: Americh v DHC Assets Limited [2021] NZSC 121 [Americh (SC)].
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 71
(b) The s 131 Claim
Viewed as a key duty in the scheme of the Act,90 s 131(1) requires a director, “when exercising powers or performing duties”, to “act in good faith and in what the director believes to be the best interests of the company”.As interpreted by the Supreme Court in Madsen-Reis v Cooper, the section empowers a court to determine whether a director subjectively believes that the acts they were taking were in the “best interests of the company”.91 If not, the director will be in breach of s 131. As will be recalled, despite uncertainty arising from “competing models of corporate governance”,92 the Supreme Court was clear that “maintaining solvency is vital”;93 the Court also noted that “it is accepted that the interests of creditors have to be considered where the company is insolvent or nearly insolvent”.94
(c) Application of s 131 in Arnerich
The acts that DHC focused on as constituting a breach of s 131 by Mr Arnerich were primarily the April 2013 distributions by Vaco to Mr Arnerich, to his family members (beneficiaries under the Vaco Trust) and to related business interests (presumably for the benefit of Mr Arnerich). Additionally, the circumstances surrounding the final payments (distributions) to Mr Arnerich’s family and business interests out of the retained funds were also said to constitute a breach.Collectively these distributions were in excess of $2.3 million. From Vaco’s perspective, the consequence of this was that the distributions eliminated the trust fund thereby undermining the right of indemnity against that trust fund. To quote from the Court of Appeal’s judgment:95
When Vaco made distributions of trust funds to discretionary beneficiaries of the Vaco Trust, Vaco was not paying away money that Vaco owned beneficially. These were not Vaco’s own funds. But by making those payments, Vaco lost its ability to meet liabilities it incurred in its capacity as trustee out of those trust funds, lost the ability to reimburse itself out of those funds, and lost its lien over those funds. When considering whether Mr Arnerich breached s 131, the focus must therefore be on whether he
72 Otago Law Review (2021) Vol 17 No 1
acted in the best interests of Vaco in deciding that Vaco should make those distributions at the relevant time and, as a consequence, lose its ability to have recourse to those funds in the event that an existing or future claim by DHC (or any other creditor of Vaco in its capacity as trustee) was made out.
(d) Revisiting the Importance of the Indemnity to a Company’s Solvency
As noted earlier, the right of indemnity is, in reality, the only asset of the corporate trustee administering a discretionary trading trust. Deliberate loss of that right (through distributions or release) when trust liabilities remain must make the company “insolvent or nearly insolvent”, contrary to the interests of the company. Shaw v Owens illustrates that the decision of directors to release human trustees from their agreed obligation to fund the company’s activities can constitute a failure to exercise the care, diligence, and skill required of them by s 137.96Angela and Ian Shaw were directors of Aluminium Plus Wellington Ltd (the Company); they were also the trustees of the I & A Shaw Family Trust (the Trust). The Trust carried on business as a glazier and manufacturer of aluminium joinery. The Company “served as a conduit for the Trust”.97 Its role was to contract with a key supplier of materials, who refused to deal with a trading trust (that supplier was the only significant supplier that dealt with the Company98). The Company had no income, no bank account, or other assets. Pursuant to a purchase and supply agreement between it and the Trust, the Company purchased goods from the supplier and then supplied those goods, along with the supplier’s invoice, to the Trust. In turn the Trust paid the supplier directly.99
Following a dispute with the supplier regarding goods that the Shaws regarded as being defective, the Shaws (“acting in their dual capacities as directors and trustees”100) decided that, in return for the Trust not pursuing claims against the Company regarding these goods, the Company would release the Trust from any obligation to pay for those goods. It was further agreed that, if sued by the supplier, the Company could counterclaim for any credits that the supplier owed.101
The release of the Trust from the obligation to pay the Company was held to constitute a breach of s 137. Two aspects of the Court’s reasoning underlying this conclusion are relevant to a director of a corporate trustee
96 Shaw v Owens [2017] NZCA 315, [2017] NZCCLR 23 [Shaw (CA)]. 97 At [3].
98 Owens v Shaw [2016] NZHC 1400, (2016) 4 NZTR 26-008 [Shaw (HC)] at
[6].
