Bankruptcy and Family Trusts – Are They Still Effective?

by Bruce Gleeson

Family Trusts have and will continue to be used into the future for a variety of purposes, in particular asset protection. Most Family Trusts notably have a Corporate Trustee. As a Registered Bankruptcy Trustee, I am quite often asked by individuals who may be a Director/Shareholder of the Corporate Trustee and/or a Beneficiary of the Family Trust (or discretionary trust) what happens if the individual goes into bankruptcy (either voluntary [themselves] or involuntarily [via the Federal Court])?
Ultimately it will significantly depend on the specific circumstances of each case and indeed the Trust Deed, but the Courts have for some time considered and will continue to exercise their minds about the extent to which Family Trusts may be impacted by the bankruptcy of a Director/Shareholder/Appointor or Beneficiary. This article examines a recent case which re-affirms that Family Trusts continue to be problematic for Bankruptcy Trustees to attack.
The case is Fordyce v Ryan & Anor; Fordyce v Quinn & Anor [2016] QSC 307 and judgement was delivered on 20 December 2016. The key facts can be summarised as follows:
• The Bankrupt was the sole Director and Shareholder of the Corporate Trustee company of the Fairdinks Discretionary Trust (“FDT”) and also the Corporate Trustee companies of Unit Trusts.
• FDT held all the units in one of the Unit Trusts and two-thirds of the units in the second Unit Trust. The major asset of both Unit Trusts was real estate.
• The Mortgagee of both Unit Trusts sold the real estate with the consequent effect that there were surplus funds available. The surplus proceeds were in excess of $200,000 in each Unit Trust.
• The Corporate Trustee for both Unit Trusts was deregistered and as such, the above surplus funds vested with ASIC – and ASIC effectively stepped into the shoes of the Corporate Trustee and either may have acted as Trustee or applied to the Court for the appointment of a new Trustee.
• FDT was as the name suggests a discretionary trust and had two (2) classes of beneficiaries. The Bankrupt was in the 2nd class of beneficiaries – being a general beneficiary.
• PRIOR to his bankruptcy, the Bankrupt who was CONTROLLING each of the Corporate Trustee companies of the Unit Trusts made distributions to the FDT and then in turn to him as a beneficiary of the Family Trust. The evidence for this was income tax returns of the various trusts.
• On 2 September 2015 the Bankrupt (Mr Michael Quinn) entered into bankruptcy and the Bankruptcy Trustee sought to recover the Bankrupt’s interest in the surplus assets of the Unit Trusts by applying to the Court to appoint Receivers so that the Unit Trusts could be wound up.
• The Bankruptcy Trustee submitted that  the Bankrupt controlled the FDT and relied on the decision of the Federal Court in ASIC v Carey (No 6) (2006) 153 FCR 509 (“Richstar”) to argue that the Bankrupt’s interest amounted to property that had vested under Section 58 of the Bankruptcy Act. The Bankruptcy Trustee was also seeking to have Receivers appointed to the Unit Trusts as part of the application.
• Relevantly the Court determined that the FDT was purely a “discretionary trust” and therefore the beneficiary is not someone who has a property interest in the trust property. In doing so it stated that the “critical question is whether effective control of a Trustee’s power of selection can transform the interest of a beneficiary of a discretionary trust into property of the bankrupt”. In addition, the Court also commented “a trust once validly constituted does not change in nature because the Trustee and some of the beneficiaries subsequently choose no longer to abide by the obligations of the trust relationship”.
• The Court found that the Bankrupt’s right as one of the general beneficiaries of the FDT did not vest in the Bankruptcy Trustee as property of the Bankrupt per Section 58. The Court also dismissed the application insofar as appointment of the Receivers to the Unit Trusts were concerned.
This case shows how difficult it can be for Bankruptcy Trustee’s to successfully attack Family Trusts. Whilst the outcome will invariably come down to the specific facts of each circumstance, Family Trusts at least at this point appear to be the kryptonite equivalent to defeat bankruptcy trustee claims. However, I think it should be expected that this area will continue to be pressed where it is believed there may be a potential recovery for creditors.
Bruce Gleeson