Overview – your wealth at risk
If you are running a business, are an ‘at risk’ professional (eg. Engineer,Doctor, Lawyer, Architect, Accountant, etc), are a director in a company, involved in activities which attract legal claims then you could become a target for someone to mount a law claim against you. If the law claim is successful against you, then you could lose you assets in bankruptcy – sometimes meeting the legal costs of just defending a spurious claim can send you bankrupt.
What happens on bankruptcy?
The financial impacts of bankruptcy are far-reaching:
The basic principle of asset protection
The basic principle of asset protection is simply to avoid having assets in your own name. The most effective defence against legal claim may be ‘you can’t get blood from a stone’.
“Asset Protection” strategies usually involve acquiring assets in the name of a spouse, company or trust or moving assets from your name and into the ownership of another ‘out of reach’ person such as a spouse or another legal structure such as a company or trust. The implementation of these strategies can sometimes have significant adverse tax implications and often a compromise has to be struck between the competing interests of taxation efficiency and asset protection. In these circumstances however, other strategies may be explored.
The best time to implement asset protection strategies
Asset protection planning should only take place when you are solvent. Leaving it until after a claim is made against you leaves any transfer of asset prone to reversal and may mean that you end up facing civil or criminal penalties as well.
The best structures for asset protection
Generally speaking, the best entity for asset protection is one which:
The structure that probably best satisfies the above criteria is a fully discretionary trust, with a corporate trustee which is not engaged in any other business or trading activity or owns any assets in its own right. In addition to the use of a discretionary trust to hold assets, superannuation is a structure where a couple may accumulate over 2 million dollars in wealth between them which generally cannot be attacked by creditors or a Trustee in Bankruptcy.
Asset protection if you are conducting a business
If you are conducting a business through a company or trust, the range of issues to consider broadens significantly. In particular:
The following general information is relevant, again subject to the warning that any asset structuring needs to be done when the company is unquestionably solvent:
Strategies for Company directors:
Directors should avoid as far as possible giving guarantees. Where it is not possible to avoid giving guarantees there may be potential to negotiate a cap or time limit on the extent of liability.
Many businesses have only one key person but still have 2 or more directors as was required prior to 1998. The additional directors may not be necessary, and relieving them of directorship may remove further exposure from their personal guarantee and other directorship-related liabilities.
A Director with few assets in his/her own name is not an attractive target for a company liquidator to pursue if the company goes into liquidation.
All Directors will be personally liable to company creditors for all company debts incurred while the company is allowed to trade while insolvent. Significant criminal sanctions may also apply.
Directors have numerous responsibilities under common law and various statutes. Being aware of these duties, attempting to perform them adequately and ensuring the company meets its tax, trade practices and other obligations can reduce personal liability risk.
A liquidator can void certain transactions with a company by a director or related entity of the company (including directors’ relatives) generally where they are favourable to the director or related entity.
Of course, a loan owed by an individual to a company will generally be a company asset available to a liquidator.
Transactions that can be set aside by the Trustee in Bankruptcy
The TIB is permitted under the law to “wind back” certain transactions. There are time limits and other constraints but broadly transactions that are capable of being wound back include:
a) Transactions up to five years before bankruptcy (unless the transfer occurred more than two years before the bankruptcy commencement date and the transferee proves that the bankrupt was solvent at the time);
b) Transactions up to two years before bankruptcy regardless of solvency;
c) Transactions up to six months before a creditor’s petition (there are other rules where a debtor’s petition is involved) where the transfer has the effect of giving a creditor a preference, priority or advantage over other creditors;
d) Transactions at any time prior to the court order if the main purpose of the bankrupt was to prevent, hinder or delay the property becoming available to creditors (this is deemed to be the case where it can be reasonably inferred from all the circumstances that the bankrupt was or was about to become insolvent, although the transferee may be protected if they can show that they did not know this).
Exempt assets – superannuation, life insurance and other exempt assets
The balance in a member’s superannuation account, up to the pension RBL ($1,176,106 as at 30 June 2004), cannot be accessed by the creditors of that member should he/she become bankrupt (per s116(2)(d)(iii)(A) of the Bankruptcy Act 1966). However, superannuation pension payments may not be protected - s116(2)(d)(iv).
· Life Insurance proceeds
The cash value or proceeds of a life insurance policy are also protected from creditors in some circumstances. Sub-Sections 116(2)(d)(i) and (ii) of the Bankruptcy Act exclude the policies and proceeds of a life insurance policy in respect of the bankrupt or the bankrupt’s spouse from claims by a creditor. If the life insurance policy is held within superannuation, the protected amount will be limited to the bankrupt’s pension RBL.
This means creditors cannot cash in policies or take the proceeds in the above situations. The protection for life insurance policies exists so that a bankrupt may insure themselves and their family against death and infirmity.
· Assets held in a Discretionary Trust
The Bankruptcy Act does not apply to property held by the bankrupt in trust for another person (per s116(2)(a) of the Bankruptcy Act).
Assets held within a Discretionary Trust will generally be protected in the event of a fully discretionary beneficiary of the trust becoming bankrupt.
This will be the case provided the bankrupt beneficiary has not gifted the asset to the trust within a clawback period of his/her becoming bankrupt.