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Focus: Trustee directors' liability: implications of Hanel v O'Neill

15 March 2004

In brief: A recent decision by the South Australian Supreme Court has important implications for directors of all corporate trustees, as well as for third parties contracting with trustees. Senior Associate Lois Dannecker reports.

On 11 December 2003, the Full Court of the Supreme Court of South Australia held, by a two to one majority, that a director of a corporate trustee of a trading trust was personally liable for the trust's debts under section 197 of the Corporations Act 2001 because the trust had no assets.1

This was held to be the case notwithstanding that the corporate trustee was 'entitled to be fully indemnified against the liability out of trust assets' under the provisions of the relevant trust deed. This ruling has important implications for directors of all corporate trustees, as well as for third parties contracting with trustees.

Mr O'Neill had obtained a judgment in the Adelaide Magistrates Court against the corporate trustee, of which Mr Hanel was the sole director, for a debt owed to Mr O'Neill. When it became apparent that the trustee could not pay the judgment sum, Mr O'Neill commenced proceedings against Mr Hanel and succeeded in obtaining a judgment against him on the basis that he was personally liable under s197. Mr Hanel appealed to the Full Court of the Supreme Court of South Australia.

No protection for directors under s197 if trust has no assets

Section 197(1) is in the following terms:

(1) A person who is a director of a corporation when it incurs a liability while acting, or purporting to act, as trustee, is liable to discharge the whole or part of the liability if the corporation:

(a) has not, and cannot, discharge the liability or that part of it; and

(b) is not entitled to be fully indemnified against the liability out of trust assets.

This is so even if the trust does not have enough assets to indemnify the trustee. The person is liable both individually and jointly with the corporation and anyone else who is liable under this subsection.

The judgments in Hanel make uncertain the precise circumstances in which s197(1) is intended to operate. The ambiguity comes from the second part of the test, namely, that the corporate trustee 'is not entitled to be fully indemnified against the liability out of trust assets'. The relevant trust deed in Hanel provided that 'the Trustee is entitled to be indemnified out of the assets for the time being comprising the Trust Fund against liabilities incurred by the Trustee...'. Do these, or similar words, mean that s197(1)(b) is applicable and therefore the directors cannot be held personally liable for the trust's debts?

The Full Court of the Supreme Court of South Australia did not agree on this issue. Both Justices Mullighan and Gray held that whether the corporate trustee was entitled to be indemnified out of the trust assets was not to be determined merely by reference to the trust deed provisions. If, in fact, the trust has no assets, then the directors are personally liable for the trust's debts. In Hanel, the corporate trustee had disposed of all of the trust assets. Their Honours held that, if there were no assets comprising the trust, the corporate trustee was not entitled to be fully indemnified against the liability out of trust assets.

On the other hand, Justice Debelle was of the view that s197(1)(b) depended upon an entitlement to an indemnity under the trust deed and not upon whether an indemnity was in fact able to be satisfied out of available trust assets. If the corporate trustee was entitled to be indemnified out of trust assets, the condition in s197(1)(b) was not satisfied with the consequence that the trust's creditor, Mr O'Neill, could not rely on s197 to impose any liability on the director for the trust's debts.

The meaning of 'This'

The Hanel case also brings to light the ambiguity surrounding the sentence in s197(1): 'This is so even if the trust does not have enough assets to indemnify the trustee'. Justice Debelle was of the opinion that 'This' refers to the director not being liable, whereas Justice Gray was of the converse view that it is a reference to the director's liability.

History of s197

Section 197 is the statutory successor of the repealed s233 of the Corporations Law. As relevant, s233(1) and (2) were clearer in meaning and provided as follows:

233(1) Where:

  1. a relevant body corporate while acting or purporting to act in the capacity of trustee of a trust, incurs a liability:
    1. in the case of a company – whether within or outside Australia; or
    2. in the case of a registered foreign company – within Australia; or
    3. otherwise – within this jurisdiction; and
  2. the relevant body corporate is for any reason not entitled to be fully indemnified out of the assets of the trust in respect of the liability; and
  3. the relevant body corporate has not discharged, and is unable to discharge, the liability or a part of the liability;

the relevant body corporate and the persons who were directors of the relevant body corporate when the liability was incurred and were not innocent directors in relation to the incurring of the liability are jointly and severally liable to discharge the liability or the undischarged part of the liability, as the case may be.

233(2) For the purposes of this section, a trustee of a trust shall not, merely because:

  1. the trust has no assets; or
  2. the assets of the trust are insufficient to indemnify the trustee in respect of the liability concerned;

be taken not to be entitled to be fully indemnified out of the assets of the trust in respect of the liability.

Thus, under s233(2) a corporation was not deemed to be not entitled to be fully indemnified out of trust assets merely because the trust had no assets or the trust assets were insufficient to indemnify the corporate trustee for the relevant liability. Where, under the trust deed, the corporate trustee was entitled to be indemnified out of the trust assets, the director was not liable merely because the assets of the trust were insufficient.

Justice Debelle was of the view that s233 has been re-enacted in s197(1), albeit in different and obscure terms. He expressed a view that, if Parliament intended that s197 should alter the operation of s233, it would have been done in clear and unambiguous terms. Contrary to this, Justice Gray was of the view that s197 is not an enactment of a section directly comparable to s233, as there was no reason why the legislator would completely redraw that subsection if all that was intended was to repeat earlier works that had a settled meaning. The fact that a new subsection was introduced, entirely replacing the old subsection, suggests that a legislative change was intended.

In the end, Mr Hanel won his appeal on other grounds and the matter was remitted to the Adelaide Magistrates Court for trial.

Conclusion

The views of Justices Mullighan and Gray mean that directors of a corporate trustee may be held personally liable in any case where there are insufficient trust assets to meet the trust's debts. However, the view of Justice Debelle would only result in automatic liability if there was no indemnity at all.

It seems that the problem has arisen from an attempt at 'plain English' drafting of s197 as a re-enactment of repealed s233. A statutory amendment is required to make clear the circumstances in which directors of corporate trustees may be held liable for the debts of the trust.

Section 197(2), which was not relevant to Hanel, does set out circumstances in which a director will not be liable under s197(1).  However that section is limited to the uncommon situation in which the director would be entitled to have been fully indemnified by one of the other directors against the liability, had all the directors of the corporation been trustees when the liability was incurred.

At this stage, it is not clear whether Hanel will be appealed to the High Court on the issue of directors' liability. An appeal may be unlikely because the matter was remitted to the Magistrates Court for trial. In the meantime, as a Court of Appeal decision, it is binding on all lower courts and single judges. Directors of corporate trustees and those contracting with trustees are left in a state of uncertainty about the extent of their personal liability for the trust's debts.

Footnote
  1. Hanel & Anor v O'Neill [2003] SASC 409

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