Legend (okay, Wikipedia) has it that the history of trusts in English common law can be traced back to the crusades, where Knights who were off freeing the Levant from the Muslim hordes left their estates in the hands of trusted relatives or other faithful custodians. When the Knight returned, often these individuals turned out to be not so trustworthy or faithful, and the Knights had to petition the King in order to establish that their lands had been held ‘in trust’.
Today, of course, trusts are contrivances used for all manner of complex reasons, and the most complex is the ‘trading trust’. I am unsure who can claim the credit for this idea but the concept is reasonably simple.
A trust is not a legal entity in itself. A trust is where an asset is held by someone for the benefit of someone else. If you give $100,000 to your lawyer to pay for your child’s education this money does not belong to your lawyer. He will not declare it as income. It is held ‘in trust’. The same is true with the family home being held in trust for the benefit of young children (and not to defeat creditors of Mum and Dad should they be sued and made bankrupt!).
Because a trust is not a legal entity there must be a trustee who holds the assets in their name. Usually this is a person but it does not have to be. It can also be an incorporated society, a limited liability company or even a law firm.
A trust can do more than just hold assets, it can actively trade. Some business people do just this, running their businesses as ‘trading trusts’ rather than limited liability companies. Rather than being the trustees themselves and risk personal liability for the trusts’ debts, they make companies act as the trustees.
They do this for two reasons:
- The Companies Act has consequences for company directors who act recklessly
- The debts of the trading trust are legally incurred by a limited liability company.
The brilliance of this idea is that if the trust cannot pay its debts, then the trustee company becomes liable. The trading trust can simply fire the old trustee company and appoint a new one, leaving creditors chasing a shell company. Whilst there are remedies available to a determined creditor the cost is usually prohibitive.
There is virtually no valid reason for a business to be run as a trading trust. They should be treated with the same caution as Nigerian princelings seeking help liberating their uncle’s money. The primary reason business people do this is to structure their affairs to limit their own exposure at the expense of their creditors. If you trade with such an entity, that creditor is you.
As a matter of policy a growing number of businesses in New Zealand are refusing to do business with trading trusts or demand personal guarantees from those involved if they do so, and this is a prudent business practice.