Legal Ground: Trustee’s personal debt

Our last article discussed the advantages of placing property in a trust. Trusts serve as an efficient method for transferring wealth between generations while legally avoiding inheritance tax, which foreign residents may be exposed to. Israel does not have an inheritance tax.

Another advantage of trusts is the privacy and discretion it affords; the property is registered neither in the names of the settlor (the creator of the trust) nor in the names of the beneficiaries (those who benefit from the trust). Rather, the property is registered in the name of the trustees who are the controllers of the assets, who act within the guidelines dictated to them with the creation of the trust.

However, some might hesitate before relinquishing control of their assets to another individual or company. This hesitation is quite understandable.

Let’s examine the case of the Martin family (all names in this article have been changed) from Australia, who purchased property almost 20 years ago via Mr. Zamir, a friend and businessman located in Israel. The property was registered in Zamir’s name, as trustee for the Martins.

In an unfortunate turn of events, Zamir found himself in debt for hundreds of thousands of dollars, was declared bankrupt and left Israel. Zamir’s creditors searched for any asset Zamir might have had in Israel and were quite enthusiastic upon discovering some prime real estate registered in his name. They quickly had a lien placed on the property and initiated legal action toward having it sold.

The Martins, in a desperate attempt to save their property (now the home in which they lived after making aliya), asked the court to uphold the trust, remove the lien and dismiss all legal action to seize the property.

Can the Martins’ property be spared from the hands of the creditors? Furthermore, could this situation have been prevented in the first place?

Theoretically, the Martins’ problem could have been avoided altogether. A warning note, or a caveat, explicitly stating that this property is held in trust, could have been registered in the Land Registry (the Tabu). That way, the creditors would not have mistakenly believed that they managed to identify property belonging to Zamir, while the Martins would not have had to beseech the court to assert their rights.

However, this was not the case with the Martins. Indeed, in most cases, for various reasons, there is no explicit mention of a trust in the Land Registry. Often, this is because of the very nature of trusts: namely, to avoid registration and maintain confidentiality.

What then can the Martins do to save their home?

On the one hand, they are protected by Clause 3(b) of the Trust Law, which states that assets held in trust will not be seized for any debt other than debt owed by the trust itself.

In our case, the debt was the trustee’s personal debt, not the trust’s debt. Therefore, we might think that the Martins could breathe a sigh of relief.

However, to complicate this matter, Clause 5 of the Trust Law, loosely translated, states: “A trust will hold true toward anyone who knew or who should have known of the trust, and if the trust was registered [in the Land Registry] it will hold true toward everyone.”

Does this clause mean that if the existence of the trust was not registered, then our beneficiaries, the Martins, are at risk of losing their property? This was, indeed, the case in the past.

Great importance is placed on accurate registration of property title in the Land Registry. The Land Registry, which is open to the public, is the most definitive authority of property ownership. As such, every property transaction depends on the accuracy of the Land Registry, to the extent that true and final ownership is only obtained with registration in the Land Registry.

However, today, Israeli courts also recognize the importance of protecting trusts: that preferring the right of a creditor over that of a beneficiary will completely undermine the very rationale behind a trust. The court also recognizes the important role that privacy plays in the creation of a trust. therefore, it reiterated that registration of a caution notifying the public of the existence of a trust is optional.

In a groundbreaking recent ruling handed down by the Supreme Court (which has since been quoted in other rulings by lower tribunals), it was clearly determined that a beneficiary’s rights to the property override those of a creditor of the trustee. This is despite the fact that no caveat (i.e., caution) was registered to note the existence of the trust.

Thus, the Martins’ property will remain safe and sound in their hands. The creditors, on the other hand, must keep searching for other methods to collect their debt.

This ruling is a key milestone that fortifies trusts in Israel as a safe and protected method of managing property. The above describes the possibilities in general terms only, and detailed advice must be obtained prior to any action taken.

israelaw@netvision.net.il

Dr. Haim Katz is a senior partner in a law firm with offices in Tel Aviv and Jerusalem that specializes in real estate, international trusts and family, inheritance and corporate law. Sam Katz is a jurist who lives in Jerusalem.