Legal Tip 251: Trust taking mortgage over personal property for asset protection

There is a strategy out there which involves a trust taking a mortgage over property owned in a personal name with this supposedly giving asset protection in the event that the person becomes bankrupt. Creditors supposedly cannot take mortgaged property.

The trustee in bankruptcy can give 6 months notice to the mortgagee requiring them to discharge the mortgage. Section 126 Bankruptcy Act allows the trustee in bankruptcy to demand that mortgages be discharged where they are held over assets of the bankrupt.

BANKRUPTCY ACT 1966 - SECT 136 Right to pay off mortgages


Example

Bart has a main residence in his own name. He has also set up a discretionary trust to buy a property. He lets the trustee take a mortgage over his personal house so that the trust can borrow because this is supposed to be a good asset protection strategy.



Bart becomes bankrupt. The trustee in bankrupty gives notice to the trustee of the discretionary trust that its mortgage must be lifted.

The trustee of the discretionary trust will need find new security for its loan. This would mean refinancing to a bank or selling its property to pay out its loan.

Bart’s house will be taken either way.

 

So if a bank has a mortgage over someone's property the trustee in bankruptcy can give 6 months notice to the mortgagee requiring them to discharge the mortgage as well?

 

Seems to be mortgage but no loan in this situation?

 

No, well yes. The mortgagee here is a secured creditor so will get paid out if the property is taken and sold

 

Hi,

What about if the Trust is the Mortgage holder on Barts property i.e. they lend Bart money to buy his home. If Bart then goes bankrupt would the mortgage need to be paid back to the Trust before and other individual making a claim is paid?

 

You are confusing mortgages and loans. A mortgage will need to be discharged to sell a property. Only an legal owner can mortgage a property. So if Bart has mortgaged his property for a trust loan it is not his debt that is being secured. The trust will basically lose its security

 

Thanks Terry,

Would this structure secure the Trusts loan?
Much like a scenario where a bank i.e. NAB Bank, have lent money to Bart to buy his house, if Bart is forced to sell his house, as the NAB have a mortgage over the house this debt needs to be paid out before any other parties/creditors are paid.

Could this scenario be applied to a Trust or have you heard of anything similar?

 

Not sure what you mean
.
If a trust has borrowed money using other person's property then the property is not safe if that person goes bankrupt.

 

Hi Terry,

Not protecting the property is okay.
What I would like to know is:

1 - Can Barts Trust lend him money to buy his house;
2 - If Barts house is repossessed, would the money the Trust lent Bart to buy his house be secured i.e. need to be paid back before creditors are paid?

 

1. Yes
2. Yes at first instance. The trustee is a secured creditor. But the strength will depend on the structure set up

 

The thing that confuses me about gift and loan backs is that if the gift is clawback-able in the event of bankruptcy, why would anyone bother with setting them up? Is there a time limitation on the clawback.

Why do law firms continue to do them, is there some specific use case? I just read through the following from McCullough Robertson -

http://www.affinityplus.com.au/wp-c...assets-without-triggering-tax-liabilities.pdf

 

s37A Conveyancing Act NSW says a transaction to defeat creditors is voidable, not void. This means that unless it is challenged it is effective. To take possession of a property with a mortgage will be more costly to creditors. They will have to potentially throw good money over bad and risk losing even more.

S120 of the bankruptcy act also says that under market value transactions says the under market value transactions are void for up to 5 years after they are made.

 

Also negotiation is the key. One lawyer who went bankrupt had transferred his house to his wife for $1 a few days before. I wondered why a lawyer would do this and hten I read the transcript of a complaint to the law society - it was a strategy to negotiate with creditors.

 

His wife would've had to pay stamp duty on the full market value of the house though, correct?

 

Yes, there are no exemptions for that in NSW