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Protecting your Lifestyle from Bankruptcy - Bankruptcy Laws, Creditors' Claims and Steps to Take - The Full Story

Newsletter 16 September 2014

At the start of each financial year the legal and financial press contains pictures with smiling faces and stories about recent appointments to the partnership of law firms (or as directors of incorporated legal practices) at the big end of town.  This is a significant milestone in a legal career and, like any significant milestone in life, should be acknowledged and celebrated.

Joining a partnership or becoming a company director can be incredibly rewarding (both professionally and financially) and partners and company directors have the opportunity to accumulate significant wealth.  However, such roles also bear significant risks and responsibilities.  Being aware of those risks and responsibilities, and how best to structure your affairs to minimise your exposure to one of those risks – bankruptcy – is essential for all partners and company directors (including new appointments).  You work hard to accumulate wealth.  Why would you unnecessarily expose that wealth to claims by creditors when proactive planning could go a long way to protecting it?

This article outlines how bankruptcy laws operate in Australia, explains what assets are exposed to creditors’ claims and suggests steps that partners and company directors can take to protect their wealth from creditors’ claims and protect their lifestyle from bankruptcy.

Bankruptcy and the Bankruptcy Act 1966 (Cth)

In Australia, bankruptcy is governed by the provisions of the Bankruptcy Act 1966 (Cth). Bankruptcy is a process that enables a person to sort out their financial affairs by providing a mechanism through which the person’s creditors can be paid (but generally only in part, not in full).  Bankruptcy is generally for a period of three years from the date on which the bankrupt filed his/her statement of affairs [1], although this period may be extended if an objection is made [2].  Upon expiry of the relevant bankruptcy period the bankrupt is released from most, but not all, debts due to creditors before the date of bankruptcy [3].

From the examination that follows, it will be apparent that the provisions of the Bankruptcy Act strike a balance between giving people the freedom to structure their affairs as they see fit and protecting the interests of creditors, by empowering a trustee in bankruptcy to challenge, and set aside, certain transfers of property made by a bankrupt prior to bankruptcy.  Timing can be critical.  If you accumulate wealth then it is best protected from your creditors by not acquiring property in your own name or by transferring it as early as possible in order to minimise the risk that it will be exposed to creditors’ claims.

When does bankruptcy commence?

Generally, bankruptcy is taken to relate back to, and to have commenced at, the time of the earliest act of bankruptcy [4] committed by the bankrupt within the period of six months immediately preceding the date on which a creditor’s petition or debtor’s position (as the case may be) is filed [5].  This includes, amongst other things, payments or transfers of property that would be void against the trustee in bankruptcy [6].

What property is divisible amongst creditors and vests in the trustee in bankruptcy?

On bankruptcy, the bankrupt’s property vests in the trustee in bankruptcy and any after acquired property vests in the trustee in bankruptcy as soon as it is acquired by, or devolves on, the bankrupt [7].  Such property is divisible amongst the bankrupt’s creditors [8].

Property is broadly defined to mean worldwide real or personal property, and includes any rights or powers (whether present or future, vested or contingent) in relation to any such property [9].  This includes jointly owned property, inheritances and debts due to the bankrupt.

Where a bankrupt owns property jointly (e.g. family home owned by a bankrupt and their spouse), the trustee in bankruptcy will generally lodge a caveat on the property to records its interest, give the spouse an opportunity to purchase the bankrupt’s interest in the property and if that is not possible or cannot be agreed then the property can be sold by agreement or application to the Supreme Court [10].  If the property is mortgaged then bankruptcy of one of the borrowers may be an event of default giving the lender the right to sell the property, discharge its mortgage (because the trustee in bankruptcy takes the property of the bankrupt subject to the mortgage) and pay the balance of the proceeds of sale to the trustee in bankruptcy and non-bankrupt spouse in proportion to their ownership interest in the property.

If a bankrupt inherits property as a beneficiary of a deceased estate on or after the date of bankruptcy and before discharge, which is usually three years, then the bankrupt’s interest in the estate is after acquired property and vests in the trustee in bankruptcy, even if the estate has not been fully administered by the time the bankrupt has been discharged [11]. This can be avoided by excluding ‘at risk’ persons from a Will (e.g. by giving their share of an estate to their spouse or children) or preparing a testamentary trust will.  In addition to protecting assets from a trustee in bankruptcy, testamentary trusts have significant tax advantages as income can be distributed in a tax effective way amongst beneficiaries and children under 18 are taxed at adult rates not penalty rates [12].

