Best Practices for Trusts and Companies when borrowing money from a bank: essential tips

Using Trusts for Property Loans

Trusts are often used to protect assets, reduce taxes, and plan for the future. The main types of trusts for loans are 3-Generation Testamentary Trusts in Wills, discretionary trusts (family trusts), unit trusts, self-managed super fund trusts, and Bare Trusts.

People use trusts to protect assets, reduce taxes, and increase future flexibility. Some trusts can be set up to allow tax-deductible interest at the individual tax level. Borrowing through a trust helps protect personally held assets, plan for the future, and have enough initial capital to make the endeavour viable.

How do banks deal with companies and trusts when lending money?

Because of the changes to the banking rules we have received this useful feedback from lawyers, accountants and financial planners that build documents on our website. These are the six disturbing trends:

1. Lenders in Australia now perceive dealing with trusts as a cumbersome process that offers them no additional benefits.
2. The new processes of applying for loans through trusts are typically complex, involving intricate legal considerations and a heavier burden of documentation before approval.
3. Most bank managers and credit staff lack a comprehensive understanding of how trusts operate, which can lead to trust-related loan applications being shuffled between various bank departments, causing delays and mistakes. In contrast, mortgage brokers are more up to speed with the new rules on lending to companies and trusts.
4. Many bank managers are unaware of whether their institutions even provide loans to trusts, as the new credit policies are vague.
5. Remarkably, one of the leading banks in Australia is unable to process residential loans for trusts due to the limitations of their IT systems.
6. Banks often refer trust loans to their business banking departments, where experienced staff can better manage them. However, this results in higher costs, increased fees, and slower processing times. Additionally, business banking may limit borrowing capacity and exclude low documentation loan options compared to residential loans.

Banks’ lawyers applying new tests on trust deeds and Company Constitutions

Because of the new banking regulations, securing business financing from banks requires not only a strong financial position but also thoroughly organised and compliant documentation. An accountant shared with Legal Consolidated the story of a client, whom we will call Michael.

Michael and his wife own a small manufacturing business and learned the hard way about the crucial importance of keeping his paperwork meticulously organised and up-to-date.

Why talk with your Accountant and Financial Planner before you talk with the bank?

Borrowing for your trust and company? Your accountant and financial planner are your friends, not the bank.

Michael decided to expand his operations and needed substantial financing. Confident about his business’s profitability and his meticulous financial record-keeping, he approached his bank for a sizeable loan. However, Michael overlooked one crucial aspect: the legal documentation of his business.

Years earlier, Michael had established a trust to manage certain business assets and had incorporated his business through a corporate trustee. This is common and standard in Australia. However, he had:

• not updated his trust deed to reflect significant changes in the business structure and compliance regulations that had evolved over the years;
• was still using Memorandum and Articles for his corporate trustee; and
• his bucket company did not even have a Constitution.

When Michael presented his case to the bank, he was confident about the financials but less prepared to handle questions about his outdated company constitution and the missing trust deed. The bank’s loan officer told him that without these critical documents in the correct order, they would not proceed. (Our client, the accountant, told us that this was beneficial because had the loan proceeded it would have been rejected. Therefore due to the bank’s credit ranking scores, this would have permanently stopped Michael from ever applying for a loan again.) The documents Michael did provide appeared disorganised and outdated to the bank. This raised concerns about Michael’s governance and compliance risks.

The Accountant and Financial Planner were able to satisfy the bank

Outdated Trust Deeds and antiquated Company Constitutions cause loan rejections.
These rejections are permanent black marks on your credit rating.

Thankfully there was no rejection of any loan. The bank manager had stopped the process before it got to their lending team in Melbourne. Michael turned to his accountant and financial planner. They built these three documents on our website:

1. Family Trust update – to remove an ex-wife, update the trustee, put in Backup Appointors and update for the new tax rules
2. Replace Company Memo & Articles with a Company Constitution
3. Remove the Replacement Rules with a Company Constitution

Thus all documents were now compliant with the latest trust laws, ASIC, tax laws and regulations.

Once the Legal Consolidated documents were updated and organised, Michael returned to the bank. This time, his application was correct and forwarded to the bank’s head office where it was approved.

Michael was lucky in this instance. If you apply for a loan and it is rejected it is a permanent black mark against your name with the credit rating companies.

Bank refuses to lend to an SMSF that does not have a Special Purpose Company

There is no legal requirement for a Self-Managed Superannuation Fund to have a corporate trustee that is a Special Purpose company. The only value of a Special Purpose Company is lower yearly ASIC fees. Nevertheless, some banks are not lending to the SMSF (obviously through the Bare/Custodian Trust) until the SMSF converts its corporate trustee to a Special Purpose Company.

