Family Business Succession and Asset Protection

This is one of an ongoing series of 10 articles on this topic. This article is the eighth in the series, and follows on from Succession to the Third Generation, Transitioning the Current Generation out of the Business, Employment and Equity in Succession to the Next Generation, Sale of the Business as an Option in the Succession plan, Succession Planning: How to Bring Non-Family Members into the Business, How to Create a Succession Plan and Understanding Business Structures for Succession & Asset Protection.

One of the key objectives in the succession planning process is to protect assets, shielding them from claims on death, divorce and debt.

Assets which can be claimed on death, divorce and debt are:

1. assets in the sole name of an individual, including assets of a business run by a sole trader, or in partnership, and debts due to the individual (for example from companies and trusts); and
2. a share of any assets held jointly as tenant in common.

Assets owned jointly, as joint tenant, are not estate assets on death; they pass automatically on death to the surviving joint owner, and therefore cannot usually be claimed on death in an inheritance /estate/testator’s family maintenance (TFM) claim, but can be claimed on divorce or by a trustee in bankruptcy.

Superannuation death benefits can be taken into account on divorce, but will not form part of the estate susceptible to a TFM claim if directed by nomination, not to the Legal Personal Representative, but to certain eligible individual dependants.  Life insurance can also be nominated to prevent it from falling into the estate on death.

NSW has unique “notional estate provisions” applying to NSW domiciled individuals and property in NSW, which provide that assets, which have been transferred out of the estate within 3 years of death, without full consideration, to another individual or a trust, are assets which remain subject to a TFM claim.  The NSW provisions can also claw back into the estate, for a TFM claim, assets which the deceased controlled but did not direct into the estate, such as super, life insurance, trust assets which the deceased could have appointed to himself before death, and assets held as joint tenant.

Various company and trust structures have traditionally been used to attempt to protect assets, particularly family businesses.  Company assets are owned by the company, not the shareholders, and trust assets are owned by the trustee of the trust, not the potential beneficiaries.

If an individual is a majority or sole shareholder of a company, and is declared bankrupt, the trustee in bankruptcy could control the company and potentially access the company assets.  An individual who is a director can be personally liable, for allowing a company to trade while insolvent, for example.  Shares in a company owned by an individual are assets taken into account on divorce, and fall into the estate on death.

Trusts are more complex.  Unless the NSW notional estate provisions apply, the assets of a trust cannot be claimed in a TFM claim on death.  Although no potential beneficiary of a trust has any right to demand income or capital from the trust, as distributions are at the discretion of the trustee, trust assets have (although rarely) been found to be the property of a potential beneficiary made bankrupt, where that beneficiary had control over trustee distributions from the trust. More recently, in similar circumstances, the Court has been more reluctant to find trust assets the property of a bankrupt.

Trust assets are more readily taken into account on divorce, where one or both parties to a marriage are potential beneficiaries, and where a party to the marriage has control over the trustee distributions from the trust, as trustee or director of the corporate trustee.  Even if the party to the marriage were not the sole trustee or director of the corporate trustee, if he or she were the sole appointor of the trust with power to remove and replace the trustee, that party could potentially have control over trustee distributions and the trust could be found for all intents and purposes to be the “alter ego” of that person, reducing asset protection.  The pattern of trust distributions is also considered, where the individual is a beneficiary, as to whether some or all of the trust assets should be taken into account.

To maximise asset protection, trusted independent trustees and appointors can be used.  Trust distributions should also be carefully considered, and possibly spread between individuals, so that any one individual recipient is not seen as influencing them.  Potential beneficiaries can be restricted to bloodline only.  Furthermore, in South Australia, where there is no restriction on the length of the term of a trust, trust deeds can be drafted to provide that capital assets will never be distributed, so that the business can be held for the benefit of future generations, but regular income distributions can be fixed with income units.  Control and benefit must be weighed against asset protection.

Binding Financial Agreements made under the Family Law Act 1975 (Cth), otherwise known as pre-nuptial or post-nuptial agreements, can also provide a further level of asset protection in case of relationship breakdown, when made properly and still relevant to the circumstances at the date of the relationship breakdown.

Some general, practical lessons to take from this are:

• Avoid running a business as a sole-trader, or in partnership;
• Separate trading companies from asset-holding companies;
• Review security and personal guarantees of debt;
• Consider whether an individual, who could potentially incur personal liability as a director or guarantor, should also own all or part of the family home or other family assets;
• Have adequate and proper insurance in place;
• Have a corporate trustee, rather than a lay trustee, as the trustee of a trust;
• Consider whether and to what extent any individual controls the trust, in terms of being a potential beneficiary, the trustee or director of the corporate trustee, the appointor or recipient of a pattern of distributions.  Consider a professional independent individual as director of the corporate trustee and/or appointor, and separate as much control as possible from any “at risk” potential beneficiary;
• Consider protective hybrid trusts;
• Consider Binding Financial Agreements for additional asset protection against relationship breakdown.  This is a far easier subject to broach if such an agreement is a requirement for all intended spouses under a Code of Family Business Principles/Family Charter, to protect the business;
• Consider passing control of the business on death rather than during lifetime;
• Don’t pass control of a company and forget about debts due from the company to the donor personally; and
• If there is potential for a TFM claim, look at limiting the assets forming part of the deceased’s estate.

10 ARTICLES TO ASSIST YOU IN HAVING A CONVERSATION, PREPARING AND SETTING UP A SUCCESSION PLAN

This was originally published in Australian & New Zealand Grapegrower & Winemaker.

This article is not intended to be a complete and definitive statement of the law and the information and views contained in it should not be regarded as a substitute for specific advice in individual situations. Further professional advice should be sought before applying the content of this article to particular circumstances.