However, certain property is not divisible amongst creditors and is therefore protected from the trustee in bankruptcy.  This includes, amongst other things, property held by the bankrupt on trust for another person; certain household property (e.g. furniture and effects, but not antiques); certain personal property; property up to a specified value for use by the bankrupt in earning income from personal exertion (e.g. work tools); and motor vehicles (up to a specified value) [13].

Property is best protected from creditors’ claims if it is paid or transferred by the bankrupt as early as possible.  A payment made or property transferred by the bankrupt before the relation back period is not the bankrupt’s property and is not divisible among the bankrupt’s creditors, unless it can be clawed back by the trustee in bankruptcy.

What about income?

Bankruptcy does not prevent a bankrupt from earning income or restrict the income earned.  However, it does limit the income that can be retained by a bankrupt during a period of bankruptcy [14] as the bankrupt must contribute a portion of their income to their bankrupt estate where their income exceeds the relevant income threshold [15].  A bankrupt must contribute half of every dollar they earn over the income threshold amount [16]. The income threshold amount is indexed twice each year in March and September and as at March 2014 it was $52,543.40. This income threshold amount increases according to the number of dependants of the bankrupt.

There are a number of amounts that are not classified as income for contribution assessment purposes. These are set out in Section 139L of the Bankruptcy Act and include amounts paid to the bankrupt for child support or maintenance of children of whom the bankrupt has custody; and certain payments to the bankrupt under legal aid schemes or services.

Income earned before bankruptcy is property of the bankrupt and therefore vests in the trustee in bankruptcy.

What transfers are void against the trustee in bankruptcy?

The following types of transfers of property are void against the trustee in bankruptcy:

  • Section 120(1) – transfers in the period beginning 5 years before the commencement of bankruptcy and ending on the date of bankruptcy, where the transferee gave no consideration or less than market value consideration for the property;
  • Section 120(3)(a) – transfers to related entities not more than 4 years before the commencement of bankruptcy, where the transferor was solvent at the time;
  • Section 120(3)(b) – transfers other than to related entities not more than 2 years before the commencement of bankruptcy, where the transferor was solvent at the time;
  • Section 121 – transfers at any time of property that would probably have become part of the bankrupt estate or would probably have been available to creditors had it not been transferred, if the main purpose of the transfer was to prevent, hinder or delay the property becoming available to creditors;
  • Section 122 – transfers in the period beginning 6 months before a creditor’s petition or debtor’s petition (as the case may be) and the transfer has the effect of giving a creditor a preference, priority or advantage over other creditors.

Undervalued transactions

Undervalued transactions are transactions where the bankrupt does not receive market value consideration from the transferee at the time of the transfer [17].  If a bankrupt transfers property for undervalue then such property may be clawed back by the trustee in bankruptcy.  In this regard, the following issues should be considered:

  • strict time limits apply, so the earlier that property is transferred the less risk that such property will be exposed to creditors’ claims;
  • the time limits are shorter if the transferor was solvent [18] at the time of the transfer and evidence of solvency is kept and maintained [19];
  • if market value consideration is given for the transfer and evidence is retained so this can be proven (e.g. bank statements and property valuation), then section 120 does not apply;
  • it is preferable to pay market value consideration to the transferor (and for it to then be spent on lifestyle expenses) , in which case any increase in value of the property will not be available to the trustee in bankruptcy, than to pay no consideration or less than market value consideration, in which case the transferee must transfer the property back to the trustee in bankruptcy in return for the consideration originally paid to the bankrupt [20];
  • consideration does not include the fact that the parties are related; love and affection; a promise to marry or become a de facto spouse; or the making of a deed by the bankrupt with his or her spouse or de facto spouse [21].

A transferor cannot avoid the operation of section 120 by directing a transferee to pay consideration to a third party (e.g. a person sells real property and directs the purchaser to pay the consideration to the person’s spouse) as any such consideration can be recovered from the third party as if it had been received by the transferor [22].

Transfers to defeat creditors

Transfers of property where the transferor’s main purpose is to prevent, hinder or delay the property becoming available to creditors are void against the trustee in bankruptcy, regardless of when the transfer occurred [23].

