"Dealing with property when it is in a trust"

1. Summary of topics dealt with in this Paper

1.1 In this paper I shall deal briefly with:

(a) The need for Trust Deeds to be flexible.
(b) Means of modifying Trust Deeds – by settlors/trustees/the Court.
(c) Drafting Trust Deeds to accommodate changes in relationships.
(d) Drafting Trust Deeds to survive sham/alter ego challenges.
(e) How Trust property can morph into relationship property.

2. The need for Trust Deeds to be flexible.

2.1 There are many reasons why Trust Deeds need to be drafted so that they can be modified to accommodate future changes. For example:

(a) If a Trust is to act as an investment vehicle, it may become too cumbersome and expensive as a result of the requirement that each trustee must sign all banking documents, property transfers, leases, renewals of leases etc.
(b) Legislative changes which have adverse effects on Trusts will create a need to modify Trusts in ways which will enable them to be restructured to best advantage.
(c) The possibility that Trustees and/or beneficiaries may decide to live in countries other than New Zealand may result in adverse taxation consequences for the Trust or for the trustees/beneficiaries.
(d) Changes in relationships will make it desirable for spouses/partners who have separated, to cease to be associated with a Trust after a settlement has been agreed upon. This will preferably involve the removal of a spouse/partner as a beneficiary, trustee, appointor or a person who possesses other administrative powers or entitlements.

3. Means of modifying Trust Deeds – by Settlors/Trustees/the Court

3.1 In my opinion it is preferable that all Trust Deeds should these days have an express power which authorises the modification of the Trust.

3.2 The statutory powers of modification of a Trust are very limited. Section 64 of the Trustee Act empowers the Court to authorise a dealing with Trust property if “it is inexpedient or difficult or impracticable to effect the same without the assistance of the Court, or the same cannot be effected by reason of the absence of any power for that purpose vested in the trustee by the Trust instrument …”. This is a cumbersome process and is little used.

3.3 Section 64A of the Act contains a limited power of modification. This section empowers the approval by the Court to “any arrangement … varying or invoking all or any of the Trusts, or enlarging the powers of the trustees of managing or administering any of the property subject to the Trusts …” on behalf of an infant, a person who is incapable of assenting, a person entitled to a future interest, an “unborn or unknown person”, and a person who is the subject of a discretionary interest under a protective Trust.

3.4 The limitations of this provision were illustrated recently in TC Clifton & Anor v Christian Clifton & Ors (2004) . Family wealth devolved to a Trust of which Christian Clifton and a solicitor were the Trustees. Other members of the family were beneficiaries. Christian Clifton became a drug addict, needed money, and decided that a convenient way to get it would be by borrowing half the assets of the Trust. To achieve this he dismissed the solicitor Trustee and replaced him with two trustees. The first was a barrister who had unsuccessfully defended him on drug charges and who was owed $40,000 in legal fees. The second was Christian’s partner who also had convictions for drug related offences and who owed $10,000 for living expenses which would also be borrowed from the Trust. The three Trustees proposed to take the $50,000 as an unsecured loan from the Trust to pay these debts. The Trust Deed was worded very broadly and appeared to permit the Trustees to advance the Trust’s monies for these purposes.

3.5 Innocent beneficiaries sought to stop the Trustees borrowing the Trust’s limited resources for these purposes. Paterson J held that it was: “pointless to make alterations to the Trustees and not to amend the terms of the Trust which gives Christian the absolute power to remove and appoint Trustees.”

3.6 Paterson J concluded that he was able to take from Christian the power of appointment of the Trustees on the basis that it did not constitute “a variation of the Trust” but was “a variation of an administrative provision and not an alteration of the Trust itself.” The Trust Deed was therefore directed to be modified so as to vest the power of appointment in another person.

This decision highlights the limited ability of the Court to approve amendment of a Trust Deed under s 64A.

3.7 For reasons which I will give shortly, it is also preferable that the modification mechanism does not vest solely in a person who is able to take full benefit of the Trust’s income and/or assets but is shared with another person.

3.8 Section 33(3)(m) of the Property Relationships Act may in certain circumstances be invoked for the purpose of modifying a Trust Deed. It is provided in s 33(3)(m) that the Court may make “an order varying the terms of any Trust or settlement, other than a Trust under a Will or other testamentary disposition” where it is “necessary or expedient to give effect, or better effect, to any order made under any of the provisions of s 25 – 32 of this Act.”

