How the creation of trusts used to avoid creditors, may be set aside

Date: May 02, 2012
Document Type: Newsletter

People who are insolvent, may choose to create a trust to defeat the interests of a creditor. However, for anyone who wishes to create a trust specifically to bypass a creditor’s interests, the law does have the power to render such trusts void, if the effect or the purpose of the trust was to avoid a creditor.

How does the court set aside a trust used to avoid a creditor?

Under the authority of the Bankruptcy Act (the Act), the courts can set aside a trust which has been created to avoid creditors if it is established that the purpose of the trust was to avoid a creditor, or has that effect.

Unless there are specific statutory protections, all of the settlor’s property, belongs to the trustee-in-bankruptcy from the date of insolvency.

Crucially, the Act under limited circumstances, can set aside any trusts that were created before the date a settlor declared bankruptcy, and can include instances of undervalued transactions, along with any transfers done with the purpose of defeating the interests of a creditor.

What are undervalued transactions?

Section 120(1) of the Act states, that undervalued transactions are void against a trustee in the following instances:

“(1) A transfer of property by a person who later becomes a bankrupt (the transferor) to another person (the transferee) is void against the trustee in the transferor's bankruptcy if:

(a) the transfer took place in the period beginning 5 years before the commencement of the bankruptcy and ending on the date of the bankruptcy; and

(b) the transferee gave no consideration for the transfer or gave consideration of less value than the market value of the property.”

However, it is important to be aware, that the powers vested in the section, can only be triggered when a trustee-in-bankruptcy either initiates an action in court, or takes the required steps to set off the provisions. So as a consequence, the term ‘void’ used in s 120(1), is generally interpreted by the courts as ‘voidable’, due to the requirement that a trustee-in-bankruptcy, must initiate the necessary actions to set off the powers under the section.

Under s 120(3) of the Act, if a transfer took place more than two years before the bankruptcy commenced, and during that period the person was solvent, then the transfer is not voidable.

In the case of a transfer made to a ‘related entity’, a transfer must have been made four years prior to insolvency, and a ‘related entity’ may include the following parties:

·         a relative

·         a body corporate in which the person, or relative of a person, is a director

·         a beneficiary under a trust of which the person, or a relative, is a trustee

·         a relative of such a beneficiary

·         a relative of the spouse, or de facto partner of a beneficiary

·         a trustee of a trust under which the person, or relative, is a beneficiary

·         a member of a partnership of which the person, or relative, is a member.

What are the types of transfers that can used to defeat a creditor?

A settlor who engages in actions of transfer which are used to defeat a creditor, may be considered void under the following s 121(1) provisions of the Act:

“(1) A transfer of property by a person who later becomes a bankrupt (the transferor) to another person (the transferee) is void against the trustee in the transferor's bankruptcy if:

(a)  the property would probably have become part of the transferor's estate or would probably have been available to creditors if the property had not been transferred; and

                     (b)  the transferor's main purpose in making the transfer was:

(i) to prevent the transferred property from becoming divisible among the transferor's creditors; or

(ii) to hinder or delay the process of making property available for division among the transferor's creditors.”

Similar to the s 120(1) provisions, the use of ‘void’ has also been interpreted by the courts as ‘voidable’.

However, it should be noted, that under s 121(4) of the Act, the transfer will not be considered as void if a transferee has acted in good faith. When making a determination of ‘good faith’, the following elements will be taken into account:

·         the consideration the transferee gave for the transfer, was at least as valuable as market value in regards to the property

·         the transferee did not know, and could not have reasonably inferred, that the main purpose of the transferor: was to prevent the transferred property from becoming divisible among the transferor’s creditors; and to hinder or delay, the process of making the property available for division among the transferor’s creditors

·         the transferee could not reasonably have inferred that at the moment of transfer, the transferor was, or was about to become insolvent.

For anyone who is experiencing an issue with matters regarding the law of trusts, it is essential that you seek the help of a lawyer who will be able to assist you with your matter. 

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