Australia: Bad asset protection strategies

A lack of trust.

When starting a new venture, failure often is not front of mind. When things start to go wrong, it's only natural to then think about asset protection strategies. We've seen a range of strategies adopted, with limited success, and detail some common strategies below.

Ex post facto trust
A common misconception is that assets held 'on trust' are protected in an insolvency administration. However, this is only the case when assets are properly vested in the trust and/or the trust was not created in response to financial difficulty. We see many cases where a trust is created after the assets were originally obtained, and assets are transferred to the trust or it is purported that assets were always held in trust.

Case study
Worrells was appointed to a bankrupt estate where real property, registered in the bankrupt's name and subject to a mortgage taken out by the bankrupt, was not disclosed in the bankrupt's formal disclosure of assets. When questioned, the bankrupt claimed that the property was purchased in their capacity as trustee of a trust. We were subsequently given a trust deed and various supporting documents.

It was soon apparent that the trust was created several years after the property was purchased. Discrepancies in the documents provided to us, including in the dating of various documents, and the lack of reference to the trust in historical documents, led us to suspect an ex post facto trust, or perhaps a sham. Further investigations using the investigative powers under the Bankruptcy Act 1966 provided further evidence to support our suspicion.

Worrells commenced proceedings, seeking a determination that the trust was a sham. The proceedings settled, with the bankrupt conceding that the property was not protected by the trust.

The tactical divorce
Binding financial agreements or a Family Law consent order made shortly before bankruptcy are common. In many cases, the majority of the assets of the matrimonial estate end up with one partner, while the majority of the debts end up with the now bankrupt partner. There is a common misconception that family law arrangements cannot be reviewed by a bankruptcy trustee. However, they can be unwound like any other transaction.

Case study
Worrells were appointed to a bankrupt estate where, shortly prior to our appointment, the bankrupt and her spouse obtained family law consent orders, where the spouse received valuable real property and the bankrupt received shares in a failed company.

Our investigations indicated that the bankrupt and her spouse were not genuinely separated, and it appeared that the agreement had been entered into primarily to defeat creditors. Worrells made a claim against the spouse, seeking the return of the bankrupt's half share in the real property pursuant to section 120, 'undervalued transaction', and section 121, 'transfers to defeat creditors', of the Bankruptcy Act.

The spouse settled the claim and paid the bankrupt estate an amount equal to the likely value of the bankrupt's equity in the real property.

Just dump it into superannuation
It is well known that superannuation cannot be realised by a bankruptcy trustee. This leads some misinformed debtors to believe that they can protect their assets by transferring them into a superannuation fund. If the bankruptcy trustee can show that an asset is so transferred with the intent to defeat creditors, then that is a voidable transaction under section 128B of the Bankruptcy Act.

Case Study
Worrells was appointed trustee of a bankrupt estate. Searches revealed that the bankrupt sold real property six months prior to bankruptcy. Bank inquiries identified a bank account controlled by the bankrupt in his capacity as trustee of a self-managed superannuation fund. Investigations showed that funds equivalent to the net proceeds from the sale of the property were transferred into the superannuation account contemporaneously with sale of the property. Bank account records showed us that it was the only deposit into that superannuation account for several years.

We determined that the deposit of funds from the sale of the property was a voidable transaction and, with the assistance of the Australian Financial Security Authority, issued notices to the bank requiring transfer of the funds to the bankrupt estate. The bank complied—with minimal delay.

Undervalued transaction
Another common strategy is to sell assets to a related company or entity prior to a formal insolvency appointment. Often, the consideration paid is less than fair market value, or in extreme cases, no consideration at all. These transactions are also often poorly documented, with no valuations obtained to support the sale price. Both liquidators and bankruptcy trustees have specific powers to unwind these kinds of transactions.

Case Study
Worrells were appointed liquidators of a company. Shortly after appointment we were advised that the company's business and assets had been sold to a new company with the same directors. A nominal amount of $10,000 had be paid to the old company as part of this purchase arrangement.

After obtaining the company's books and records, it became evident that the business and its assets were worth well in excess of $10,000. Worrells retained a business valuer, whose valuation report confirmed this.

Worrells made a claim pursuant to section 588FB, 'uncommercial transactions and section 588FDA, unreasonable director-related transactions seeking compensation for the business and the transferred assets. The directors settled the claim.

Diluting the creditor pool
The final common strategy we see is insolvent parties inventing related-party creditors for the purpose of influencing the voting on resolutions by creditors or to participate in dividends and recover assets that would otherwise be available to real creditors.

Case Study
Worrells were approached by a debtor to administer a Part X agreement. The agreement provided for a lump sum payment to creditors. Third-party creditors were not in favour of the proposal, but related creditors controlled sufficient number and value to control outcomes at a meeting of creditors; or so they had thought.

The related-party creditors lodged their respective proofs of debt and supporting documentation shortly prior to the creditors meeting. The bankruptcy trustee adjourned the meeting for five business days to review those claims. Upon review there were significant discrepancies in the supporting documents provided by the related-party creditors and they were not allowed to vote for the full amount of their debt at the meeting of creditors. The Part X agreement failed.

Last-minute asset protection strategies are rarely effective. The better approach when financial difficulty strikes is to meet with Worrells to work through your options within the law. Better still, consider asset protection when you start a venture or when you acquire valuable assets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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