Legal Tip 348: General Confusion Over Trusts and Asset Protection

Originally this was an answer at Legal Tip 11: Other legal ownership structures

There seems to be a general confusion out there about discretionary trusts and asset protection.


There are 2 aspects to it.

a) the legal owner of the asset getting sued

b) a beneficiary of the trust getting sued


The legal owner of trust property is the trustee. They could be sued by tenants if the property is held in a trust or by creditors of a business if the trust is operating a business. The assets of the trust could be lost. But also the personal assets of the trustee could be lost too. This is why companies are favoured as trustee where the trust assets will be risky in terms of getting sued. If you are trustee and the tenant breaks their back your non-trust assets could be lost.


There is generally little risk of getting sued if the trust only holds shares, especially exchange traded shares. Where the trustee holds shares in private companies there is a risk of shareholder disputes and trustees suing other shareholders.


On the other side is personal bankruptcy. If someone sues a beneficiary for defamation, for example, the assets held by the trustee of a discretionary trust are generally not at risk of falling into the hands of the creditors of this beneficiary.


If you are the trustee of the trust and you are sued for defamation, or anything not related to your role as trustee then if you end up bankrupt the assets of the trust would not fall to your creditors either.


(note there are exceptions galore to the above, so only take asset protection advice from a lawyer).


Example 1


Homer is trustee of the ABC Trust which conducts a business. Homer is the business – akin to a sole trader. The trust offers him no protection against business creditors.


Homer manufactures a faulty product and someone sues for negligence and breach of contract. Homer only holds the business as trustee, there are no other assets of the ABC Trust so Homer’s house, car, shareholdings, inheritance etc is at risk of being lost.




Example 2


Homer is trustee of the ABC Trust. Homer is sued for defaming a property spruiker and has been ordered to pay $800,000.


The assets of the ABC Trust are not at risk. Homer will lose his house, car, shareholdings and inheritance though.




Example 3


Homer is the trustee of the ABC Trust and his wife, Marge, goes bankrupt over a contractual dispute with Peter Townsend of the Who. Marge goes bankrupt. She is still a beneficiary of the trust but the trust assets are safe. If Homer causes the trust to distribute income or capital of the trust to Marge, while she is bankrupt, the creditors will take it.




Example 4


Homer is Director of Company Pty Ltd which acts as trustee of the ABC Trust. The trust operates a business, and the company is sued in relation to this business. The assets of the company are just $2 in paid up share capital and $10 Homer mistakenly transferred into the wrong account. These are lost as would be the business itself. Creditors would take it and sell it to satisfy any debts.




Example 5


As above, but Homer is sued for defamation by the reverend Pu Pu of the Church of Unscientific. Homer is bankrupted and can no longer be a director, so Marge sets up and becomes a director – but the trust keeps going with the company unaffected.