Asset protection is one of the most important issues when considering wealth building. How tragic it is when people work hard for years to accumulate wealth, only to then lose it due to poor planning decisions.
Threats to assets include loss in market value, physical destruction and litigation. Loss in market value usually results from poor investment decisions e.g. paying too much for assets which then subsequently decrease in value. Physical destruction can be easily remedied by insurance. Litigation is becoming more of a risk as Australia is becoming an increasingly litigious society. Significant causes of litigation include bankruptcy actions by business creditors or negligence claims and marriage breakdown disputes.
Bankruptcy
Generally, the property of bankruptcy vests in the trustee in bankruptcy and is normally available to creditors.
It is important to note that “clawback” provisions in the Bankruptcy Act 1966 (Cth) (“Bankruptcy Act”) enable the trustee in bankruptcy to trace and reclaim assets that were transferred before a person becomes bankrupt.
- A transfer can be overturned (subject to certain exclusions):
- if the transfer took place within two years before the commencement of the bankruptcy where no consideration was paid or where consideration was less than market value (section 120(3) Bankruptcy Act) – or four years for related entitles;
- if the transfer took place within five years before the commencement of the bankruptcy and at the time of the transfer the person was insolvent, where no consideration was paid or where consideration was less than market value (section 120(1) Bankruptcy Act); or
- if the transfer took place within six months before the commencement of the bankruptcy, the transfer is to a creditor, the creditor obtains a preference, priority or advantage over other creditors and at the time of the transfer the transferor was insolvent (section 122 Bankruptcy Act); or
- at any time where the main purpose in making the transfer is to prevent the transferred property from becoming divisible or to hinder or delay the process of making the property available for division, among creditors (section 121(1) Bankruptcy Act).
Marriage breakdown
Where a marriage (or de facto relationship) breakdown occurs, it is difficult to protect assets. The Family Law court has extensive powers regarding property settlements. A binding financial agreement (“BFA”) (aka pre-nuptial agreement) is one of the most effective ways of protecting assets. Essentially it is an agreement entered into by both parties as to how assets are to be allocated in the event of a marriage breakdown. However, a BFA must be done properly and the advice of a family law expert is a must in this regard. Even so, it is not a guarantee of protection.
Separate assets from risk
The aim here is to avoid holding valuable assets (e.g. real property) in an entity that is overly exposed to the risk of litigation. In a business context, risky entities would include trading entities and directors of such.
It is safer to hold valuable assets in non-trading entities or potentially in individuals with low risk e.g. spouses who are not directors or otherwise engaged in business. In large businesses, there are often multiple entities set up solely to separate risk from valuable assets.
Note that even individuals not engaged in business still have the potential to be sued. For example, a motor vehicle or other accident resulting in personal injury. The likelihood may be low, but it is still a risk that needs to be considered. Also, if assets are transferred to a spouse, that can introduce risk in the form of the possibility of marriage breakdown.
Protective structures
Discretionary trust
In the context of bankruptcy, the best asset protection structure to hold valuable assets is generally a discretionary trust. The main reason is that the beneficiary of a discretionary trust will not have an interest in the trust assets that are considered to be “property” for purposes of the Bankruptcy Act.
In the context of family law, unlike trust law, the court takes a broad view of what is “property”. Generally, the assets of a trust that is controlled by a party will be considered to be the property of that party. What constitutes control is not clear from the case law, however, there are some guidelines. Even where a trust is not “property” to be divided, access to a trust by one party can mean that party has a “financial resource”, causing an adjustment in a property settlement. All things considered, a discretionary trust, structured correctly, can potentially be an effective asset protection vehicle in the event of a marriage breakdown.
Superannuation fund
In the context of bankruptcy, the best asset protection structure to hold valuable assets is generally a discretionary trust. The main reason is that the beneficiary of a discretionary trust will not have an interest in the trust assets that are considered to be “property” for purposes of the Bankruptcy Act.
In the context of family law, unlike trust law, the court takes a broad view of what is “property”. Generally, the assets of a trust that is controlled by a party will be considered to be the property of that party. What constitutes control is not clear from the case law, however, there are some guidelines. Even where a trust is not “property” to be divided, access to a trust by one party can mean that party has a “financial resource”, causing an adjustment in a property settlement. All things considered, a discretionary trust, structured correctly, can potentially be an effective asset protection vehicle in the event of a marriage breakdown.
This article is for general information only. It does not make recommendations nor does it provide advice to address your personal circumstances. To make an informed decision, always contact a registered tax professional.