Asset Liability and Protection - Essay Example

17 May 2008 ASSET LIABILITY AND PROTECTION INTRODUCTION An asset may be defined as a probable future economic benefit obtained or controlled by a particular entity, who or which is denoted as the owner of that asset, as the one who hopes to benefit from it. An important consideration for many people contemplating the purchase of shares, property, a business or other types of assets is asset protection and the mechanisms through which personal assets may be protected in the event of bankruptcy or liability. In terms of financial accounting, a liability may be defined as an obligation towards any entity, which may arise out of past transactions or events, the settling of which may involve in transferring and usage of one’s assets, providing services or other economic benefits. A liability is not necessarily legally enforceable, but most probably will be based on equable or constructive obligations in terms of future projects or transactions. Asset protection, on the other hand, denotes immunity from asset liability. This may be called as protecting one’s property from legal or monetary claims, problems and taxes during life and even after death of the asset “owner”. It is a form of financial “self-defense” which places one’s assets beyond reach of the creditors. Traditionally, there have been two major strategies employed to protect personal assets, namely, gifting and the use of trusts Asset protection, though legally justified in terms of its owners, is not morally rationalized when viewed on behalf of the creditors. Asset protection, thus, is a method, by which an individual or an entity, protect their assets, through procedures such as having layers of multiple entities by which the actual perpetuator always remains anonymous, and therefore, unaccountable, for their assets, or by having trusts and insurances. This article aims at identifying and zeroing in upon the logical fallacies and loopholes in the current system of asset liability and asset protection in Australia, if any, and the reforms necessary to correct the same. ASSET PROTECTION (AussieLegal, 2003 – 2007) It has now become almost an undeniable reality that one will be sued for something or the other during his/her lifetime. And in most cases, this type of lawsuit involves asset liabilities. Asset protection has thus become a necessity. Asset protection is no longer a luxury to be afforded to the very rich.  It has become a necessity for upper middle class and even middle class.  Simply put, asset protection devices are strategies and legal structures designed to put one’s assets out of reach of creditors and business partners. The top asset protection devices:  1. Annuities 2. Life Insurance 3. Offshore Corporations 4. Trusts 5. Gifts to spouses 6. Shares 7. Corporations (In limited situations) In light of recent legislative changes and decisions of the Australian Courts, these asset protection schemes are now examined in order to arrive at the logical fallacies in their structures and to determine what kind of reforms are necessary in the laws of Australia to overcome the same. BANKRUPTCY ACT The Bankruptcy Act of Australia was enforced in 1966 in order to protect investors and creditors from the liabilities arising due to bankruptcy of their company or sponsored agency or individual. There have been numerous amendments made in the act since then in order to improve its logicality and prevent any loopholes. But even then, we see from the following example that further changes are necessary in order to protect everyone’s interests and prevent cons of any kind. The sample case: The case was filed against Mr. X did not lodge any income tax returns during his 45 year career as a barrister and was declared bankrupt in 2000, owing unsecured creditors in excess of $1 million. The major creditor was the Australian Taxation Office (ATO). In 1987, Mr. X did give away two gift deeds. He had transferred his legal and beneficial interest in the family home to his wife. Mr. X and his wife had originally purchased the property as joint tenants in the 1970’s. On the same date he also transferred to his family trust 6000 shares in a Sydney barrister’s chambers he occupied. The transfer was considered a "gift” as Mr. X received no consideration for each transfer. The bankruptcy trustee challenged the validity of the two transactions, applying section 121 of the Bankruptcy Act. This section allows a bankruptcy trustee to get back certain gifts of property if the main purpose of the gift is to put the asset beyond the reach of creditors or to hinder or delay the creditors in obtaining the asset. This purpose is taken as established if the person making the gift was, or was about to become, insolvent at the time of the gift. “The High Court considered whether Mr. X was solvent at the time of the transfers in 1987, and in particular whether Mr. X had a taxable income. The High Court determined that Mr. X’s appointment as a Queens Council, in addition to his ownership of shares and property and the lack of any evidence that he had been financially supported by his wife, was sufficient evidence that Mr. X had been in receipt of a taxable income at the time of the transfers. In the absence of proof of a taxable income, it could not be assumed that Mr. X had arranged his affairs to