How will Bankruptcy affect my entitlements under a family trust?

What is a Trust?

A trust is a legal structure which is typically used to split income amongst family members and to protect family assets. That is why many trusts are referred to as “family trusts”.

A trust has several participants including a settlor, a trustee and beneficiaries.

The Settlor is the person who creates and settles the trust for the benefit of the beneficiaries. The Settlor must be a separate person to the Trustee and the beneficiaries.

The Trustee is the person or corporate entity who administers the trust assets for the benefit of the beneficiaries. The Trustee legally owns the trust assets but holds the assets “on trust” for the beneficiaries.

The beneficiaries are natural persons or companies who have been listed to receive income or capital distributions from the trust. While the beneficiaries do not legally own the trust assets, they can hold a “beneficial interest” in the trust assets.

The two most common forms of trust are:

  • Discretionary Trust
  • Unit Trust


What is a Discretionary Trust?

A discretionary trust is usually used for family situations and is commonly referred to as the family trust. In a discretionary trust, the beneficiaries do not have a fixed entitlement or interest in the trust assets. It is at the complete discretion of the Trustee to calculate and make distributions to the beneficiaries. Whilst the Trustee has complete discretion to calculate and make distributions, the Trustee must only make distributions to the listed beneficiaries.

For example, if a discretionary trust has 5 listed beneficiaries, the Trustee could make an income distribution to 2 of the 5 listed beneficiaries. In practice, that could mean that a husband and wife receive an income distribution, whereas their children, being the other beneficiaries, receive nothing.

What is a Unit Trust?

A unit trust is similar to a company where the unit holder (the beneficiary) holds a fixed amount of units in the trust. When the Trustee makes a distribution to the unit holders, it must be strictly in accordance with the unit holders’ entitlements. For example, if there are 2 unit holders in a unit trust holding an equal amount of units, the Trustee must make a distribution of 50% to each unit holder.

Trusts and Bankruptcy

In the context of bankruptcy, it is critical to establish the type of the trust involved. There are a number of key differences between a discretionary trust and a unit trust in bankruptcy.

Discretionary Trusts and Bankruptcy

If a discretionary trust is in place (more commonly referred to as a family trust) and a listed beneficiary becomes bankrupt, the trustee of the trust has complete discretion whether to “include” or “exclude” the bankrupt beneficiary in any further trust distributions.

The Bankruptcy Trustee (on behalf of the bankrupt beneficiary’s creditors) is entitled to copies of the trust deed and trust accounts. However, the Bankruptcy Trustee cannot demand that the trustee of the trust include the “bankrupt beneficiary” in future trust distributions.

Therefore, a discretionary trust can be a very effective structure to protect family assets from a Bankruptcy Trustee.

A Bankruptcy Trustee is entitled to challenge any transfer of assets into a family trust if they were made with the intention to avoid or defeat creditor claims. If assets are transferred with that intention, the transaction may become void against the Trustee in Bankruptcy under section 121 of the Bankruptcy Act.
In other words, the transfer of assets into the family trust could be “attacked” or “clawed back” by the Bankruptcy Trustee.

Unit Trusts and Bankruptcy

If a unit trust is in place and the listed beneficiary becomes bankrupt, the trustee of the trust does not have any discretion and must pay the bankrupt beneficiary all distributions in accordance with the trust deed. The Bankruptcy Trustee may even be able to force the Trust to be wound up and the trust assets to be distributed to the unit holders.

Restrictions on Advice and Assistance

This area of law is very complicated. This article only provides a basic outline of trusts and their role in bankruptcy. We do not warrant the accuracy of the information on this site. You should seek independent legal advice if you have a family trust and are considering bankruptcy.

If you or your spouse are contemplating bankruptcy and you want to understand how your rights under a family trust may be affected, then call us today on 1800 462 767 to discuss your options.

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