The trustee in bankruptcy generally has the onus of proving the transferor’s main purpose [24], but there are no limits on the ways of establishing the main purpose [25].  The requisite purpose:

  • will be established if it can reasonably be inferred from all the circumstances that, at the time of the transfer, the transferor was, or was about to become, insolvent [26];
  • is presumed if the transferor has not kept and maintained books, accounts and records [27].

If the main purpose is established then the transfer of property will be void against the trustee in bankruptcy, unless:

  • the consideration that the transferee gave for the transfer was at least as valuable as the market value of the property; and
  • the transferee did not know, and could not reasonably have inferred, that the transferor’s main purpose in making the transfer was to prevent, hinder or delay the property becoming available to creditors; and
  • the transferee could not reasonably have inferred that, at the time of the transfer, the transferor was, or was about to become, insolvent [28].

If a bankrupt transfers property and his/her main purpose is to prevent, hinder or delay the property becoming available to creditors then such property may be clawed back by the trustee in bankruptcy.  In this regard, the following issues should be considered:

  • no time limits apply, so any transfer could be set aside (even if the transferor proves they were solvent and had no creditors at the time of the transfer);
  • if property is transferred at a time when there is impending liability [29], anticipated creditors [30] or a hazardous business venture on the horizon [31], or if bankruptcy occurs soon after the transfer [32], then there is a real risk that the transfer will be set aside;
  • it is preferable to pay market value consideration to the transferor (and for it to then be spent on lifestyle expenses), in which case any increase in value of the property will not be available to the trustee in bankruptcy, than to pay no consideration or less than market value consideration, in which case the transferee must transfer the property to the trustee in bankruptcy in return for the consideration originally paid to the bankrupt [33];
  • although no time limits apply, the operation of section 121 is limited to circumstances where the main purpose of a transfer was to prevent, hinder or delay the property becoming available to creditors.  Protect yourself and your assets by preparing evidence at the time of the transfer to demonstrate that there were a number of purposes for the transfer.

A transferor cannot avoid the operation of section 121 by directing a transferee to pay consideration to a third party (e.g. a person sells real property and directs the purchaser to pay the consideration to the person’s spouse) as any such consideration can be recovered from the third party by the trustee in bankruptcy as if it had been received by the transferor [34].

Alternatively, or in addition to a creditor’s rights under the Bankruptcy Act, a creditor can itself take steps to recover an asset for its own benefit if a persona alienates property with the intention of defrauding creditors [35].

Preference payments

A transfer of property by a person who is insolvent in favour of a creditor is void against the trustee in bankruptcy if the transfer had the effect of giving the creditor a preference, priority or advantage over other creditors and was made in the period beginning 6 months before presentation of the creditor’s petition and ending immediately before the date of bankruptcy [36].  However, it does not apply to transfers involving third parties who acted in good faith and who gave consideration at least as valuable as the market value of the property [37].

Controlled entities

A trustee in bankruptcy may apply to the Court for an order under Division 4A of Part 6 of the Bankruptcy Act [38] directing property of a third party or an amount of money to vest in the trustee in bankruptcy.  These provisions are targeted towards property acquired by a third party using the bankrupt’s financial resources in circumstances where the bankrupt retains or obtains some benefit, including property owned by natural persons (e.g. a spouse) and entities other than natural persons (e.g. companies and trusts).

Property owned by natural persons

It is not uncommon for partners in law firms to purchase their family home (and other assets) in the name of their spouse.  However, this strategy isn’t bulletproof.  There is a risk that such assets (or part of their value) could be clawed back and transferred to a trustee in bankruptcy where:

  • a person acquired property (or the value of their interest in property increased) as a direct or indirect result of financial contributions made by a bankrupt prior to bankruptcy;
  • the person still owns the property;
  • the bankrupt used or derived a benefit from the property; and
  • the property was acquired in the relevant period specified in the Bankruptcy Act [39].

For example, where a bankrupt made a contribution towards the purchase of a property in the name of his/her spouse or made contributions towards mortgage payments or the cost of renovating a property owned by his/her spouse.

