AN OVERVIEW OF ASSET PROTECTION DOCUMENTATION

The purpose of the asset protection documentation is obviously to protect your assets from creditor’s
claims. The protection comes from mortgaging your equity in ownership of your assets to a trust.
Everything that you own or have an interest in is your equity. Ownership equals equity. Assets that
you hold that are not subject to debt provide you with 100% equity. Assets that you hold carrying debt
still give you equity on the basis that it is highly likely that the loan to value ratio is less than 100%. If
you buy a house on an 80% loan, then you have a 20% equity in it.

There is no transfer or change of ownership involved in this, it involves you mortgaging your equity
to a trust so that everything that you own is 100% under finance. Because your equity in your assets is
mortgaged, or subject to a charge in favour of a lender (being your trust), then creditors cannot seize
your assets to satisfy their claims. The debt claimed will not disappear, liability for payment will still
remain, but it puts you in control of how to handle creditors rather than the creditors having unlimited
choice on what to do with you to recover payment.

The rules and scope of the powers of the asset protection trust are set out in the deed of trust.
Dominique Grubisa creates a trust as settlor and she signs the trust with your trustee. The trustee can
be an individual whom you trust or it can be a company of which you are the director. The assistance
and co-operation of the trustee becomes very important.

The trustee agrees to administer the trust according to the scope of its entitlement to act as set out in
the trust deed. There have to be beneficiaries of the trust otherwise it would serve no purpose. The
beneficiaries under the trust will be you, your children, your company or whomever you wish.

By means of an equitable mortgage you will mortgage your equity in your assets to the trust to secure
an unspecified loan. The trust will then get a charge over your equity in your assets and to protect its
position the trustee will register a caveat against the title to your real estate and in respect of personal
property an entry can be made in the Register of Personal Property Charges with the Australian
Securities and Investments Commission.

To underpin the equitable mortgage there will be a deed of gift where you give your equity in your
assets to the trustee. The trustee will not want the gift but will accept it and allow you to have
possession so that you continue to use everything. To further underpin the transaction you will sign a
promissory note in favour of the trust and to agree to repay the money lent you if and when a demand
for repayment is made by the trustee.

The protection of equity in assets should also include any other companies that you have and
yourselves. All parties will be signatories to the equitable mortgage.

Where the money come from? The asset protection trust will have its own bank account. The deed of
trust prohibits borrowing so this trust cannot borrow and it will not have any debt. It will not come
under attack from creditors because it won’t have creditors as it will not be able to borrow. If the trust
borrowed and defaulted then a creditor with a Court judgment would have recourse to the whole of
the trust’s assets which is what we want to avoid. Your income and the income of the companies, if
you wish, will be paid into the trust bank account. The bank account will be a cheque account earning
no interest. What you deposit into the trust will be available to you for withdrawing. The money that
you will draw from the account is treated as an interest free loan and the basis of a debt that you owe
the trust. The drawings you make from the account are repayable on demand and are interest free.

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The equity in your real estate will be covered by a caveat registered on title. The order of priority
would be that the bank is first mortgagee, the caveat is registered after it and should a creditor
register a judgment it will rank in third place. If the assets are sold the first and second creditors are
paid and because the equitable mortgage is elastic as to amount owed, the third and subsequent
creditors receive nothing.

The trust itself will not be liable for income tax if, by the 30th June each year, distributes income to the
beneficiaries. Whatever is not distributed is then taxed in the hands of the trustee. When a full
distribution of income is made by 30th June, the beneficiaries receiving a distribution declare it in their
own personal income tax returns.

What is deposited into the trust bank account is not income of the trust and therefore not taxable. If
you think of it in terms of a lawyer or a real estate agent holding client’s money in their trust accounts,
it clearly isn’t their money and it isn’t taxable because it isn’t their money. The agent and the lawyer
are holding funds on behalf of the owner of the money so, (a) the agent and the lawyer didn’t earn the
money so it isn’t taxable income for them and (b) they are holding the money for the owner pending
instructions on what to do with it. The owner of the money is ‘parking’ the money in the agent’s or
lawyer’s trust account to deal with it as directed. Because the money ‘parked’ in the trust account is
taxed at source and as the trustee doesn’t own the money, it isn’t income of the trust. The income that
you receive from other sources is taxable in your hands because you received the salary, wages, rents,
dividends, interest etc. Whatever the trust itself earns is taxable in its hands (unless it distributes the
income to beneficiaries before 30th June). As the trust can’t borrow but is merely a holding vehicle, it
won’t have an income, unless perhaps bank interest on the account.

The end result of this mechanism is that there is no change of ownership of assets and so no liability
for capital gains tax. It is not a tax evasion or tax avoidance scheme, it is simply the creation of “good
debt” over the equity in assets to control those assets from potential creditor’s claims.