In practical terms, the power to vary a Trust solely for the purpose of implementing an order which the Court thinks appropriate, is a confined power and it has been little used to date. The power under s 33(3)(m) was resorted to in McGill v Crozier . A yacht was bought and refurbished from a wife’s funds. The husband established a Trust and without his wife’s knowledge or consent, he transferred the yacht to it. The Judge in that case exercised the power under s 33(3)(m) “to vary the husband’s Trust by excluding his interest in [the yacht] from it and by treating [the yacht] as matrimonial property not included in the pre-nuptial agreement.”

3.9 Section 182 of the Family Proceedings Act has much greater potential for the modification of trusts than has generally been recognised to date. It contains a potentially unlimited power to modify a Trust deed. If it can be invoked as part of a settlement of a property dispute, in a consent order, it will achieve almost any change which can reasonably be contemplated.

3.10 It may sometimes be possible to overcome problems arising from the inflexibility of a Trust Deed by re-settling the Trust assets on another Trust. The extent to which a re-settlement on a Trust which has more flexible terms than the Trust it replaces will be lawful is a subject which is too complex to be dealt with in this Paper.

3.11 It would not be appropriate to leave this topic without referring to the so-called “alter ego” doctrine. This has been used to “modify” trusts in the sense that the Courts have by its use felt free to ignore the terms of a Trust.

3.12 The alter ego doctrine is an especially Australian notion and it has been spoken against in this country. Justice Chisholm dealt it what appeared to be a death blow in Official Assignee v Wilson (April 2006) . He said, in effect, that the doctrine did not exist in New Zealand law except perhaps as a means of helping to prove the existence of a sham trust. I refer to the doctrine because in the subsequent decision of Olliver v Sparkes a Family Court Judge considered that the doctrine is still available to our Courts to defeat the terms of a Trust. I refer to this decision in more detail later in this Paper.

3.13 The alter ego doctrine has seeped into our law via the Family Courts in Australia. It should be understood that there is a statutory distinction between our laws and the corresponding laws in Australia which may have given rise to this development. Section 90A of the Family Law Act 1975 allows the Federal Courts, “in relation to the property of a party to a marriage to make an order that is directed to, or alters the rights, … or property interests of a third party”. Section 90AC says that the Act overrides “anything in the Trust Deed or other instrument.” Section 90AE provides that “the Court may make any … order that directs a third party [ie a Trustee] to do a thing in relation to the property of a party to the marriage; or alters the rights … or property interest of a third party in relation to the marriage.”

3.14 In circumstances where the legal capacity of a third party to comply with an order could be affected by the terms of a Trust Deed, the Court may make an order which will, in effect, override the terms of the Deed: s 90AC1.

3.15 If the Australian jurisprudence on alter ego Trusts is to be fully imported into New Zealand, the extent of its reach may best be illustrated by the case of Richstar v Carey (No. 6). In that case French J of the Australian Federal Court held that numerous Trusts of which directors and officers of Westpoint Realty Pty Limited were involved could be seized for the benefit of the Company’s creditors on the basis that the Trustees of the numerous Trusts were effectively the alter egos of the main beneficiaries of those Trusts.

3.16 If this reasoning were to be applied in New Zealand, it would I suspect give rise to the possibility that a great many Trusts here would be declared to be the alter ego of the settlor/major beneficiary. One way to avoid this possibility is for the power to amend a Trust Deed or to make appointments to vest in at least two people, one of whom will preferably be truly independent of the other. The following statements from French J in Richstar show the reasoning which supports this proposition:

“… where a discretionary trust is controlled by a Trustee who is in truth the alter ego of a beneficiary, then at the very least a contingent interest may be identified because, to use the words of Nourse J, ‘it is as good as certain’ that the beneficiary will receive the benefits of distributions either of income or capital or both.”

“… the beneficiary who effectively controls the Trustee’s power of selection because he is a Trustee or one of them and/or has the power to appoint a new Trustee has something approaching a general power in the ownership of the Trust property.”

