Lane v Deputy Commissioner of Taxation

The case of Lane v Deputy Commissioner of Taxation involves the rights of a trustee in bankruptcy in relation to the insolvent trustee's right of exoneration. The court was required to determine the nature of the right of exoneration, whether the funds are to be distributed to all creditors or only to trust creditors, and whether the right of indemnity is "property divisible among the bankrupt’s creditors" or trust property. The court also considered whether the priority regime in section 109 of the Bankruptcy Act 1966 (Cth) applies to the use of the right of exoneration and whether the right of exoneration should be exhausted before dividends are paid.

The court held that a trustee has a right to indemnification from the assets of the trust in respect of trust debts properly incurred and for any tortious liability not improperly incurred. The right of indemnity comprises a right of recoupment and a right of exoneration. The value of the indemnity is ascertained by taking the accounts of the trust and applying the "clear accounts rule". The trustee has an equitable lien supporting the right of indemnity. Upon the insolvency of the trustee, all existing trust creditors are equally entitled to be subrogated to the right of exoneration and supporting lien, but not to the right of recoupment. Both rights of recoupment and exoneration are part of the personal property of the insolvent trustee and pass to the bankruptcy trustee as "property of the bankrupt divisible amongst creditors". The right of exoneration is a limited right to use trust funds to discharge trust debts and cannot be used to pay the costs, expenses, and remuneration of the bankruptcy trustees.

The court concluded that the right of exoneration should be exercised by the bankruptcy trustee to pay the trust creditors pari passu. The "hotchpot" principle applies in the distribution of the proceeds of the bankrupt's property, such that the trust creditors must bring into account the amounts they have received by the application of the right of exoneration before participating in the distribution. The costs, expenses, and remuneration of the bankruptcy trustees relating to the performance of work necessary for exercising the right of exoneration may be paid from the pool of funds generated by their work before the right of exoneration is exercised.

The court did not determine whether the amount of the bankruptcy trustee’s entitlement can be debited against the interest of the trust’s beneficiaries as opposed to the interest of the trust creditors in the pool of funds created as no "trust assets" remained.