The business is under pressure. The letters from creditors are getting more demanding. And the one thing you always assumed was safe, the family trust you set up years ago, is suddenly the thing you lie awake worrying about. Can they reach it?
The short answer is no, not automatically. Assets held in a properly run discretionary trust are usually out of a bankruptcy trustee’s reach, because they are not the bankrupt person’s property to lose. But that protection is not automatic, and it is not absolute. It holds or breaks on three things: who really controls the trust, whether the trust is genuine, and when the assets went in. Trusts do not magically protect assets, but they are not automatically vulnerable either.
Before we get into the law, here is how to tell if your trust is exposed:
- The control test. Does the bankrupt person effectively run the trust and treat its assets as their own? The more control, the more exposure.
- The sham test. Is the trust a real arrangement with real records, or a paper shell set up to keep assets away from creditors?
- The timing test. When did assets go into the trust? Transfers made in the years before bankruptcy can be unwound.
The rest of this page works through each one, splits the risk by who actually goes bankrupt, and finishes with a checklist you can act on.
What you need before you start
Before you can answer the question for your own trust, get these in front of you:
- The trust deed, so you can see who holds which powers.
- The names of the appointor and the trustee, and whether the trustee is a person or a company.
- The dates and amounts of any assets transferred into the trust.
- A list of distributions the person at risk has actually received from the trust.
With those four things in hand, most of what follows becomes a straightforward read of your own situation.
Are family trusts safe from bankruptcy?
Start with the principle that does the heavy lifting. When someone becomes bankrupt, their own property passes to a trustee in bankruptcy to be shared among creditors. Trust assets are different. Property a person holds on trust for other people is excluded from the pool of divisible property, so it does not pass to the trustee in bankruptcy at all.
That is why a well-run family trust protects what it holds. The assets belong to the trust for the benefit of the beneficiaries, not to the bankrupt person, so there is nothing there for creditors to take.
The same logic protects the trust when the person who controls it goes under. The bankruptcy of a trustee or an appointor does not, by itself, break the trust. The power to remove and replace a trustee is a power, not property, so it is not something creditors can seize and use.
Reference: Bankruptcy Act 1966 (Cth) s 116(2)(a); Lewis v Condon [2013] NSWCA 204.
What breaks the protection
This is where a lot of people get caught out. The exclusion protects genuine trust property, but three things can pull assets back within a creditor’s reach.
The trust is a sham. If the trust was never a real arrangement, only a front to hold assets away from creditors while the person carried on as the true owner, a court can look straight through it.
The bankrupt effectively controls it. A trust the person runs as their own alter ego, directing distributions to themselves and using the assets like a personal bank account, invites the argument that the protection is a fiction.
The bankrupt has a beneficial interest. The clearest example is a trustee’s right to be indemnified out of trust assets. That right can itself be property that passes to the trustee in bankruptcy, which is the nuance most pages miss. On its own, holding the role of trustee is not a safe harbour.
Reference: bankrupt’s own property vests under Bankruptcy Act 1966 (Cth) s 58; the trustee’s right of indemnity as divisible property, Boensch v Pascoe [2019] HCA 49.
Who is exposed: trustee, appointor or beneficiary?
Who becomes bankrupt changes everything, so it helps to take the three roles one at a time.
- The trustee goes bankrupt. The trust survives, and a new trustee can be appointed. The thing to watch is the trustee’s right of indemnity, which can be exposed even when the trust assets are not.
- The appointor goes bankrupt. The power to hire and fire the trustee is a power, not property, so it does not pass to creditors (Lewis v Condon [2013] NSWCA 204).
- A beneficiary goes bankrupt. A discretionary beneficiary has no fixed entitlement, so there is usually nothing to take. But any distribution actually paid to a bankrupt beneficiary can be claimed.
Transfers before bankruptcy: the clawback window
Even a valid trust does not protect assets that were moved in too late. A trustee in bankruptcy can unwind gifts and undervalued transfers made up to five years before bankruptcy. And a transfer made to defeat creditors can be set aside with no time limit at all.
The honest lesson is about timing. The moment to structure a trust properly is well before there is any hint of creditor trouble, not once the pressure has started. Moving assets in late does not build a wall around them. It hands a trustee in bankruptcy a reason to look closer.