In addition, where a husband and wife purchase a property and the property is registered in the name of one of them (e.g. the homemaker) there is a presumption, in the absence of evidence to the contrary, that the owner of the property holds it for the husband and wife in equal shares [40].  The only evidence that is relevant and admissible in determining the intention of the husband and wife is evidence that existed before, at the time of, or immediately after, their acquisition of the property [41].  This means that the husband and wife should enter into a Deed of Intention (or something similar) before acquiring the property to clearly state their intention, specify the contributions of the husband and wife (particularly if the spouse in whose name the property is to be acquired contributed a substantial proportion of the consideration) and any other evidence that may assist in rebutting the presumption of equal ownership.

Property owned by other entities

There is also a risk that property owned by other entities could be clawed back and transferred to a trustee in bankruptcy where:

  • a bankrupt supplied personal services [42] to an entity controlled by the bankrupt;
  • the bankrupt received no remuneration or remuneration less than would be expected in an arm’s length relationship;
  • the entity acquired property (or its net worth substantially increased) as a direct or indirect result of the personal services rendered by the bankrupt;
  • the bankrupt used or derived a benefit from the property;
  • the entity still owns the property; and
  • the property was acquired in the relevant period specified in the Bankruptcy Act [43].

For example, where a bankrupt is employed by a business owned by a company or a trust controlled by the bankrupt, the bankrupt is underpaid for the services provided and as a consequence the business is profitable and enables the company or trust to buy assets that benefit the bankrupt.

Careful planning must be undertaken to avoid the risk materialising.

Superannuation

A bankrupt’s interest in a superannuation fund is protected if the fund has made an election to become regulated under section 19 of the Superannuation Industry (Supervision) Act 1993 (Cth) and sections 128B, 128C and 139ZU of the Bankruptcy Act do not enable the trustee in bankruptcy to recover any contributions to the relevant fund [44].  Similar protection exists for policies of life insurance in respect of the life of the bankrupt, the bankrupt’s spouse or de facto and the proceeds of such policies if received on or after the date of bankruptcy; and the bankrupt’s interest in any regulated superannuation fund.

Section 128B

Section 128B operates in a similar way to section 121, but only in respect of superannuation contributions.  Like section 121, it provides that transfers of property (in this case, contributions to superannuation) are void against the trustee in bankruptcy if their main purpose was to prevent, hinder or delay the transferred property from becoming divisible among the bankrupt’s creditors [45].

In determining the main purpose:

  • if it can be reasonably inferred from all the circumstances that, at the time of the transfer, the transferor was, or was about to become, insolvent then the main purpose will be made out [46];
  • regard must be had to whether, prior to the contribution in question, the contributor ‘established a pattern of making contributions’ and if so, whether the contribution is ‘out of character’ [47].

Section 128C

Section 128C is similar to section 128B except that it relates to contributions by third parties, not the bankrupt.  Consequently, it applies to contributions by employers (e.g. salary sacrifice).

Section 139ZU

If a superannuation contribution is void against the trustee in bankruptcy under section 128B or 128C and the bankrupt has rolled-over some or all of that void contribution to another superannuation fund then the Court may order the superannuation fund trustee to make a payment to the trustee in bankruptcy [48].  This enables a trustee in bankruptcy to trace void contributions so that the bankrupt cannot defeat creditors’ claims simply by rolling over his/her superannuation interest.

Making contributions

If you are a partner then you will not be an employee of the partnership and will therefore not receive any superannuation guarantee contributions.  You will be responsible for your own superannuation contributions.  In order to establish a pattern of contributions, maximise your concessional (i.e. tax deductible) contributions to superannuation.  The annual cap is currently $30,000. There is a temporary higher concessional cap of $35,000 for persons aged 49 years or over on 30 June 2014. This temporary higher cap will cease when the general contributions cap is indexed to $35,000.

You should also consider making non-concessional (i.e. after tax) contributions in order to maximise your superannuation member balance for retirement and to establish a pattern of contributions, particularly if you receive a significant sum of money (e.g. inheritance) or are approaching retirement age.  The annual cap is $180,000, but persons under 65 can make a maximum contribution of $540,000 by bringing forward two years of contributions.

Any superannuation planning strategies should be carefully documented to evidence the purpose of the contributions so as to minimise the risk that the main purpose of a contribution could be found to be to prevent, hinder or delay the transferred property from becoming divisible among the bankrupt’s creditors and liable to attack by a trustee in bankruptcy.