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 73
of a trading trust (and the application of s 131). The first involves the recognition of the significance of the indemnity. The court observed:102
The nature of [the Company] was that it had no assets or income to meet its liabilities other than from recourse to matching payments made by the Trust. Its solvency was entirely dependent upon the Trust’s financial support. The nature of the directors’ decision was to release the Trust from its contractual obligation to indemnify [the Company] against all liabilities. Insolvency was its inevitable and immediate consequence, leaving the creditors’ interests without protection.
This reasoning is directly applicable to the trading trust situation. To state the obvious, in this situation a corporate trustee who has no right of indemnity, yet is personally liable for trust debts to creditors, will be insolvent “leaving the creditor’s interests without protection”. The presumption must be that in distributing the trust fund, the director was not acting in the best interests of the company. As noted in the earlier extract from Heath and Whale: Insolvency Law in New Zealand, a trustee is entitled to retain trust assets until the indemnity is met.
Of course, there may be unique situations where the decision to forgo the right of indemnity may be appropriate. But any decision to do so will need to be a well-informed and reasoned one. This is the second aspect of Shaw that is of relevance to the corporate trustee.
In Shaw it was argued that the release of the indemnity was of benefit to the Company; the argument was that in return for the release, the Company was released of any liability for the goods (claimed to be defective) and had the right to counterclaim against the supplier. This was the Court’s evaluation of this argument:103
... a release from its contingent liability to the Trust was of no tangible benefit to [the Company] unless the directors (a) formed an opinion independently of the Trust that the company was liable to the Trust; (b) resolved affirmatively to contest [the supplier’s] claim; and (c) secured an unconditional right to indemnity from the Trust if its defence and counterclaim failed. In any event, ... there was no certainty that the counterclaim would equal [the supplier’s] claim.
Not developed in Shaw (probably because the focus of the s 137 claim is on whether the directors exercised the care, diligence, and skill required of them) but present nonetheless in the above extract is the fact of the underling self-interest of the Shaws and whether this removed
74 Otago Law Review (2021) Vol 17 No 1
their ability to make reasoned decisions regarding the release of the indemnity.104
(e) Self-interest
Equity’s long-standing concern with self-interested (or conflicted) acts and decisions by those “entrusted with the interest of others”105 is well established and provides a common link between trustees and directors.106 Equity’s response to this concern, as expressed in the well-known summary of Cranworth LC from Aberdeen Rail Co v Blaikie Brothers, is:107
... it is a rule of universal application that no one having [fiduciary] duties to discharge, shall be allowed to enter into engagements in which he has or can have a personal interest conflicting or which possibly may conflict
with the interests of those whom he is bound to protect.
The Act may have codified aspects of this concern,108 but the wider concerns (and equity’s over-watch) remain, both in the self-dealing context109 and more generally.110 The risk of self-interested decisions is readily apparent in the situation of a trading trust, where the director is also a beneficiary, especially so in the situation where because of the corporate trustee’s insolvency, its director is “required to have regard to the interests of creditors and not just shareholders”.111 The observation of Fogarty J in Sojourner v Robb, that “[d]irectors of a company who are also the only shareholders of the company do not naturally believe that the best interests of the creditors of the company are the best interests of the company” 112 has added relevance for a director of a corporate trustee when they are also a discretionary beneficiary.
(f) Self-interest and s 131
The presence of self-interest is important for the s 131 duty. Notwithstanding s 131’s subjective focus, the Supreme Court in
corporate assets to a phoenix company).
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 75
Madsen-Reis v Cooper did recognise that this focus is subject to “a number of exceptions and qualifications”.113 The Court identified four “riders” where a director’s statement as to their belief that the act was in the company’s best interests would be evaluated and not necessarily accepted.114 These are:115
(a) where there is no evidence of actual consideration of the best interests of the company;
(b) where, in an insolvency or near-insolvency situation, there is a failure to consider the interests of creditors;
(c) where there is a conflict of interest or where the action was one no director with any understanding of fiduciary duties could have taken (although some would suggest these may rather be treated as breaches of the duty of good faith (as the High Court did in this case) or of s 133 (powers must be exercised for a proper purpose)); and
(d) where a director’s decisions are irrational.
