30 Jun 2005

Personal liability of directors of corporate trustees

by Paul James, Paul Molnar

New amendments to the Corporations Act aim to restore some of the immunities previously available to trustees. Trustee company directors should soon be able to breathe a little easier.

Upcoming amendments to the Corporations Act will restore immunities from personal liability for trust debts. The amendments have been necessitated by the 2003 case of Hanel v O'Neill, which effectively stripped away many of the personal immunities that trustee company directors had previously enjoyed.

Hanel v O'Neill

A corporate trustee distributed all of its assets to a beneficiary. Now without assets, the corporate trustee could not pay its rent. The landlord claimed that the director of the corporate trustee was personally liable for the rent, under section 197(1) of the Corporations Act.

Up until this point, section 197 had been interpreted as making directors liable for trust debts only in certain limited circumstances, and certainly not just because the trust and the trust company had no assets. However, the Court noted that the section had been rewritten in 2000 (as part of the CLERP program). One change made by the amendments, said the Court, was to make a director of a corporate trustee liable simply because the trust and the trustee company had no assets.

The practical effect of the Hanel decision was that directors of corporate trustees were in a considerably worse position than directors of other companies.

In a "normal" corporate situation, directors are only personally liable for their company's debts if the director has breached their duty to prevent insolvent trading and cannot rely on any of the statutory defences to insolvent trading liability.

Before Hanel's case, trustee company directors could generally escape liability if the trustee company had a full indemnity against trust assets. After Hanel's case, that indemnity provided no defence unless the trust had the assets to back it up. In that case, trust directors were left exposed to personal liability, with none of the defences available in a "normal" insolvent trading situation.

As many commentators pointed out at the time, it wasn't clear that the CLERP rewrite of section 197 had been intended to have this effect. Back in 2000, it had been generally understood that the rewrite had been intended to do nothing more radical than turn section 197 into "Plain English", without changing its long-held effect.

This was a situation that cried out for legislative action, and that is now going to happen.

Corporations Amendment Bill (No. 1) 2005 (Cth)

The Bill was placed on the parliamentary agenda on 2 June 2005. Its main aim is to reverse Hanel's case.

The Bill makes it clear that a trustee director will not be personally liable for trust debts simply because the trust and the trustee company have no assets.

In detail, it provides that the director of a company which incurs a debt while acting as a trustee, is liable for the debt if the company:

  • has not discharged, and cannot discharge, the debt; and
  • is not entitled to be fully indemnified against the liability out of trust assets solely because of one or more of the following reasons:
    • a breach of trust by the corporation;
    • the corporation is acting outside the scope of its powers as trustee; or
    • a term of the trust denying, or limiting, the corporation's right to be indemnified against the debt.

Essentially, this means that a director of a corporate trustee will be personally liable only where the company's right of indemnity as trustee has been lost through disentitling conduct on the part of the company (such as breach of trust or ultra vires conduct) or through a restriction in the terms of the trust that purports to deny a right of indemnity.

How it will work in practice

This intended operation can be illustrated by considering the following examples:

  • A trust has no assets. The trust deed provides that the trustee's right to be indemnified out of the trust funds is capped at $5,000. The corporate trustee incurs a debt of $3,000 which has not been, and cannot be, discharged. If the debt was incurred bona fide in carrying on the business of the trust, the director will not be liable for the debt, despite there not being sufficient assets to discharge the liability. If however the indemnity is lost for one of the reasons listed above, the director will be personally liable.
  • A trust has $500,000 worth of assets. The trust deed provides that the corporate trustee's right to be indemnified out of the trust fund is capped at $250,000. The corporate trustee has a liability of $300,000 which has not been, and cannot be, discharged. Because the corporate trustee's right of indemnity is limited, the director of the corporate trustee may be liable for the whole $300,000.

The Bill is welcome news to many business organisations that use the structure of a corporate trustee, from large superannuation trusts to trading trusts running a small business. The proposed amendments address the arguable unfairness of the Hanel decision, and align the liabilities of directors of corporate trustees with other company directors.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.