In corporate insolvencies, company creditors often try to establish that they are secured creditors to
avoid proving in the liquidation along with the company’s unsecured creditors.
In the normal course, this will involve the creditors (ahead of time) registering their security interests
on the Personal Properties Securities Register or registering mortgages or caveats over real property
owned by the company.
However, not all creditors have the benefit of formal instruments entitling them to a security interest especially in situations where the debt owed by the insolvent company has arisen outside normal commercial activity (such as in circumstances where a fraud or a breach fiduciary duty has occurred).
In those circumstances, aggrieved creditors will often seek a declaration that property owned by the insolvent company is held on constructive trust for the benefit of that creditor. Essentially, by seeking a declaration imposing a remedial constructive trust, the creditor seeks to elevate its unsecured claim to that of a secured or proprietary claim.
However, while the imposition of a constructive trust provides substantial benefits to the aggrieved creditor, it imposes large costs on the other unsecured creditors of the company as the assets available for distribution by the liquidator are consequently (and often drastically) diminished.
are not unaware of these costs and have repeatedly held that the rights of third-party creditors must be taken into account before imposing a remedial constructive trust in the event of an insolvency. This is especially the case as the imposition of a constructive trust is an equitable remedy which involves the exercise of the Court’s discretion. Below are some extracts from the relevant cases.
1. Bathurst City Council v PWC Properties Pty Ltd [1998] HCA at paragraph 42.
“42 In any event, before the court imposes a constructive trust as a remedy, it should first decide whether, having regard to the issues in the litigation, there are other means available to quell the controversy. An equitable remedy which falls short of the imposition of a trust may assist in avoiding a result whereby the plaintiff gains a beneficial proprietary interest which gives an unfair priority over other equally deserving creditors of the defendant.”
2. Giumelli v Giumelli [1999] HCA 10 at paragraph 10.
“At the heart of this appeal is the question whether the relief granted by the Full Court was appropriate and whether sufficient weight was given by the Full Court to the various factors to be taken into account, including the impact upon relevant third parties, in determining the nature and quantum of the equitable relief to be granted.”
3. Robins v Incentive Dynamics Pty Ltd (in liq) (2003) 175 FLR 286 at paragraph 74.
“In general, the court will need to be satisfied that a remedial constructive trust (or charge if that suffices) is necessary to protect the legitimate rights of the plaintiff and does no injustice to the rights of third parties, such as creditors.”
4. Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6 at paragraph 510.
“The interests of innocent third parties who would be affected by the award of proprietary relief whether as unsecured creditors; because legitimate rights, interests or expectations have been generated in them in relation to the property in question because of subsequently occurring events; or otherwise…must be borne in mind.”
Importantly, the High Court has also expressly noted that it is not enough to simply point to the impecuniosity of the company in order to obtain the benefit of a constructive trust.
This was a key issue in the decision of John Alexander’s Clubs Pty Limited v White City Tennis Club Limited [2010] HCA 19 which involved the dispute as to the ownership of land in Sydney.
In that case, the respondents asserted that the equitable compensation or an account of profits would not be a just remedy because the offending parties were without significant assets to meet such a judgment. Accordingly, the respondents asserted that the land was held on constructive trust for them.
In response, the High Court noted that, following the decision Giumelli v Giumelli:
“third party interests must be borne in mind in deciding whether a constructive trust should be granted. That line of cases does not permit a constructive trust to be declared in a manner injurious to third parties merely because the plaintiff has no other useful remedy against a defendant.”
Accordingly, as the imposition of a constructive trust would detrimentally affect the interests of the appellant (who had an unregistered mortgage over the disputed land which would be of no effect if the constructive trust were imposed), the High Court declined to provide that relief.
Conclusion
Insolvency practitioners should examine the basis upon which creditors assert to be entitled to the benefit of a constructive trust very closely.
If it can be demonstrated that third party interests will be detrimentally affected by the imposition of a constructive trust in favour of the aggrieved creditor, it may be open to the liquidator to oppose that order to the benefit of the company’s unsecured creditors.
Like all equitable remedies, there is no hard and fast rule and it will depend on the facts of the case and the particular circumstances of the parties.
However, the relevant decisions (many of which are from the High Court) demonstrate that the Courts are cognisant of the effects that their orders have on third parties and third party interests are interests which the Court will take into account before imposing a remedial constructive trust.
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