Trusts reform in spotlight

ROB STOCK
Last updated 05:00 07/01/2012

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The Law Commission is seeking views on whether the veil of secrecy surrounding trading trusts needs to be lifted to protect both creditors and the integrity of the Companies Register.

Trading trusts are structures where the trustee of the entity is a limited liability company, instead of a person.

The assets of the company are held by the trust for the benefit of the trustee. One result of this is that if the business fails, creditors can face significant legal hurdles in trying to get paid.

In its latest discussion paper on trust law, the Law Commission says there are concerns that creditors are unaware that they are dealing with a trust when extending credit.

"They may wrongly assume that assets are held both legally and beneficially by the company, when in fact they are held on trust and the company itself has very limited assets, which may affect the creditor's prospect of recovering their debt," the commission said.

In particular, creditors need to be very sure that the debts are not being incurred outside the terms of the trading trust's deed or they could prove unenforceable, leading to the equivalent of a windfall to beneficiaries.

There have been concerns raised in New Zealand over trading trust secrecy, including by Justice Richard Blanchard who commented on the lack of transparency in trusts and queried whether trustees ought to be required to reveal the existence of the trust.

The Insolvency and Trustee Service has also told the commission that it has encountered at least one case where creditors have thought they were dealing with a company but the assets were in fact held on trust.

The commission said: "Without disclosure of the fact that the company is acting as trustee, the creditor is not aware of the need to take greater precautions to protect its position, such as requiring security, guarantees, or making enquiries about the nature of the trust arrangement, the authority of the trustee to incur liabilities, the status of the trustee's right to indemnity, and the value of the company's assets owned outright.

"There is also an argument to be made that if there continues to be no disclosure requirement, widespread use of the trading trust structure could impact on the integrity of the Companies Register as it would only show an incomplete picture of the company."

The commission is seeking submissions on proposals including requiring trading trusts to reveal their existence, which could be done through a new register of trusts.

However that could prove costly.

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An alternative would be to require disclosure of a company's status as a trustee through the Companies Register, though the commission commented: "This may be a bit of a waste of time, as in practice, creditors may not use the Companies Register to check the status of the company."

Another option would be to place a positive obligation on the directors of the company to inform creditors and prospective creditors that the company was acting as a trustee, the commission said.

There could also be the requirement to reveal the fact in all contracts and company documents, which would have to state something along the lines of "(name here) Trust trading through (name here) Limited".

A similar suggestion was made in Australia in the mid-1980s but did not go ahead, something that some commentators have later rued.

But the commission is by no means certain that bringing in greater disclosure for trading trusts – and there is uncertainty about how many there actually are – would have much impact on its own.

"Disclosure about trustee status and potentially other relevant information is still likely to be insufficient in and of itself in protecting creditors, especially unsophisticated ones who do not appreciate the implications of dealing with a trustee. Disclosure would probably need to be considered in conjunction with other possible reform options," it said.

These could include changing the law to strengthen the protections and channels for creditors seeking to be repaid by trading trusts.

WHAT IS A TRADING TRUST?

The term "trading trust" is often used to describe a structure in which the trustee of a trust is a limited liability company, instead of a person.

The assets of the company are owned by the beneficiaries of the trust, so that if the company fails, creditors can face great difficulty in getting paid.

Often they are operated by professionals like lawyers and accountants for clients. Creditors need to tread with great care when lending or extending goods or services to a company acting as a trustee.

- Canterbury

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