How to protect family interests in real property?

It’s becoming increasingly common that parents provide financial assistance to their adult children to purchase real property. In the unfortunate event that their adult children were to later be declared bankrupt, how can parents protect their interests in that property?  And can parents keep the property within the family?

When a person is declared bankrupt, he or she loses control of their assets to their trustee in bankruptcy (except for those which are exempt pursuant to relevant provisions of the Bankruptcy Act 1966 (“the Act”). The assets may be sold by the trustee for the benefit of the bankrupt estate. This is what it means when trustees in bankruptcy say the bankrupt’s assets “vests” in them and that they will “realise” the assets for the benefits of creditors.

Unfortunately, the family home or any other real property owned by a bankrupt doesn’t normally fall within the “exempted assets” category and therefore it “vests” in the Trustee of Bankruptcy upon his or her bankruptcy.

There are a number of options parents may consider to protect their interest in their children’s property (i.e. funds advanced for the purpose to purchase the real property).  These include the following:

Parents may consider lodging a caveat over the real property to protect their own interest. A caveat is a legal document lodged to provide notice of a legal claim to a real property. So long as a valid caveat remains registered on a title, no other transactions can be registered against the title until the caveat is resolved.

However, please note that not just any creditor can lodge a caveat over real property owned by the debtor. This can only be validly done by someone who has advanced money to the registered owner and the owner has granted a caveatable interest to the lender over that property. It is therefore recommended that parents engage lawyers to prepare a formal funding or loan agreement to be entered with their children to ascertain their caveatable interest, then prepare and lodge a caveat accordingly with the land title office.

Scenario:

  • Mother assisted daughter to purchase the daughter’s first home and advanced her $150,000.
  • Both parties had agreed that the funds advanced is considered a loan secured against the property and it would be repaid by the daughter over a period of time.
  • This agreement was documented by way of a loan agreement which was prepared by their lawyers. Upon the execution of the loan agreement, $150,000 was advanced by the mother to the daughter.
  • Regrettably, five years after the daughter purchased the property, she was declared bankrupt.
  • Over the last 5 years, the daughter had only managed to repay $50,000 to her mother. The amount owing to the mother as at the date of bankruptcy was therefore $100,000.
  • At the time of bankruptcy, the property has a net equity in the amount of $100,000, calculated as below:
Market Value of the Property $500,000
Less:
Mortgage $300,000
Money owing to Mum $100,000 (protected by valid caveat)
Net Equity $100,000

Possible outcomes:

  • Mum preserved her interest and will be paid $100,000 (the outstanding balance of the funds advanced) from the sale proceeds if the Property is sold by the Trustee.
  • Alternatively, subject to her financial capacity and willingness to assist the daughter, mum may consider making an offer to purchase the net equity of the property (i.e. $100,000) from the bankruptcy trustee and prevent the daughter’s home being sold on the market.

Pursuant to s116(2)(a) of the Act, the property held by the bankrupt in trust for another person is exempted and does not vest in the bankruptcy trustee.

This means that if children merely hold the legal title of the property on trust and the parents have the actual beneficial ownership of the property, the property may not vest in the bankruptcy trustee in the event of bankruptcy.  However, it is crucial that this arrangement is properly documented at or before the time of the purchase of the property. Again, it is recommended that a lawyer be engaged to prepare the relevant agreement for both parents and children to sign.

What if there was no formal agreement entered and a property has been bought by parents in the name of their children? Parents may wish to speak to a lawyer who is specialised in trusts and have a trust agreement prepared and executed as soon as possible. Parents may wish to consider the abovementioned first option by lodging a caveat over the property to protect their interests in the property.

Scenario:

  • Parents fully funded the purchase of a studio apartment for their son to live in. It was agreed that the son would hold the title of apartment on trust for the parents and the son would pay rent to his parents.
  • The above agreement was documented when the property was purchased – a trust agreement was prepared by the parent’s lawyers and signed by the parents and the son.
  • The son has lived in the apartment and has been paying rent to his parents monthly by bank transfer.
  • The parents have recorded rent income in respect to this studio apartment in their tax returns.
  • The son has had gambling issues and was made bankrupt 5 years after the studio apartment was purchased.
  • It is noted that the property is held by son on trust for the parents, therefore it is protected property (i.e. it does not vest in bankruptcy trustee).
  • There is sufficient documentary evidence proving the apartment is property held on trust by the son for the parents.

Outcome:

The property is protected from creditors and stays within the family.

The two scenarios above are typical scenarios where contemporaneous records were kept:

  • there were written agreements prepared by lawyers and signed by both parents and children at the time they purchased property; and
  • payments were made by bank transfers, not cash. There were bank statements showing these transactions.

Scenario:

  • Parents provided their son with large sums of cash over a period of time. The son used these funds to partly fund his purchase of a house.
  • The son is the sole owner registered on title of the property.
  • The son later became bankrupt.
  • The property vests in the bankruptcy trustee and it is the Trustee’s duty to sell the house for the benefit of creditors.
  • The parents objected to the trustee selling the house asserting that at least part of the house was held by their son for them on trust because part of the cash they advanced to the son was used to purchase the property. There was no written documentation provided by the parents, nor the son, in support of such assertion.

Outcome:

Due to the lack of evidence (i.e. no documentary evidence showing the parents advanced funds to the son to purchase the house, no written agreement between the parents and son evidencing the trust, no other documentary evidence showing the intention of a trust at the time of purchasing the house), the property vests in the bankruptcy trustee and the trustee proceeded to sell the house.

Generally speaking, more often that it is too late once a bankruptcy process starts to keep property owned by the bankrupt away from the trustee in bankruptcy. It is therefore recommended measures, like the ones suggested above, are taken to protect family interests in real property when it is first acquired. Finally, seek assistance from qualified legal professionals.

Want to know more?

If you would like to know more about the issues raised in this article, please contact Louisa Sijabat our Insolvency & Reconstruction Director for assistance.

An Important Message

While every effort has been made to provide valuable, useful information in this publication, this firm and any related suppliers or associated companies accept no responsibility or any form of liability from reliance upon or use of its contents.  Any suggestions should be considered carefully within your own particular circumstances, as they are intended as general information only.

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