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November 2008

Transfer of Property to Family Trust set aside

In a recent decision the Supreme Court has overturned earlier decisions of the Court of Appeal and the High Court and in doing so ordered the trustees of a family trust to transfer a half interest in a house property to the Official Assignee for the benefit of creditors of one of the settlors of the trust.

Factual Background

A company owned by a Mr and Mrs Lightbody was heavily indebted to one of its suppliers, Regal Castings Limited (“Regal”). In 1995 Regal agreed to convert the company’s indebtedness to a term loan and wrote off accrued interest. It was further agreed that the term loan would be paid by monthly instalments with a balance to be paid at the end of a five year period. As part of these arrangements Mr Lightboby accepted personal liability for the term loan. The company duly commenced making the monthly payments, but fell into arrears in relation to its ongoing trading account with Regal.

In 1998, and without the knowledge of Regal, Mr and Mrs Lightbody transferred their home, which was their only asset of significance, to a family trust of which they and their solicitor were the trustees. As is usually the case in such transactions, Mr and Mrs Lightbody initially advanced the purchase price for their property to the trust by way of a loan, which was gradually forgiven over the following five years. The practical effect of these arrangements is that the family home was transferred to the trust over the five year period without any money changing hands.

Subsequently the company was placed in liquidation at which time a substantial amount remained outstanding to Regal, including part of the term loan. Mr Lightbody was declared bankrupt.

The Court Proceedings

Unable to recover anything from Mr Lightbody personally by virtue of his bankruptcy and the company being insolvent, Regal brought an application in the High Court under Section 60 of the Property Law Act 1952 to have the transfer of Mr Lightbody’s half interest in the house set aside on the basis that the transfer of the house property was undertaken with intent to defeat creditors and as such was voidable.

Regal failed in the High Court and was also unsuccessful in the Court of Appeal where a majority of that Court had found that the transfer had not been undertaken with the necessary intent of defeating creditors.

Regal then appealed to the Supreme Court, which unanimously allowed the appeal and ordered the trustees of the family trust to transfer a half interest in the house to the Official Assignee for the general benefit of Mr Lightbody’s creditors, including Regal. The Supreme Court held that in transferring the home to the trust in 1998, Mr Lightbody had acted with intent to defeat, hinder or delay Regal’s recourse to that asset, even though he did not have the express purpose of causing Regal loss. The Supreme Court found that it was sufficient for Regal to have established that the transfer in question inevitably exposed it to the risk of loss in the event that the company was unable to pay its debts (as proved to be the case).

The Moral of the Story

Depending on individual’s circumstances, the establishment of a family trust to take ownership of a family home and other assets can be a worthwhile exercise for a variety of reasons, including the protection of assets from creditors. However, timing is of critical importance. Firstly, if a transfer of a family home to a family trust is not to be regarded as a sham, the trust must purchase the property for a proper price. Whilst the purchase price can gradually be forgiven, only $27,000.00 (per individual) can be forgiven each year without attracting gift duty. Therefore, in the case of a couple transferring their home to a family trust, the purchase price can only be forgiven at the rate of $54,000.00 per annum. In the case of a $500,000.00 home, it would take in excess of 9 years for the purchase price to be forgiven. Until such time as the purchase price has been completely forgiven, the remaining balance remains an asset of the transferor and can be subject to recovery action by creditors of the transferor. Secondly, as occurred in this case, the Lightbodys left transferring the property to the trust until such time as their business was in financial difficulty and in circumstances in which the Supreme Court unanimously found that there was an overwhelming inference that transfer was undertaken with intent to defeat creditors.

The moral of the story is that if there is to be a transfer of a family home to a family trust, such action should take place sooner, rather than later and certainly should not be left until times of financial difficulty. Transfers of major assets to a family trust, if undertaken sufficiently ahead of time, may provide protection against unexpected financial difficulties. Such transactions will not, however, provide protection when those financial difficulties have already arrived.

The transfer of property to family trusts can be a useful and prudent step. However, whether or not such steps are appropriate will depend on clients’ individual circumstances. We can assist in advising clients as to whether or not a family trust is appropriate for their circumstances and, if so, assist in the establishment of the family trust.