Bank refuses to lend to a company that is both trustee of a Family Trust and a Self-Managed Superannuation Fund

The client to ‘save money’ is using the company to be both trustee of the SMSF and of the Family Trust. This is legal. A company is allowed to wear two hats. However, several banks are refusing to lend to the company. They only want the company to wear one hat. They want a separate company for the Family Trust.

Legal Consolidated agrees with the banks. While it is legal to use the same company for these multiple purposes, practically, it is risky. It is easy to make mistakes and transfer money from the wrong bank account. (1) You should have one company to be the trustee of the Family Trust and (2) a company as the trustee of the SMSF (which might as well be a Special Purpose Company to save on the yearly ASIC fees).

Talk with your accountant and financial planner before you speak with the bank

When seeking finance for your business or investment activities through a bank, the clarity and compliance of your documents are paramount. Banks meticulously scrutinise every aspect of your application. Your business structure and trust deeds are no exception. Consult with your accountant and financial planner before approaching the bank is strategic:

1. Professional Scrutiny of Your Documents

Your accountant is there to help you succeed. Unlike the bank, which assesses your application primarily for risk, your accountant aims to ensure your business thrives. Your accountant and financial planner meticulously review your trust deeds, company constitution, and other legal documents to ensure they are not only compliant with current laws but also structured optimally for your specific needs. Sloppy, outdated, or non-compliant documents result in the bank viewing your application unfavourably. You often only get one chance to make a good impression; make sure your paperwork reflects your professionalism and readiness to engage in a financial agreement.

2. Understanding the Latest Regulations

Laws and regulations governing business entities, including trusts, are complex and change frequently. Your accountant and financial planner are abreast of these changes and provide invaluable advice. They help you navigate the complexities of regulatory compliance, ensuring that every i is dotted and every t is crossed. This proactive approach prevents unpleasant surprises during the bank’s review process.

3. Strategic Advice on Business Structure

The way your business is structured significantly impacts how banks perceive your loan application. Your accountant and financial planner offer strategic insights into the advantages and disadvantages of different business structures (like sole proprietorships, partnerships, trusts and corporate trustee companies) and how they align with your financial goals and lending requirements. This strategic advice is crucial in presenting a solid business case to the bank.

4. Preparing for the Bank’s Expectations

Banks expect applicants to be fully in control of their financial and legal affairs. Your accountant and financial planner help ensure that your financial statements, tax returns, and other financial documents are in order, up-to-date, and ready for rigorous examination. They also prepare forecasts and financial models that support your application, demonstrating to the bank that your business plans are viable and well-thought-out.

5. Best Practices for Trusts and Companies when borrowing money from a bank

Having your documents in order and understanding your financial position thoroughly gives you leverage in negotiations with the bank. Your accountant and financial planner help you understand the terms and conditions of proposed loan agreements and advise on negotiation points. This preparation puts you in a stronger position to negotiate favourable terms.

The bank is not your friend – your accountant and financial planner are

Approaching a bank for a loan with well-prepared, compliant, and professionally reviewed documents is essential. Your accountant and financial planner play a critical role in this preparation. They ensure that your business structure and documentation are not just in order but optimised for both compliance and success. Before you step into the bank, make sure you step into your accountant’s office. Remember, in the realm of business financing, the bank is not your friend, but your accountant and financial planner are. They are your ally in ensuring that your first impression with the bank is a powerful and positive one.

Update Trust Deeds and Company Constitution before talking to your bank for a loan

Securing a loan from a bank involves more than just proving your financial capability; it also requires showing that the legal structures within which you operate are sound and up-to-date. This is particularly true for entities like trusts, Self-Managed Super Funds (SMSF), and companies, where the governing documents—trust deeds, SMSF deeds, and company constitutions—play a crucial role. Updating these documents before applying for a loan smooths the process. Here is why:

1. Ensuring Compliance with Current Laws

Laws and regulations affecting financial entities, including trusts and SMSFs, change. An updated deed or constitution ensures compliance with the latest legal requirements, reducing the risk of legal issues that might concern a lender. For example, superannuation laws in Australia have undergone significant changes in recent years, impacting how SMSFs must be managed. If your SMSF deed is outdated, it may not comply with current legislation, potentially making lenders hesitant to offer finance.

