The ability of third parties to attack arrangements on the basis they are void because they are a sham has been looked at in previous posts (please contact me if you would like access to these and can not easily locate them).
Arguably one of the leading cases which explores the ability of a trustee in bankruptcy to attack trust assets using the rules in relation to sham transactions is Lewis v Condon; Condon v Lewis [2013] NSWCA 204. As usual, please contact me if you would like a copy of the decision.
Although the facts were somewhat complex, at the centre of the dispute was a trust that had been established by a lady who subsequently became bankrupt and admitted that the structure facilitated ‘her purpose to deceive her former husband, the Family Court and to avoid tax’.
In considering whether the assets of the trust were exposed to attack from a trustee in bankruptcy on the basis that the trust was a sham the Court held relevantly as follows –
Before any trust will be held void as a sham, it is necessary to show that there was an intention that the structure created not bear its apparent legal consequence. That was not the case here;
Even where a trust is established with an admitted purpose of deceiving, this is not enough to mean it is a sham, indeed here such an intention was in fact ‘entirely consistent with the creation of a genuine discretionary trust’;
Once it was established that the trust on creation was not a sham, subsequent events cannot turn the structure into a sham.
The decision also confirmed that in a practical sense, a new trustee holds office from the time of their appointment replacing the previous trustee and not from the time trust property is formally transferred.
As usual, please make contact if you would like access to any of the content mentioned in this post.
** For trainspotters, ‘Within you; Without you’ is the only George Harrison written song on the Beatles release ‘Sgt Peppers Lonely Hearts Club Band’.
Following last week’s post, this week we explore one example of a factual scenario we have been asked to assist with that highlights the importance of advisers working collaboratively in this area to deliver value to clients is as follows:
An accountant had provided a written recommendation to a willmaker that testamentary trusts should be included in their will for asset protection purposes - this advice included a specific recommendation in relation to 1 beneficiary who had a history of financial misadventure in business activities.
The advice was provided to the willmaker's long-standing, although unspecialised, lawyer who dismissed the recommendation for testamentary trusts on the basis that it was an 'unnecessary complication that accountants and financial planners push as part of their product sales'.
At the time of the willmaker's death, the relevant son was indeed bankrupt.
In working to discharge their duties, the executors of the will asked us to assist in obtaining probate of the will and also confirm that they were obliged to pay the bankrupt beneficiary's entitlements to the trustee in bankruptcy. We were able to obtain probate and also confirm the duty that the executor was obligated to pay to the trustee in bankruptcy.
The executors also sought advice from specialist litigation lawyers as to whether the accountant or the lawyer could be potentially liable for failing to ensure that the willmaker included a testamentary trust in their will.
The specialist litigation advice suggested that the prospects of recovering any damages were in fact quite low for the bankrupt beneficiary.
The primary reason for this was that if a testamentary trust had been used, then the bankrupt beneficiary would have simply been 1 of many potential beneficiaries, and the only 'asset' that they would have received would have been the right to due administration of the testamentary trust. This right to due administration would arguably have no monetary value and therefore the damages awarded on suing the lawyer and accountant would have probably only been nominal.
The above conclusion was not ultimately tested through the court system. It would therefore seem an unnecessarily risky approach for advisers to dismiss the benefits of testamentary trusts for bankrupt beneficiaries on the basis that they may not be liable if their advice is later shown to be inappropriate.
Key points to note
The need to take active steps to protect assets and wealth, as well as concerns with the overall effectiveness of the steps taken, are not new concerns.
Arguably however, those concerns have never been taken more seriously by a greater number of people than they are currently, particularly in relation to superannuation death benefits.
The recent case law in this area is a timely reminder of the need to ensure comprehensive asset protection strategies are implemented as part of an integrated tax and estate planning exercise.
The above post is based on the article we had published originally in the Weekly Tax Bulletin.
As usual, please make contact if you would like access to any of the content mentioned in this post.
** For the trainspotters, the title of today's post is riffed from the Eurythmics song ‘When tomorrow comes'.
Following on from the posts over the last few weeks, it is important to be aware that some commentators argue that the interest of a default beneficiary constitutes property that may vest in the trustee in bankruptcy if a default beneficiary is declared bankrupt.
It has generally been argued that the interest of default beneficiaries is of a different character from that of a discretionary object and may well be property of a bankrupt (see - Dwyer v Ross (1992) 34 FCR 463).
