Family Trusts and Asset Protection: Myth vs Reality in Australia

In the complex world of wealth management and asset protection, the family trust is often held up as the ultimate shield—an impenetrable fortress designed to safeguard a family’s wealth from the risks and uncertainties of business, creditors, and legal disputes. For many successful business owners and high-net-worth individuals in Melbourne and across Australia, the discretionary family trust is a cornerstone of their financial strategy.

However, the belief that a trust offers absolute protection is a pervasive and dangerous myth. While a properly structured and managed trust is an exceptionally powerful tool, its defences are not unassailable. Australian courts, particularly in the realms of family law and bankruptcy, have demonstrated an increasing willingness to ‘look through’ the trust structure, scrutinising who truly benefits from and controls the assets within.

This article demystifies the asset protection capabilities of family trusts in Australia. We will explore the foundational principles that make them effective, examine the critical scenarios where courts can pierce the trust veil, and provide practical guidance for ensuring your trust is as robust as possible. Understanding the line between myth and reality is the first step towards genuine, long-term asset protection.

When the Fortress Stands Strong: The Theory of Trust Asset Protection

To understand the limits of a trust, one must first appreciate how it is designed to work. A discretionary family trust is not a separate legal entity like a company. It is a legal relationship, established by a trust deed, where a person or corporate entity (the Trustee) holds assets for the benefit of a group of potential beneficiaries.

The core principle of asset protection flows from a simple but critical distinction: ownership. The assets held within the trust (e.g., property, shares, investments) are legally owned by the Trustee. The beneficiaries do not own the assets; they merely have a right to be considered by the Trustee when it exercises its discretion to distribute income or capital.

This separation is the key. If a beneficiary runs into financial trouble—for instance, their business fails, they are sued for negligence, or they face personal bankruptcy—their creditors cannot automatically claim the assets of the trust. Because the beneficiary does not legally own those assets, they are, in theory, beyond the creditor’s reach.

A Practical Example:

Consider a successful surgeon in Melbourne, Dr. Anya Sharma. Her parents established a family trust years ago. The trust’s assets include a share portfolio and a commercial property in Richmond. Anya is one of several beneficiaries, alongside her siblings and their children. The Trustee is a corporate trustee, with her financially astute uncle and the family’s accountant as directors. Anya has no role in managing or controlling the trust. If Anya is unexpectedly sued for medical malpractice and her professional indemnity insurance is insufficient, the trust’s assets are highly likely to be protected. She does not own them and has no power to control them, so her personal creditors have no claim over them.

In this ideal scenario, the fortress stands strong. The trust is operating as intended, protecting family assets from the specific liabilities of one beneficiary.

Piercing the Veil: When Courts Challenge the Trust Structure

The protective veil of a trust is most often challenged when a key individual, typically the person who was the source of the trust’s wealth, is seen to have retained an excessive degree of control. In these situations, courts may determine that the trust is not a separate, independent structure, but rather the “alter ego” or “puppet” of that individual.

This scrutiny is most prevalent in two key areas: family law property settlements and bankruptcy proceedings.

The “Control” Test and Family Law: The Landmark Case of Kennon v Spry

The High Court of Australia’s decision in Kennon v Spry (2008) fundamentally shifted the landscape for family trusts in the context of a divorce. The case involved a family trust where the husband was the Settlor, Trustee, and Appointor. Throughout the marriage, he had sole discretion over the trust’s assets and distributions. After separating from his wife, he made changes to the trust to exclude her and their children from benefiting.

The High Court found that the husband’s absolute power and control over the trust’s assets meant that those assets could be treated as part of the marital asset pool available for division in their property settlement. His power as Appointor—the ability to appoint and remove the Trustee—was deemed tantamount to ownership for the purposes of family law.

The key takeaway from Kennon v Spry is the “control test.” If a party to a marriage has effective control over trust assets, whether as a Trustee, Appointor, or both, the Family Court is likely to view those assets as a financial resource or even the property of that party, making them available for distribution to the other spouse.

The Sham Trust and Defeating Creditors

In commercial law and bankruptcy, a trust may be disregarded if it is found to be a “sham.” This occurs when the trust deed is created to give the appearance of a legitimate legal arrangement, but in reality, the parties intend for the assets to be dealt with as if they still belong to the individual.

More commonly, trustees in bankruptcy will rely on specific “clawback” provisions in the Bankruptcy Act 1966 (Cth). These provisions allow a bankruptcy trustee to void certain transactions that occurred before the date of bankruptcy.

