The importance of being crystal clear

The High Court on 4 March 2015 handed down a unanimous judgment in the case of Korda v Australian Executor Trustees (SA) Limited. The case is important because it highlights the various factors that a court considers before finding that an express trust has been created for the benefit of commercial investors.

The facts of this case are quite complex due to the nature of the contractual arrangements between the parties, and they certainly will not be covered in-depth here, but they can be summarised as follows.

Background

The Forest Company (Forest Co, the third appellant) planted pine trees on land that it owned or leased. When the trees were mature, a three-way agreement (discussed below) required the Milling Company (Milling Co, the fourth appellant) to fell the trees and sell the logs. Milling Co was associated with, and possibly controlled by, Forest Co.

Under the relevant legislation, Forest Co was also required to enter into a trust deed with the Trustee Company (Trustee Co, the respondent). Trustee Co was a trustee for various scheme investors known as “Covenantholders.

Each of these Covenantholders was entitled to a certain amount of monies which depended on the details stated in the Covenantholder’s application. These details included the net proceeds from the timber apportionable to a particular area planted by Forest Co and the planting year. The amount which the Covenantholder gained from taking up their covenant under the deed was a rateable share in the change in value of the land as assessed at planting and its value as assessed after harvesting. The deed, amongst other things, required the Trustee Co to establish a separate bank account (for the benefit of the Covenantholders) where proceeds from the sale of timber would be paid into by Forest Co.

Importantly, although it was clear that Trustee Co was to act as trustee for the Covenantholders, there was no express provision in the trust deed that said that Forest Co would act as trustee for the Covenantholders.

There was also a three-way agreement between Forest Co, Trustee Co and Milling Co. Under this agreement Milling Co would sell the logs and retain the proceeds. The agreement also stated that, after certain deductions and allowances were made, Milling Co had to pay the residue of the proceeds of sale to Forest Co.

Issue

Forest Co and Milling Co gave security over their assets to certain lenders (these lenders lent to other companies within the same corporate group that Forest Co and Milling Co were a part of). Forest Co and Milling Co went into receivership and, in September 2012, the lenders appointed the first and second appellants as receivers.

The question for the 5-judge bench was whether certain proceeds of the sale of timber made were either:

a) assets that were subject to the receivership; OR

b) held by Forest Co and/or Milling Co on trust for the Covenantholders?

If the answer was a), in favour of the appellants, the proceeds would presumably be used to repay debts owed to the secured creditors who lent monies to Forest Co and Milling Co.

If the answer was b), in favour of the respondent, the Covenantholders would receive the benefit of the monies.

Answer

The Court unanimously found in favour of the appellants. Therefore the proceeds were not held on trust by Forest Co and Milling Co for the Covenantholders.

Justices Hayne and Kiefel at [82] to [84] emphasised that Forest Co was not bound by any deed or agreement to keep the net proceeds given by Milling Co separate from its own monies. In fact, the evidence demonstrated that the amounts received by the two companies could, and would, be mixed with the company’s own moneys. Therefore payments from Forest Co to the Trustee Co would be made out of the relevant company’s own monies. As Justice Gageler later noted at [111], it is the hallmark duty of a trustee to hold trust money separate from one’s own.

At [82] Justices Hayne and Kiefel noted, by way of rhetorical question, that the Covenantholders could not have any proprietary interest in any identified part of the plantation or any identified trees. This was because the trees were felled, milled and sold on land which Forest Co owned or leased.

At [81] their Honours also noted that it was Forest Co, and not the Trustee Co, who had access to Milling Co’s books of account. It is implied that this was some indication that Milling Co could not be a trustee of the monies for the Covenantholders. Milling Co was also not obliged to keep its proceeds of sale separate from its own monies.

Justice Gageler noted at [109] that a Court would impose a trust only if and to the extent that the trust structure is the legal mechanism which is appropriate to give legal effect to the relationship. At [110] and [111] His Honour held that the absence of any contractual indication that Forest Co and Milling Co should hold the proceeds separately from other moneys of their own was surely fatal to the claim that the monies were held on trust for the Covenantholders.

Hence, Forest Co and Milling Co owed merely contractual obligations to the Covenantholders, and the relationship was not one of trustee and beneficiary.

Chief Justice French and Justice Keane also allowed the appeal but their Honour’s decisions are not the subject of analysis in this article. (Of course, I also pause here to note that I have not exhaustively gone through the reasoning of Justices Hayne, Kiefel and Gageler either but rather I have merely pointed out a few interesting concepts.)

Lessons of the Day

The case highlights, firstly, the importance of drafting contracts with absolute clarity and careful consideration. Failure to provide an express clause, such as in this case, the failure to expressly appoint an entity as trustee to hold proceeds of sale for investors (and to draft further provisions to that effect), could have serious ramifications for the relevant parties in the future.

Secondly, it is critical that a company’s actions and commercial realities (as governed by the relevant contractual agreement) reflect their true intentions. A failure to properly consider not only the operating mechanics of a contract’s clauses at the time of drafting, but also how those clauses might serve the intended trustee-beneficiary relationship, can result in a court finding that there is in fact no trust at all.

One might ask: Why subject yourself to the scrutiny of the other side’s lawyers (and a court) when you have the opportunity of ensuring that everything is crystal clear in the agreement from the start? Of course, it is unclear if the relevant parties in this case actually intended a trust relationship to be created. In fact, it is quite possible that these “trust arguments were raised as an afterthought to the agreement only when the receivers were appointed!

However, giving the benefit of the doubt, if we assume that a trust structure was intended by the relevant parties in Korda, then this case demonstrates that being crystal clear about your intentions is most definitely easier said than done.

 

By Andre Lim, Solicitor.

McAuley Hawach Lawyers

Telephone: (02) 9633 1826

Email: reception@mcauleyhawach.com.au

 

 

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