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Trading trusts come in for attention from commission

The New Zealand Law Commission is proposing changes be made to rules surrounding trading trusts.

Monday, June 24th 2002, 2:09AM

Trading trusts have been used in Australia for many years, and are now also becoming popular in New Zealand.

What is a "Trading Trust"?

A trading trust is simply a trust which trades or is in business. Because a trust is not a separate legal entity, in the same sense as a company, the business is actually undertaken in the names of the trustees of the trust, and it is often not apparent that the trustees are in fact acting as trustees of a trust.

For example, Bill Smith and John Brown might be trading under the name "Smith & Brown" in a retail business. However, they may in fact be acting as trustees of the Smith Family Trust, but this may not be disclosed to any third parties who do business with Smith & Brown.

The Deed of Trust for a trading trust will look very much like a Deed of Trust for a standard family trust, except that it will probably give the trustees specific powers regarding the establishment of a business, and the general day to day aspects of running a business.

Apart from these specific powers, the Deed of Trust will have a settlor, trustees, and beneficiaries, as would a deed for a family trust.

The trustees of a trading trust might be individuals, or, more commonly, a private limited liability company might be appointed as the trustee. This can also be confusing for a third party who is dealing with the business, as the business operator will be identified as the limited liability company, and again, it may not be disclosed that this company is in fact acting as a trustee of a trading trust.

There is a general legal principle to the effect that a trustee, be it a person, or a limited liability company, who is acting in accordance with the powers given to the trustee in the deed of trust, will be indemnified (i.e. reimbursed) from the trust assets.

This means that the trustee can call on the trust assets to meet any liabilities or losses which the trustee may properly incur, in the course of operating as a business. However, it is becoming common for trustees of trading trusts (especially if the trustee is a limited liability company) to try to relinquish its right to be indemnified from the trust assets, in order to protect the trust assets from claims by third parties, eg. creditors of the business.

Creditors would often not be aware of the effect of this restriction on the trustee’s right to be indemnified.

In practice, many limited liability companies that act as trustees have no assets of any substance, so that if the company can not meet its obligations arising from its trading operation, and can not be indemnified from the trust assets, then the creditor can not recover the amount owing.

This problem is compounded by the fact that income received by the trustee from its business operation, can, under the terms of the deed of trust, usually be distributed to the beneficiaries of the trust, and is therefore not available to meet the liabilities incurred by the trustee in the business.

A recent working party established by the New Zealand Law Commission has reviewed the current situation with trading trusts.

In particular, it has addressed the concerns voiced by a number of commentators, who consider that there are sufficient grounds for Parliament to intervene, by way of legislation.

These concerns relate to the uncertainty surrounding the rights of trustees of trading tTrusts to relinquish their right to be indemnified from the trust assets.

A further area for concern is the lack of statutory regulation as to how the trustees of trading trusts go about conducting their business.

There are different views as to the rights and duties of the trustee of a trading trust, and the working party has come to the conclusion that it would be desirable to bring some degree of certainty into this area.

The working party has come to the conclusion that the best way to bring some certainty into the law regarding trading trusts is to give legislative recognition to the following principles:

  1. To put it beyond doubt that the trustee of a trading trust can not relinquish the right to be indemnified from the trust assets, so that the trust assets will always be available to meet the liabilities or losses properly incurred by the trustee, in the normal course of operating the business, and

2. To impose on the trustee of a trading trust, where the trustee is a limited liability company, the same obligations, in relation to distributions to beneficiaries of the trust, as are imposed in relation to dividends and other distributions by companies, under the Companies Act 1993. These obligations would require that the company satisfy a solvency test, before making a distribution from the Trust.

These recommendations have been put forward by the working party, in an effort to bring some degree of certainty to the duties of a trustee of a trading trust, and also to give a greater degree of protection to third parties (especially creditors) who deal with the trustee of a trading trust, in the normal course of its business activities.

The working party also considered a number of other issues relating to trustees, as part of an overall review of trustee law in New Zealand.

The working party has made a number of recommendations to the New Zealand Law Commission, and we await with interest the outcome of those recommendations. Some of the other issues considered by the working party will be reviewed at a later date.

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