A key principle which is critical to understand in any asset protection exercise is the difference between limited liability and the ‘domino effect’.
Put simply, limited liability is the protection that is provided by trading through a company structure, either in its own capacity or in its capacity as trustee of a trust.
Specifically, the exposure for any claim which may be made against the company is usually limited to assets of the company and not the underlying shareholders or directors.
This is particularly relevant for the trustee of a trust, as a trust is not a separate legal entity at law and the trustee carries the responsibility (and liability) for any actions undertaken by the trust.
The principle of limited liability is subject to some important exceptions.
A shareholder may still be personally liable if they have unpaid or partly paid shares (to the extent of the unpaid amount on those shares) or if they have provided a personal guarantee for a company’s debts.
A director can be liable for a company’s debts in a wider range of situations, including:
- Where they have personally guaranteed the company’s debts
- Where they have been personally negligent
- If the company has been insolvently trading
- In relation to some tax debts, such as unpaid PAYG or SGC amounts
- Where there is a breach of workplace health and safety obligations
While there may still be personal liability for the individuals in these limited circumstances, the use of a company still provides significant asset protection.
Consider for instance a scenario where a discretionary trust operates a business and is sued for breaching a supplier contract.
If the trust has an individual trustee, then that individual would be the party being sued (in their capacity as trustee for the trust) and if the trust’s assets were insufficient to satisfy the claim, their personal assets would be exposed.
By contrast, where the trust has a corporate trustee, if the trust’s assets are insufficient to pay the claim then the directors would have the ability to liquidate the company.
The directors would typically not have any personal liability, provided they acted promptly to avoid an allegation of insolvent trading and the claim did not fall within any of the other exceptions listed above.
In light of the significant protection provided by a company’s limited liability and the comparatively nominal cost of establishing a trustee company (typically less than $1,000), the conservative approach is to ensure a corporate trustee is appointed whenever a client establishes a trust.
For further information, please contact Patrick Ellwood on 0400 503 111 or patrick@cloverlaw.com.au.
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