WHAT YOU NEED TO KNOW

Family assets are commonly protected by the use of a structure named a discretionary trust (sometimes referred to as a ‘family trust’).

This type of trust provides a firewall of protection for family trust assets. What happens, however, if the trustee or appointor of a discretionary trust goes bankrupt? Or the beneficiary submits to personal insolvency?

Benefits of a Discretionary Trust

The trustee of a discretionary trust owns the assets legally, which are held on trust for the benefit of others. Beneficiaries receive income or capital distributions at the trustee’s discretion.

Discretionary Trust Distributions

Unlike the trustee of a unit trust, the trustee of a discretionary trust has the discretion as to whether or not to make distributions to a bankrupt beneficiary. As any distributions owed to a bankrupt vest in their bankrupt estate (meaning the trustee is entitled to realize distributions or outstanding entitlements) it is common for a trustee of a discretionary trust to decline to make distributions to a bankrupt. Further, the trustee in bankruptcy cannot compel the trustee to exercise its discretion in favour of the bankrupt beneficiary.

Discretionary Trust assets

Family or discretionary trust assets are generally protected from claims by creditors of a bankrupt beneficiary as the trustee of a discretionary trust is the legal owner of those assets.
The trustee will hold any property beneficially for the beneficiary which means the property cannot be taken by a creditor in bankruptcy unless the debt relating to the creditor was a trust debt. The same applies when a property is held on trust by a corporate trustee. Any properties held in trust can only be attacked by creditors of that trust.
Fortunately for trust beneficiaries, a recent NSW Court of Appeal decision[i] has confirmed that a trustee in bankruptcy will not be able to seize family trust assets for the benefit of creditors in the event of a bankrupt trustee or appointor (except if the trust is set up as a sham)[ii]. In that case, property held by the bankrupt in trust transferred to the trustee in bankruptcy but it was subject to the existing trust (ie, not available to creditors).

Purpose of trust

If a bankrupt has tried to prevent trust property from being divisible amongst the bankrupt’s creditors by transferring trust property at a time when they were insolvent or on the edge of insolvency, the trustee may rely on s 121 of the Bankruptcy Act 1966 (Cth) (Act) to apply to the court to void the transfer.

Advisor tips

The discretionary or family trust is a fairly robust investment structure however it is not without its limitations.
The proper establishment of a discretionary trust through a carefully drafted trust deed is essential. Those who are run a high risk of becoming bankrupt due to employment or nature of business dealings should be excluded as directors of corporate trustees should not hold the position of appointor and should only hold a small percentage of shares (or none at all).
Furthermore, loans or gifts to a trust, unpaid distributions and default beneficiaries are all open to attack from trustees in bankruptcy and clawback provisions under the Act (see ss 120 and 121 of the Act).

[i] Lewis v Condon [2013] NSWCA 204
[ii] s 116(1) Bankruptcy Act 1966 (Cth)

For more information on bankruptcy and family trusts review the resources below or contact us today.

PERSONAL INSOLVENCY RESOURCES

PERSONAL INSOLVENCY OVERVIEW

From sudden employment and over-reliance on credit to relationship breakdowns and ill health, there are many reasons why people suffer financial hardship and experience unmanageable debt. If an individual cannot pay their debts they may and haven’t been able to reach an agreement with creditors, they may declare themselves bankrupt. Bankruptcy can either be voluntary or involuntary.

DECLARING BANKRUPTCY – WHAT’S INVOLVED?

Declaring bankruptcy voluntarily in Australia is a straight forward process and involves completing two separate forms and lodging them with the Australian Financial and Security Authority. This article outlines declaring bankruptcy in four step.

CANCELATION OR ANNULMENT OF BANKRUPTCY

Annulment is effectively the cancellation of a bankruptcy. This article outlines the three ways a bankruptcy may be annulled.

ASSETS, DEBTS AND INCOME IN BANKRUPTCY

Many people do not know what will happen to their income, debts and assets once they become bankrupt. To assist in advising those on the brink of personal insolvency, here is a broad overview of the bankrupt’s entitlement to hold on to certain assets and income during the period of bankruptcy.

BANKRUPTCY AND EMPLOYMENT

While bankruptcy doesn’t directly affect your employment, it may have consequences if you hold various licences or qualifications including building, property management, liquor and financial brokerage licences.

BANKRUPTCY AND HOUSES

If an individual is made bankrupt, it is not necessarily the case that their house will be sold from under them. Given that in most bankruptcy cases we are dealing with the family home, it pays to have knowledge in this field to provide the best outcome for your client and hopefully “save the house”.

DISCHARGE OR FINALISATION OF BANKRUPTCY

The discharge of bankruptcy means that the individual is no longer bankrupt.
The date of discharge of bankruptcy will vary depending on the type of bankruptcy.

PERSONAL INSOLVENCY LEGAL ACTION

There are many ways a creditor can seek to recover payment of a debt from an individual who cannot, or refuses to, pay that debt. This article covers the rights and obligations of individuals facing debt collection and exposed to legal action and enforcement.

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