Trust Law

THE EROSION OF TRUSTS AS A TOOL FOR ASSET PROTECTION Background

It has become common and prudent practices for high net worth individuals to structure their personal and business affairs in a way that gives them both • Tax effectiveness, and • Asset protection. Many organisations have at considerable cost re-structured and re-engineered the manner in which assets are held, choosing new entities and controlling interests to either hold assets or direct their application.

The principles behind the use of trusts as an assets protection tool will continue, however, the manner in which they should now (in light of recent case law) be set up must now be reviewed.

Why has it become necessary to review the setup of your discretionary trust?

Basic Discretionary Trust principles:

• A beneficiary does not have an interest in the trust assets. A beneficiary has a right only to have the trust administered in accordance with its terms. The beneficiary has expectancy only. • Therefore, if a beneficiary becomes bankrupt, the creditors will not have a right to the assets of the trust unless the trustee chooses to apply trust assets to that beneficiary. • This, in simple terms, is how the assets become “protected” However the principle developed some fuzziness when Richstar Enterprises Pty Ltd v Carey No 6 [2006] FCA 814 suggested: • “…a beneficiary who effectively controls the trustee of a discretionary trust may have what approaches a general power and thus a proprietary interest in the income and corpus of the trust” (per French J). • Where the trustee is the alter ego of a beneficiary, then the beneficiary has at least a contingent interest in the trust.

Section 116 of the Bankruptcy Act (Commonwealth) (1966) defines what property divisible among the creditors means. It is long and arduous to read but s 116(1)(b) can be paraphrased that the divisible property of a bankrupt includes “the capacity to exercise …all such powers in, over or in respect of property as might have been exercised by the bankrupt for his own benefit..”

If it is ultimately decided by a court that the trustee is controlled by a beneficiary there is a danger that the court will regard the assets of the trust as “property” and hence available to creditors in the event of bankruptcy. The protection may be compromised. However it is not the conclusion to be drawn with every trust as it is dependent on the facts of each individual case.

Suggestions for remedy

The ultimate decider of the effectiveness of the trust can only be agitated in the courts and it is difficult to predict outcomes purely by looking at the trust deed. We suggest the following as the starting point with clients who are high net worth individuals seeking protections of lifetime accumulated assets.

• Review the terms of the trust • How is the trust managed • Who makes the decisions and how are decisions recorded and made • Is a change of approach and structure required to the controlling of the trust • Should the trustee be excluded as a beneficiary • Review the structure of the trustee • Review the role of the Appointor/Principal – Why? – The appointor will usually have the power to remove the trustee. Some cases (Dwyer v. Ross (1992) 34 FCR 463) argue that the power to remove and appoint a trustee is “divisible property” i.e. that the power is an asset of the bankrupt and that the trustee in bankruptcy could use this power to remove a trustee and appoint another to make a distribution to the bankrupt beneficiary and then apply the property to the creditors. Consider then:

 Having joint appointors

 Retirement of the appointer if declared bankrupt and retirement generally

 Remove the high net worth individual as an appointor

Conclusion

We recommend a review of the business structure as the effects of the Richstar decision and recent changes to the Bankruptcy Act may not have been contemplated at the time of set up. There are many other matters to consider in the decision to restructure which decision should only be made after careful consideration of all the circumstances surrounding the setup and consequent application.

For more information contact Evan Sarinas: esarinas@sarinaslegal.com.au