24 Sep Does your trust protect your assets?
A discretionary trust is a great way to separate different assets and protect these from business risk. A discretionary trust works by separating “ownership” from “control”. By using a trust you may ensure that your personal assets are not put at risk. Trusts are based on legal technicalities, so it is necessary to take care, simple technical failures in the management can undo the protection that a trust offers. Too often we find that advisors do not take care to ensure that the arrangement actually works, or having set up the trust properly, over time the original intention of protecting the asset is forgotten. Please read our story about Ralph to see how the most carefully constructed trust will not offer protection when improperly managed.
Take heart however, a properly managed trust is a very powerful legal tool and is perhaps the cheapest insurance, that you will buy.
Firstly lets consider how a discretionary trust works by looking at Ralph, the businessman. Ralph does some quick calculations and decides that renting doesn’t make sense, it is cheaper to buy office space. Ralph has an inheritance from his late father and he intends to use this together with a bank loan to buy an office in Duporth Avenue.
Ralph talks to his lawyer who suggests that a trust be set up. The lawyer tells Ralph that a trust can ensure that creditors will never be able to take the office building from his children. Ralph loves this idea and for several hundred dollars the trust is set up with the beneficiaries of the trust being Ralph and his three children.
Ralph will control the office building but he does not own it, the trust provides that the assets are held (at the discretion of the trustee) and only for the benefit of the Ralph and his children.
A number of years go by and Ralph’s business is going well and the office building is almost paid off, but then disaster strikes. Ralph is sued by a large customer in relation to some floor coverings that he imported from overseas and which were installed in the customers business. The floor coverings do not meet Australian standards and must be removed. The overseas supplier will not pay up. The claim is for hundreds of thousands of dollars. Ralph must declare bankruptcy. Ralph resigns as trustee of the trust and appoints his sister to be the new trustee. Ralph hopes that this will save office building from creditors.
Ralph owns his home and his business. Ralph’s trust owns the office building. Will Ralph will lose his home and the business but, will he also lose the office building?
The answer to this questions depends upon how much care was taken in the initial set up of the structure and how it was managed after the date of set up. There were lots of things that could go wrong and some obvious problems that could have been avoided from the start.
Unfortunately (as is very often the case) there was no real care taken, beyond setting up the trust. The lawyers and accountants involved with Ralph did not communicate at all. At the time of setting up the trust Ralph borrowed the money from his bank and lent it to the trust so that the trust would have funds to complete the purchase. This was his first mistake. The trust should have borrowed the money directly. The personal borrowing by Ralph meant that the trust owed money to Ralph not to the bank. When Ralph became bankrupt the the Bankruptcy trustee demanded repayment of the loan by Ralph. In order to repay the loan the trust had to sell the office building. Once the trust repaid the loan to Ralph the creditor took these funds.
There were other mistakes. Ralph changed accountants and the new accountant did not know the purpose of the trust and did not speak with Ralph’s lawyer. Over the years each payment made by Ralph to the trust including the inheritance was also recorded as a loan in the financial records of the trust. It was really a gift but Ralph did not understand the financial statements. This made the problem greater and also put the inheritance at risk. Ralph argued that this was an error and that he knew nothing about it. The creditors did not accept this. Because the entries had been in the financial accounts for a number of years it was not possible to successfully argue that these loans were not real.
Be warned, the little entries that accountants make in your financial accounts really do mean something, they have real legal effect and in the case of a trust they can be the difference between a trust achieving what it is intended to or failing.
If your trust is for asset protection purposes speak with Riba Business Lawyers. We will audit your trust to ensure that the trust will be effective. We are happy to pass on the information and tools needed to ensure the correct management of your trust.
Riba Business Lawyers
Strength Through Knowledge
Franchising, Leasing, Acquisitions
Head office: 34 Duporth Avenue, Maroochydore, Sunshine Coast, Queensland.
Maroochydore: 07 54791488