Withdrawing money from super

If your superannuation interest cannot be voided by 128B, 128C and/or 139ZU, what should you do to protect it from creditors’ claims?  This will depend on your circumstances, but the following general principles apply:

  • If you have passed retirement age and are approaching bankruptcy, do not withdraw a lump sum superannuation interest as this amount (or the property purchased with the amount) will vest in your trustee in bankruptcy and be property divisible among creditors [49].  Instead, take the minimum pension;
  • If you have passed retirement age and are bankrupt, any lump sum withdrawal of your superannuation interest is protected and will not vest in your trustee in bankruptcy.  If possible, do not take a pension (unless the amount of the pension is below the bankruptcy income threshold), otherwise you will have to pay some of it to your trustee in bankruptcy [50];
  • You cannot refuse to pay, or stop paying, a pension to a superannuation fund member simply because they are bankrupt.  Any provision in a superannuation fund trust deed that has the effect of cancelling, forfeiting, reducing or qualifying any part of the superannuation interest of a member who becomes bankrupt or commits an act of bankruptcy or empowers the superannuation trustee to exercise a discretion relating to any such member, is void [51].
  • Superannuation death benefits received from your spouse or someone with whom you have an interdependency relationship may be exposed to creditors’ claims.  If this risk is a concern to you (and outweighs your desire for tax effective estate planning) then any such benefits could be left to a testamentary trust, another eligible beneficiary or paid as a pension, in order to minimise the value of benefits exposed to creditors’ claims.

Discretionary Trusts

Asset protection and tax planning are generally the primary considerations in the structuring and operation of discretionary trusts.

The Federal Court decision in the Richstar case [52] provides some guidance as to how discretionary trusts should be structured to minimise the risk of trust assets being exposed to claims by creditors of a person who stands to benefit from trust assets.  In that case, in which orders were sought under the Corporations Act 2001 (Cth), the Federal Court held that a discretionary trust was the ‘alter ego’ of the beneficiary who effectively controlled the trust and as a consequence the beneficiary had an interest in the trust property that was akin to a contingent or proprietary interest.  In the context of the provisions of the Bankruptcy Act, such an interest could vest in the trustee in bankruptcy.

What does this mean for discretionary trusts?  Important decisions must be made regarding the appropriate structure of a discretionary trust, in particular who should be the trustee, appointor and beneficiaries.

Trustee

If a bankrupt owns shares in a corporate trustee of a discretionary trust then those shares are property of the bankrupt and therefore vest in the trustee in bankruptcy.  If this occurs, a trustee in bankruptcy could therefore control a discretionary trust by exercising its rights as a shareholder of the corporate trustee, appoint new directors of the corporate trustee and instruct those directors to distribute the trust assets to the bankrupt so they become available to the bankrupt’s creditors.  Fortunately for the bankrupt and the trust, this would be a breach of trust and fraud on the power as it would have the effect of preferring the interest of the bankrupt (or more relevantly, the bankrupt’s creditors) over the other beneficiaries of the trust, which is not in their best interests, and the trustee in bankruptcy would risk litigation in his/her personal capacity if it sought to exercise such rights.

If a bankrupt is the trustee of a discretionary trust then the assets of the discretionary trust are not personal assets of the bankrupt, do not vest in the trustee in bankruptcy and therefore are not divisible among the bankrupt’s creditors [53].  However, the bankrupt must have evidence to confirm the existence of a trust (e.g. trust deed, minutes and financial statements) and a new trustee must be appointed to replace the bankrupt as trustee, which means that the trust assets will need to be transferred to the new trustee.  This could be an administrative nightmare.

Given the issues identified above, the trust should have a corporate trustee (which only acts as trustee of the trust and not in any other capacity), a person who is at risk of bankruptcy should not be a director of the corporate trustee or he/she should be one out of two or more directors and should not own shares in the corporate trustee or only own a small percentage/interest (e.g. less than 10%).

Appointor

The right of a person (known as the appointor) to appoint or remove the trustee of a discretionary trust (i.e. the power of appointment) is a personal right and does not vest in the trustee in bankruptcy [54].

