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It is reasonable and ethical for architects to ensure that their practice is covered by a level of professional indemnity insurance which is appropriate for the value of the projects their firm undertakes. Architects should also consider protecting their personal assets, including their family homes, from claims by undertaking some reasonable asset planning. Expert advice will need to be sought to both setup & maintain the operation of a discretionary trust and one’s asset management strategy.
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What is asset planning?
The objective of asset planning is to minimise the assets of a person that will be available to satisfy a successful legal claim against the person (eg for professional negligence). This can be done in a number of ways. One is for a person to transfer their assets to, or have their assets held in, the name of their spouse/domestic partner or a discretionary trust. Note however, that if the person has insufficient assets (and insurance) to fully satisfy a claim, the person may be bankrupted. Bankruptcy can have adverse consequences, both professionally and personally. Moreover, in certain cases, some asset planning steps undertaken before bankruptcy can effectively be reversed under bankruptcy laws (see below).
Asset planning involves complex legal, tax and financial issues. Some of those issues are touched on below. Before deciding which person or entity should hold an asset you are considering acquiring, or before making any changes to the way your existing assets are owned and held, you should seek timely advice from a suitably qualified and experienced lawyer, accountant and/or financial adviser.
What is a discretionary trust?
The legal owner of assets held in a trust is the trustee. A discretionary trust is a form of family trust set up by many professionals. The trust is described as 'discretionary' because the possible beneficiaries are any one or more of a large class of beneficiaries. The usual beneficiaries are spouses/domestic partners, their children, grandchildren, parents, brothers and sisters. An individual beneficiary has no entitlement to any of the income or capital of the trust until the trustee decides that, at a particular time, a share of the income or capital will be paid to that specific beneficiary. This means that, in the event of a claim against a beneficiary, the trustee may simply decide not to allocate any further income or capital to that beneficiary, but to other family members.
Should the discretionary trust run the business or own the assets?
Where a claim is made that an architect has been negligent, it can be made against the owner of the architectural practice (which may be a company or a trust), but it may also be made against the individual architect who it is alleged carried out the negligent work. If the actual architect carrying out the work has been negligent, then they will be personally liable and, accordingly, it is better to have the discretionary trust owning the assets to be protected rather than operating the business.
Are there any disadvantages?
A discretionary trust usually has a company as the trustee. Lawyers’ and accountants’ fees will be incurred in incorporating and registering the company, and for the preparation of a trust deed and ancillary documents. There are continuing obligations to prepare income tax returns for the trust, and pay annual review fees to the Australian Securities and Investments Commission (ASIC) for the trustee company. Furthermore, if existing real estate or shares are to be transferred to the trust, then stamp duty will be incurred and capital gains tax may apply. If both spouses/domestic partners are at risk, then the family home may be transferred to the trust, but it would lose its exemption from capital gains tax. An exemption from land tax may also be lost. If one spouse/domestic partner is not at risk, then the family home could be transferred from joint names into the name of that spouse/domestic partner.
Who should the trustee be?
To be effective, the trust must be kept at some distance from the professional and their spouse/domestic partner. It is common for the trustee to be a company in which a small number of shares are issued in the name of each spouse/domestic partner. The real control of the discretionary trust resides with the 'appointor' or 'guardian' of the trust who has the right to remove the trustee and appoint a new one.
When should asset planning be implemented?
It is not wise to wait until trouble is likely as protection is not immediate. Certain assets can be traced, particularly where it is apparent that a person has shed assets in an attempt to avoid paying creditors. In particular, the Bankruptcy Act 1966 (Cth), allows a trustee in bankruptcy to recover assets acquired by the bankrupt using their resources, but transferred to a third party prior to bankruptcy. A central feature is the bankrupt's purpose in making a transfer. If the main purpose was to avoid, hinder or delay the payment of debts, the transfer will be void and the assets will be ‘clawed back’ by the trustee in bankruptcy and used to pay creditors.
The above claw-back provisions do not affect genuine sales to purchasers who have paid full value. Also exempted are transfers of assets made by the bankrupt without the purpose of defeating creditors, at a time when the bankrupt was solvent, to unrelated persons or entities occurring more than 2 years before bankruptcy, or to related persons or entities (eg to a spouse/domestic partner or family trust of the bankrupt) occurring more than 4 years prior to bankruptcy. Transfers of assets made by the bankrupt without the purpose of defeating creditors which occur more than 5 years before bankruptcy are not caught.
Where planning takes place well before a possible claim, and new assets are purchased in the name of the trust which have never before been owned by you, protection is maximised.
Disclaimer
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