3.17 The extent to which the Australian Federal Court categorised such Trusts as being the alter ego of a person was illustrated in one of the Westpoint Trusts in which a Mr Beck had a power to distribute no more than 39% of the income or capital to any beneficiary without a unanimous resolution from the appointor authorising the distribution. “The current appointor is his wife. In my opinion, this Trust gives Mr Beck at least a contingent interest in the whole of the Trust property and what amounts to ownership of at least 39% of it.”

3.18 Mr Beck was associated with another Trust – The Beck Unit Trust which owned 23 properties. The corporate unit holder was a Company of which Mr Beck and his wife were directors and secretary and he beneficially owned all of its capital. Notwithstanding the involvement of his wife, it was held that he “is able to exercise complete control over the property of [that] Trust” so that the assets of that Trust were also treated as belonging to Mr Beck pursuant to the alter ego doctrine.

3.19 It is important to note that the power of the Federal Court to make the orders which it made in the Richstar case derive from s 1323 of the Corporations Act 2001 (Cth) which provides “that the Court may make an order prohibiting a person holding … property from … parting with possession of the … property”. “Property” itself is defined as meaning “any legal or equitable estate or interest (whether present or future and whether vested or contingent.” The Court is empowered by the section to appoint as a Receiver or Trustee a person who holds “property” “otherwise than as sole beneficial owner, for example … as Trustee for … another person; or in a fiduciary capacity.”

These are wide words and a New Zealand Court may consider that, to the extent that the alter ego doctrine may exist in New Zealand law, it is not applicable in circumstances such as existed in the Richstar case because there is not a comparable statutory basis for making such orders.

4. Drafting Trust Deeds to accommodate changes in relationships

4.1 Because of the likelihood that any Trust which is to last for many years may need substantial modification, it is in my opinion fundamental that Trust Deeds should contain an express power of variation.

4.2 In the context of a family Trust, if the power of variation is vested in a husband and wife jointly, there will be a prospect of a stalemate if they should fall out and be unable to agree on the resolution of their disputes. This may prevent the parties from being able to modify the Trust.

4.3 Because the power of modification of a Trust Deed can potentially result in the person who holds that power manipulating the Trust so that he/she receives all the benefits of it, it is desirable that the power should vest in more than one person so as to (a) defeat the prospect that the Trust may be set aside as being the alter ego of the person concerned, or (b) being held to be a sham, or (c) resist an order that no Trust was ever created in the first place.

4.4 Where there is a general power of amendment it should be possible to enable a Trust Deed to be altered so that where parties separate they can, having resolved their disputes, arrange for the orderly removal from the Trust Deed of the spouse/partner who is no longer to be associated with the Trust. With the increased powers of discretionary beneficiaries to gain access to Trust books of account and documents relating to Trust decision-making, it is not desirable that a spouse/partner who has otherwise settled all relationship property claims can pursue the trustees relentlessly into the future with requests for information etc.

4.5 There are a number of mechanisms which are typically employed in the establishment of Trusts which it is assumed will enable them to withstand judicial attack. Many of them were employed in the establishment of a Trust for a Mr Sparkes and the failure of the Trust to withstand a subsequent attack shows that the form of a Trust is of little benefit if it is not accompanied by the substance which the law requires. The case of Olliver v Sparkes – which was decided in December last year – is a compelling illustration of the problems which can arise with Trusts in circumstances where the settlor and trustees do not understand the nature of their obligations.

Olliver v Sparkes

4.6 Ms Olliver began to live with Mr Sparkes in 1994. She was 33 years old and had a five year old daughter from a previous relationship. He was 47 years old and had recently come out of a 10 year relationship from which he had a son and a daughter.

4.7 About 15 months after they began to live together, Mr Sparkes bought a property which became the family home.

4.8 He established a Trust, after receiving legal advice to the effect that if his assets were owned by the Trust he would be protected against any relationship property claim. The purchase price of the home was $220,000. Mr Sparkes was essentially responsible for the payment of the deposit. There was a mortgage which was initially in his sole name but this was subsequently changed to the Trustees of the Trust being himself, a solicitor and an accountant. The settlor was a solicitor – who was also one of the three Trustees.

In short, the Trust was established in accordance with convention advice that (a) the husband should not be the Settlor of the Trust , and (b) the Trust should have professional Trustees so as to avoid any perception that it was a sham or Mr Sparkes’ alter ego.

