Ejecting “ejection clauses”: is the game worth the candle?

Banks and financial institutions have arguably never faced greater scrutiny. With the spectre of a Royal Commission still lingering, a Banking Tribunal proposed and the augmentation of unfair contracts legislation on the cusp of commencement, fair dealings between banks and their customers is a matter that remains anchored in the spotlight.

It is through this prism that we consider the approach of some financiers to use their superior bargaining power to insist in all cases on the removal of “ejection clauses” from trust deeds prior to transacting with trustees. “Ejection clause” is a term which has gained acceptance as a descriptor for a clause in a trust deed that provides for the automatic vacation of the office of trustee upon the occurrence of some (usually insolvency related) event concerning the trustee.

This article further explores the proposition that a party considering advancing credit to a trustee ought to, if possible, insist upon the removal of an ejection clause prior to transacting. It suggests a more expansive set of considerations to which persons (and particularly banks) transacting with trustees might have regard when considering the removal of an ejection clause. It propounds the argument that, in the current regulatory environment, financiers ought to satisfy themselves that insisting on the removal of an ejection clause can be justified as being in furtherance of the financier’s legitimate business interests.

Ejection clauses — how do they work?

As referred to above, ejection clauses generally provide for the automatic vacation of the office of trustee. The range of “triggers” is typically varied but commonly involves the occurrence of an insolvency event, such as the appointment of an external administrator. It is also not unusual that a variety of events that may be anterior to such an appointment (such as insolvency) trigger the operation of the ejection clause.

Why do ejection clauses exist?

The presence of ejection clauses in trust deeds reflects the common law position that it is generally not appropriate that an insolvent entity act as trustee.

There is some authority for the proposition that a bankrupt trustee will be removed by the court as a matter of course.[1] However, the more widely accepted (and better) view is that the removal of an insolvent trustee is a discretionary matter informed by the interests of the beneficiaries, the security of the trust property, the efficient and satisfactory execution of the trusts, and a faithful and sound exercise of the trustee’s powers.[2] This more flexible approach recognises (as was the case in Wells v Wily[3] ) that it will usually be of no detriment to beneficiaries for a corporate trustee to remain in the control of a registered liquidator.

While there is no strict position as to the appropriateness of an insolvent entity holding the position of trustee, it may be accepted that there will be many circumstances in which it will be inappropriate. Thus, the rationale for the ejection clause is the protection of beneficiaries from the (at least potentially) hazardous circumstance of an insolvent entity holding the office of trustee.

Benefits of removing the clause

The problem created for liquidators by ejection clauses has been widely discussed; with the generally accepted position being that upon the removal of a company as trustee, its liquidator loses the power (conferred by the trust deed) to sell trust assets, absent the intervention of a court.

The problem for secured creditors is much narrower. There is no suggestion of the loss of a power of sale upon the removal of a trustee. Rather, the pertinent question is whether in exercising a power of sale, a receiver can do so as agent for the (removed) trustee.

The issue is narrower still when one accepts that the agency question will not arise in respect of land encumbered by a registered mortgage in circumstances where (as is usually the case) the mortgage instrument, carrying with it the benefit of indefeasibility, provides for the appointment of a receiver to sell the property as agent for the mortgagor. There is no real scope for debate as to whether these agency provisions are ancillary to the exercise by the lender of its proprietary rights over real property so as to obtain the benefit of indefeasibility.[4]

Shortly stated, the problem created for a secured creditor is that any receiver appointed by it to sell personal property of a trustee may not act as agent for the grantor. This loss of agency will expose the mortgagee to liability arising from the acts of the receiver, though this belies the willingness of mortgagees to appoint receivers on the basis of a grant of indemnity, or take possession themselves. The loss of agency could be of more significance if the receiver is carrying on the business of the entity to which the receivers are appointed. Therefore, the benefit of removing an ejection clause is to ensure that a receiver appointed by a secured creditor retains the powers conferred by the trust deed, such that it can act as the grantor’s agent.

It is important to note, however, that this benefit will subsist only so long as an appointor does not exercise his or her power to appoint a new trustee.

So, it can be seen that there is a fairly narrow benefit to the secured creditor in the removal of an ejection clause, and one that can be wholly undone by the replacement of the trustee.

Should ejection clauses be removed?

The option to insist on the variation of a trust deed so as to remove an ejection clause will only be available to a party that holds sufficient bargaining power to compel a borrower (or guarantor) to do so. There are both legal and reputational reasons why the use of superior bargaining power to interfere in a customer’s contracts should be avoided unless necessary to further the bank’s legitimate business interests.

In particular, from 12 November 2016, the existing unfair contract term protections for consumers will be extended to cover “standard form” small business contracts. Without undertaking a comprehensive analysis of the breadth of the new regime, it may apply to contracts for the provision of finance of up to $1 million. A term of a contract may be found to be unfair if it is not reasonably necessary to protect the legitimate interests of the party that would benefit from its inclusion.

A bank’s insistence on the removal of an ejection clause may be relevant to other causes of action advanced by a borrower to which imbalance in bargaining power is an element.

As outlined above, ejection clauses are designed to protect beneficiaries. Conversely, the removal of that protection might cause detriment to beneficiaries. In the case of an ejection triggered by the appointment of an external administrator, it is unlikely that any loss will arise by reason of the ejection. The trustee will either already be insolvent or an external administrator acting properly is unlikely to significantly diminish the trust assets. But what about other events referred to in ejection clauses that might trigger a removal?

Consider the following scenario. Substantial real estate holdings are held pursuant to a unit trust. The trustee refinances with a bank that insists upon the removal of an ejection clause in the trust deed, in addition to obtaining security by way of first registered mortgages over real property. The particular ejection clause provided for the automatic removal of the trustee of a unit trust upon the filing of a winding up application. An application to wind up the company is filed at a time when the value of the assets of the trust is substantial. The application does not proceed; however, the ejection clause is nevertheless triggered.[5] Following this, the trustee sustains significant losses and all of the equity is lost.

It is not inconceivable that a beneficiary, whose interest in the trust has substantially diminished in value, might argue that but for the bank’s insistence on the removal of the ejection clause, the loss would have been avoided. While a beneficiary may have difficulty framing a viable cause of action against the bank, equally, the bank may have difficulty justifying (to, for example, a regulator or a Parliamentary Standing Committee on Economics) its insistence on the removal of the ejection clause. The removal of the ejection clause may have served no useful purpose, having regard to the fact that the property held in trust was subject to registered mortgages which likely provided for the appointment of a receiver acting as agent for the registered proprietor.

Conclusion

While ejection clauses can have a profound impact on the ability of liquidators to realise assets, the impact on secured creditors is much less significant. In the case of a trustee company that holds only real property, the removal of the clause is likely to be of no benefit at all, provided the bank holds a registered mortgage. While it is understandable for a financier to seek to take a “belts and braces” approach to its security, it should be borne in mind that the removal of an ejection clause removes a measure designed to protect the beneficiaries of the trust. In the current political and economic environment, we would urge financiers considering insisting on the removal of an ejection clause to ensure that it is in a position to justify its legitimate interest in taking that position if ever called upon to do so. While there will undoubtedly be a tangible benefit to the removal of ejection clauses in some cases, a “one size fits all” approach should be avoided.