(g) The Self-interest in Arnerich
These riders were considered in Arnerich. Earlier the Court concluded that the liabilities Vaco incurred in its capacity as trustee included those arising from the contract with DHC.116 In turn the DHC liabilities extended to the $367,768 judgment debt arising from the Adjudicator’s determination and any disallowed claims ultimately allowed by the High Court. This was so, even though at the time of the distributions in that case (April through to September 2013) DHC was still to formally establish its claims.
76 Otago Law Review (2021) Vol 17 No 1
Mr Arnerich’s defence to the s 131 claim was that at the time of the distributions “he genuinely believed that DHC had no further valid claims under the construction contract”.117 As noted by the Court, Mr Arnerich conceded that:118
... he knew that DHC was unhappy with Vaco’s refusal to pay any further amounts, and with the decisions made by the engineer to issue payment schedules denying their claims. But he considered that DHC had, albeit reluctantly, decided not to take any formal steps to pursue those claims. And in any event, even if DHC did pursue its claims further, he saw those claims as hopeless. So there was no need to retain funds to meet such claims.
The Court accepted that Mr Arnerich “believed that the risk of a
successful claim by DHC was very low”119 and that:120
... if the s 131 test were purely subjective, Mr Arnerich would have a respectable argument that in making decisions about dealings with funds held by Vaco, he could disregard the risk of claims by Vaco in excess of the amount set aside [$500,000] by way of provision when the Lincoln Road property was sold.
Nevertheless, it concluded that the riders (a), (b) and (d) applied. In reaching this conclusion the Court noted the following points:
Vaco’s interests were “clear[ly] disadvantage[d]” by making the distributions.123
117 At [152].
118 At [152].
119 At [163] (Court’s emphasis). 120 At [164].
121 At [167].
122 At [168].
123 At [169]. See also Americh (SC) above n89 at [14].
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 77
from those risks.”124 These risks included “the possibility that their personal assessment of the risk – without the benefit of legal advice – might be proved wrong”.125 The Court continued:126
At the very least, before taking the irreversible step of paying away all or almost all of the trust funds, a rational director who was considering whether payment was in the best interests of Vaco would identify all potential liabilities that Vaco might face in its capacity as trustee of the Vaco Trust, including the maximum conceivable liability to DHC, and ensure that Vaco retained access to funds sufficient to meet that maximum liability if it materialised.
With regard to the last two points the Court observed:129
It seems clear from the reasons Mr Arnerich put forward to explain why he felt comfortable with making the distributions that he did not in fact understand, or give consideration to, the interests of Vaco as a separate entity during the period when he was approving substantial distributions to himself and to his interests. There was no evidence that he actually turned his mind to Vaco’s best interests. He did not seek any formal advice on Vaco’s exposure to DHC. He did not prepare, or ask anyone else to prepare, a schedule of Vaco’s potential future liabilities to DHC, the IRD and other creditors. This was not mere carelessness: rather, the interests of Vaco as distinct from the Vaco Trust and his family simply were not on his radar.
And the Court’s conclusion:130
It is in our view clear that Mr Arnerich did not actually consider the best interests of Vaco as a separate entity before authorising these payments. He had an obvious conflict of interest. No director with any understanding of fiduciary duties could have acted as he did. It would be irrational for a director who understood their fiduciary duties, and was seeking to act in Vaco’s best interests, to act in that way.
124 At [170].
125 At [170].
126 In a footnote the Court noted that retained access to the funds could be achieved “[e]ither by actually retaining the funds, or (depending on the circumstances) by retaining the ability to have recourse to the funds, for example by providing them to beneficiaries as advances rather than outright distributions, or by making distributions subject to indemnities from the [beneficiaries]”: at [170], n 66. See also Americh (SC) above n89 at [15].
