This unique legal structure, often used for asset protection and tax planning, comes with its own set of challenges and considerations, particularly when it comes to borrowing money from banks.
One critical aspect of this process is the requirement for personal guarantees from the beneficiaries of the trust. Here, we explore the requirements for these guarantees, the risks involved, and the potential issue that guarantors may never benefit from the trust.
Understanding Discretionary Trusts
A discretionary trust, sometimes known as a family trust, gives the trustee the discretion to distribute income and capital among the beneficiaries as they see fit. This flexibility makes discretionary trusts a popular choice for families and businesses looking to manage their assets and tax liabilities effectively.
However, this discretion also means that beneficiaries have no fixed entitlement to the trust’s assets or income until the trustee makes a distribution.
Banks and Lending to Discretionary Trusts
When a discretionary trust seeks to borrow money, banks often require additional security to mitigate their risk. One common requirement is a personal guarantee from one or more of the trust’s beneficiaries.
A personal guarantee is a legal commitment by the guarantor to repay the loan if the trust fails to do so. This provides the bank with an additional layer of security, reducing their risk in lending to a structure where beneficiaries’ entitlements are not fixed.
The Risks for Beneficiaries
For beneficiaries, providing a personal guarantee can be fraught with risks. The primary risk is financial liability.
If the trust defaults on the loan, the guarantor is personally responsible for repaying the debt. This liability can extend to the guarantor’s personal assets, potentially leading to significant financial hardship.
Moreover, there is a unique risk associated with discretionary trusts: the guarantor may never benefit from the trust despite their financial commitment.
Since beneficiaries’ entitlements are at the discretion of the trustee, there is no guarantee that a guarantor will receive any benefit from the trust in the future.
This means a guarantor could end up repaying a substantial debt without ever having received any financial benefit from the trust.
Personal Guarantees: A Necessary Evil?
While personal guarantees are a standard requirement for banks lending to discretionary trusts, they can create significant financial exposure for the guarantor.
It’s essential for beneficiaries to understand these risks fully before committing to such agreements. Seeking independent legal advice is crucial to navigate these complexities and ensure that beneficiaries are fully aware of their potential liabilities.
We can help you understand the full scope of your obligations and risks, ensuring that you make informed decisions when providing personal guarantees.
Conclusion
Banks lending to discretionary trusts often require personal guarantees from beneficiaries to mitigate their risks. However, this can place significant financial liability on the guarantors, who may never benefit from the trust due to the discretionary nature of distributions.
At ILA Australia, we are here to provide you with the independent legal advice you need to navigate these complex arrangements and protect your interests.