defeat creditors. The High Court concluded that Mr. X’s purpose in transferring his assets in 1987 was to make his property inaccessible to creditors, and accordingly ordered Mrs. X to transfer her husband’s half share in the property to the bankruptcy trustee. Mrs. X had argued that, because she had contributed 76.3 percent of the purchase price for the family home, it followed that she should be obliged only to transfer the remaining 23.7 percent to the bankruptcy trustee. The High Court rejected this view, instead applying a long-standing legal presumption that where spouses to a marriage contribute to the acquisition of a property then, in the absence of contrary evidence, it is to be taken that they intended to be joint beneficial owners.” (PriceWaterHouseCoopers Legal, 2008). There is a logical fallacy in respect of de facto spouses, a consequence of this decision is that there is a presumption a bankruptcy trustee will likely be able to recover one half of the value of the matrimonial property even if the property is wholly registered in the name of one spouse, notwithstanding the extent of that spouse’s contribution to the purchase price. Inference: The couple, thus, had foreseen this “bankruptcy” of Mr. X and had taken ample measures to protect themselves against the same. Though, they are legally entitled to protect their money, this cannot be done at the expense of other tax payers. Thus it is the duty and obligation of the system and the laws to prevent such misuses of the loopholes in the current law system, and to make sure the creditors are rewarded aptly. Asset protection schemes and devices, such as the “gift” system used here cannot be used to evade taxation and debts to investors and creditors. It lies with the legal system to prevent such occurrences in the future. May 2006: amendments to the Bankruptcy Act It became obvious to us from the afore said example that amendments were necessary to remove the fallacies against the trustees in the Bankruptcy Act in order to further immunize it to protect trustees. Amendments to the Bankruptcy Act were made on 31 May 2006 to further strengthen the ability of bankruptcy trustees. The provisions gave power to the trustee to recover property owned by a spouse or a family trust, in circumstances where the bankrupt either previously owned the property or substantially funded its acquisition. “The main amendments were made to sections 120 and 121 of the Bankruptcy Act, in addition to the inclusion of a new section 121A(PriceWaterHouseCoopers Legal, 2008). These changes include: Provision for voiding a transfer of property in circumstances where the transferee should, or should reasonably have inferred, that the bankrupt person’s main purpose in making the transfer was to defeat creditors Creating a rebuttable presumption of insolvency where a bankrupt carried on business and failed to maintain proper books, accounts and records, and Conveying on the bankruptcy trustee a right to recover property from a third party where a person who later becomes bankrupt has transferred property for consideration to a transferee, but directs that the consideration be paid to the third party. In such circumstances, the legislation deems that the property was transferred from the bankrupt to the third party, and allows a bankruptcy trustee to recover the consideration from the third party.” (PriceWaterHouseCoopers Legal, 2008) Another amendment made to avoid the fallacies in section 121 provides that, when a bankrupt transferor has transferred property to a spouse, any grant by the transferee spouse to the transferor of a right to live at the transferred property, will not amount to valuable consideration unless the grant relates to an agreement or a transfer or settlement of property under the Family Law Act of 1975. .” (PriceWaterHouseCoopers Legal, 2008) July 2006: proposed further amendments to the Bankruptcy Act On the 27th July 2006, the Attorney General announced further enforced some more amendments to the Bankruptcy Act which will allow a Court to consider whether a bankrupt person’s historical superannuation contributions are of a nature that may be considered "out of character”, in order to determine whether the contributions were made with the intention to defeat creditors (PriceWaterHouseCoopers Legal, 2008) “The amendments will allow a bankruptcy trustee to recover the value of contributions made by: the bankrupt to their own superannuation plan or to a third party to defeat creditors, or a person other than the bankrupt for the bankrupt’s benefit where the bankrupt’s main purpose is participating in the arrangement to defeat creditors.” (PriceWaterHouseCoopers Legal, 2008) Thus, the Bankruptcy Act is not yet perfect. It needs constant polishing and re-structuring in order to accomplish its purpose of providing justice for all concerned in a manner which is both logical as well as just. TRUSTS AND TRUSTEES Background: The “Westpoint Case” The case, ASIC v Carey, arose out of the litigation over the collapse of the Westpoint group. Australian Securities and Investment Commission (ASIC) filed case against the directors of the Group, on 20 April 2006, the Federal Court granted ASIC orders permitting it, amongst other things, to appoint receivers to secure and preserve the assets of certain directors of the Group. At ASICs