However, it has also been argued that the interests of takers in default do not have a vested interest in the assets of the trust until the trust vests, and until that event occurs, the assets of the trust have not been the subject of an effective appointment.
That is, such interests can be deferred or taken away at any time prior to vesting or termination of the trust and, accordingly, such interests are ‘mere expectancies’ in respect of property that is not capable of vesting in a trustee in bankruptcy.
The preferred position adopted by the cases remains that a default beneficiary does not have an interest in trust assets that amounts to property that is attackable by a trustee in bankruptcy.
This said, it is always appropriate, when establishing a trust, to consider carefully who should be nominated as the default beneficiaries to ensure that the assets of the trust do not become unnecessarily exposed to claims against those beneficiaries if the law in this area changes.
As usual, please make contact if you would like access to any of the content mentioned in this post.
** For the trainspotters, the title of today's post is riffed from the Psychedelic Furs song 'All of this and nothing’.
Arguably one of the leading cases which explores the ability of a trustee in bankruptcy to attack trust assets using the rules in relation to sham transactions is Lewis v Condon; Condon v Lewis [2013] NSWCA 204. As usual, a link to the decision is as follows – http://www.austlii.edu.au/au/cases/nsw/NSWCA/2013/204.html.
Although the facts were somewhat complex, at the centre of the dispute was a trust that had been established by a lady who subsequently became bankrupt and admitted that the structure facilitated ‘her purpose to deceive her former husband, the Family Court and to avoid tax’.
In considering whether the assets of the trust were exposed to attack from a trustee in bankruptcy on the basis that the trust was a sham the Court held relevantly as follows –
Before any trust will be held void as a sham, it is necessary to show that there was an intention that the structure created not bear its apparent legal consequence. That was not the case here;
Even where a trust is established with an admitted purpose of deceiving, this is not enough to mean it is a sham, indeed here such an intention was in fact ‘entirely consistent with the creation of a genuine discretionary trust’;
Once it was established that the trust on creation was not a sham, subsequent events cannot turn the structure into a sham.
The decision also confirmed that in a practical sense, a new trustee holds office from the time of their appointment replacing the previous trustee and not from the time trust property is formally transferred.
The Federal Court's decision in Cunningham (Trustee) v Gapes (Bankrupt) [2017] FCA 787 (Federal Court, Collier J, 13 July 2017) (Cunningham) is vital guidance for all advisers in relation to the interplay between superannuation death benefits and the Bankruptcy Act 1966.
In particular, the case highlights the fact that a superannuation death benefit paid via a deceased estate to a bankrupt beneficiary is divisible amongst the creditors of the bankrupt.
At a minimum therefore, advisers should consider advising clients who have at risk potential beneficiaries to utilise a binding death benefit nomination (BDBN). The BDBN should mandate that any death benefit is paid directly from the superannuation fund to a beneficiary at risk of bankruptcy. Testamentary trusts
One additional strategy that should be considered in the context of deceased estates generally, and specifically in relation to superannuation death benefits, is the use of comprehensive testamentary trusts.
As readers will be aware, 1 of the key reasons that testamentary trusts are often recommended is due to the asset protection offered by the structure generally, and in particular where a potential beneficiary is at risk of suffering an event of bankruptcy.
This approach can help protect beneficiaries, regardless of whether a BDBN is in place, or where a BDBN is implemented and mandates payment of the death benefits to the legal personal representative for distribution under the will.
Unfortunately, we have seen a number of examples recently where no testamentary trust has been incorporated under a will, with superannuation death benefits passing directly to the estate and then in turn to a bankrupt beneficiary. In other words, creating the exact same factual matrix as existed in Cunningham.
Key issues to remember
In summary, the key issues to be aware of in this type of situation are as follows:
Where a beneficiary is bankrupt at the time of the death of the willmaker, the bankruptcy legislation mandates that the bankrupt's entitlements are to pass to their trustee in bankruptcy.
If there are any assets remaining after the bankruptcy has been discharged, then the beneficiary is entitled to those assets.
The right to due and proper administration of the deceased estate is an asset that forms part of the bankrupt's estate, and therefore also vests in the trustee in bankruptcy.
If an executor of an estate seeks to avoid assets passing to a trustee in bankruptcy where a beneficiary is entitled personally under the will, the executor will themselves be personally liable.
Importantly, each of the above issues can be legitimately avoided by the appropriate structuring of a testamentary trust into a will, prior to death.