• Section 120: Undervalued Transactions. If a person transfers an asset to a trust (or anyone else) for less than its market value, the transfer can be voided by the bankruptcy trustee if it occurred within a specific period before bankruptcy (up to five years).
• Section 121: Transfers to Defeat Creditors. This is the most powerful provision. A transfer of property can be voided, regardless of when it occurred, if the main purpose of the transfer was to prevent, hinder, or delay the property from becoming available to creditors.

A Practical Example:

Imagine a Melbourne-based property developer, David Chen. He foresees a significant downturn in the property market and is concerned about personal guarantees he has made to lenders. He transfers his multi-million dollar family home in Toorak into a newly created family trust for a nominal sum of $100. A year later, his development company collapses and the lenders call on his personal guarantees, forcing him into bankruptcy.

The bankruptcy trustee would almost certainly succeed in having the transfer of the home voided under the Bankruptcy Act. The transfer was for less than market value, and its timing strongly suggests its main purpose was to defeat creditors. The house would be sold to pay David’s debts, and the trust structure would have offered no protection whatsoever.

The Critical Role of the Appointor and Trustee

As the Kennon v Spry case illustrates, the roles of Appointor and Trustee are the focal points of any legal challenge.

• The Appointor: This role holds the ultimate power. The Appointor has the authority to “hire and fire” the Trustee. Therefore, whoever is the Appointor is the ultimate controller of the trust.
• The Trustee: This role makes the day-to-day decisions, including who receives distributions of income and capital.

Concentrating these powers in the hands of the person most at risk of being sued or becoming bankrupt is the single biggest mistake in asset protection planning. If the at-risk individual is the sole Trustee and sole Appointor, it becomes far easier for a court to argue that they are, for all practical purposes, the true owner of the assets.

To enhance asset protection, consider:

• Appointing an Independent Appointor: This could be a trusted family friend, a professional advisor, or a combination of people.
• Using Joint Appointors: Requiring two or more people to act jointly makes it impossible for one person to exercise unilateral control.
• A Corporate Trustee: Using a company as the Trustee can provide a layer of liability protection and simplify succession. However, this is only effective if the directorship and shareholding of the corporate trustee do not rest solely with the at-risk individual.

Bolstering Your Defences: Actionable Steps for Robust Asset Protection

A family trust remains a highly effective asset protection vehicle, but only if it is structured, managed, and respected as a separate legal arrangement. For families and business owners in Victoria, we recommend the following actionable steps:

• Separate Control: Critically review the roles of Appointor and Trustee. Ensure the at-risk individual is not in sole control. The person who “put the money in” should not be the one with the power to “take the money out.”
• Document Everything: Maintain meticulous records. The Trustee should hold regular meetings, keep minutes of decisions, and clearly document the reasons for all distributions. This reinforces that the Trustee is acting independently and in the best interests of all beneficiaries.
• Respect the Trust: Do not treat the trust’s bank account as your personal account. All transactions must be consistent with the terms of the trust deed.
• Transfer Assets at Market Value: Never transfer an asset to the trust for a nominal amount. Obtain independent valuations and document the sale at full market value.
• Act Early: The best time to establish and fund a trust is when you are solvent and there are no storm clouds on the horizon. Asset protection is about long-term planning, not a last-minute emergency measure.
• Conduct Regular Reviews: A trust deed is not a “set and forget” document. Your family and financial circumstances will change. We advise having your trust structure reviewed by a specialist lawyer every 2-3 years to ensure it remains aligned with your goals and current laws.

Conclusion

The family trust is not a magic wand. It is a sophisticated legal instrument that, when used correctly, offers significant advantages in wealth preservation and succession planning. Its effectiveness as an asset protection shield depends entirely on its structure, its administration, and the clear separation between the assets of the trust and the personal affairs of its beneficiaries.

The myth of the impenetrable fortress can lead to a false sense of security. The reality is that proactive, expert legal advice is essential. By understanding the pressure points and taking steps to reinforce your trust structure, you can move from relying on a myth to building a reality of genuine, enduring asset protection for your family’s future.

*

Disclaimer: This article provides general information and is not a substitute for professional legal advice. Your circumstances are unique, and you should consult with a lawyer to discuss your specific needs.

To discuss a tailored asset protection strategy for your circumstances, contact the specialist wealth management and legal team at our Melbourne office today.