Asset protection: the ground rules are changing

Traditionally, there have been two general strategies employed to protect personal assets, namely gifting and the use of trusts.

This article will consider each of these methods in the light of recent legislative change and decisions of the Australian Courts, in addition to providing some practical suggestions in relation to effective asset protection strategies going forward.

March 2006: High Court decision

On 6 March 2006, the High Court of Australia handed down its decision in respect of an action brought by the trustee in bankruptcy against a former barrister (who for the purposes of this article will be referred to as "Mr X”). Mr X did not lodge any income tax returns during his 45 year career as a barrister and was declared bankrupt in 2000, owing unsecured creditors in excess of $1 million. The major creditor was the Australian Taxation Office (ATO).

In 1987, Mr X had transferred his legal and beneficial interest in the family home to his wife. Mr X and his wife had originally purchased the property as joint tenants in the 1970’s. On the same date he also transferred to his family trust 6000 shares in a Sydney barrister’s chambers he occupied. Each transfer was considered a "gift” as Mr X received no consideration for each transfer. The bankruptcy trustee challenged the validity of the two transactions, applying section 121 of the Bankruptcy Act. This section allows a bankruptcy trustee to "claw back” certain gifts of property if the main purpose of the gift is to put the asset beyond the reach of creditors or to hinder or delay the creditors in obtaining the asset. This purpose is taken as established if the person making the gift was, or was about to become, insolvent at the time of the gift.

The High Court considered whether Mr X was solvent at the time of the transfers in 1987, and in particular whether Mr X had a taxable income. In the absence of proof of a taxable income, it could not be assumed that Mr X had arranged his affairs to defeat creditors. The High Court determined that Mr X’s appointment as a Queens Council, in addition to his ownership of shares and property and the lack of any evidence that he had been financially supported by his wife, was sufficient evidence that Mr X had been in receipt of a taxable income at the time of the transfers.

The High Court concluded that Mr X’s purpose in transferring his assets in 1987 was to defeat creditors, and accordingly ordered Mrs X to transfer her husband’s half share in the property to the bankruptcy trustee. Mrs X had argued that, because she had contributed 76.3 percent of the purchase price for the family home, it followed that she should be obliged only to transfer the remaining 23.7 percent to the bankruptcy trustee. The High Court rejected this view, instead applying a long-standing legal presumption that where spouses to a marriage contribute to the acquisition of a property then, in the absence of contrary evidence, it is to be taken that they intended to be joint beneficial owners. Although the position is less clear in respect of de facto spouses, a consequence of this decision is that there is a presumption a bankruptcy trustee will likely be able to recover one half of the value of the matrimonial property even if the property is wholly registered in the name of one spouse, notwithstanding the extent of that spouse’s contribution to the purchase price.

May 2006: amendments to the Bankruptcy Act

Amendments to the Bankruptcy Act came into force on 31 May 2006 to further strengthen the ability of bankruptcy trustees to "claw back” property disposed of prior to bankruptcy. The provisions give greater scope to the bankruptcy trustee to recover property owned (for example) by a spouse or a family trust, in circumstances where the bankrupt either previously owned the property or substantially funded its acquisition.

The main amendments were made to sections 120 and 121 of the Bankruptcy Act, in addition to the inclusion of a new section 121A. These changes include:

• provision for voiding a transfer of property in circumstances where the transferee should, or should reasonably have inferred, that the bankrupt person’s main purpose in making the transfer was to defeat creditors

• creating a rebuttable presumption of insolvency where a bankrupt carried on business and failed to maintain proper books, accounts and records, and

• conveying on the bankruptcy trustee a right to recover property from a third party where a person who later becomes bankrupt has transferred property for consideration to a transferee, but directs that the consideration be paid to the third party. In such circumstances, the legislation deems that the property was transferred from the bankrupt to the third party, and allows a bankruptcy trustee to recover the consideration from the third party.

July 2006: proposed further amendments to the Bankruptcy Act

On 27 July 2006, the Attorney General announced further proposed amendments to the Bankruptcy Act which will allow a Court to consider whether a bankrupt person’s historical superannuation contributions are of a nature that may be considered "out of character”, in order to determine whether the contributions were made with the intention to defeat creditors.

The amendments will allow a bankruptcy trustee to recover the value of contributions made by:

• the bankrupt to their own superannuation plan or to a third party to defeat creditors, or

• a person other than the bankrupt for the bankrupt’s benefit where the bankrupt’s main purpose is participating in the arrangement to defeat creditors.

Following the grant of these orders by the Federal Court, ASIC sought to amend the orders to bring into their scope property held by a third party as a trustee for any trust in which a director of the Group was a beneficiary.

Pursuant to s1323 of the Corporations Act, ASIC sought orders that the "property” include property held by a third party:

• as trustee for a trust, where an individual defendant is the beneficiary of the trust, including in respect of discretionary trusts, and

• on behalf of a superannuation fund, where an individual defendant is a beneficiary of the superannuation fund.

On 29 June 2006 Justice French, in ruling for ASIC, distinguished between cases where the individual defendants had a mere hope of receiving a distribution from the trust and where it was reasonable to conclude that the defendants would be able to materially influence the trustee’s decisions. In particular, where the individual defendants were beneficiaries of a discretionary trust and were directors of the corporate trustee, or they or their relatives had the power to appoint the trustee, Justice French found that this amounted to effective control sufficient to characterise their interests under the trust as "property” within the meaning of the Act. Any such property would therefore fall within the scope of the property available to the receivers to secure and preserve.

Recommendations

The recent decision of the Federal Court in the ongoing Westpoint litigation holds particular significance in respect of asset protection strategies involving discretionary trusts. Their effectiveness in shielding assets from creditors must be questioned where a person the subject of receiver orders under the Corporations Act is a beneficiary under a discretionary trust and has an interest in the trust sufficient to characterise it as "property” within the meaning of the Corporations Act.

In addition, in order to ensure the continuing effectiveness of gifting as a method of asset protection, individuals should give careful consideration to ensuring the following matters are satisfied:

• solvency at the point of making a gift (able to pay debts as and when they fall due)

• no circumstances existing at the time of making the gift which may ultimately result in the imposition of a significant liability, and

• the keeping of usual and proper financial records, if carrying on a business.