request, the Court appointed receivers over the property of a number of directors and companies in the Westpoint group (pending the outcome of further proceedings). “Following the grant of these orders by the Federal Court, ASIC sought to amend the orders to bring into their scope property held by a third party as a trustee for any trust in which a director of the Group was a beneficiary. Pursuant to s1323 of the Corporations Act, ASIC sought orders that the "property” includes property held by a third party: as trustee for a trust, where an individual defendant is the beneficiary of the trust, including in respect of discretionary trusts, and On behalf of a superannuation fund, where an individual defendant is a beneficiary of the superannuation fund.” (PriceWaterHouseCoopers Legal, 2008) “Under the Corporations Act "property” includes any legal or equitable estate or interest (whether present or future and whether vested or contingent) in real or personal property of any description and includes a thing in action” (PriceWaterHouseCoopers Legal, 2008). Using this description, ASIC sought, in particular, to obtain from the order, to include property held by third parties who were trustees for any trust of which the defendants were beneficiaries. In a nutshell, ASIC ambitiously sought to expand the range of property of those directors to which receivers could be appointed under section 1323(1)(h) of the Corporations Act 2001 (Act) and also sought to argue that the defendants interest as beneficiaries of these trusts amounted to "property" for the purposes of the Act. In Judgment the Judge distinguished between “cases where the individual defendants had a mere hope of receiving a distribution from the trust and where it was reasonable to conclude that the defendants would be able to materially influence the trustee’s decisions. In particular, where the individual defendants were beneficiaries of a discretionary trust and were directors of the corporate trustee, or they or their relatives had the power to appoint the trustee, Justice French found that this amounted to effective control sufficient to characterize their interests under the trust as "property” within the meaning of the Act. Any such property would therefore fall within the scope of the property available to the receivers to secure and preserve” (PriceWaterHouseCoopers Legal, 2008). The judge thus accepted the traditional view -- contrary to ASICs ambition but then made an important leap in his reasoning. The collapse of the Westpoint Property Group ("Group”) received significant amount of media attention for over 6 months Justice French ruled that when some individual or entity hopes or “expects” to benefit from a trust or other source, it becomes something of a property of the concerned entity or individual. This represents a significant leap in the way of thinking of the law governing these situations. This is now explained in detail below. By tradition, a beneficiary of a discretionary trust would not be considered to” hold an interest that amounted to property for the purposes of the section 9 definition. Instead, in most cases, a beneficiary would have an "expectancy" which is not sufficiently certain or proprietary in nature to amount to "property"”(Cleardocs, 2001). Judge’s Perception And Reasoning Of the Case: The Judge used the following facts to determine the legality of expectancy of the beneficiary through following facts and reasoning. 1. “Facts: A family trust with: a defendant as a beneficiary, and a director and a secretary of the trustee company (along with his wife), and a trust deed that conferred wide discretion to distribute to one beneficiary to the exclusion of others. Judges reasoning: The defendant had effective ownership of the trust property for the purposes of the Act. 2. Facts: A trust: with a defendant as current trustee and a member of an open class of beneficiaries (with other family members and a range of charities); and in which the defendant had a discretion to distribute 39% of the income or capital to any beneficiary. Judges reasoning: The defendant had effective ownership of at least 39% of the trust property for the purposes of the Act. 3. Facts: A trust with: a defendant as one of an open class of beneficiaries the defendant having the power to remove and appoint new trustees. Judges reasoning: The defendant had at least a contingent interest in the property of the trust, if not a general power of selection that approached ownership of trust property for the purposes of the Act.” (Cleardocs, 2001). According to the Judgement” if the beneficiary effectively controls the trustees power to make distributions, then the beneficiary has something approaching a proprietary interest in the trust property for the purposes of the Act. That is, if the trustees of the discretionary trusts were alter egos of their beneficiaries (or otherwise subject to their effective control), then the beneficiaries would have an interest for the purposes of the section 9 definition. If so, then a receiver order could be made over the trusts property”( Cleardocs, 2001). The decision of the Federal Court in the Westpoint litigation holds particular significance in respect of removing the fallacies in asset protection strategies involving discretionary trusts. The decision provides method for shielding