Ring fencing is a strategy that allows individuals and institutions to separate out a group of assets and shield them from certain risks that they’d otherwise be exposed to. This article will explain how ring fencing works, and how you can successfully ring fence assets by utilizing a Trust in your Estate Plan.
What is ring fencing?
Ring fencing is a term that describes the act of putting legal structures into place so as to separate assets or an entity from others. The purpose of doing so is to protect these assets by insulating them, or so that they’re recognized as a different entity altogether. It is a common practice used across multiple sectors by governments, businesses and individuals.
There is no standard method of ring fencing. The way in which a business might ring fence a subsidiary or the way in which an individual might ring fence financial assets will often look completely different from one another. However, the concept of shielding and protecting through separation is the common thread.
Learn more on the topic by reading our What is Ring Fencing guide.
Does ring fencing protect against bankruptcy?
Ring fencing can be used as a mechanism to protect assets against bankruptcy.
For instance, a corporation could “ring fence” by creating a subsidiary whose assets are completely separate from the parent company and its affiliates. Even if the parent company were to file for bankruptcy, the subsidiary would maintain its own credit rating. To ring fence successfully, corporations must follow certain regulatory guidelines. For instance, the subsidiary must be created for a limited purpose and may only conduct business or incur debt for that specific purpose. The entity must be careful not to commingle assets with the parent company by maintaining separate bank accounts.
Alternatively, an individual may explore options to ring fence important assets when filing for bankruptcy. Here, the key is to look for mechanisms that protect these assets from creditors. A possible ring fencing tool in this case is a Trust.
A Trust is a legal structure formed by an individual when planning their estate. Any assets and property transferred into the Trust are not subject to probate court, and can be distributed to loved ones with less hassle. There are many different types of Trusts to choose from, and they are either revocable or irrevocable.
Revocable Trusts are usually most popular in estate planning because they can be revoked or changed at any time. It is tricky to plan for the future when the future is uncertain, so having the ability to make those changes provides peace of mind. However, Revocable Trusts may not provide strong enough protections if you are filing for bankruptcy. Because you are still the legal owner of the Trust and its assets, they are not shielded from creditor claims.
If you would like to set up a Trust to shield against bankruptcy specifically, then it’s best to go with a type of Trust that is irrevocable. These typically cannot be changed or terminated, making their protection mechanisms more rigid. Once you transfer assets into this type of Trust, you are no longer the rightful owner. While you are relinquishing control over these assets, you get several protections in return. First, these assets are removed from your personal taxable estate. Second, because these assets are no longer in your name, creditors cannot go after them. However, be careful to note that the timing of setting up your Trust is critical. If a court determines that you already owed money at the time that you set up the Trust and transferred assets to it, the court may reverse the Trust. That is why it is wise to set up your Estate Plan and fund your Irrevocable Trust when you are in good financial standing and aren’t filing for bankruptcy. However, once in place, this legal tool can provide a safeguard against something that could happen in the future and ensure that assets are protected for your beneficiaries.
Should you decide to use a Trust as a ring fence to protect assets, you’ll want to do so properly. The next section provides tips on how to properly separate your assets using a Trust.
How to ring fence - guidelines for using a Trust to protect assets
If you choose to use a Trust to protect your assets — in other words, to ring fence your assets — you’ll want to make sure you set up and utilize your Trust correctly. Here are some tips:
Ensure the Trust is single-purpose
Ensure the Trust does not merge with other entities
Ensure the Trust incurs no additional debt
We elaborate on each of these tips below.
Ensure the Trust is single-purpose
First and foremost, ensure that the entity you’re using for ring fencing is a single-purpose entity. Any activities conducted by the Trust and Trustee must be restricted to the Trust terms as closely as possible to ensure that the Trust stays intact. The Trust will not have conducted any business or activities unrelated to its structure or its terms.
This may help reduce the risk of any third party claims against the Trust, such as creditor claims, or a court decision to reverse the Trust itself. To better protect the assets, you may want to consider specifically naming restrictions placed upon the Trust in the language. That way, the Trustee will not only better adhere to the Trust terms but also to any specific restrictions or limitations that are specified. It will also serve as a record in case the Trust and related activities are ever reviewed by a court.
Ensure the Trust does not merge with other entities
Next, be careful that the Trust does not merge with any other entities, such as another Trust. The bankruptcy-shielded status of the Trust should not be undermined by any actions that could potentially render it exposed to risk. For this reason, creating an irrevocable Trust is the safest option as it prevents the Trust terms from being reversed or modified.
Ensure the Trust incurs no additional debt
Last but not least, make sure that the Trust does not incur any debt of its own, aside from what is necessary for normal business operations. What you are trying to avoid is an involuntary bankruptcy filing. As long as the Trustee (and thus the Trust) is careful to avoid any debt or expenses that are not consistent with normal business purposes, this risk will be limited. Third parties, such as creditors, are less likely to pursue involuntary petitions and go after the Trust’s assets. Again, it may be advised to specify restrictions on the Trust’s ability to incur such debts.
Set up your Trust today
Ring fencing is the act of separating assets from others to shield them from exposure to risks. This strategy is utilized across sectors for a variety of reasons, and the way in which ring fencing is implemented varies based on the circumstances.
For example, this guide talked about how a corporation may ring fence assets by creating a subsidiary. If the subsidiary were to ever have to file for bankruptcy, the parent company’s assets would be shielded, and vice versa. In this case, the ring fencing would likely look like creating a separate business entity and managing separate financial accounts and business activities.
An individual can also ring fence assets by transferring them into a Trust. However, not all Trusts are created equal. A revocable Trust can be modified or terminated, meaning that the assets aren’t always well-shielded from creditors or bankruptcy. In comparison, an irrevocable Trust completely removes assets from the owner’s control, and thus is excluded from their personal estate can provide better protection from third parties and bankruptcy. We discussed several examples of how to use a Trust to ring fence assets effectively as a part of a larger estate planning strategy.
Advanced techniques such as ring fencing can be tricky to understand and implement on your own! At Trust & Will, we’re here to help keep things simple. You can create a fully customizable, state-specific estate plan from the comfort of your own home in just 20 minutes. Take our free quiz to see where you should get started, or compare our different estate planning and settlement options today!
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