Trust or debt? The significance of Quistclose trusts in insolvency processes

24 November 2014

In this issue:

Nature and operation of Quistclose trusts
Significance of Quistclose trusts in insolvency processes
Equitable principles underlying the Quistclose trust
Quistclose trusts and the Personal Property Securities Act 2009

Introduction

Generally, in commercial transactions when A advances money to B the relationship between A and B is debtor and creditor. However, circumstances may arise resulting in trust obligations between the parties and not mere debt.

For example, a trust relationship may arise where money is advanced by A to B with the mutual intention that it should not become part of the assets of B, but should be used by B exclusively for a specific purpose, with the money to be held on trust for A until the purpose of the advance has been achieved. In the event that the purpose fails the money is to be repaid to A.

This situation arose for consideration in Barclays Bank Ltd v Quistclose Investments Ltd (1970) AC 567, and the term “Quistclose trust” has emerged to describe the type of trust encountered in that case.

The significance of the “trust or debt” issue for insolvency processes

With respect to a company undergoing an insolvency process, it will not be unusual for the insolvency administrator to learn that certain funds in the possession of the company are, allegedly, held on trust for a particular person or entity. As a consequence such funds do not form part of the assets of the company so as to be excluded from normal insolvency processes.

For example, in terms of the Quistclose trust, monies may have been advanced to a company experiencing financial difficulties with a view to meeting the claims of particular pressing creditors. If for any reason the purpose cannot be carried out, for example, the company proceeds into an insolvency administration, it is intended that the monies are to be returned to the lender.

In a case of this kind the essential question for the insolvency administrator is whether under principles of trust law (see below) the company holds funds subject to a trust; or whether those funds form part of the general assets of the company so as to be available for normal insolvency processes, usually for the benefit of unsecured creditors.

In reviewing the possibility of a Quistclose trust the insolvency administrator will be alert to the fact that the Quistclose trust is not limited to situations involving money paid for the purpose of discharging existing debt, and may arise where funds have been advanced for other specific purposes. For example, money may have been advanced to a company under a Quistclose trust arrangement to purchase equipment, or to subscribe for shares: see George v Webb (2011) NSWSC 1608, 20/12/2011, para. 199. Also, depending on the company taking suitable steps on or before receiving the money, customers’ prepayments for ordered goods may be the subject of a Quistclose trust and not form part of the general assets of the company: see Re Kayford Ltd (in liq) (1975) 1 W.L.R. 279; similarly prepaid college fees may be the subject of a Quistclose trust: see Re Mowbray College (in liq) (rec and mgr apptd) (2013) VSC 565, 23/10/2013.

It is apparent that in the course of insolvency administrations equitable principles giving effect to Quistclose trust arrangements will often be encountered as beneficiaries of such arrangements seek to assert their rights over unused funds in the possession of a company.

At this stage it is appropriate to canvass a number of trust principles that are particularly relevant when determining the existence or otherwise of a Quistclose trust.

Relevant trust principles underlying the Quistclose trust

The following principles relating to Quistclose trusts have been conveniently summarized by the courts on a number of occasions (see, for example, Compass Resources Ltd v Sherman (2010) WASC 41, 5/3/2010, para’s 67-78):

While the reference to Quistclose trust suggests a novel species of trust, Australian courts have consistently analysed the Quistclose trust in terms of conventional trust principles as an express or inferred trust in which the beneficial interest is held subject to the exercise of a power or a mandate. Accordingly, orthodox trust principles relating to identifiable subject matter, specified beneficiary and intention to create a trust, remain relevant.
As discussed above, Quistclose trusts involve an advance of funds for a specific purpose, such as discharging existing debt, and until such purpose is satisfied the lender retains a beneficial interest in the funds.
To establish a trust it is not sufficient to show that the parties intended that moneys be used for a particular purpose. Not every contractual arrangement involving the use of funds for a specified purpose gives rise to a trust of the moneys lent.
A Quistclose trust depends upon the intention of the parties involved, to be ascertained objectively from all the facts and circumstances, including the relevant documents, the language used, the nature of the transaction and the parties’ relationship. The trust need not be expressly designated as such, and its existence may be objectively inferred.
An express requirement that the funds be kept separate from other moneys of the borrower until utilized for the proposed purpose is a significant consideration in determining the question of intention.

A related matter

Is the Quistclose trust a security interest for the purposes of the Personal Property Securities Act 2009?

Section 12(1) of the Personal Property Securities Act 2009 (PPSA) provides that an interest in personal property that in substance secures payment or performance of an obligation amounts to a security interest for the purposes of the Act.

Security interests caught by section 12(1) will need to address PPSA rules about perfection of security interests, which most usually will involve registration on the Personal Property Securities Register.

Significantly, section 8(1)(h), PPSA provides that the Act does not apply to:

“a trust over some or all of an amount provided by way of financial accommodation, if the person to whom the financial accommodation is provided is required to use the amount in accordance with a condition under which the financial accommodation is provided.”

This express exemption means that in Australia the issue whether a Quistclose trust in substance secures payment or performance of an obligation has been avoided.

Notwithstanding, there is ongoing debate as to whether the exemption is inconsistent with the fundamental “in substance” approach adopted by the PPSA relating to security interests over personal property.

Perhaps the most compelling reason put forward justifying exemption from the PPSA is that at the time when moneys are advanced under a Quistclose trust the lender is not retaining beneficial interest in the funds on the basis that the borrower is under a payment obligation. Rather the beneficial interest is retained in the funds pending the intended use of the funds by the borrower. It is at the stage when the funds are used for the intended purpose that a debt obligation arises. It is also then that a conventional security interest may be put into effect by the lender to secure payment of the debt, with PPSA provisions then becoming relevant.

A final comment

Putting to one side arguments that justify the exemption of Quistclose trusts under the PPSA, such exemption gives rise to real concerns that creditors dealing with a company will do so without notice of a Quistclose trust over unused funds in the possession of the company. Essentially a Quistclose trust operating outside the registration requirements of the PPSA gives rise to a false perception of wealth vested in the borrower with respect to unused funds in the borrower’s possession.

As a consequence it is predicable that, in the context of insolvency processes and the interests of creditors, the courts will demonstrate a willingness to restrict the effective use of Quistclose trusts by employing ever-increasing technical interpretations geared towards classifying unused funds in a company’s possession as generating “debt payable” and not “trust property.”