Family Trusts

Family Trust Property Value Crisis: Your Obligations

Dear Reader,

Recently I received a couple of questions from a Reader who was in a difficult dilemma.   This Trustee was faced with the problem of having purchased a property on behalf of the Family Trust a couple of years ago.  The property, due to current prevailing economic conditions, had decreased in value.

To make matters worse, the Trustees borrowed money to buy the property and the interest rate on the existing loan was 10.25% p.a. The Trustees wanted to know if they had a legal duty to sell the property.

They also wanted to know if they did decide to keep the property, should they try to refix the existing loan to a new lower loan rate.

I thought I would answer these questions as I think it likely the situation being faced by this particular Trustee Reader, is being considered by many Trustees in the present time.

Family Trusts:  Your legal Duty

We need to remember Trustees have a legal duty to protect capital and assets held by a Trust.  This duty has far reaching tentacles.  For example, Trustees have a duty to ensure they invest and borrow prudently.

When deciding whether to sell a property held by a Trust, this fundamental duty has to be considered by the Trustees.  If there is no risk of foreclosure by the Bank and if Trustees can meet the monthly loan repayments, then I believe it would be best to retain the property.  I am basing my view on the belief that the property market is not in the best of shapes at present and a sale, whilst being achievable, may not result in the best of sale prices.

On the other hand, if the Trustees cannot afford to meet the loan repayments, then they should take immediate action to either market the property and sell it or look to refinancing the existing loan to a point whether they can afford to meet the loan repayments.  Trustees need to do this as one of their main legal duties is to protect the assets of the Trust (eg: the initial deposit put into the property) and losing a property at a mortgagee sale does not demonstrate satisfaction of this duty.

So, whilst Trustees do not have a legal duty to sell a property in a falling property market,  they do indeed have a legal duty to weight up the pros and cons of the situation and to make their decision accordingly.  Once that decision is made, Resolutions recording the decision should be completed by the Trustees.

On the basis that the Trustees do decide to retain the property, they should then consider if they will stick with the present loan term or will seek to refix the term of the existing loan.  Trustees may well want to refix to take advantage of new lower interest rates that are now on offer.

When deciding this question, Trustees must be prudent.  This means taking into account a couple of facts such as pre-determining what the cost of refixing the existing loan will be and what quantum of savings will be made as a consequence of moving to the new lower interest loan rate.

Interest Rates & Trusts

One matter to be aware of is that Reserve Bank has slashed the Official Cash Rate from 8.25% mid 2007 to 3.5% as at 29 January 2009.  Big deal you say.  Why should Trustees care? Because the OCR is one of several factors that influence the interest rates Banks set, which in turn, determines how much Borrowers will repay in loan payments each month.

Will the OCR decrease further?  That’s a million dollar question but some of NZ leading Economists think that the OCR could go as low as 2% by the middle of this year.  What that may mean is that interest rates could continue to decrease, maybe even reaching low levels such as 5.5% p.a or lower.

We would all be multi millionaires if we knew when the OCR was going to reach rock bottom.  I’d probably consider giving up my day job as well if I could predict when interest rates will reach the bottom of the trough as well.  Because unfortunately I don’t possess ESP, I believe Trustees should adopt a prudent approach in the current market, and only fix their loans for a short period of time – say 6 months.  That way when the bottom of the loan interest rate barrel is in view, Trustees will only have a small amount of break fee costs to pay to the Bank when they chose to break the short term fixed rate and move to a long term fixed rate contact.

I’m also an advocate of not being too greedy.  According, if a new low interest rate, such as 5.5% p.a. was to come on the horizon, I may well take that up rather than wait for the rate to drop to say 5.3% p.a.  As a Trustee I would run the numbers.  It may not be worth running the chance that the rate would increase.  After all, how much would the savings of say 0.2% really amount to on the loan?

With respect to working out what sort of break fee costs Trustees will pay if they do chose to refix an existing loan to a new lower interest rate, advice should be obtained from the Bank.  Once this information is to hand, Trustees should compare the quantum of the break fee costs they will have to pay against the savings they will make each month on the loan at the new lower interest rate over the course of the new fixed term.

