TRUSTS IN FAVOUR OF CREDITORS

CONTENTS

1.0    Introduction

2.0    Objectives

• Main Content
• Features and purposes of Trusts in Favour of Creditors

4.0    Conclusion

5.0    Summary

6.0    Tutor-Marked Assignment (TMA)

7.0    References/Further Readings

INTRODUCTION

Trusts in favour of creditors are a unique feature which the law of trusts can be put into. Trusts in fact cover a series of situations which results from the nature of equity not suffer a wrong to be without a remedy. From this nature, trust develops constructive and resulting trusts, and trusts can therefore be expressly declared in favour of creditors or presumed from the surrounding circumstances as examined below. The objective of having a trust created in favour of creditors is for no other purpose than to secure the interest of the party in whose favour the trust is being declared, and in the case of creditors, to secure their money. Trusts, as will be seen in this unit obviously have advantage over enforcing debt in contract.

OBJECTIVES

In this Unit, you will be taken through the features of trusts in favour of creditors, the forms of such trusts and what it requires to create them. You will also learn the advantages of creating a trust in favour of creditors and the legal consequences   that flows from this. You will also be familiarized with the principle of law in Quistclose Trusts which established a two-trust mechanism. At the end of this  Unit, you should be able to:

• Know what trusts in favour of creditors are
• Understand the features and formality of trusts in favour of creditor
• Explain the advantage of having a creditor’s interest secured by trust
• Explain the legal consequences of declaring a trust of a company’s asserts
• Understand practical uses of trusts in favour of creditors

MAIN CONTENT

Features and Purposes of Trusts in Favour of Creditors

Trusts may be created or an agreement to create a trust in favour of those  advancing moneys for specific purposes and other varying purposes. These may be in respect of customers’ deposits, loans generally or to insolvent companies or companies in liquidation, money for payment of  sub-contractors,  moneys advanced to borrowers from which they are to pay third party creditors. This practice is however common but not limited to insolvency cases. Creating trusts in favour of creditors can take many forms. You need to note that to create a trust of money requires no formality of writing and there is no need to use the word ‘trust’. However, it is important that specific agreement or memorandum be put in place for this, in order to ensure certainty of intention to create a trust.

In the absence of clear intention to create a trust in favour of creditors, the relationship between the parties will be regarded purely as that of contract and not one based on trust. See the Canadian case of Seller v. Industrial Incomes Ltd. (1963) 44 W.W.R. 485, 41 D.L.R. (2d) 329. In the Canadian Supreme Court case  of Industrial Incomes Limited v. Maralta Oil Company Limited [1968] S.C.R. 822 the trial judge in fact held that the matter between the parties rest solely  on contract, the Supreme Court however overturned this and held that a trust was created in favour of creditors. Such a confusing state might trail relationship between the parties in the absence of a written memorandum.

There are ways to create a trust in favour of creditors and this can take the form of:

i.) Property may be transferred or money is paid to a named supervisor in  pursuance of a company’s voluntary arrangements (CVA) with the property or money held on trust for creditors who are parties to such agreement.  The  advantage of this is that in the event of winding up of the company, the assets forming the subject matter of the CVA cannot be assessed by other creditors. See Re TBL Realisations Plc, Oakley-Smith v. Greenberg [2004] B.L.C. 81. Only the parties to such agreement can take benefit under it. See R.A. Securities Ltd v. Mercantile Credit Co Ltd [1995] 3 All E.R. 214.

ii.)  An agreement by a company to a named supervisor to transfer assets which   are identified or identifiable on the bases of entering into company’s voluntary arrangements is also sufficient to create a trust. See Re TBL Realisations Plc, Oakley-Smith v. Greenberg (supra). The reason why form of trust is enforceable is based on the equitable maxims that equity looks on that as done that ought to be done and equity imputes an intention to fulfill an obligation. Thus, an agreement to deposit the proceeds of production from an oil well in a separate account in a named bank will suffice as trust. See Industrial Incomes Limited v. Maralta Oil Company Limited (supra).

