Historically, an important principle of Trusts has been the separation of legal ownership from beneficial ownership. However, in recent years questions have arisen as to whether a trustee in bankruptcy can seize the assets of a trust where the trustee or controller of the trust is bankrupt.

In an important decision handed down by the NSW Court of Appeal on 4 July 2013 in Lewis v Condon (2013) NSWCA204, the three Appeal Justices upheld the principle and would not permit a trustee in bankruptcy in that case to seize the family trust assets for the benefit of creditors.

Background

The Family Trust had been established in 2001 with a corporate trustee. Colleen Lewis was the appointor and effectively controlled the corporate trustee. The trust purchased a property. Evidence from Colleen's accountant suggested an 'improper purpose' – to conceal the property purchase from her former husband. However the Court found that the trust was not a sham. In 2005, Colleen surrendered her interest as a beneficiary of the trust, retired as appointor and was appointed as the new trustee.

As part of the settlement of the Family Court proceedings, the Court ordered that the property be transferred to Colleen's name. In 2010, Colleen borrowed from the ANZ bank on the security of the property and used the funds for her private purposes. Colleen defaulted on the loan and the bank took possession. After Colleen became bankrupt, her trustee in bankruptcy (Mr Condon) caused himself to be registered on the title to the property and purported to seize the funds available after repayment of the secured amount to the bank. Colleen's daughter opposed this on behalf of the beneficiaries of the trust.

Leeming JA said in his findings:

'it is clear law that those statutory vestings do not destroy any trust of which the bankrupt was a trustee.'

The Court relied upon s 116(2)(a) of the Bankruptcy Act 1966 (Cth) which excludes from vesting, property held by the bankrupt in trust for another person; and s 82 of the Real Property Act 1900 (NSW) which excludes recording notice of trusts on the Land Titles Register. Therefore the trustee in bankruptcy held title to the property, subject to the existing trust. It was important that the Court found that the establishment of the trust was not a sham. Had it been a sham, the result may have been different. Importantly, the Court went on to say:

'The power to remove and replace a trustee is precisely that: a power, not property.'

How does this affect you?

Taxation Office statistics for 2010-11 disclosed that 729,622 trusts lodged tax returns. Discretionary Trusts are a commonly used investment structure in Australia. This decision provides reassurance to beneficiaries of discretionary trusts that the bankruptcy of a trustee or appointor will not enable a trustee in bankruptcy to seize the assets of a trust except in exceptional cases where the trust had been set up, or is operated, as a sham.