Reference: undervalued transfers, Bankruptcy Act 1966 (Cth) s 120; transfers to defeat creditors, s 121.
When bankruptcy meets a property settlement
Here is the part most pages never reach, and it is the one that matters most for families. Bankruptcy is one question. A property settlement is a different question, and it can reach a trust that a bankruptcy trustee could not.
In a family law split, a court does not just look at whose name is on the title. It asks who really controls the trust and for whose benefit it has been used, and it will trace the power rather than accept the labels.
Trust assets can be treated as property if one party has such effective control that the trust is essentially their alter ego. Think appointed powers, the ability to replace the trustee, a track record of directing distributions to themselves, and using trust assets like it’s their personal bank account.
So a trust one spouse truly controls can be pulled into the property pool, even where a bankruptcy trustee could not reach it, because the two systems are asking different things. Here is what that looks like in practice.
Her husband had a discretionary family trust he assumed was untouchable. And because he controlled it and used it for family expenses, we argued it was effectively part of the asset pool, and that made a six-figure difference in the final settlement.
Control cuts both ways, though. Where a spouse is genuinely at arm’s length from a trust, the result is very different.
A wife was a discretionary beneficiary of her parents’ trust. She had no appointed power, her brother and an accountant were controllers, and there were irregular distributions for gifts, but no pattern of control or spending from the trust. We characterised her interest as a financial resource only. The overall split moved a few percentage points against her to reflect her potential benefit, but the trust stayed off the property schedule.
The dividing line is control and conduct, not the name on the deed. If you are going through a separation and a trust is in the picture, that is exactly the question our property settlement lawyers get right early.
How to protect your trust
If you want a trust that actually holds up, the work happens long before any trouble. A saveable checklist:
- Use a corporate trustee rather than an individual.
- Keep an independent appointor, not the person most at risk.
- Never treat trust assets as a personal bank account.
- Document trustee decisions and distributions as you go.
- Keep personal and trust affairs strictly separate.
- Get advice before transferring assets in, not after.
None of these is complicated on its own. Together they are the difference between a trust that protects and one that unravels the moment someone looks at it closely.
Talk it through
If a bankruptcy and a family trust are colliding in your life, or a separation is about to test one, the worst move is to guess what’s ahead. Structuring works before the pressure hits, not after, so the earlier you get clear advice the more you can protect. Reach out to us for a free discovery call on 1300 614 732. We will explain where you stand and what your real options are, whether that involves our property settlement lawyers or just a straight conversation about your trust.
Frequently Asked Questions
Are discretionary trusts protected from bankruptcy?
Not automatically, but usually yes for genuine trusts. Assets held in a discretionary trust are excluded from the property that passes to a trustee in bankruptcy, because they are not the bankrupt person’s to lose. That protection breaks if the trust is a sham, if the bankrupt effectively controls it, or if assets were moved in too late.
Can a trustee in bankruptcy take assets held in a family trust?
Generally no. Trust property is excluded from a bankrupt person’s divisible assets, so a trustee in bankruptcy cannot simply take it. They can, however, reach a trustee’s right of indemnity, any distribution actually paid to a bankrupt beneficiary, and assets transferred into the trust to defeat creditors.
Does the bankruptcy of a trustee or appointor expose the trust's assets?
No, not on its own. The trust survives if a trustee goes bankrupt, and a replacement can be appointed. When an appointor goes bankrupt, the power to hire and fire the trustee is a power, not property, so it does not pass to creditors. The trustee’s right of indemnity is the exception to watch.
How far back can transfers into a trust be clawed back before bankruptcy?
A trustee in bankruptcy can unwind gifts and undervalued transfers made up to five years before bankruptcy. A transfer made to defeat creditors can be set aside with no time limit at all. This is why timing matters: structuring a trust well before any creditor trouble is far safer than moving assets in late.
Can a bankrupt person still benefit from a discretionary trust?
A discretionary beneficiary has no fixed entitlement, so bankruptcy usually leaves nothing for creditors to take from the trust itself. But any distribution actually paid to a bankrupt beneficiary can be claimed. And if the bankrupt effectively controls the trust, that control can expose it in ways a mere beneficiary’s interest would not.