For example, let us assume Trustees decide to refix an existing original 30 year loan of $500,000 of which has been running for 2 years at an interest rate of 10.25% p.a. which has 3 years left to run, to enjoy a new loan interest rate of 5.99% p.a.  Let us further assume that the Trustees decide to lock in this new rate for 5 years.

The old repayments under the loan were $4,531.  The new repayments will be $3,072.  This means the Trustees are saving $1,459 per month in loan repayments. The break fee costs the Bank is going to charge is set at $50,731.  So the comparison is against the expected savings over the term and the break fee costs to be charged.

Based purely on this financial criteria only, I’d expect the Trustees to refix as the savings they will make outweigh the costs they will incur.   However, it must be remembered that the break fee costs will need to be paid up front.  This of course has to be taken into consideration. Once the decision has been made, Trustees should record it in Resolutions.

As to the question whether the Bank will try to charge the Trustees break fee costs for breaking the existing loan term, I say check your loan contracts.  Most of the contracts I have seen spell out very clearly what the Bank is entitled to charge for in the case of an early termination.  Solicitors usually go through this particular issue when acting for a Borrower as well.  Remember, it is a contract that Trustees sign at the time of borrowing funds.  Breaking legal contracts have consequences – usually penalties!!!

At present, there is much talk in the media about whether Banks will be stopped in their tracks from charging break fee costs.  We need to understand a couple of things however in this respect.

1. First, the sanctity of contact should be upheld.  If we all broke the contracts we made simply because a better deal (such as a lower interest rate) came along later on, where would we be?  Absolute commercial chaos would reign.
2. Secondly, Banks have placed reliance on Borrowers honouring their contracts.  In this vein, Banks have gone out and borrowed funds to on lend to their own customers.  This means than when a customer breaks their existing loan contract, the Banks will forgo the interest they expected to earn.
3. Lastly, if having a fixed contract simply means that the contract can be broken without any break fee costs being incurred by a Borrower, I imagine that Banks will offer only floating contracts rather than fixed contracts.  This has implications for all Borrowers eg: no certainty of payments each month.

All this commentary aside, as a Trustee I would still ask the Bank if they would consider wavering or reducing any break fee costs they had decided to charge.  After all, you don’t get if you don’t ask.  Need more help?  Go ahead Request a Call.  It’s free to take the first step.

Janet Xuccoa

All the best,

Janet Xuccoa BCom LLB
Professional Trustee Services
FamilyTrusts.co.nz
Gilligan Rowe + Associates Ltd

Learn more about Janet

_________________________________________________

More Information?

If you have any questions or queries relating to asset protection or family trusts you can Request-A-Call for a no-risk chat or to set up an interview.  Otherwise just call Janet Xuccoa. Janet can be contacted by emailing janet@familytrusts.co.nz or telephoning (09) 522 7955.

Financial Statements & Family Trusts

Here’s a question from Mr Warren H. from Christchurch:

“Am I required to have financial statements completed for all
Trusts or just for Business Trusts”?

Thanks Warren T.

Janet Xuccoa

ANSWER: Warren, the Inland Revenue Department places a duty on Trustees to prepare financial statements and file tax returns if the Family Trust or other Trust earns income.  Trustees may also have to prepare and file GST returns.

Trustees need to remember that they are personally liable for the affairs of the Trust and this includes paying any taxes that are due to the Inland Revenue Department.

Good record keeping, including having bank statements evidencing transactions the Trust has engaged in, is crucial to preparing accurate financial statements from which the Trust’s tax returns can be compiled and the Trustees can be made aware of their taxation responsibilities.

Even if a Trust does not produce any income and simply holds passive assets such as a family home, I still recommend financial statements be prepared for the Trust.  These type of financial statement will note advances made by the Settlors to the Trust, loans the Trust may have made to other entities, the gifting position, the assets the Trust holds and the liabilities the Trust has incurred.  Again, such financial statements help the Trustees satisfy their duty when accounting to the Beneficiaries of the Trust.  Reduced accounting fees may well apply for the preparation of these types of financial statements.

