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

Decisions regarding the appropriate structure of a discretionary trust can be divided into three categories: trustee; appointor; and beneficiaries.

Trustee

A 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 either not be a director of the corporate trustee or should be one out of two or more directors and should either not own shares in the corporate trustee or only own a small percentage/interest (e.g. less than 10%).

Appointor

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 either 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 could provide that if an appointor commits an act of bankruptcy then that person ceases to be appointor.

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.  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 to the general rule.

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 of the Bankruptcy Act 1996.

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 on the basis that the trustee has failed 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.

Some tips for protecting trust assets from bankruptcy

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 either not be a director of the corporate trustee or 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 either 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 either 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.

Conclusion

You should seek advice from an experienced lawyer or accountant with the relevant expertise as establishing a discretionary trust can be an effective way of minimising your assets that are exposed to creditors’ claims.

Matthew Payne

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