4.9 When the relationship between Mr Sparkes and Ms Olliver broke down he showed her no quarter. She tried to stay on in the home with her daughter. Although she was described in the Trust as one of its two “primary beneficiaries” (Mr Sparkes was the other) this was no help. She was peremptorily removed as a beneficiary and was given a trespass notice. Although the mortgage for the property had been paid from their joint account, Mr Sparkes’ attitude was that she was not entitled to a cent. The Trustees appeared to support him in this.

4.10 The Judge summarised Ms Olliver’s plight: “In this case the applicant is left with nothing. She is not even a mere beneficiary under the Trust because she had been removed by the Trustees.”

4.11 The following questions and answers show that many mechanisms which will supposedly enable a Trust to resist challenges from disaffected parties, may be of little or no use.

Q. Did the presence of “independent” Trustees (one was an accountant and the other a solicitor) enable Mr Sparkes to keep the assets of the Trust away from Ms Olliver?
A. No.

Q. Did the fact the a third party had been the settlor of the Trust assist Mr Sparkes to keep the assets away from Ms Olliver?
A. No.

Q. Did the existence of the power to appoint and remove beneficiaries enable the appointors to remove Ms Olliver from the Trust and prevent her from receiving compensation?
A. No.

Q. Was the advice that his lawyer gave him (which was relayed to the Court) that he “would be protected against any relationship property claim” correct?
A. No.

4.12 This was the Judge’s reasoning. She said that:

“… where a sham exists it can either exist from the outset or develop over time if the parties develop an intention to mislead. The intention to mislead must be shared by all trustees and parties. If a sham is established from the outset or by emerging over time, the result is that the Court will set aside the Trust to give effect to the true agreement …”

She said that:

“There is no basis for finding that the trustees had a common intention to mislead [Ms Olliver]. What I have found is that Mr Sparkes had effective control of the Trust and dealt with it as if it were his own property and the trustees acquiesced in that. I doubt that this enables the Court to simply disregard the terms of the Trust and treat the assets as Mr Sparkes’ property.”

The Judge referred to Official Assignee v Wilson where Chisholm J had said that the alter ego doctrine did not exist in New Zealand law except as a means of helping to prove the existence of a sham trust. Other High Court Judges have spoken with a different voice on this topic and these decisions were referred to in the Judgment.

4.13 As a result of the Judge’s belief that she had to find that an intention to mislead “must be shared by all trustees and parties” the orders which he made in respect of Mr Sparkes were not structured around his finding that the Trust was Mr Sparkes’ alter ego.

4.14 It is worthwhile to recite some of the factors which had led the Judge to the conclusion that the Trust was Mr Sparkes’ alter ego. These were some of the factors which led her to this conclusion.

• Mr Sparkes had the power to appoint and remove Trustees.
• “Records were not kept and significant transactions between Mr Sparkes and the Trust were not recorded. No acknowledgment of debt or other record exists to show the debt owing to Mr Sparkes and Ms Olliver for the deposit money paid at the time of purchase.”
• “Although the mortgage was in the Trust’s name the repayments were met by the parties through their joint account. Other outgoings were also paid, including insurance, rates, and improvements were made to the property. There appear to be no records kept by the Trust whatsoever in relation to these payments regarding their asset. The tax returns for the Trust do not show the mortgage liability or any rentals received to offset that liability or payments being made by the beneficiaries and occupants of the property in lieu of rental.”
• “There was no written rental agreement or any other contemporaneous record of rent being paid to the Trust for occupation, or mortgage repayments being made in lieu of rent.”
• “There is … no evidence of any meetings of the Trust, no minute books, no resolution or other records recording financial transactions in respect of [the house]”.
• “There is no record of any monies paid by the Trust for improvements to the property …”
• In his evidence to the Court Mr Sparkes said “The intention was that any further property which I purchased would be bought through the Trust. I would not own any significant assets personally. My legal adviser told me that by having assets owned by the Trust I would be protected against any relationship property claim.”
• On the day before the Trustees executed a Deed excluding Ms Olliver as a beneficiary under the Trust, Mr Sparkes’ solicitor wrote to the Police and said that “Mr Sparkes tells us that she is in the process of being removed as a beneficiary … as he is entitled to do” (my emphasis). There were three Trustees and the power to remove a beneficiary appears to have vested in all three of them – not in Mr Sparkes alone - but Mr Sparkes presumably spoke to his lawyer in ways which led the lawyer to believe that Mr Sparkes had the sole ability to achieve the removal of a beneficiary.
• There was correspondence from Mr Sparkes’ solicitor to Ms Olliver’s solicitor which referred to Mr Sparkes’ wish to sell the property immediately and, in the words of the Judge, “the correspondence refers to that being his wish and intention as opposed to the Trustees.”
• In his evidence at the trial he told the Judge that “I had to retain control” of the Trust , thereby implying that he had sole power over the Trust’s destiny and that in truth, the other trustees were compliant agents who would do what they were told.