127 At [172].
128 At [172].
129 At [171]. See also at [172]. 130 At [173].
78 Otago Law Review (2021) Vol 17 No 1
While “DHC did not plead the case on the basis that [at the time it made the distributions] Vaco was insolvent or near-insolvent because of liabilities to third parties”,131 the Court also observed that at that time there was “a strong argument that rider (b) [failure to consider the interest of creditors in an insolvency or near-insolvency situation] applies”.132 This was because the “effect of the distributions was that Vaco became insolvent or near-insolvent as it progressively lost the ability to resort to trust assets to meet claims”.133
The end result was the Court’s confirmation that Mr Arnerich had breached s 131, at least regarding the $367,768 awarded against Vaco and for any further sums for which Vaco became liable for arising from the High Court’s consideration of the disallowed claims.134
The message is clear – a corporate trustee’s right of indemnity against the trust fund is an asset of the trustee and any decision to reduce the value of that asset through a distribution must, at the very least, be a well-informed, reasoned, rational and non-conflicted one. If not personal liability for breach of s 131 may follow.
V Some Unanswered Issues
In some respects Arnerich was a relatively straightforward case. This is because it involved a distribution of effectively all of the trust funds to the beneficiaries, which impacted upon one trust creditor. So while it assists in the resolution of some issues associated with the imposition of liability upon the director of a corporate trustee, it does not answer, let alone address, all of the issues.Continuing with the simple case of a distribution of effectively all of the trust funds impacting upon one trust creditor, two issues should be noted:
or the creditor.In the following sections these two issues are noted rather than considered in depth.
More complicated cases will arise, for example, when there is a number of trust creditors. Here both the ability of a creditor to bring the claim under s 301 and questions associated with the relative priority of individual trust creditors to receive payment arise. Another complicating variable is where the corporate trustee has access to funds to repay trust
131 At [174].
132 At [174].
133 At [174].
134 At [5] and [190]–[192].
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 79
creditors but these funds are insufficient to pay the trust debts that the trustee subsequently incurs.
(a) Relevance of Other Duties
A feature of the case law involving claims against the directors of insolvent companies has been the use of a range of duties – typically ss 131, 135, 136 and 137; indeed, it is common for all four duties to be relied upon.135 This may be explained by an apparent overlap in the scope of these duties but, perhaps, also by a failure to fully appreciate fundamental differences between the individual duties; key differences being their respective origins and mischief to which they respond. Section 131 is a fiduciary duty but, as the Supreme Court reminded us in Madsen-Reis v Cooper, “Not all directors’ duties are seen as fiduciary.”136 Section 137 owes its origins in the common law and “ss 135 and 136 are considered to be statutory duties only”.137
One consequence of this difference is variations in “the appropriate approach to awarding relief for breach”.138 This was noted by the Court of Appeal in Yan v Mainzeal Property and Construction Ltd (in liq) (Yan). Regarding a s 131 breach:139
... the remedy will be assessed in accordance with the principles governing claims for breach of fiduciary duty. The remedy may be gain-based, or may take the form of compensation for loss assessed on a generous basis that takes as its starting point all losses that would have been incurred but for the breach, with the onus on the director to justify any reduction from that starting point.
In contrast, where the breach is of s 137:140
... compensation will be assessed on the approach that is normally adopted in negligence cases. The loss recoverable will depend on the harm that the director had a duty to avoid. “But for” causation is a necessary but not sufficient requirement when assessing the loss that is caused by, and fairly attributable to, breach of a duty of care.
80 Otago Law Review (2021) Vol 17 No 1
And when the breach is of ss 135 or 136 “the appropriate approach to assessing compensation will depend on the nature of the breach”.141
Should the corporate trustee trade and incur trust debts when there is no right of indemnity to ensure the availability of funds for payment (or insufficient funds for payment in full), s 135 may be relevant.142 In this situation there must be a substantial risk of loss to the trust creditor(s),143 if not a certainty of some loss.144 The issue would then appear to become whether the director(s) had “carefully thought-through strategies, with a good prospect of success” to ensure that the corporate trustee could pay the debts from new trust funds arising through trading income.145
So too, in the situation of continued trading and the incurring of new debts, s 136 may be relevant; indeed, as noted in Yan, of the two sections (ss 135 and 136), s 136 may be the “more promising vehicle for claims that focus on harm to new creditors”.146 Also noted in Yan, the s 136 claim “may relate to specific obligations, an identified class of obligations, or all obligations incurred by the company after a given point in time”.147 Again, compliance or breach of the duty would appear to depend on whether the director(s) of the corporate trustee had “reasonable grounds” for expecting that it could pay these debts from the trading income.148
This leaves s 137. The relevance of the loss of the right of indemnity to s 137 was shown in Shaw. Although in that case the business structure distanced the supplier from the trust and the Company incurred the debt in its own right and not as a trustee, similar reasoning should apply to a corporate trustee that releases the right of indemnity.