2. Reflecting Changes in Structure or Purpose

Over time, the purpose or structure of a trust or company changes. Perhaps a trust was initially set up to manage a family business but now holds primarily investment properties. Similarly, a company might shift its business model due to market changes. Updating the governing documents to reflect these changes ensures that there is no discrepancy between what the entity currently does and what its documents say it does, a consistency that banks look for when assessing risk.

3. Enhancing Flexibility and Powers

Banking requirements and loan conditions are stringent. Legal Consolidated trust deeds, SMSF deeds, and company constitutions are designed to include provisions that provide greater flexibility in borrowing, investment, and other financial activities, which can be restricted in older versions. By updating these documents, you can ensure that the entity has the necessary powers to engage in required transactions, like offering assets as security for a loan.

4. Facilitating the Loan Approval Process

Banks conduct thorough due diligence before approving business loans, including a review of an entity’s foundational documents. Outdated documents slow down this process and from what we have seen lead to a denial of the loan application because they do not meet the bank’s criteria for clarity, compliance, or risk management. Updated documents streamline the approval process by promptly addressing these concerns.

5. Preparing for Future Opportunities

Updating your documents not only aids in securing a current loan but also prepares your entity for future opportunities. Whether it’s refinancing under more favourable conditions, pursuing new business ventures, or restructuring the entity, having current, compliant, and clear documents means being ready to act when opportunities arise.

Best practice for Trust Deeds and Company Constitutions when borrowing money

Before approaching the bank for a loan, taking the time to review and update your trust deed, SMSF deed, and company constitution, with your accountant, is a crucial step. This not only enhances your chances of loan approval but also positions your trust, SMSF, or company to operate more effectively and comply with contemporary legal standards. By ensuring these documents are current, you safeguard your interests and lay a solid foundation for your financial endeavours.

Family Trust Updates:
1. Everything – Deed, Appointor and Trustee (recommended) – includes succession planning
2. Upgrade the Family Trust Deed only – streaming, Bamford, trust law & tax
3. Change the Appointor – includes succession planning
4. Replace the trustee only
5. Change Name of the Family Trust
6. Exclude a Beneficiary in the Family Trust

Why lawyers no longer use ‘Schedules’ in their legal documents

Q: As a banker, I found Schedules (some of the old boys at the bank still call them ‘extracts’) useful just to copy that particular page of the SMSF, Trust deed, Loan or Lease agreement. But law firms no longer use them. Why?

A: “Schedules” are a sheet of paper attached to the legal document. They carry some, but not all of the variables. Schedules have no terms of the agreement. For example:

• For a 3-Generation Testamentary Trust Will, it is a list of ‘Executors’ and ‘Primary Beneficiaries’.
• For a Lease, it lists “Leasee”, “Lessor”. “Lease Fee” and “Term”.
• For a Family Trust, it lists “Appointor”, “Back-up Appointor”, “Trustee”.
• For a Loan Agreement, it lists “Lender”, Borrower”, “Amount Lent”, “Interest Rate”.
• For a Division 7A Loan Deed, it is a list of the “Lenders”, “Borrowers” and “Addresses”
• In an Employment Contract “Employer”, “Employee”, “Salary”.
• For an SMSF they state the date of the deed, members and trustees, but it contains none of the rules of binding nominations and SIS Requirements.
• For a Partnership Deed, it is a list of the “Partners” and their “percentage interest”.

Lawyers rarely use Schedules in their legal documents, these days. They are considered old-fashioned and lazy drafting.

Schedules in legal documents were popular before word processors. Until the 1970s, the lawyer (a man in those days) went to a printing shop. He prints out the substantive part of the legal document. A big stack of them. His secretary (a woman in those days) merely types in the agreement’s main variables- the Schedule or Extract. E.g. Lender, Borrower, Amount Lent and Interest Rate.

The schedules look terrible. No self-respecting lawyer is caught dead with them these days. A sure-fire way to find out that the legal document is being ‘resold’ by a non-law firm website is to see a “Schedule”.

Since the 1980s law firms have incorporated all parties and terms into the substantive part of the legal document. It looks better. It tells the whole story.

Further, you cannot expect to just copy the Schedule and think you know the entire legal document.

Prudent banks and lenders review the entire legal document

Now let us turn our minds to the banker. A careless banker just copies the Schedule containing the parties’ details. That is a useless amount of misinformation. Proper due diligence is reviewing the entire legal document.

A banker who merely reviews the schedule of an old legal document (or something prepared by a non-law firm website) only gets part of the story.

