Legal Tip 140: A Unit Holder of a Hybrid Trust Becoming Bankrupt

A Unit Holder of a Hybrid Trust Becoming Bankrupt

Let’s consider Hybrid Trusts and asset protection on the bankruptcy of the unit holder. I don't think there is much in the way of asset protection if the unit holder were to become bankrupt.


Imagine the scene:

ABC Pty Ltd as Trustee for the DEF Trust owns a property. Tom, the director of ABC Pty Ltd and sole unit holder of the DEF Trust has borrowed money from a Bank to acquire the units in the trust. ABC Pty Ltd has guaranteed the loan and provided an indemnity to the bank and given the property as security for Tom’s loan.


Later Tom becomes Bankrupt because he invested in a scheme involving plantations that his financial planner recommended.


What will happen to the property?


Firstly the units Tom owns in the trust will be seized by Tom’s trustee in bankruptcy (TIB) (the creditors). The TIB’s duty is to sell Tom’s assets and try to get back as much money as possible for the creditors – which may be the Bendigo Bank which Tom used to fund a margin loan he used to buy $1mil worth of units in the plantation trust.


So the units of the trust are now gone. The TIB has them now. The trustee company ABC Pty Ltd was controlled by Tom as director. However he can no longer be a director as he is now bankrupt. Tom knew he was going down well in advance so he put this wife in there as the director and he resigned from the role.


If Tom owns the shares in ABC Pty Ltd these are also property that can fall into the hands of creditors – the TIB will take the shares. The first thing the TIB will do then is to vote, as the shareholder, to change the directors. The wife will be out and a TIB associate will then be appointed director. The TIB will control the trustee which controls the trust. TIB will then cause the trust assets to be sold and make a distribution to the unitholders – which was Tom, now the TIB in the shoes of Tom. The whole of the trust assets, after the bank is paid out, will go to the TIB and then to creditors after he has taken out his fees (which include $5 per Timtam during work meetings).


But say Tom didn’t own the shares, but a trustee of a discretionary trust did. Those shares may not fall into the hands of creditors. Things are still not that safe for the trust of Tom’s family.


The TIB will have the deed reviewed and attempt to exercise any and every power available to have the trustee removed and a new friendly one placed in. Voting power may depend on the number of units owned, or this power may be reserved for another role such as an Appointor to exercise. This will all depend on how the deed is set up.


The TIB will also be making sure the unit holders get all of their income and none is diverted to other beneficiaries. Tom had set it up in such a way that he was able to claim the interest on the loan in his personal name. But to do this the deed would have be drafted in such a way that Tom would be absolutely entitled to both income and capital of the trust. So the TIB would be entitled to the income of the trust just like Tom would have been. Whether the TIB can force the trustee to sell the property or not will depend on the ability for him to control the trust and the powers the unit holders have to cause the trustee to distribute the capital of the trust. It is likely the unit holders would be able to force this if the trust was set up in such a way as to be able to claim the interest.


Tom’s wife may be battling to cause the trustee company to spend money so that there is less income to distribute. She has to take care doing this so as to not be seen as trying to help Tom defeat creditors. The trustee could divert some funds from the rents to spend on the property itself. Repairs and maintenance maybe.


Meanwhile, the bank who loaned the money to Tom has been notified of Tom’s bankruptcy. Changing directors without their permission is a breach of the agreement as is a unit holder going bankrupt. They want the loan repaid within 28 days. This would very likely mean the trustee would need to sell the property to pay the loan out. It would probably be very difficult to refinance in such a situation.

 

Note that in this example I don't think the bank could call in the loan just because the director became bankrupt, but I think they could if the directorship has changed. And since a director is automatically disqualified on bankruptcy it must change.