Despite the potential application of ss 135–137, a number of factors suggest that s 131 should be the first duty to consider. The first is the particular concern, identified in Levin, of distributions of effectively all the trust funds to beneficiaries of trading trusts. This raises the law’s traditional concern with self-interested behaviour. Then there is the law’s more recent reconsideration of a company’s interests; this is another concern that is particularly relevant in the trading trust situation because of the creditor’s practical dependence upon the trustee’s right of
141 At [290].
148 At [287].
Corporate Trustees: Replacing Liability as a Trustee with Liability as a Director 81
indemnity for recovery. The third factor is more practical and a response to the above concerns – the application of the “but for” approach to causation and the onus of proof noted in Yan above that is applicable to s 131.
(b) Section 301
Sections 131 and 133-137 are duties that are owed to the company. Absent the company’s liquidation, a creditor cannot bring a claim against the director. Upon liquidation, the liquidator can bring a claim alleging breach of these duties – either suing in the company’s name149 or through s 301 of the Act. In the case of a typical corporate insolvency, irrespective of how the liquidator brings the claim, any compensation recovered from the director(s) are funds of the company and, as noted in Yan, “The court is not given any power to direct that the compensation be applied other than in accordance with the usual order of priority in a liquidation.”150But s 301(1)(c) does confer upon a creditor (and others, not just the liquidator) the power to apply to the Court for its evaluation of the director(s) actions etc. Where the application is made by a creditor, the court can order the director(s) “to pay or transfer the money or property or any part of it with interest at a rate the Court thinks just to the creditor”.151 The scope of this power is unclear, however. In Madsen- Reis v Cooper the Supreme Court noted:152
It has been suggested that under s 301(1)(c), at least in cases where the liquidator takes no steps, the Court can order all restitution or compensation to go to the particular creditor.
However, the Court “le[ft] consideration of creditors’ rights under s 301(1)(c) to a case where it arises and has been fully argued”.153
Arnerich did involve a s 301 claim by a creditor (DHC) but there were no other creditors and the liquidator took no part in the proceedings. As noted earlier the Court of Appeal ordered Mr Arnerich to pay DHC directly the $367,768 judgment debt awarded against Vaco and additional sums awarded by the High Court in regard to the disallowed claims.
149 At [304].
so the Court just noted this uncertainty: at [309].
82 Otago Law Review (2021) Vol 17 No 1
Reinforcing this result, but not considered by the Court, is that Arnerich involved the loss of the right of recoupment (regarding DHC’s debts) arising from the effective distribution of all of the trust fund.
More complicated cases will arise, for example, when there is a number of trust creditors. Here questions associated with the relevance of a creditor’s right of subrogation impacting upon the relative priority to payment will arise considered arise.
VI Conclusion
A director of a corporate trustee is not the trustee; as a result the director does not owe duties to the beneficiaries, nor assumes direct personal liability to trust creditors. But the director does owe duties to the corporate trustee and to the extent that breach of those duties causes loss to the company, becomes personally liable for that loss.The message from Arnerich for a director of a corporate trustee is clear
– while use of an incorporated company may insulate the director from personal liability as a trustee, personal liability for breach of a director’s duty in the administration of the trust remains. Because Arnerich involved a distribution of effectively all of the trust funds to the beneficiaries impacting upon one trust creditor, it highlights the relevance of the s 131 duty. Uncertainties remain regarding variations on this situation but a director of a corporate trustee must also be mindful of the other duties. The focus of this article has been on trust creditors but decisions of the corporate trustee that constitute a breach of duty to the beneficiaries will result in liability for the corporate trustee, and may also constitute a breach of a director’s duty to the corporate trustee.
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