Following on from our previous article, the second aspect of asset protection which is critical to understand is the ‘domino effect’.
The ‘domino effect’ occurs where a single entity owns multiple assets. In the event that a claim is made against that entity in relation to one specific asset, the single ownership means all of those assets are exposed.
The most common examples of the ‘domino effect’ in practice are:
- A trust owns multiple investment assets, including investment properties, a share portfolio and a partnership interest in a business. If a claim is made against the trustee in relation to one of those assets (say, a ‘slip and fall’ claim by a tenant of an investment property), then all of the assets of the trust are exposed and may be lost
- A company operates a trading business and has substantial retained profits on its balance sheet. In the event a claim is made against the company, all of the retained profits are exposed. By contrast, if steps had been taken to declare those retained profits as a dividend to the shareholder (and potentially lent back to the company as working capital under a secured loan agreement), the amount declared as a dividend would be protected.
Managing the ‘domino effect’ for a client’s assets requires some pragmatism.
The optimal outcome from an asset protection perspective would mean that every asset which carries a degree of risk for the owner (i.e. all asset classes other than cash and passive investments such as shares/bonds) would be owned in a separate investment vehicle.
In a practical sense, the administration expenses and professional costs of having each asset in a separate entity are usually uncommercial to incur, so compromises need to be made.
There may also be tax drivers which necessitate having multiple assets in a single structure, such as a desire to ensure tax losses can be utilised effectively by offsetting losses from some assets against income or gains from other assets.
The ownership of assets should therefore be determined by balancing the cost effectiveness and simplicity of having all assets in a single structure with the asset protection benefits of having each asset owned separately.
Depending on the client’s risk tolerance, this may mean ‘high risk’ assets, such as businesses, are owned in separate entities while lower risk assets are owned together.
Another approach is for the client to determine their risk threshold and ensure a new structure is established each time that threshold is reached.
For instance, if their threshold is $1 million per claim, they would acquire up to $1 million of assets in a single trust and then establish a new trust for future acquisitions, once that threshold is met.
This approach effectively ‘caps’ their exposure in relation to a single claim at the value of the assets in that particular trust.
An effective asset protection structure will need to balance the often-competing objectives of limited liability, the ‘domino effect’, cost consciousness, administrative simplicity and tax effectiveness.
For further information, please contact Patrick Ellwood on 0400 503 111 or patrick@cloverlaw.com.au.
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