Legal Tip 322: Trusts and Limited Liability

Unlike companies trusts are not separate legal persons. When a trust enters a contract it is the trustee that enters it. The trustee is personally liable for the debts of the trust so for asset protection it can be a good idea to have a company as trustee. This is because Companies are separate legal persons and the directors and shareholders of a company are not liable for the debts of the company.

If the ‘trust’ is sued it will be the company trustee that is sued and this company should be one that doesn’t have any assets at all.

There is no limit to the liability – it will extend to the trustee’s personal assets.


Example

Homer sets up a trust to hold an investment property. Homer is the trustee.

Homer self manages the property, and the tenant has been complaining about a tile lifting in the front foyer area. Homer doesn’t do anything about it and then it happens – the tenant trips on the tile and injures themselves. Homer thinks they are putting it on a bit, but he is soon served documents and sued by the tenant’s insurance company. Homer is the trustee, so he is the one sued. The property was worth $500,000 with a $400,000 loan on it so Homer is not too worried he says.

He loses and the court awards $800,000 plus $200,000 in legal fees to the tenant.

Homer’s trust loses the property but that only covers $100k of the debt he owes the tenant, so they take his family home, other investment property and his new campervan.

The next day as Homer is loading his furniture in a removalist truck the tenant drives by in a brand new car peeping his horn and waving.

Had Homer set up the trust with a company as trustee the investment property itself would have been lost but they could not have come after Homer’s personal assets – unless they could have somehow made Homer personally liable.


See

Legal Tip 42: Suing a Trust Legal Tip 42: Suing a Trust

Legal Tip 43: Suing a Corporate Trustee Legal Tip 43: Suing a Corporate Trustee

 

Hence why a Directors guarantee is required where a company is trustee. If the company has trivial assets this gives the lender access to personal assets to meet any shortfall.

This issue comes up with SMSF loans. These loans are limited recorse giving the lender NO right to acess any other smsf assets to meet a shortfall. However the trustee Directors will have a guarantee that extends to their assets. They would be called on to meet any deficiency.

 

which translated into English means:
Your assets are not protected if there's a loan

 

But only to the extent of the shortfall. I used to do some insolvency work with a liquidator and found its far cheaper to negotiate a settlement than it is to action matters in a court. This also occurs with (some) lenders in some instances. eg a guarantee given by 88 year old nanna may not be actioned if her sole asset is her home as he lives on a pension. For a $20K debt its never worth the media for a major lender to kick her from her home.

But if Fred the developer has a trustee debt shortfall of $500K and lives in Rose Bay (unencumbered) its very different.

 

Generally even if there is not a loan your assets are not protected either!

 

this thread is relevant too

Legal Tip 260: Impecuniosity as an Asset Protection bargaining tool Legal Tip 260: Impecuniosity as an Asset Protection bargaining tool

 

And yet we have a lawyer who claims to be an expert in asset protection distributing a trustee FAQ document that claims the following

Will I be responsible in any way for the debts of the Trust?

No. Your assets are separate from the Trust’s assets and they will never merge. As a Trustee, you do not become liable for the debts of the Trust or vice versa. Everyone remains separate and existing responsibilities do not change. We are taking all the risk and you are holding all of our assets and income for us

How can any lawyer make such a ridiculous comment that a trustee is not liable for the debts of a trust?

 

That is a good question!