Where testamentary trusts are not included under a will, best practice dictates that the executor should obtain a formal declaration from each beneficiary, before making distributions to them under the will, whereby each beneficiary confirms that they are in fact solvent.
If a beneficiary refuses to provide the declaration, then further searches should be made by the executor to minimise the prospect that the executor might become personally liable to a trustee in bankruptcy.
A case study example
One example of a factual scenario we have been recently asked to assist with that highlights the importance of advisers working collaboratively in this area to deliver value to clients is as follows:
An accountant had provided a written recommendation to a willmaker that testamentary trusts should be included in their will for asset protection purposes - this advice included a specific recommendation in relation to 1 beneficiary who had a history of financial misadventure in business activities.
The advice was provided to the willmaker's long-standing, although unspecialised, lawyer who dismissed the recommendation for testamentary trusts on the basis that it was an 'unnecessary complication that accountants and financial planners push as part of their product sales'.
At the time of the willmaker's death, the relevant son was indeed bankrupt.
In working to discharge their duties, the executors of the will asked us to assist in obtaining probate of the will and also confirm that they were obliged to pay the bankrupt beneficiary's entitlements to the trustee in bankruptcy. We were able to obtain probate and also confirm the duty that the executor was obligated to pay to the trustee in bankruptcy.
The executors also sought advice from specialist litigation lawyers as to whether the accountant or the lawyer could be potentially liable for failing to ensure that the willmaker included a testamentary trust in their will.
The specialist litigation advice suggested that the prospects of recovering any damages were in fact quite low for the bankrupt beneficiary.
The primary reason for this was that if a testamentary trust had been used, then the bankrupt beneficiary would have simply been 1 of many potential beneficiaries, and the only 'asset' that they would have received would have been the right to due administration of the testamentary trust. This right to due administration would arguably have no monetary value and therefore the damages awarded on suing the lawyer and accountant would have probably only been nominal.
The above conclusion was not ultimately tested through the court system. It would therefore seem an unnecessarily risky approach for advisers to dismiss the benefits of testamentary trusts for bankrupt beneficiaries on the basis that they may not be liable if their advice is later shown to be inappropriate.
Conclusion
The need to take active steps to protect assets and wealth, as well as concerns with the overall effectiveness of the steps taken, are not new concerns.
Arguably however, those concerns have never been taken more seriously by a greater number of people than they are currently, particularly in relation to superannuation death benefits.
The recent case law in this area is a timely reminder of the need to ensure comprehensive asset protection strategies are implemented as part of an integrated tax and estate planning exercise.
As usual, if you would like copies of any of the cases mentioned in this post please contact me.
The above post is based on the article we had published in the Weekly Tax Bulletin.
** For trainspotters, ‘skirting the shoals of bankruptcy’ is a line from a song named ‘Accountancy Shanty’ by Monty Python from their 1983 movie ‘The Meaning of Life’, watch here – https://www.youtube.com/watch?v=7YUiBBltOg4
As usual, a
transcript of the presentation for those that cannot (or choose not) to view
the presentation is below –
The Jodee
Rich case related to Mr Rich who was one of the directors of One.Tel.
The allegations were that almost immediately
before, that is a matter of days, before it became public knowledge that
One.Tel had been insolvently trading, Mr Rich took steps to transfer
significant assets out of his name and put them into his spouse's name. He did
that using particular provisions under the family law legislation, which at the
time actually took priority over the bankruptcy laws.
As most will know, the bankruptcy legislation
allows trustees in bankruptcy to clawback assets that are disposed of
immediately before bankruptcy. When Mr Rich did the transfers, the family law
rules allowed the bankruptcy rules to be ignored, so the creditors would have
been left exposed.
In the particular factual scenario of Mr
Rich's situation, he actually voluntarily agreed to unwind the transfers. However, the fact that Mr Rich had even tried
to do the transfers was enough of a catalyst for the government at the time to
bring in amending legislation.
The law now requires anyone that has both a
relationship issue and creditors in play at the same time, for all of those
parties to be heard before the same judge and for that judge to then make a
decision as to how the assets should be dealt with.
As usual, a transcript of the presentation for those that cannot (or choose not) to view the presentation is below –
It’s fair to say Richstar is seen as probably the high watermark in relation to how the assets of a trust may be exposed in the context of some sort of bankruptcy litigation. Interestingly, it has remained almost as an outlier decision.