Note however that when a company creates a trust its ownership in the assets  which now forms the trust property is extinguished. See Re N.T. Gallagher & Sons Ltd Sheierson v. Tomlinson [2002] B.L.C. 867.

iii.) An insolvent company may seek to declare a trust in favour of creditors in that case; those who continue to pay deposits to the company are converted to beneficiaries under a trust and are no longer treated as creditors. See Re Kayford  (in liq) [1975] 1 W.L.R. 279. In that case, there is transformation of the contract to property and conversion of the debt to trust.

iv.) An insolvent company or company in liquidation still operating may convert  its assets into a trust fund for the benefit of creditors in such an instance;  preference to general creditors may be disallowed. In this case, trust accounts are used to protect customers of insolvent businesses. See Re Kayford [1975] 1 All

E.R. 604

v.) A company can create a trust in favour its customers by making itself a trustee of the monies paid by its customers. In that case, as soon as the company is receiving these moneys, the money goes into  a trust account. See Farepak Foods  & Gifts Ltd. [2006] EWHC 3272. The purpose here was to protect creditors who continue to pay moneys into the company following their declaration to cease trading.

From the time a company makes itself a trustee of some of its customers, the relationship between them is based on trust and not contract because from the inception, the customers are beneficiaries and not creditors and as such their priority is assured over those that are creditors. See Re Nanwa Gold Mines Ltd.

[1955] 1 W.L.R. 1080. The consequence being that the trust property which is the money paid by those customers has to be transferred to those who originally paid them in on trust. See Re Nanwa Gold Mines Ltd. (supra). An example here is deposit for purchase of shares and where share cannot be allotted to the depositors, they have to get their money back.

vi.) In some jurisdictions, such as United States of America, trusts may be created in favour of some creditors by statute, owing to the nature or importance of their services and the huge capital outlay required to run or execute such businesses.

vii.) Where monies were received on the understanding that it will be keep in a separate account to be applied towards the depositor’s use or purpose, the person whose account the money is, holds the same on trust for the sender. See Re Australian Elizabethan Theatre Trust, (supra).

You have to know that generally the relationship between a creditor and borrower is that of contract and creating a trust has the double advantage of making transaction enforceable both at contract and equity. For instance, where there is a contractual obligation between the borrower and the lender to pay some third party creditors, it will be presumed that concurrent intention to create a trust in favour of the third party creditors exist and the borrower will hold the money on trust for the lender. However, where no such contractual obligation exits between the parties, the borrower will hold the money on express trust for the lender but subject to a trust declaration by the lender that the monies should be used to pay creditors. See Re Australian Elizabethan Theatre Trust (1991) 102 ALR 681 at 689 per  Gummow J. Quistclose Trust

You need to know that in some instances, there may arise a two-trust situation in the same transaction. This principle of law arose as a result of the decision in Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567 commonly known as Quistclose Trust. This is to the effect that where there is agreement between the lender and the borrower as to how the loan granted is to be utilized, then a primary trust is created and if the actual purpose of the loan fails, then there is a secondary trust (resulting trust) which will take effect in that event.

SELF ASSESSMENT EXERCISE (SAE) 1

Discuss the principle of a two-trust mechanism established in Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567.

CONCLUSION

Trusts in favour of creditors are very useful from the practical points of view as discussed above. Creditors enjoy an added advantage or having their money protected in the event of liquidation of the borrowers. The position of trust coverts the relationship of lender and borrower to trustee and beneficiary. The lender or creditors enjoys priority by such higher position of trust than one based on  contract. With the exposure you have in this area, you should be able to employ trusts in favour of creditors in practical situations for the benefit of your clients after becoming professionally qualified.

SUMMARY

In this Unit, you have learnt that about trusts in favour of creditors, its formality, features, uses and practical advantages. You have learnt that the importance of trusts in favour of creditors is primarily for the protection of creditors, customers and sub-contractors, among others and that in the event of liquidation, the class of mentioned are not left in limbo. You further examine practical situations where trusts in favour of creditors exist and the legal consequences flowing from this.  with the principle of two-trust in Quistclose Trust which is to ensure that loans advanced for specific purpose is not diverted and that should the purpose fail, the lender will get his money back. In the next Unit, you will learn about appointment of trustees.

TUTOR-MARKED ASSIGNMENT (TMA)

1. Discuss the legal consequences that will flow from a company creating a trust in favour its customers by making itself a trustee of the monies paid by its customers
2. In order to create a trust in favour of creditors, the intention to create such trusts must be clear. Discuss the formalities of creating a trust of this nature and state the consequences of inability to infer such an intention with respect to  the enforcement of the debt by the creditor

REFERENCES/FURTHER READINGS

Hayton, D.J. (2001). Hayton & Marshall Commentary and Cases on The Law of Trusts and Equitable Remedies. London: Sweet & Maxwell.

Ong, Denis SK (2007). Trusts Law in Australia. Sydney: The Federation Press. 3^rd Edition.

Tesiero, Donald E. (1998) Constructive Trusts and the Construction Loan, Florida Bar Journal, June 1998.