4.15 Although the Judge said that the Trust was Mr Sparkes’ alter ego, she did not treat the Trust assets as Mr Sparkes’ personal property but gave relief to Ms Olliver by the mechanism of a section 44C order and by the finding that there was a constructive trust.

4.16 It was held that Mr Sparkes, as a “primary beneficiary” had “a contingent future interest” but that this interest was his separate property. The Judge was satisfied that Mr Sparkes had transferred the property to the Trust to defeat “the claim or rights of [a] person” but she was not satisfied that the Court could make an order that the Trustees should pay monies to Ms Olliver because she was not satisfied that, in accordance with s 44(2)(b) of the PRA they had received the property otherwise than “in good faith and for valuable consideration”. There was no evidence that the solicitor and accountant trustees were aware of Mr Sparkes’ intentions at the outset.

4.17 The Judge held that compensation should be paid pursuant to s 44C of the PRA for relationship property which had been disposed to a Trust. The Judge held that approximately $5,500 of the deposit was relationship property; that the parties had paid $128,000 of relationship property in respect of the mortgage; and that Ms Olliver had paid an additional sum of approximately $6,600 in respect of the mortgage. These were treated as dispositions which “had the effect of defeating her claim” under the PRA.

4.18 When faced with the prospect that an order might be made against him under s 44C Mr Sparkes responded that he had “no separate property out of which he [could] be directed to compensate.” Ms Olliver. The Judge was not convinced and was prepared to make an order that he should pay her 23% of the proceeds of sale of the house.

4.19 As a fall-back finding, the Judge also held that the circumstances justified a finding that there was a constructive trust under which Ms Olliver was entitled to receive $75,000. This arose in part because she had helped to pay the mortgage; she had worked in Mr Sparkes’ shops which had enabled him to develop his business and income; that they had pooled their income and paid the outgoings for the property from their joint account; and that she had undertaken extensive redecoration of the home which had significantly improved it. Mr Sparkes’ evidence that he had made it clear to her from the beginning of their relationship “that she would only benefit under the Trust if they remained together” was met with the response from the Judge that “I find it quite improbable Ms Olliver would have remained with Mr Sparkes for 10 years and made the contributions to the property and to their relationship in general if she had understood Mr Sparkes’ true intentions in relation to [the house] …”

4.20 There is authority in England which would, in my opinion, have justified a decision in the Sparkes case that the Trust was a sham. In Midland Bank PLC v Wyatt Mr D E M Young QC sitting as a Deputy Judge of the High Court held that a Trust which had been executed at a time when the husband was in financial difficulty was a sham. He said that “a sham transaction will still remain a sham transaction even if one of the parties to it merely went along with the ‘sham’ not either knowing or caring about what he or she was signing …” . In that case a wife had said that she would have signed whatever was put in front of her without reading it and she appeared to have no understanding of the workings of the Trust.

4.21 The decision was followed by Singer J in the English High Court in a case involving the Fountain Trust. There, the husband held two letters of wishes both bearing the same date but in mutually contradictory terms. Following delivery of a Judgment the husband produced a third letter of wishes which he had “apparently” discovered in which it was said that the wife was not intended to receive distributions from the Trust. It was clear that the Court believed the husband had manufactured the document. There were some other factors which suggested that the Trust was not genuine. It was held that the Trust was a sham and the Royal Court of Jersey (the Trust being situated in Jersey) allowed Singer J’s order to be enforced.

4.22 It was notable that the presence of professional Trustees did not save the Trust from being held to be a sham. The Judge said that the “Trustees were privy to that sham, at least in the sense that they went along with the intentions of the husband.” By the same reasoning it could be said that in Olliver v Sparkes the trustees “went along with the intentions of the husband” in much the same way as the professional trustees of the Fountain Trust had done.