There really haven't been any decisions that have supported the landing the court reached in relation to Richstar. On top of that, the cases like Smith which have come down since Richstar, effectively completely ignore Richstar and go to the extent of saying it doesn't actually represent good law.
Ultimately, pragmatically and practically what the position seems to be is as long as a trust is structured appropriately it will provide a very good level of asset protection from creditors and should be seen as probably the choice structure in an estate planning exercise under a will - in other words, the use of a testamentary discretionary trust - in order to provide an adequate level of protection.
As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses the issue of ‘Is appointorship an asset?’ If you would like a link to the video please email me.
As usual, a transcript of the presentation for those that cannot (or choose not to) view the presentation is below –
Whether the appointor role is an asset on the holder’s bankruptcy is probably one of the most contentious issues to have arisen in recent years. Certainly, the feeling amongst lawyers that act on behalf of trustees in bankruptcy or creditors is that absolutely the role is a potential asset.
If it is an asset, then it forms part of the bankrupts’ estate. The reality however when you actually look at the decisions that have been handed down is the exact opposite. So in other words, the role of an appointor is a personal role, akin to a directorship. Therefore, that’s not an asset that can be handed onto creditors.
Having said this, the issue does not seem to be going away and the conservative view would be that you would try, when setting up this type of structure, to ensure that you do one of a myriad of things.
So for example, making sure that if there is an at risk person that is needing to fulfil the role of appointor or principal, that they don’t fulfil that role individually and solely, that ideally there's some other person acting with them.
Secondly, the way in which the role is structured, it's embedded under the trust instrument, whether it be a family trust or a testamentary discretionary trust, the appointor is automatically disqualified in the event of committing an act of bankruptcy.
Until next week.
In this case, a bankrupt transferred assets to family members while he was solvent, but knowing that he was likely to start engaging in a 'risky' business activity in the future.
The court held that the transfers could not be clawed back and the key aspect of the decision was as follows –
‘Once it is acknowledged, as upon the evidence I think it must be, that in 1926 the bankrupt was in a perfectly sound financial position and had nothing to fear, subsequent conduct and events form an insufficient basis for a finding that the documents were shams, or that he had an intent to defraud his creditors, or that they were made subject to a suspensory condition allowing them to take effect only in case of attack by creditors.’.
As set
out in earlier posts, and with thanks to the Television Education Network,
today’s post addresses the issue of ‘Why would a professional partnership
incorporate?’. If you would like a link to the video please let me know. As usual, a transcript of the
presentation for those that cannot (or choose not) to listen to the
presentation is below – The number of answers to this
question are probably only limited to the number of professional practices
there are out there. There are a range of reasons. Tax is one and we keep coming back
to that, but that can sometimes be in the eye of the beholder from that
perspective. We're seeing, certainly from a risk
management perspective and asset protection and the credit crunch and
everything else that’s going on and the changes to the bankruptcy rules in the
recent past mean that everyone is much more aware that when things go wrong,
it's very attractive to have your liability limited. Obviously, that’s probably the
biggest advantage of an incorporated model. There's also I guess the sense from
people talking about retaining key staff and the skills shortage that many
professional organisations are facing these days that it tends to make sharing
of equity a lot easier if you've got a true corporate model. That can sometimes be as simple
from a perception viewpoint that a lot of times staff or key employees are much
more aligned and find it much easier to understand a company setup as opposed
to some sort of fancy trust arrangement or a service trust arrangement for that
matter. Certainly, the transaction costs
side of things, in terms of the hard costs, particularly stamp duty, in most
states now, the concept of having to pay stamp duty on the transfer of listed
shares is basically a thing of the past. So that can be very attractive
to people. The last main reason and perhaps
this is touching on the perception side of it again, I think the corporate
model from a governance perspective, it tends to be a lot easier for people to
understand. We've done a lot of work in this area and it is interesting
that by becoming a director, and by having a board and by having shareholders
and all of these sorts of more formal things, even though the deck chairs
haven't really changed in the organisation, there seems to be an air of
governance around the place that just wasn't there while they remained as a
partnership. Until next week.
As set
out in earlier posts, and with thanks to the Television Education Network,
today’s post addresses the issue of ‘When do ‘gift and loan’ arrangements need
to be refreshed?’ at the following link - http://www.youtube.com/watch?v=QuRRvCIx9e8&feature=relmfu
As usual, a transcript of the
presentation for those that cannot (or choose not) to view the presentation is
below –
There's two real reasons that the top up arrangement can come into
effect.