Careless bankers are duped. For example, the client merely puts misleading information in the Schedule. And then puts the full story in the legal document. The careless banker is none the wiser. I doubt a banker is silly enough to just look at a Schedule and believe that the bank’s due diligence is complete!

That would be akin to the banker getting married to someone on the strength of just their Facebook page. The careful banker reviews the entire deed.

Adams on Contract drafting expresses concerns with Schedules.

To appease the bank and their ‘due diligence’ copy the entire document and email it to them.

Banker wants a ‘certified’ copy of the document – not extracts

A bank asks for a certified copy of your document. Not realising the dance to be performed to satisfy the bank you innocently go to the local chemist, photocopy the deed and get the pharmacist to certify the deed as a ‘true copy of the original’. You then post the certified copy to the bank. The bank manager telephones you and states that, while pharmacists and many other professionals can certify documents as true and original, it is never good enough for the bank.

The bank manager forgot to tell you that the bank wants to certify the trust deed itself. But you are reluctant to courier the original deed to the bank in case it goes missing. So you get in your boat, car, aeroplane or bicycle and go off to the bank offices, if there are any branches left in your neck of the woods.

You take the original trust deed and two photocopies. (Copy the deed yourself as the bank manager often damages your original trust deed when they try and put it through their copier.) Take all three to the bank and the bank certifies both copies. With a pretty stamp, it will say:

‘Certified by the Commonwealth Bank of Australia by Manager John Smith on 13 March year‘

Take one of the certified copies back home with you.

In twenty years when CBA has lost the certified copy, you can post CBA the second CBA certified copy. They often accept that. Other banks will not, but the bank that certified it twenty years ago may. If not, take the original trust deed back to the bank and start the dance again. Let’s hope you have not lost your original deed.

Banker wants a list of the beneficiaries of the Family Trust

Q: We are building our client’s Family Trust deed on your website. I specify the Default Beneficiaries. These are ‘the children of Colin Jones and Muriel Jones’. This shows on the Family Trust deed. However, the client’s banker is asking for a list of all the Family Trust’s beneficiaries.

A: I suggest that you read the above information again. We are an Australian-wide tax law firm. We know little about banking. It may be the case that the banker knows little about Family Trusts, Unit Trusts, Bare Trusts, Partnership of Family Trusts, and companies. And that is fine.

Bankers ask for the Beneficiaries of Unit Trusts, Bare Trusts, and Self-Managed Superannuation Funds. And the banker asks for the shareholders of the company. These are usually finite and ascertainable.

The list of beneficiaries of a Family Trust is in the 1,000s. So a banker does not ask for a list of beneficiaries in a Family Trust. Instead, the banker, for a Family Trust, wants:

• Appointors – this is the person who controls the Trustee of the Family Trust
• Back-up Appointors – these are the lucky people who control the Family Trust after the Appointor dies
• Trustee or Corporate Trustee of the Family Trust
• Default Beneficiaries (also called Takers in Default, Specified Beneficiaries and Named Beneficiaries)

Show the banker this article. The banker defers to his or her superior. Their superior helps the banker read the Family Trust deed to get the information required.

Banker wants to know about classes of beneficiaries in a Family Trust

Q: The banker is asking if any of the beneficiaries are a member of a ‘class’. Do the terms of the trust identify the beneficiaries as members of a beneficiary class (eg unit holders, family members of a named person, charitable organisation, or cause)?

A: Again, as stated above, these are not questions for a Family Trust. Almost all beneficiaries in a Family Trust, of which there are 1,000s, are referenced by the ‘class’ they are in.

For example, ‘the children of the Appointor’ is a class. So are ‘all religious groups and educational organisations’. Most Family Trusts in Australia are structured that way. So to answer the two questions is always yes. This is for all Australian Family Trusts. But as I said, it is a silly question to ask. This is because the answer is always yes.

Banker wants a Specified Beneficiary removed from a Discretionary Trust

There may be Capital Gains Tax and stamp duty issues when changing a Default Beneficiary. Build this document to exclude a Beneficiary of a Family Trust. (On another topic, sometimes you have to do things to reduce a foreigner beneficiary for state land tax and stamp duty surcharges. But that is another matter.)

A default beneficiary does have a contingent interest in the Family Trust property. But the interest is contingent upon the trustee not otherwise exercising its discretion. This rarely happens. See Chief Commissioner of Stamp Duties (NSW) v Buckle (1998) HCA 4; 192 CLR 226.

The ATO believes that neither an ordinary nor a default beneficiary has an ‘interest’ in a discretionary trust of the type referred to in section 104-70. See ATO TD 2003/28.