Court Clarifies When Trust Property Vests in a Trustee in Bankruptcy

High Court Clarifies When Trust Property Vests in a Trustee in Bankruptcy

By Maxim Oppy, Law Clerk and Alicia Hill, Principal, MST Lawyers

 

In 2019 the courts repeatedly grappled with the complex intersection of insolvency and trust law, culminating in the significant High Court decision of Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20. Rounding out the year, the decision in Boensch v Pascoe [2019] HCA 49 saw the High Court return to this intersection, this time in relation to bankruptcy.

In this dispute, the formerly bankrupt Mr Boensch claimed that a caveat lodged over property he held on trust was done without reasonable cause.

In dismissing his application the High Court considered in what circumstances property held on trust by a bankrupt is vested in their trustee in bankruptcy and how to ascertain whether a caveat lodgement is reasonable.

Background

On 17 March 2004 Mr and Ms Boensch executed a Deed of Trust in relation to their real property in Rydalmere in New South Wales. Mr Boensch was to hold the property on trust for the benefit of their children.

On 23 August 2005 the Federal Court made a sequestration order against Mr Boensch and Mr Pascoe was appointed as Mr Boensch’s trustee in bankruptcy.

On 25 August 2005 Mr Pascoe lodged a caveat over the property on the basis of legal advice he had received to the effect that the trust was either a sham trust, or that Mr Boensch had a proprietary interest in the trust property by virtue of his right to indemnity.

In 2006, after numerous requests from solicitors representing Mr Boensch to remove the caveat, Mr Pascoe applied to the Federal Magistrates Court seeking a declaration that the Trust was void for being a sham trust.

Mr Pascoe was unsuccessful both at trial and on appeal and after their completion in 2009 Mr Pascoe allowed the caveat to lapse.

After being discharged from bankruptcy, Mr Boensch commenced proceedings against Mr Pascoe in the New South Wales Supreme Court. Relying on section 74P of the Real Property Act 1900 (NSW) (the Victorian equivalent is section 118 of the Transfer of Land Act 1958 (Vic)), he sought compensation on the basis that Mr Pascoe had lodged the caveat on the Rydalmere property without reasonable cause and failed to withdraw it after being requested to do so.

At first instance and on appeal to the Full Court of the Federal Court Mr Pascoe was successful. Mr Boensch was granted special leave to appeal to the High Court, however, Mr Pascoe was again successful.

When will property held on trust by a bankrupt be vested in their trustee in bankruptcy?

The High Court held that property held on trust by a bankrupt trustee will vest in their trustee in bankruptcy when the bankrupt has some beneficial interest, no matter how small, in the trust property, either vested or contingent. In such a case, the entire property vests in the trustee in bankruptcy subject to the equities in favour of third parties such as the beneficiaries of the trust.

Under section 58 of the Bankruptcy Act 1966 (Cth), all property of a bankrupt vests in the trustee in bankruptcy. Property held on trust by the bankrupt is not considered to be property of the bankrupt for the purposes of section 58, however, where a trustee incurs personal expenses in administering a trust they obtain an equitable interest in the trust property to indemnify their expenses (this is known as the right of indemnity).

Crucially, Mr Boensch had incurred costs in paying for the mortgage and utilities of the Rydalmere property, leaving him with a right of indemnity in the property.

As such the Rydalmere property was in fact equitably vested in Mr Pascoe in his capacity as Mr Boensch’s trustee in bankruptcy, subject to the terms of the trust. Further, it was immaterial that the right of indemnity was likely of very little value and that Mr Pascoe did not have actual knowledge of Mr Boensch’s right of indemnity at the time of lodging the caveat.

When is it reasonable to lodge a caveat?

The High Court confirmed the test from Beca Developments, that a claimant under section 74P of the Real Property Act 1900 (NSW) must establish that the caveator did not have either a caveatable interest or an honest belief based on reasonable grounds that the caveator had a caveatable interest.

Therefore if the trustee in bankruptcy has an honest belief on reasonable grounds that a bankrupt trustee has a legal or equitable (but not statutory) interest in trust property, such as a right of indemnity, the lodgement of the caveat will not give rise to liability for compensation. In this instance Mr Pascoe had both a caveatable interest and an honest belief due to legal advice.

Commercial Considerations

This decision clarifies when a trustee in bankruptcy can lodge a caveat over land held by the bankrupt on trust, it is particularly useful for practitioners given how common trusts are for structuring purposes.

The High Court also reiterated the test for the reasonableness of lodging a caveat, which provides protection to trustees in bankruptcy when lodging caveats and facilitates the protection of creditors.

Please contact Alicia Hill on 8540 0200 or Alicia.hill@mst.com.au if you have any queries in respect of this article.