“Illusory Trusts” – a new doctrine to invalidate Trusts. Part I
Readers of my column know of sham Trusts, the “alter ego” doctrine, the Bundle of Rights “doctrine”, and other means that the Courts have used, and have tried to use, to invalidate Trusts. To this list of Trust-defeating devices there is a new pretender - the “illusory” Trust doctrine.
During his marriage Mr Clayton established a number of trusts. One of them (I will call it the X Trust) was held by the Family Court to be “illusory” with the consequence that its assets were to vest in Mr Clayton personally. He was directed in turn to give half the value of the assets to his former wife. The contagion didn’t stop with the X Trust: the Court held that his former wife was “entitled to share equally in the net equity in the assets of all other Trusts…” Rodney Hansen J has upheld this decision: see Clayton & Others v Clayton [2013] NZHC 301.
The Family Court held that Mr Clayton had an array of powers that negated the ability of the beneficiaries to call him to account and that, by implication, the Trust did not satisfy the “irreducible core of obligations” that Millett LJ said in Armitage v Nurse [1998] Ch 241 are necessary for a Trust to exist.
R Hansen J held that the Family Court was wrong to hold that the trustee was not accountable to the beneficiaries but he went on to say that the Trust gave “Mr Clayton unfettered power to distribute the income and the capital of the trust to himself if he wishes and to bring the trust to an end at any time he pleases.” [90]. He said that “Mr Clayton is able to deal with trust property just as he would if the Trust had never been created” [90] and that “the Trust is illusory” [91].
In reaching this decision, reliance was placed on two cases. The first was the Privy Council’s decision in TMSF v Merrill Lynch [2011] UKPC17. In that case the Privy Council held that where a debtor has a power to revoke a Trust, the Court can give the power to a creditor. In reaching this conclusion, the Privy Council did not suggest that a power of revocation rendered a Trust “illusory” or in any way invalid (see para 49 of that decision) and the word “illusory” does not appear in the decision.
The second case on which reliance was placed was FMA v Hotchin [2012] NZHC 323 where the FMA argued that the powers that Mr Hotchin had in a Trust indicated that “he did not intend to give or part with control over the property sufficient to constitute a trust” [30]. Winkelmann J held that on the facts of that case, the FMA’s arguments had “no prospect of success” [42]. The word “illusory” does not appear in this Judgment either.
Although it is not mentioned in the two decisions, the notion of an “illusory trust” is in fact known to the law. In Jacob’s Law of Trusts in Australia 7th ed, it is said that the term is applied to arrangements where the settlor has not manifested an intention of transferring the beneficial interest in property to the apparent beneficiaries. The applicability of this reasoning to the Clayton case is not straightforward since R Hanson J held that the X Trust was not a sham [79] and added “It is clear that Mr Clayton intended to create a trust and intended to do so for legitimate business purposes.” [79] Lawyers who believe the simplistic statement that a Trust needs “three certainties”, one of which is a genuine intention to create a Trust, will conclude from an ordinary reading of that sentence that Mr Clayton had a genuine intention to create the X Trust.
The relevant question for Trust lawyers is therefore whether a Trust that is not a sham, and which was always intended to be a genuine Trust, can be stripped of its status because a person (usually the settlor) has powers of control that enable the Court to treat him/her as the owner of the “Trust” assets. This can be viewed as a variant of the Bundle of Rights “doctrine”.
Quite apart from the quandary that I describe in the previous paragraph, it appears to have been accepted that at all relevant times, Mr Clayton took advice from two advisers on what he should do as trustee and he invariably acted on their recommendations. The fact that Mr Clayton never sought to exploit his powers for personal advantage was held to be irrelevant. What was of overriding importance was that he could “basically … do whatever he wants with trust property.” [90]
I understand that an application will be filed for leave to appeal this decision. I hope that the Court of Appeal gets the opportunity to consider whether a trust that is not a sham, and which is genuine in the sense that the settlor has a genuine intention to create a trust, can be ignored on the grounds that a person can “basically do whatever he wants with trust property.”
To the extent that the judicial reasoning was based upon the Privy Council’s decision in the TMSF case it should be noted that the Privy Council did not suggest that a power or revocation renders a Trust either “illusory” or non-existent. A ruling to that effect would have had ramifications for a great many trusts in many countries.
And to the extent that the reasoning relied upon Winkelmann J’s statement in Hotchin that where a person “retains such control that the proper construction is that he did not intend to give or part with control over the property sufficient to constitute a Trust,” the reasoning may be seen as a phoenix-like re-emergence of the Bundle of Rights “doctrine” in a somewhat altered form.
The lesson for trustees and settlors who have significant powers of control in a Trust, is to diversify them.