assets from creditors must be questioned when a person, the subject of receiver orders under the Corporations Act, is a “beneficiary under a discretionary trust and has an interest in the trust sufficient to characterize it as "property” within the meaning of the Corporations Act. Trusts, though a relatively useful tool for asset protection, must not be used for the wrong purposes. They should continue to be effective and a popular device for the same, at the same time being answerable to prosecution. Therefore, in order to ensure the continuing effectiveness of gifting as a method of asset protection, individuals should give careful consideration to ensuring the following matters are satisfied: solvency at the point of making a gift (able to pay debts as and when they fall due) no circumstances existing at the time of making the gift which may ultimately result in the imposition of a significant liability, and The keeping of usual and proper financial records, if carrying on a business. In summary, while gifting and the use of discretionary trusts should continue to remain popular and effective methods of asset protection, greater consideration should be given to the financial circumstances existing at the time of making a gift and, in relation to the use of discretionary trusts, the structure and characterization of such trusts. ”(PriceWaterHouseCoopers Legal, 2008) IMPORTANCE OF ASSET PROTECTION Asset protection is extremely important nowadays in order to safeguard one’s hard earned money from money grabbing creditors and lawsuits and litigations. In many cases, it even becomes important to be safeguarded against sudden changes in taxation laws and estrangement of marriages. Under such volatile conditions, in order to not be taken for granted or made a fool of, asset protection becomes inevitable even for middle class families and individuals. Thus, various forms of asset protection have now come into play, the majority of which were listed earlier. There are also many other asset protection devices and strategies that a qualified attorney can help one with.  Not every one of the above asset protection devices will protect everyone in every occasion.   To start an asset protection plan one should sit down and speak with an attorney who is qualified in asset protection, collection law and bankruptcy law.  Normally only an attorney who has seen how creditors will attack one’s assets can give the required knowledge needed to protect one’s assets. That being said, it can sometimes be very difficult to find an attorney who is competent in asset protection strategies and techniques.  In all honestly there are few attorneys throughout the country who concentrate solely on asset protection (Navado Lawyers and Solicitors, 2001). On the other hand, there are numerous agencies and financial advisors working for corporations, who can advise Professionals and other individuals in relation to Asset Protection and Estate Planning type matters. These agents would have established Discretionary Trusts for individuals; and can advise them in relation to Taxation treatment of such Trusts. They can help one in “bankrupting” a person who is indebted to one, and who refuses to pay. They also advice professionals related to establishing and running of Unit Trusts, and on operating them as Service entities. They also help in arranging Powers of Attorney or Wills that are ‘asset-protection’ conscious. Most of these agencies are familiar with commencing Applications filed in the Insolvency Trustee Service of Australia (ITSA) and following through with Bankruptcy Proceedings in the Federal Court of Australia. CONCLUSION Thus we see that asset protection devices are mandatory in order to save one’s money and savings from prosecution and take over. The assets can be protected against laws and taxes by a variety of methods. These methods have been examined critically with respect to the Australian Laws. But these asset protection devices are not without their disadvantages. As has been seen through a couple of examples, these are often used by individuals or entities to ‘escape’ payment to creditors and to evade taxation from the government, against the laws. The logical loopholes in the taxation system and legal proceedings have to be filled. Inherent unfairness to creditors in these laws has created many lawsuits and legal ramifications. The logical fallacies inherent in current Australian laws which permits company directors and officers to evade liability using asset protection devices have to be reformed and measures for the same have been suggested. WORKS CITED “Asset Protection Law/Estate Planning Law/Bankruptcy Law”. Navado Lawyers and Solicitors. 2001. 16 May, 2008. < http://www.navado.com.au/Practice-Areas/Asset-Protection-Law-Estate-Planning-Law-Bankruptcy-Law/> “Asset Protection: the ground rules are changing”. PriceWaterHouseCoopers Legal. 2008. 16 May, 2008. “AussieLegal – Free Australian Legal Information”. AussieLegal. 2003 – 2007. 16 May, 2008. “Discretionary Trusts: Challenge to asset protection role”. ClearDocs. 16 May, 2008. < http://www.cleardocs.com/clearlaw/trusts/asset-protection-outcomes-challenged> “Glossary of Estate Planning/Asset Protection Terms”. DIY Asset Protection. 2008. 16 May, 2008. < http://www.diyassetprotection.com/estate-planning-glossary.html> Read More