The first one, and hopefully for most people, even in a post GFC
environment, is that the actual underlying asset has gone up in value.
So in other words, you end up with a gap between the amount that was
originally forwarded and the underlying asset value. So in that instance,
there is obviously a desire to ‘catch up’ that gap or to remove that gap and
that can be done by effectively recycling or regenerating a debt back to the
trust and then making sure that the mortgage arrangements are updated to catch
that additional amount.
The other reason that it might take place, and this particularly can arise
in relation to master trusts, is where there's a feeling amongst the family
unit that all arrangements are to be on a commercial basis.
In that instance, it's quite often the case that there are interest and
principal repayments. So in that scenario, you'll start to get a gap
between the level of security that the trust might have over the particular
asset and the debt that’s actually outstanding.
The critical point in relation to either of those scenarios, so in other
words the asset going up in value or the debt being reduced, or for that
matter, both things happening at once, is that whenever that gap is removed,
you will generally find that there is wealth being moved away from an at-risk
individual into a protected environment being the trust. Obviously in
that scenario, in each and every instance that it takes place, you've
potentially got to be aware of and advise the client, in relation to the
application of the bankruptcy clawback provisions.
Two weeks ago, we touched on a situation where the gifting of a family home was potentially exposed under the bankruptcy clawback rules.
As I mentioned, if the original transaction had been structured slightly differently, around 20% of the value of the property could have been protected.
In simple terms, instead of a straight gift of the property, the following steps could have been taken:
1. The house could have been sold by the husband to his spouse for its market value 3½ years ago. 2. The transaction should have been structured under a vendor finance arrangement.
3. Following completion of the sale transaction, the husband could have forgiven the outstanding debt for 'natural love and affection'.
4. Assuming that all steps would have been properly legally documented, then the wife would have had at least a reasonably arguable case that the capital growth in the asset since the date of the initial transfer would have been quarantined to her benefit and not available to creditors on the bankruptcy of her husband.
Last week, I was reminded about the importance of proper planning when implementing asset protection strategies.
The particular scenario involved the potential clawback under the bankruptcy rules of a family home that had been gifted by a husband to a wife approximately 3½ years before a bankruptcy event. Many of you will be aware that changes to the bankruptcy rules extended the clawback period from 2 to 4 years a few years ago.
Whether the transfer could in fact be clawed back for this client was an issue which is as yet unresolved. The issue last week, however, was in relation to whether the value of the house as to today’s date could be clawed back or whether its value 3½ years ago was the relevant value.
The question was quite critical because notwithstanding the intervening GFC, the value of the house had gone up by more than 20% over the 3½ year period.
As the original transfer had been crafted simply as a gift for 'natural love and affection', we had to advise the client that the house itself was the asset that would be exposed and therefore the value at today’s date was at risk.
Next week, I will try to provide an example of how the original arrangement could have been structured differently to potentially limit the total value exposed under the clawback provisions.
This last week I had a timely reminder that while those tax driven issues are critical, they are in fact not as important as the underlying loan or UPE itself.
In particular, I was helping an accountant who had a client whose trading company had been served with litigation proceedings. My role was to help review all structures in the group from an asset protection perspective, although as the litigation lawyer here politely reminded us (I do not get involved in any actual court work if I can avoid it), it was probably not the most opportune time to be doing the asset protection audit - hence Friday's Twitter posting 'in times of peace - prepare for war' www.twitter.com/mwb_mcr
In any event, while the overall structure of the group was fairly sensible, there was one, very large asset on the trading company’s balance sheet. That asset was a UPE (or if the ATO chooses to ignore industry feedback and finalises its draft ruling – a loan) owed to the trading company by a passive investment trust.
Despite bankruptcy clawback rules, there may be a solution for this client that we are currently exploring. The situation they have to address, now urgently, is of course less than ideal and was a timely reminder that all clients should be encouraged to undertake an asset protection 'audit' regularly.
For those interested, the particular solution potentially available to the client here was somewhat unique and fairly complex and I have added it to the list of ideas for presentation topics at a future Intensive or a Master Class by our firm.
Next week (or if another more relevant topic arises, within the next few weeks), I will relay one other difficulty with this client’s structure that is likely to not be able to be addressed – but could have been with some forward planning. Matthew Burgess
