Are discretionary trusts still useful for asset protection?
April 18, 2017
In Death and Taxes: Tax-effective Estate Planning (6th ed., 2014), the authors state at [2 215]: “Statutory law reform and judicial decisions in recent years have eroded the protection provided by an inter vivos trust for assets from creditors or other action.”
Is this accurate? Some recent case law suggests to the contrary.
Why use discretionary trusts?
Discretionary trusts serve two general purposes;
The reason why discretionary trusts are considered ideal for asset protection is because the trustee has a discretionary power when allocating income and capital of the trust, which means no particular beneficiary has beneficial ownership of the trust assets or any part of them (until the trustee resolves to make a distribution to a particular beneficiary or a distribution is made under a “default beneficiary” clause – however the beneficiary will only be entitled to whatever discrete portion of income or capital is distributed).
It follows that creditors of a beneficiary cannot use the assets of a discretionary trust to satisfy a judgment against a judgment debtor who is a beneficiary of a discretionary trust.
It is worth noting that typically, a discretionary trust will be structured so that an “appointor” can remove and appoint trustees of the trust, and typically the trustee cannot alter the terms of the trust without the consent of the appointor.
As a matter of practicality, the appointor has effective (albeit “high level”) control over the trust.
This has made for some interesting case law in the field of bankruptcy where the bankrupt or potential bankrupt is a beneficiary and/or appointor of a discretionary trust.
Can trustees of bankrupts get access to discretionary trust assets?
In the case of Dwyer v Ross (1992) 34 FCR 463, Mr Ross was the subject of a creditor’s petition and a member of a class of beneficiaries of a discretionary trust. Mr Ross was also the appointor of that trust. The trust was shortly to receive $1.6 million owed to it by a third party.
The Dwyers were creditors of Mr Ross, and made an application to prevent distribution of that $1.6 million from the discretionary trust, pending the hearing of a petition to sequester Mr Ross’s estate. The Dwyers also argued that Mr Ross’s power of appointment over the trustee of the discretionary trust was property of Mr Ross that would be divisible among Mr Ross’s creditors, should he be made bankrupt.
The Court found it unnecessary to decide whether Mr Ross’s power of appointment was property that could vest in his trustee in bankruptcy. Instead, it declined to make the order which the applicants sought on the basis that distribution of the $1.6 million was a matter for the trustee of the discretionary trust and no part of it (at least while it remained in the trust) could form part of Mr Ross’s property that would be divisible among his creditors, should be be made bankrupt. The Court also mentioned that it would be improper to let a power of appointment be used in aid of the bankrupt’s creditors, rather than for the benefit of the beneficiaries of the trust.
It has since been held by the NSW Court of Appeal that a power of appointment is only a power, and not property that can vest in a bankrupt’s trustee: Lewis v Condon (2015) 85 NSWLR 99.
More recently, last year in the matter of Fordyce v Ryan  QSC 307, the Supreme Court of Queensland dismissed an application by a trustee in bankruptcy to have a receiver appointed to a discretionary trust and to have the trust wound up (presumably in the hope that on the winding up of the trust, the trust assets would be distributed to the bankrupt in his capacity as beneficiary and therefore vest in the trustee in bankruptcy as after-acquired property).
The bankrupt has been the sole director and shareholder of the trustee company (which had since been deregistered), and therefore had effective control of the discretionary trust. Furthermore, during the period in which the bankrupt had control of the trustee company, the bankrupt was the sole recipient of distributions of income from the trust.
Nevertheless, the Court dismissed the application, upholding the principle that a discretionary beneficiary has no proprietary interest in the assets of a discretionary trust, despite whatever de facto control the beneficiary may exercise over the decision-making process of the trustee company.
On the state of the law at present, discretionary trusts remain an effective tool for asset protection, at least in terms of protection from creditors. Protecting assets in family law disputes is an entirely different matter, due to the broad powers available to the Court to deal with property and interests in property under the Family Law Act 1975.
Care should also be taken to ensure that a discretionary trust is not established for the purpose of defrauding or defeating creditors, which may render transfers of property to the trust or declarations of trust over property liable to be set aside under s 37A of the Conveyancing Act 1919 (NSW).
For more information contact Daniel Fleming on firstname.lastname@example.org
This article is intended to provide general information in summary form on a legal topic, current at the time of publication. The contents do not constitute legal advice and should not be relied on as such. Formal legal advice should be sought in specific circumstances.