September 1 2009

Bankruptcy and Trusts

The present economic downturn has thrown up the problem of what to do when a settlor and/or a trustee becomes bankrupt. This article looks at possible remedies for both situations.

Bankrupt settlor

The last year has seen a number of trust settlors become insolvent. Unfortunately the present economic climate suggests that this trend will continue, at least in the short term. Bankruptcy affects any trust set up by the bankrupt particularly if the trust owes him or her any money.

Any debt owed to the bankrupt is an asset in his or her ‘estate’. As a consequence the Official Assignee has the right to take it over and demand repayment. In turn, that could force the trustees to sell trust property in order to produce the cash needed to repay the debt.

It also defeats what was probably at least one of the purposes the trust was set up to achieve, namely, securing the assets for the beneficiaries of the trust. If you want to make sure your assets are protected against business risk, our advice is it is important to complete any gifting programme promptly, to ensure that any debt owed by the trust is fully written off well before any insolvency issues arise.

Transactions intended to defeat creditors

Any gift (or other transfer at less than market value) made with the intention of defeating creditors can be set aside by the court. This is contained in ss344-350 of the Property Law Act 2007.

The court can make an order in favour of the Official Assignee, a liquidator, creditor or other person. The order can be for cash compensation or for the return of the property transferred to a third party, such as a trust. The following article on page 3 (Transfer of Assets to a Trust) on the Supreme Court case of Regal Castings Limited v Lightbody considers these issues.

What is relevant is the intention of the settlor and trustees at the time the transfer or gift is made. Any file notes, mortgage applications or other evidence of that intention will be sought out by creditors, should the circumstances arise.

As long as the settlor has sufficient other assets to pay their debts at the time a gift is made, then the gift is not likely to be seen as having been made with the intention to defeat creditors. (We would say ‘impossible’, but you are not going to get a 100% guarantee of any court result from a lawyer!)

Bankrupt trustee

Unfortunately, a bankrupt settlor is often also a trustee. Bankruptcy does not necessarily mean that person cannot continue as a trustee, however, it does depend on the terms of the trust deed.

Many deeds specify that a trustee must either resign, or automatically cease, as a trustee if particular events occur, such as mental incapacity or absence for extended periods. Some trust deeds also provide that bankruptcy leads to that same result; but many deeds do not include that provision.

The Trustee Act 1956 does not require automatic resignation or removal of a trustee in the event of bankruptcy. Rather, the court has power under s51 to appoint a new trustee or trustees whenever it is expedient to do so. Before the court can appoint a new trustee, it must first be found to be inexpedient, difficult or impracticable so to do without the court’s assistance. In other words, attempts must be made to remove the trustee, or to get him or her (or them) to resign, before an application is made to the court for such an order.

Moreover, the court would need to be satisfied that it is appropriate to remove the trustee. The mere fact of bankruptcy is unlikely to be sufficient grounds alone to allow the removal of a trustee, otherwise there would be provision in the legislation to do this.

If it sees fit, the court can appoint one or more new trustees, either in substitution for or in addition to any existing trustee or trustees.


The bankruptcy of a settlor or a trustee can have a severe effect on a trust. Obviously the best course of action is to avoid bankruptcy!

Read more about our Trusts and Asset protection services here and if bankruptcy is a possibility or is unavoidable please contact us for advice on how best to handle this from the trust’s perspective.