Discretionary family trusts are common asset protection structures. Generally, when a debtor becomes bankrupt, the property of a bankrupt vests forthwith in the bankrupt’s trustee: section 58(1) of the Bankruptcy Act 1966 (Act). However, trust assets held by the bankrupt as trustee do not form part of the bankrupt’s divisible assets and are not available for the benefit of creditors: section 116(2)(a) of the Act. If the bankrupt is a beneficiary under the family trust, the trust will not make any distributions to the bankrupt as those distributions would likely become divisible assets or assessable income during the bankruptcy period.
The full bench of the High Court recently clarified when trust property will vest in the debtor’s trustee. In Boensch v Pascoe  the Court dismissed an appeal from the Federal Court by discharged bankrupt, Mr Boensch, who was claiming compensation under section 74P of the Real Property Act 1974. Mr Boensch claimed that Mr Pascoe (the trustee in bankruptcy) had lodged a caveat over the title to property in Rydalmere owned by Mr Boensch as co-trustee of a family trust without reasonable cause. The caveatable interest claimed by Mr Pascoe in the Rydalmere property was a ‘Legal Interest pursuant to the Bankruptcy Act’.
The High Court concluded that “there is no reason to doubt that, upon the making of the sequestration order, the Rydalmere property vested in equity in Mr Pascoe by reason of Mr Boensch’s right of indemnity and, therefore, that Mr Pascoe had a caveatable interest in the property…….. On the facts as found, Mr Pascoe did not lodge or refuse to withdraw the caveat without reasonable cause”.
In practical terms, this means that a trustee’s right of
indemnity to be paid out of trust assets for costs incurred in administering
that trust, such as rates, mortgage payments and utilities, is a sufficient
interest to cause the trust property to vest in the trustee in bankruptcy. In
other words, the trust can be attacked.Circumstances where property would not vest in
the trustee in bankruptcy are if the trust had no debts or expenses or if debts
and expenses accrued but went unpaid for the bankruptcy period or if the
trustee had no right to be remunerated out of the trust assets.
 HCA 49