A power of appointment is not property that passes to a trustee in bankruptcy.  If it did then there would be a risk that the trustee in bankruptcy would exercise that power to appoint a new trustee to distribute the trust assets to the bankrupt so they become available to creditors.  Fortunately for the bankrupt and the trust, this would be a breach of fiduciary duty and fraud on the power as it would have the effect of preferring the interest of the bankrupt (or more relevantly, the bankrupt’s creditors) over the other beneficiaries of the trust [55], which is not in their best interests, and the trustee in bankruptcy would risk litigation in his/her personal capacity if he/she sought to exercise the power.

Given the issues identified above, the choice of appointor and the wording of the appointor clause in the trust deed must be carefully considered.  Clearly, a person at risk of bankruptcy should not be an appointor of the trust or should be one out of two or more appointors who must make decisions unanimously.  In addition, the trust deed should provide that if an appointor commits an act of bankruptcy or is declared bankrupt then that person ceases to be appointor.

Interests of beneficiaries

Assets in a discretionary trust 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 and most discretionary trust beneficiaries are mere discretionary objects who have the right to due administration of the trust [56].  This is a personal right that does not vest in the trustee in bankruptcy [57].  Beneficiaries of a discretionary trust receive trust distributions as determined by the trustee, which means that if a beneficiary is bankrupt the trustee in bankruptcy cannot compel the trustee to exercise its discretion in favour of the bankrupt beneficiary.

However, there are exceptions.

Firstly, if a bankrupt beneficiary is a default income or capital beneficiary of a discretionary trust then the beneficiary (and therefore the beneficiary’s trustee in bankruptcy) may have an interest in the trust assets.  This is easily avoided by removing default beneficiaries from the trust deed.

Secondly, any amounts owed to a bankrupt beneficiary by a trust (e.g. unpaid trust distributions or loans from the beneficiary to the trust) will vest in the trustee in bankruptcy and a demand for immediate repayment may be made.

Thirdly, if a bankrupt beneficiary makes gifts to a trust (e.g. assets or money) then those gifts may be clawed back by the trustee in bankruptcy pursuant to sections 120 and/or 121.

Fourthly, if there is a pattern or history of distributions by a trust to a beneficiary and those distributions cease upon the beneficiary becoming bankrupt then the trustee in bankruptcy may commence proceedings against the trustee of the trust for failing to exercise its power to consider all of the beneficiaries and as a consequence seek to have the trustee replaced.

Given the issues identified above, default beneficiary clauses should be removed from a trust deed (unless there are compelling reasons to include them) and the trust deed should include a broad class of beneficiaries, each of whom should not receive distributions from the trust that demonstrate a pattern of distributions or entitlement to an ascertainable proportion of trust income.

Ways to minimise exposure of your wealth to creditors’ claims

From the start …

  • If you are a partner in a partnership, seek an indemnity from your other partners in relation to partnership liabilities (this generally only applies to non-equity partners).
  • If you are a company director, ensure you are covered by a directors and officers (D&O) insurance policy and have signed an indemnity deed (also known as an Officer Protection Deed) with the relevant companies.
  • Take out and maintain a professional indemnity insurance policy while you are in the business and for a period of seven years after leaving the business.  If your business has a policy carefully review it, in particular any special conditions and exclusions.
  • Do not give any personal guarantees, particularly if you are a company director.
  • Buy your family home in your spouse’s name, minimise your contribution to the purchase and ensure that any home loan is in the name of your spouse so they, not you, are liable to repay the loan.
  • Contribute to superannuation.
  • Setup a discretionary trust.
  • Buy assets in a company, the shares in which are owned by another company that is the trustee of a discretionary trust.  Alternatively, buy assets in your spouse’s name, not your name.
  • Spend as much of your income as possible on lifestyle expenses so any mortgage payments or savings can be attributed to your spouse’s income.  If there is money leftover, give it to your spouse.
  • Loans made by you (e.g. to your spouse, a trust or company) and unpaid trust distributions (i.e. amounts that a trustee of a trust resolves to distribute to you but which are retained within the trust) are assets and are exposed to creditors’ claims.  Keep them to a minimum.
  • Don’t inherit anything!  Ask your parents to make a testamentary trust will so that your spouse and children, not you, receive the inheritance.
  • Exclude a bankrupt from being a beneficiary of a discretionary trust or testamentary trust for the period of bankruptcy.

