Keeping it in the family: asset protection, succession planning and bankruptcy

By William Moore, David Dickens and Sam Baring

Bankruptcy concerns are becoming very real for many clients in the succession planning space.

More clients are concerned with the risk of having their family assets exposed to a bankruptcy during their lifetime, or the risk that the beneficiaries of their estate may have an inheritance exposed to creditors.

This is a particular concern for clients with partners and children in high-risk occupations, such as professionals and directors of companies, as they can be personally liable for debts owed by their business or negligence claims.

Fortunately, there are strategies you can put in place to limit the exposure of your assets to creditors both during your lifetime and on your death.

Strategies on death

A comprehensive Will and estate plan will provide the best opportunity to protect an inheritance from being exposed to creditors in the event of a bankruptcy.

At a minimum, we strongly recommend the implementation of testamentary trust Wills. A testamentary trust is a trust created by the terms of a deceased’s Will. Instead of the inheritance passing to a beneficiary directly, their share of the estate instead passes into a discretionary testamentary trust.

If a bankrupt beneficiary inherits assets directly, they will pass to the Trustee in Bankruptcy. However, assets that do not pass to a beneficiary directly, but instead are held in a discretionary testamentary trust for the benefit of the beneficiary will not be considered property for bankruptcy purposes, and are less likely to be dissipated to the Trustee in Bankruptcy or creditors.

Another structure that may be utilised for asset protection is a right to occupy. This relates specifically to any property (usually a principal place of residence) which may form part of the estate. Essentially, the Will provides that the beneficiary (usually an at-risk partner or children) is permitted to live in the property for life, but will not own the property. This prevents the property passing to the at risk person, making it difficult for a creditor to claim it is property for bankruptcy purposes if any issues arise in future.

When the right to occupy ends (for example, when the beneficiary dies), the property would then form part of the residuary estate. A further benefit of this structure is that it may also allow the main residence capital gains tax (CGT) exemption and land tax exemption to continue in respect of a principal place of residence.

Strategies during your lifetime

There are also a number of strategies and structures that can be implemented during a person’s lifetime to help reduce exposure.

One of those is the use of discretionary family trusts. A corporate trustee of a family discretionary trust is a separate legal entity that can hold assets (such as real estate and shares), invest those assets to generate income, and then distribute the income and assets to beneficiaries of the trust. The assets of the trust will not be considered part of the personal estate of a beneficiary on death and will continue to operate in favour of its beneficiaries.

Importantly, under the Bankruptcy Act, any assets held for the discretionary family trust will not be available to a beneficiary’s creditors in the event of bankruptcy. There are a number of exceptions, including antecedent transactions (eg gifting assets to the trust) and a beneficiary also has some general rights such as the due administration of the trust. If a beneficiary became a bankrupt and has unpaid present entitlements, these will vest in a bankruptcy trustee and allow it to make a claim against the assets of the trust.

It is also always important to consider the tax implications before gifting assets to a trust or purchasing assets through a trust.

Other strategies, such as loan agreements and security may be appropriate in minimising the exposure of assets to creditors depending on the circumstances.

The best way to ensure that wealth is best protected from a bankruptcy is to seek advice and have a health check of assets, potential risks, structuring and the succession plan. Hall & Wilcox has a team of experts in the areas of bankruptcy and insolvency, directors’ liability, structuring and succession planning who work together in assessing risk and implementing structures to minimise exposure.

We continue to assist clients in the current circumstances via phone or Zoom meetings. We are also able to witness the execution of documents via audio-visual means.