You may figure that you have your creditors at bay and everything is under control. The unexpected
can cause turmoil, in a simple example, consider being involved in a motor vehicle accident and your
insurer denies the claim on the basis that you had a bald tyre or some defect with the vehicle. You will
have to meet the other party’s claim. You would be uninsured and have to bear the cost of repairs to
your vehicle as well as the repair account for any other vehicles or property involved. In the
circumstances you’d really have no defence to a damages claim and the other party would, with a
Court judgment, become a creditor of yours. To enforce the judgment for recovery of money from
you they can garnishee your bank account but that would fail because you’d have your money in the
trust bank account and because it isn’t an account in your name a Court garnishee would fail.

Further, consider this, you engage a builder or a tradesman to do work on your property. You sign a
contract so that you know what work will be done and what you will be paying. But do you read the
small print? Most of us don’t. You engage the person because you think he knows what he’s doing
and you trust him. Tradie’s contracts usually contain a ‘caveat clause’ which means that when you
sign the contract you give him the right to lodge a caveat against the title to your real estate ‘as
security for getting paid’. It depends on the wording of each contract but in principle, the effect is the
same; the tradesman has a claim on your property. Now, if you have a mortgage on the title then the
caveat will rank second. If you have no mortgage (the property being debt free) then the caveat will
rank first. The caveat will stay on your title with the interest meter ticking, until you pay. It gets worse
if you have a dispute with the tradie over the quality of the work done or dispute claims for payment.

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You are then dealing with a person who is holding you to ransom because he has a caveat on your
title.

The most important thing to grasp is that if you have real estate with or without a mortgage on the
title, a creditor with a Court judgment can register a writ of execution on the title to your property.
The writ will remain on your title until you sell, re-finance or simply pay it. It will attract Court
interest until payment at about 8.5% a year until you do something about it. With a writ registered
next after your bank mortgage, the creditor must be paid when you want to sell or re-finance because
there’s really nothing you can do to otherwise have it removed. As indicated above, this is where a
caveat comes into focus. Your trust registers a caveat on the title after or behind the bank’s first
mortgage. The caveat will rank second and a writ from a creditor will rank third in line. The equitable
mortgage is sufficiently elastic to ‘mop up’ all of your equity in the property so that there’s nothing
for the creditor to take under the writ. It happens a lot, creditors with writs don’t like it but have to
withdraw with nothing.

Try selling the property or re-financing your mortgage with the tradie’s caveat sitting on your title.
It’s like having a pebble in your shoe. But if you had an asset protection caveat on your title (second
after the bank mortgage, or first with no mortgage) the tradie’s caveat would rank after your caveat. In
terms of payment priorities it means that the tradie ranks last. With the caveat/equitable mortgage
structure all equity in your assets is already ‘under finance’ so that the tradie’s caveat security
becomes worthless. This doesn’t mean that you don’t have to pay the tradie, nor are you cheating him.
What it means is that you are able to control your assets without the tradie controlling your property.

The asset protection mechanism germinated in a decision of the Full Bench of the Federal Court of
Australia in a 1988 case of Official Trustee in Bankruptcy v Sharrment. The citation of the case is
1988 FCA 179 (if you want to read the Court’s judgment then Google this reference and it will
appear). The brief history is that Mr Sharrment owed the Australian Taxation office about
$7,000,000.00. He died. The trustee in bankruptcy claimed the tax against his Estate because he had
significant assets.

The Court said that the trustee’s claim must fail and the Estate kept the assets and the tax was not
paid. Essentially, the Court ruled that the success or failure of an asset protection scheme depended on
2 things – intent and timing. If a person set up the trust mechanism at a time when he/she was not
under financial distress and the intention was for wealth preservation for the next generation and
family it would stand up. Conversely if the plan was set up at a time when the person was under
financial pressure and the intention was to avoid paying debts then it would fail. Mr Sharrment did
everything properly and his assets were shielded.

Further, the Court said that every component in the chain of documentation had to be done properly
and created at about the same time. That is, if it is said to be a trust then it must look like a trust. In
other words that rules out the proposal we occasionally get from clients of ‘part now and part later’.
That means you can’t implement part of the mechanism now and the remaining parts later ‘just before
the Sheriff comes’. The unpredictability is knowing when the Sheriff will come. It’s just like saying
that you’ll go to the doctor to get your vaccinations the day after you get sick with an infection; it’s
too late then. If it is to weather storms it has to be well insulated and the only way to pass the
‘genuine trust’ test is to set it up once and for all and use it. It works very well indeed.

Dominique Grubisa BA (Hons) LLB. LLM.

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