If you have assets and think it’s too late …

  • Take steps to protect your assets when you have no creditors.
  • If you have assets then transfer them as early as possible so that time starts to run in your favour.  Suffer the consequences, if any, later.
  • If you transfer assets to your spouse (or another entity or third party) document the reasons for the transfer (e.g. estate planning or tax planning).
  • If you transfer assets and receive consideration for the transfer, verify the value of the assets transferred (e.g. by obtaining a valuation) in order to establish fair market value.
  • Document any consideration that you receive for any assets transferred.

Superannuation – For everyone …

  • Make sure you contribute as a member of a regulated superannuation fund.
  • Establish a pattern of superannuation contributions by making both concessional and non-concessional contributions, in particular at any time after receiving a substantial sum of money (e.g. inheritance).
  • Maximise concessional contributions in order to minimise assets exposed to creditors’ claims and maximise your tax benefits.

Superannuation – If you have a SMSF …

  • Your SMSF should have a corporate trustee, not individual trustees.  As the SMSF’s assets are owned by the trustee, not the individual members, if an individual member is bankrupted the SMSF’s assets would not need to be transferred to a new trustee and there would be no dispute as to the capacity in which the assets are owned.
  • A bankrupt cannot be a director of a company. If you are a director of the corporate trustee of your SMSF then you will cease to be a director on bankruptcy.
  • In order to comply with superannuation legislation you must be a director of the corporate trustee, but you do not have to own shares in the corporate trustee.  Any shares in the corporate trustee could be owned by your spouse or the trustee of a discretionary trust.

If you have a discretionary trust …

The following structure should minimise the risk that assets held in a discretionary trust will be exposed to claims by creditors:

  • The trust should have a corporate trustee, which only acts as trustee of the trust and not in any other capacity.
  • You should not be the sole director of the corporate trustee. You should be one out of two or more directors.  For example, the directors could be you and your spouse (or another relative) and/or a professional adviser (e.g. your accountant or lawyer).
  • You should not own shares in the corporate trustee or if you do then it should only be a small percentage/interest (e.g. less than 10%).
  • You should not be an appointor of the trust or if you are then you should be one out of two or more appointors who must make decisions unanimously.  For example, the appointors could be you and your spouse (or another relative) and/or a professional adviser (e.g. your accountant or lawyer).
  • You should not be a default income or default capital beneficiary of the trust.
  • You should be one of a number of beneficiaries of an unrestricted class and should not receive distributions from the trust that demonstrate a pattern of distributions or entitlement to an ascertainable proportion of income.

If you and your spouse are both exposed to risk in the practise of your profession (e.g. you are a lawyer and your wife is a doctor) or are exposed to the same risk (e.g. you are partners in the same law firm) then the following alternative structure may better protect trust assets:

  • Setup two trusts, one for each of you and your spouse.
  • You should be a beneficiary of one trust and your spouse the beneficiary of the other.
  • You, or a third party, should control your spouse’s trust (i.e. by controlling the trustee and appointor).  Your spouse (or a third party) would control your trust.
  • You both should have professional indemnity insurance.

If you or your spouse do not want to relinquish control of the trust to a third party then control of the trust could be vested in the spouse who is more likely to cease work or change their role in the future (e.g. to raise children).

What does all this mean?

Asset protection is an integral part of tax effective structuring and estate and succession planning.  It requires the expertise of lawyers and accountants, but most importantly it requires you to be proactive, not reactive.  You should seek advice as early as possible and whenever your circumstances change in order to protect your lifestyle from bankruptcy and minimise the risk of your wealth being exposed to creditors’ claims.