4.23 Future Judges when faced with facts such as those which existed in the Olliver v Sparkes case may feel more emboldened by the English and Jersey decisions when faced with allegations that a Trust was a sham.

5. Drafting Trust Deeds to survive Sham/Alter Ego challenges

5.1 If a Trust is to survive claims that it is the alter ego of a Trustee/beneficiary or a sham, it should in substance fulfil the necessary requirements of a Trust. This means that it should not be worded in such a way that the settlor has the power to ensure that the assets can be utilised by him/her as a beneficiary in ways which he/she prefers. This means that powers of appointment should preferably be shared with independent trustees; or vested in them alone and that powers to appoint and remove trustees and beneficiaries should also be shared with independent trustees or appointors, or vested in them alone.

5.2 If a Trust is operated in such a way than an “independent” trustee/appointor is a cipher who does whatever the settlor/beneficiary wishes, there will be a material prospect that a Court will try to set the Trust aside.

5.3 Assets which are transferred to Trusts should be treated as Trust property and the financing arrangements in relation to them should be structured to accord with the true ownership of the asset. In this way loans will preferably be paid by the Trust and not by the beneficiaries. Similarly, borrowings will be incurred by the Trust and not by the individuals.

5.4 In short, if a Trust is to withstand the scrutiny of the Court, it should be structured, and operated, so that it is in substance a Trust – and is not merely a Trust in form.

6. How Trust property can morph into relationship property

6.1 The fact that property is vested in a Trust will not prevent it from being vulnerable to the claims of others, nor will the fact that distributions from it which are intended to be the separate property of the recipient prevent them from losing that status and being converted into relationship property. These are some of the ways in which Trust property can metamorphose into relationship property.

(a) Trust property can be held to be the subject of a constructive trust. It has been held in one case that it is necessary for all the Trustees to know the representations which are being relied which justify the imposition of a constructive trust. In other cases the Courts have imposed a constructive trust notwithstanding the ignorance of the Trustees of the representations which were being made and relied upon. In the light of this conflict it is wise to work on the assumption that a constructive trust will be imposed upon trust assets notwithstanding the fact that some of the trustees have no knowledge of the representations which are being made and relied upon in respect of Trust assets. Trustees should therefore take an active role in the management of Trust assets so that they are likely to become aware of such representations.

(b) Section 8(1)(ee) of the PRA stipulates that all property which is acquired after a relationship began will be relationship property if it was acquired out of property owned by either of the partners “for the common use or benefit” of the parties generally. Trust property which is distributed to a spouse/partner can by this provision become relationship property.

(c) If Trust monies are distributed to a spouse/partner and any income or gains derived from it are attributable wholly or in part to the application of relationship property then the increase in value is liable to be relationship property – s 9A(1) PRA.

(d) Any increase in the value of separate property which is derived by a partner from a Trust and which is attributable to actions of the other partner is liable to be converted into relationship property: s 9A(2) PRA.

(e) Where any separate property (ie Trust distributions) is used for the acquisition or improvement of any relationship property, it will morph into relationship property: s 9A(3) PRA.

(f) Where Trust distributions have been “sustained by the application of relationship property or the actions of the other partner” the Court may “increase the share to which the [other partner] would otherwise be entitled in the relationship property; or order [the owning partner] to pay the [non owning partner] a sum of money as compensation”: s 17(1)-(2) PRA.

7. Conclusion

7.1 Trusts are often created so that wealth can devolve from one generation to the other in the belief that the wealth will remain with the next generation and will not be intercepted by relational partners or others. The provisions which I have summarised above are sufficient to show how easily such intentions can be frustrated.

7.2 There is no easy solution to avoid these difficulties. In practice, the only way by which Trust wealth can safely remain with those whom the settlor and/or trustees wish to have the wealth is by education. Both the beneficiaries and trustees need to have a good understanding of Trust laws, of the provisions of the Property Relationships Act, and of the equitable doctrines which apply to Trusts such as the alter ego and sham trust doctrines. They also need to understand the nature of fiduciary obligations and responsibilities and realise that powers which are not exercised responsibly may lead to the setting aside of decisions - or worse, the unravelling of the Trust itself.