Lifting the corporate veil AICD Review

The Government should move swiftly to ensure that directors of trustee companies are not exposed to any greater personal liability than directors of non-trustee companies, says Bruce Cowley.

The Government should move swiftly to ensure that directors of trustee companies are not exposed to any greater personal liability than directors of non-trustee companies, says Bruce Cowley*

As a result of a recent South Australian Full Court decision interpreting section 197 of the Corporations Act, it seems that where a trust has a corporate trustee and the trust has insufficient assets to meet debts incurred by the trustee (ie the trust is effectively insolvent), the directors of the trustee will be personally liable for those debts.

This is a significant extension of what we previously understood to be the situation, namely that the corporate veil will protect directors from personal liability unless they allow the company to trade while insolvent. To add insult to injury, while directors of non-trustee companies are only liable for debts incurred during the period when the company was trading while insolvent, directors of trustee companies are potentially liable for all debts of the trust.

Section 197 of the Corporations Act 2001 provides for personal liability of directors of trustee companies in certain circumstances. Under the section, liability is said to arise where the trustee is "not entitled" to be indemnified out of trust assets.

The section goes on, somewhat enigmatically, to say that "This is so even if the trust does not have enough assets to indemnify the trustee".

The predecessor to this section, before amendments made in 2000, was clear that directors would not be personally liable if the corporate trustee still had a right of indemnity, even if the trust was insolvent.

The recent South Australian Full Court decision in Hanel v O'Neill [2003] SASC 409 is the first judicial consideration of section 197 and highlights the ambiguous language of the new section.

The case concerned whether the sole director of a trustee company was personally liable in accordance with section 197 for payment of a debt arising out of default in rental payments by the trustee company under a commercial lease.

In the same year as the default occurred, the trustee company distributed over $500,000 of trust assets to the beneficiary. The trust was left without assets. There were no allegations of impropriety and the trustee company had not lost its usual right of indemnity.

The court was divided in its approach to the director's liability.

The majority, Justices Mullighan and Gray, accepted that if there were no assets comprising the trust there was no "entitlement" for the trustee company to be indemnified, with the result that the director was personally liable to meet the debt under section 197 even though the trustee company had not lost its usual right of indemnity.

Gray J felt the fact that the legislature had entirely reworded section 197 suggested an intention to move away from the settled, narrow view of the previous section and that the change in language necessarily widened the scope for directors' liability.

Debelle J (the minority judge) thought that the trustee company director was not personally liable if the trustee company remained entitled to be indemnified, notwithstanding that the trust assets were insufficient to satisfy the indemnity. In contrast to Gray J, he said that section 197 was essentially a re-enactment of the former position, "albeit in different and obscure terms".

The fallout from the majority's decision may greatly reduce the usefulness of trust company structures.

While it is easy enough to understand why the majority in Hanel v O'Neill took the view that they did, it is not at all clear that the legislature intended to critically weaken the protection afforded by the corporate veil by effectively making directors of a trustee company personally liable for all of the debts of the trust. The Explanatory Memorandum introducing section 197 made no mention of such an intention and, given its significance, one would have expected at least passing reference to such a major change in policy.

Clarification of this issue is urgently required. Hopefully the Government will move swiftly to ensure that directors of trustee companies are not exposed to any greater personal liability than directors of non-trustee companies, although a little lobbying along these lines would not go astray.

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