[1] section 149(2) of the Bankruptcy Act 1966 (Cth)
[2] section 149A of the Bankruptcy Act 1966 (Cth)
[3] see section 82 of the Bankruptcy Act 1966 (Cth) for debts that are provable and not provable in bankruptcy
[4] section 40 of the Bankruptcy Act 1966 (Cth)
[5] section 115(1) and (2) of the Bankruptcy Act 1966 (Cth)
[6] section 40(1)(b) of the Bankruptcy Act 1966 (Cth)
[7] section 58(1) of the Bankruptcy Act 1966 (Cth)
[8] section 116(1) of the Bankruptcy Act 1966 (Cth)
[9] section 5 of the Bankruptcy Act 1966 (Cth) definition of “property”
[10] for example, see section 66G of the Conveyancing Act 1919 (NSW)
[11] Silvia v Thomson (1989) 87 ALR 695 at 697 and Official Receiver in Bankruptcy v Schultz (1990) 96 ALR 327 at 332; section 58(1) of the Bankruptcy Act 1966 (Cth)
[12] section 102AG(2)(a) of the Income Tax Assessment Act 1936 (Cth)
[13] section 116(2) of the Bankruptcy Act 1966 (Cth) and Division 2 of Part 6 of the Bankruptcy Regulations 1996 (Cth)
[14] which is defined in section 139L of the Bankruptcy Act 1966 (Cth)
[15] section 139P of the Bankruptcy Act 1966 (Cth)
[16] section 139S of the Bankruptcy Act 1966 (Cth)
[17] section 120(7)(c) of the Bankruptcy Act 1966 (Cth)
[18] section 5(2) of the Bankruptcy Act 1966 (Cth)
[19] section 120(3A) of the Bankruptcy Act 1966 (Cth)
[20] section 120(4) of the Bankruptcy Act 1966 (Cth)
[21] section 120(5) of the Bankruptcy Act 1966 (Cth)
[22] section 121A of the Bankruptcy Act 1966 (Cth)
[23] section 121 of the Bankruptcy Act 1966 (Cth)
[24] Prentice v Cummins (No. 5) [2002] FCA 1503 at 97
[25] section 121(3) of the Bankruptcy Act 1966 (Cth)
[26] section 121(2) of the Bankruptcy Act 1966 (Cth)
[27] section 121(4A) of the Bankruptcy Act 1966 (Cth)
[28] section 121(4) of the Bankruptcy Act 1966 (Cth)
[29] Barton v FCT (1974) 131 CLR 370 at 374
[30] Ebner v The Official Trustee in Bankruptcy (1999) 91 FCR 353 at 371
[31] Official Trustee in Bankruptcy v Alvaro (1996) 66 FCR 372 at 421
[32] Ashton v Prentice (1999) 92 FCR 68 at 81
[33] section 120(4) of the Bankruptcy Act 1966 (Cth)
[34] section 121A of the Bankruptcy Act 1966 (Cth)
[35] section 37A of the Conveyancing Act 1919 (NSW)
[36] section 122(1) of the Bankruptcy Act 1966 (Cth)
[37] section 122(2) of the Bankruptcy Act 1966 (Cth)
[38] section 139A of the Bankruptcy Act 1966 (Cth)
[39] sections 139CA, 139DA and 139EA of the Bankruptcy Act 1966 (Cth)
[40] The Trustees of the Property of John Daniel Cummins, A Bankrupt v Cummins (2006) HCA 6 at para 68
[41] Charles Marshall Pty Limited v Grimsley (1956) 95 CLR 353 at 365
[42] see definition in section 5(1) of the Bankruptcy Act 1966 (Cth)
[43] sections 139CA, 139D and 139E of the Bankruptcy Act 1966 (Cth)
[44] section 116(2)(d) of the Bankruptcy Act 1966 (Cth)
[45] section 128B(1) of the Bankruptcy Act 1966 (Cth)
[46] section 128B(2) of the Bankruptcy Act 1966 (Cth)
[47] section 128B(3) of the Bankruptcy Act 1966 (Cth)
[48] section 139ZU(1) of the Bankruptcy Act 1966 (Cth)
[49] Worrell v Kerr-Jones [2002] FCA 1090 at paras 23-24
[50] sections 139L, 139P and 139S of the Bankruptcy Act 1966 (Cth)
[51] section 302A of the Bankruptcy Act 1966 (Cth)
[52] Australian Securities and Investments Commission (ASIC) in the matter of Richstar Enterprises Pty Ltd v Carey (No .6) [2006] FCA 814
[53] section 116(2)(a) of the Bankruptcy Act 1966 (Cth)
[54] Re Burton; Wily v Burton & Ors (1994) ALR 557 at 560
[55] Dwyer v Ross (1992) 34 FCR 463 at 467
[56] Gartside v Inland Revenue Commissioners [1968] AC 553 at 561
[57] Dwyer v Ross (1992) 34 FCR 463 at 466


Matthew Payne, Partner
Sydney

Newsletter 16 September 2014
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