Asset Protection and Discretionary Trusts (Part Two)

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In a recent blog I discussed some general comments about Discretionary Trusts and Asset Protection. In this blog I will speak more specifically about the limitations of Trusts in Asset Protection.

Limitations on Asset Protection of Discretionary Trusts

It is very important to understand some limitations that a trust has for asset protection strategies:

  1. Family law – for years Family Law Courts have looked through formal trust structures to make family settlements according to who had the de-facto ownership, or control, of the trust property;
  2. Trustee’s right of indemnity – a trustee is entitled to be indemnified from the trust assets from liabilities that it incurs as trustee of the trust. This means that assets of a trust could be available to pay creditors of a trustee if trust liabilities have been incurred by the trustee. If a trustee becomes bankrupt or insolvent, this right of indemnity will vest in the liquidator or trustee in bankruptcy who could sell trust assets to pay creditors. It is therefore very important that the trustee of a trust that holds valuable assets should not engage in any risky activity, like giving guarantees etc;
  3. Unpaid entitlements – if a trustee makes a distribution but does not immediately pay the distribution, the beneficiary (or its creditors) could call upon the trust to pay that amount; and
  4. Control – if a beneficiary effectively controls the trustees power to make distributions (for example if the beneficiary is an appointor, trustee or director of the trustee company), the Courts could decide that the beneficiary has effective ownership of the trust property and include that in the beneficiaries assets to be made available to creditors.

Steps to protect assets

A number of strategies can be implemented, but it is important to follow the following steps:

  1. Consider the assets you wish to protect;
  2. Consider who owns the assets you wish to protect;
  3. Who controls the assets that are at risk (trust assets);
  4. Decide who will hold the important roles in the trust such as trustee, appointor etc
  5. Separate the control from the risk – the appointor should not be taking on any risk such as personal guarantees etc and should have its own assets completely separated (for example:
    • Mum owns the family home,
    • Dad should run the business through a trust or a company that dad is the sole trustee and shareholder of;
    • The business should own no other valuable assets; and
    • Mum can be the appointor so she has effective control of the trust.

It is very important to ensure that detailed legal and accounting advice is provided before a structure is finalised. Please do not hesitate to contact me if you have any queries regarding Discretionary Trusts or asset protection.