Properly prepared financial statements are a great tool that Professional Trustees use to ensure the Trust is being administered correctly and that all Trust documentation is up to date and in place.  Without financial statements, this task is severely hampered.  Correspondingly, poorly prepared financial statements will be a hindrance to Trustees and in some situations can be very dangerous.  For these reasons, it is important to choose a qualified accountant who is familiar with accounting for Trusts, such as GRA.

For readers of this blog, GRA offer free accounting services for the first year for Trusts and Companies.  There are however a couple of conditions which will be disclosed to Readers on enquiry.

All the best,

Janet Xuccoa BCom LLB
Professional Trustee Services
FamilyTrusts.co.nz
Gilligan Rowe + Associates Ltd

Learn more about Janet

_________________________________________________

More Information?

If you have any questions or queries relating to asset protection or family trusts you can Request-A-Call for a no-risk chat or to set up an interview.  Otherwise just call Janet Xuccoa.  Janet can be contacted by emailing janet@familytrusts.co.nz or telephoning (09) 522 7955.

Tags: Trust Statements

Family Trusts & Bank Accounts

Here’s a question from Chantelle M. from North Shore:

“Thank you for the great information! Can I just keep a good record of her accounts or do I really need to get a separate bank account for the family trusts stuff”.

Thanks, Chantelle

Janet Xuccoa

ANSWER: Frequently, Trustees have to consider whether they should open a bank account for the Family Trust.  This consideration usually arises when a Family Trust either receives funds or the Family Trust has to make a payment.

My view is that a bank account should be opened when the need exists for such an account.

So, if the Trust is going to receive funds or pay out funds, then a bank account is necessary.  Hence, if a Trust holds shares and will be receiving dividends, then those dividends will belong to the Trust and thus should be banked into the Trust’s bank account.

Correspondingly, if a Trust is going to incur expenses, such as having to pay for a new roof for the home that it owns, these expenses should be paid out of the Trust’s bank account.

The reason why I think a bank account should be opened for a trust is because it assists Trustees to meet two particular duties they owe.

• The first duty is to ensure monies belonging to the Trust do not get mixed up with Trustees’ funds.  Clearly, having a bank account for the Trust where funds are paid in and paid out assists in meeting this duty.

• The second duty is that Trustees must be able to account to Beneficiaries for the administration of the Trust.  Having a separate bank account and keeping copies of all the Trust’s bank statements showing all the transactions undertaken by the Trustees is of enormous help in satisfying this duty.

It also assists your Accountant to accurately record transactions in the financial statements they will prepare for the Trust.  Lastly, having a separate bank account with bank statements helps your Professional Trustee conduct a full review of the affairs of the Trust and to catch up on any Trust administration that is required.  This exercise should be carried out annually once the financial statements are to hand.

So in conclusion, I think that a bank account for the Family Trust Chantelle, should be opened when necessity dictates. That is, when the Trust is in receipt of income or is having to pay out on expenses incurred.

All the best,

Janet Xuccoa BCom LLB
Professional Trustee Services
FamilyTrusts.co.nz
Gilligan Rowe + Associates Ltd

Learn more about Janet

_________________________________________________

More Information?

If you have any questions or queries relating to asset protection or family trusts you can Request-A-Call for a no-risk chat or to set up an interview.  Otherwise just call Janet Xuccoa.  Janet can be contacted by emailing janet@familytrusts.co.nz or telephoning (09) 522 7955.

Disclaimer:

© Gilligan Rowe & Associates Ltd
This article is intended to provide only a summary of the issues associated with the topics covered. It does not purport to be comprehensive nor to provide specific advice. No person should act in reliance on any statement contained within this article without first obtaining specific professional advice. If you require any further information or advice on any matter covered within this article, please contact the author.