Gifting to family trusts or family members – The dangers of subsequent bankruptcy

11 July, 2012 | Peter Smith

Family trusts can be an excellent way to protect your assets in the event of future bankruptcy or business liquidation.  However the law prevents people from knowingly defrauding their creditors through the use of family trusts.  To ensure that the assets you have gifted to a family trust are not reclaimed by creditors through court action.

Section 54 of the Insolvency Act 2006 provides that any gifts made within 2 years of bankruptcy are void.  Further, any gift made within 5 years of a bankruptcy must be made in circumstances where the bankrupt was not insolvent at the time of making the gift.

Section 60 provides that if a person transfers property to another person (this includes a trust) with the intention of defrauding creditors, then that transfer of property is void.

Recent Case – The Official Assignee v T

A recent case – The Official Assignee v T discussed both Section 54 and Section 60 of the Insolvency Act 2006 and the Court of Appeal reached a robust decision in respect of the rules contained within those sections.

The brief facts of the case were that T setup a family trust and transferred her home to that trust.  Over the years she entered into a gifting programme and gifted $27,000.00 a year to the trust by way of reduction of the debt incurred by the trust in purchasing the property off T. The issues were:

– Was T fraudulent in setting up the trust because she knew that she was in financial trouble at the time of establishing the trust and wanted to defraud her creditors (Section 60)?; and/or
– When did T become insolvent in terms of the look back rules set out in Section 54?

Initial High Court Ruling

The Judge in the first instance latched onto the belief that T knew that she was in a financially difficult position when she set up the trust and deliberately set up the trust to defraud her creditors.  Further, the Judge found that during the 5 years prior to T’s adjudication of bankruptcy, that she was unable to pay her debts as they fell due (in other words she was insolvent) and that accordingly all of the gifting that she had done to her family trust was void.  This meant that the trustees of the family trust had to pay to the official assignee the many thousands of dollars in the gifts that T had made to the trust over the years.

Final Court of Appeal Ruling

The Court of Appeal reversed the High Court ruling.  The Court of Appeal found that T’s actions in setting up the trust and establishing a gifting programme were no more than the same actions of many hundreds of thousands of New Zealanders who have set up trusts. The Court of Appeal found that the High Court Judge was wrong in determining that T knew she was in financial strife at this time of setting up the trust.  The Court of Appeal also reversed the Judge’s findings on the issue of when T became insolvent. They found that during the 5 year period prior to bankruptcy there were only circumstances of ill health and lack of organisation of T’s affairs that prevented payment of her debts as they fell due, and that she was, in fact, able to pay all of them.

Needless to say T’s trustees can now heave a sigh of relief in that they do not have to refund all of the money that was gifted by T to the trust during the gifting period save for a couple of small gifts that were made to the trust in the 2 years immediately preceeding the bankruptcy.

This case will also be a relief to many law practitioners and their clients, as it confirms the law as it is generally understood to be.

Lessons Learned

The lesson to be learnt however, is that with the abolition of gift duty on 1 October 2011 and the ability of persons to make so called ‘super gifts’ of large amounts of money or significant assets to their family trusts or other family members, that they first consider the position of creditors and the solvency test before making the gift.  Prior to gifting they must be satisfied that they are:

1. not setting up the trust to defraud creditors; and
2. that after making the gift to the trust their personal assets will still exceed  personal liabilities (i.e. assets held outside the trust exceed liabilities owed outside the trust) and that they are able to pay their debts as they fall due.

It is best practice that people establishing family trusts or gifting to family trusts should sign a declaration of solvency at the time that they make each gift.

If you wish to seek further advice to ensure that your gifting meet the solvency requirements, please contact Auckland family trust solicitor, Peter Smith by phone on 09 837 6882 or email peter.smith@smithpartners.co.nz