Trusts are established for many reasons. One of the most common is asset protection.
The recent decision of Boensch v Pascoe  HCA 49 from the High Court gives some insight into how that asset protection could be undone in the event of the bankruptcy of an individual trustee.
As part of a matrimonial settlement between Mr Boensch and his former wife, it was agreed that a jointly owned property (“the Rydalmere property”) would be held on trust by Mr Boensch for the benefit of their shared children. A simple memorandum of trust was executed by them, although the memorandum contemplated a further ‘detailed trust document’ would be prepared. No steps were taken to prepare the further trust document or transfer the Rydalmere property to Mr Boensch as sole trustee until some years later when Mr Boensch had been served with notice of bankruptcy proceedings against him. Mr Boensch had occupied the Rydalmere property and personally paid its expenses including mortgage and rates.
Mr Pascoe was appointed the trustee in bankruptcy for Mr Boensch. He formed a view that the trust was a sham to defeat creditors and proceeded to lodge a caveat against the Rydalmere property claiming a ‘Legal Interest Pursuant to the Bankruptcy Act 1966’.
In extensive subsequent proceedings, it was found that the trust was not a sham given it had been initially documented well prior to the bankruptcy. Mr Pascoe therefore allowed the caveat to lapse and did not pursue any further claim against the Rydalmere property.
The matter before the court was actually a subsequent claim by Mr Boensch against Mr Pascoe seeking compensation for an improperly lodged caveat under Section 74P(1) of the Real Property Act 1900 (NSW).
Relevant Bankruptcy Provisions
The Bankruptcy Act 1966 (Cth) provides that:
- Section 58(1) – upon a person becoming bankrupt all property then belonging to the bankrupt that is divisible amongst their creditors, together with any rights and powers in relation to that property, vests in the trustee in bankruptcy.
- Section 116(2)(a) – property held on trust for another person is excluded from being property that is divisible amongst their creditors.
The High Court considered how the provisions under the Bankruptcy Act relate to property held on trust by a bankrupt as this informed whether Mr Pascoe had a proper basis for his caveat.
The High Court found that:
- In the scenario where a bankrupt holds property as trustee, if they have any vested or contingent interest in the trust property (no matter how remote), then the trust property will vest in their trustee in bankruptcy (albeit still subject to the terms of the trust). Further, it is ordinarily for the bankrupt to prove the absence of such a beneficial interest.
- Even if the bankrupt is not a beneficiary under the trust, they can still hold a beneficial interest via the trustee’s right of indemnity. That is, because Mr Boensch, as trustee of the trust, had paid the mortgage and other costs for the trust personally he was entitled to be repaid from the trust and that right of repayment passed to his trustee in bankruptcy.
- The caveat therefore had a proper basis as the trust property vested in Mr Pascoe due to the trustee’s right of indemnity owed to Mr Boensch. It did not matter that Mr Pascoe had not pursued the right of indemnity and allowed the caveat to lapse, the point was that it had nevertheless been a proper caveat.
- A trustee in bankruptcy is warranted in lodging a caveat over property held by a bankrupt as trustee if there is an honest belief that the bankrupt has a beneficial interest in the trust (including by way of trustee’s right of indemnity).
The decision will be of crucial importance for bankruptcy practitioners, but also contains useful lessons from an estate planning and structuring perspective:
- The decision reaffirms that a corporate trustee should be an essential component of trust structuring. Acting as the individual trustee invites examination of the trust property on bankruptcy and could well result in the trust property vesting in the trustee in bankruptcy.
- Trustees must be clear as to trust assets and personal assets. Mixing the two, for example by paying trust expenses out of your personal account, can dilute asset protection and open the trust to a trustee in bankruptcy.
- Similarly, loan accounts, unpaid entitlements and other contributions to the trust must be managed if asset protection for the trust property is to be maintained.
- Establishing a trust requires careful consideration of its purpose and circumstances. Selecting the key controllers can be critical.
For more information or guidance, please do not hesitate to contact us.