Trusts & Wills – Issues to consider for new beneficiaries - :: Anthony Grant

“Trusts & Wills – Issues to consider for new beneficiaries”.

1. Introduction

1.1 When people die their assets don’t go with them. The Egyptians tried to take their wealth to the after-life. They built elaborate tombs and filled them with all their possessions so that they could better enjoy the after-life. But the possessions stayed behind to be seen these days by tourists and visitors to museums.

1.2 Assets should therefore be directed on a pathway of efficient distribution either before death or at the time of death. There are two primary mechanisms for the intentional distribution of wealth:

Wills.
Trusts.

1.3 The devolution of wealth via Wills in New Zealand is subject to a statutory regime of relational preference. The Family Protection Act provides that a large number of family members can request the Courts to set aside a testator’s wishes. The vagueness of the Statute, and the fluidity of the way in which the Courts apply its provisions, means that many testators can have little confidence that their wishes will be respected.

1.4 The fact that we still have the Family Protection legislation is anomalous. A requirement to transfer assets to people (a) who don’t know how to manage them, and (b) who are liable to become demotivated and lazy with the use of the assets, makes no sense. A recent survey of individuals with a net worth of $10m or more in Canada showed that 30% considered their main challenge as “maintaining a strong work ethic and a sense of values in my family” and 24% were worried that their children and grandchildren would become less demotivated because of family wealth –a condition which is known as “affluenza”.

1.5 It can be noted that the Family Protection legislation is much less onerous than the forced heirship statutes which are in place throughout much of continental Europe and countries which are governed by Islamic laws. Many trusts practitioners overseas are involved in the substantial “industry” of establishing trusts to circumvent these laws.

1.6 The problems with the Family Protection Act can be illustrated by reference to “blended” families. As life expectancies have increased so the number of partners which a man and a woman may have through the course of a lifetime has increased. With two or three marriages and two or three sets of children there is a heightened likelihood that a chosen set of dispositions will be unsettled by the Courts. The Foreman litigation illustrates this dynamic, albeit in the context of Trusts. Bill Foreman has had three marriages. There were four children of the first marriage, two from the second and two from the third. His third wife additionally has two children by a previous marriage. In circumstances where substantial wealth is at stake it would be difficult to devise a Will which would not be challenged by one or more of his ten children or three wives under the Family Protection Act.

1.7 Quite apart from the inherent uncertainties of the Family Protection Act there is the difficulty of convincing inheritees of the most advantageous ways by which wealth can devolve. A child in his/her twenties, with a mortgage can be told to create a trust and enter into a loan agreement for the reduction of the mortgage but to a person who is unsophisticated in corporate structuring this will seem to be an inconvenient and unnatural device. It will seem so much easier to use the money to retire the debt on the family home and be quit of the mortgage – in which event the wealth will be instantly converted into relationship property – to be lost if the child’s marriage or relationship ends.

1.8 The outright disposition of wealth to people who may have no experience of its management is also a problem. Far from benefiting them, it can be their undoing.

1.9 The Testamentary Promises legislation can also be a potential difficulty in some circumstances.

1.10 Gifting is a problem since the State will only allow the gifting of the modest sum without imposing a gift tax.

1.11 Loans are problematic since they require repayment.

1.12 So far as income tax is concerned, with some exceptions the disposal and acquisition of a taxpayer’s assets on death are deemed to occur at market value on the date of his/her death. This has the consequence of reducing the size of an estate as a result of the recovery of depreciation on the assets which are to be distributed. A Trust structure which has been put in place before death will be advantageous since there is no deemed disposal of the Trust’s depreciated assets at the time of the settlor’s death.

1.13 It is factors such as these which have caused those with wealth to give consideration to alternative pathways for the devolution of wealth.

1.14 The strange creature of equity – the Trust – is the most logical mechanism, of all the mechanisms which are available under our laws, for the orderly transfer of wealth. The English law’s notion of a “Trust” is extraordinarily casual. It does not involve the incorporation of any statutory entity nor even require confirmation in writing. The simplicity of the structure is deceptive since many have invoked it in the belief that it makes little difference to the realities of private ownership. These people run the risk that the so-called Trust which they create will be held to be a sham or that the assets of the Trust are merely held by the Settlor as his/her “alter ego” - and their intentions will be defeated.

2. Trusts

2.1 Although the legal concept of a Trust has been well known in English law for ages, the current popularity for the structure has exceeded the general knowledge of the factors which are necessary to ensure that its use will result in the successful transfer of wealth. I refer first to the liability of trustees.

3. Liability of Trustees

There is widespread misunderstanding about the nature of Trusts and it is likely that many Trusts which have been established would, if challenged, be found to be invalid. The Courts have begun to lower the bar on trustee accountability in ways which should make all prospective trustees wary about taking on the office of Trustee unless they intend to have a close involvement with the activities of the Trust.

Baragwanath J recently spoke about the widespread misunderstanding about the nature of Trusts:

“Recent experience in more than one case suggests that the concept of trust is used more often than it is understood. Unlike a Company or an incorporated society a “Trust” is not a legal person recognised as distinct from humans who direct their affairs. On the contrary, trustees can contract only in their own right: either they do so and are personally liable to the extent provided by the ordinary law which the agreement may modify or there is no agreement at all.”

Unless a trustee contractually stipulates to confine his/her liability to the assets of a Trust he/she will be liable for the full amount of any liability. In this context, the addition of the word “trustee” alongside a trustee’s signature will not serve to limit the trustee’s liability.

Trustees need to have an accurate understanding of their powers. In a recent case trustees who appear to have been mis-advised about their powers by one of the country’s large law firms were held by the Court of Appeal to be personally liable for a breach of trust and were not entitled to relief from liability under s.73 of the Trustee Act:

“Mr Scott argued that the trustees acted on the advice of their solicitors that the proposed payment was within the power conferred on them, and that the trustee’s conduct could not be characterised as ‘dishonest’. But acting on incorrect advice cannot of itself provide trustees with a shield . . .”.

“It was not merely unreasonable – it was downright foolish – to proceed to implement a scheme of this kind knowing that it could come under critical legal scrutiny, as being an allegedly unlawful device.”

The trustees were held liable in their personal capacities to restore a sum of $250,000 together with interest which was fixed at 7% from the date of the advance to the date of the restoration of the monies to the Trust.

The exposure to liabilities does not stop there. It has been held that a trustee may also be liable for the unauthorised actions of a co-trustee. In ASB Bank v Davidson one trustee committed his two co-trustees (his wife and the partner in a major law firm) to various obligations without informing them – giving the explanation that if he had told them what had proposed to do, they would not have permitted him to do it. The husband and wife had given a guarantee to the Bank in respect of a prior borrowing. Decisions of trustees which are not unanimous are ineffective in the absence of a Trust term to the contrary. The Bank was aware of this but did not ask to see any documentation to confirm that the new borrowing had the unanimous approval of all the trustees. Notwithstanding this the Trustees were held liable to the Bank on the basis of unjust enrichment. The Court of Appeal also held that the Bank’s indemnity was worded widely enough to require both Mr and Mrs Davidson to indemnify the Bank. “Innocent” trustees were criticised for failing to properly supervise the affairs of the Trust and were held liable to pay $50,000 to the Bank. This decision was upheld in the Court of Appeal. They were held liable under the terms of a Deed of Guarantee which they had given to the Bank in connection with a prior borrowing. In the High Court Laurenson J said:

“. . . Mr Davidson is yet another example of a person who, having arranged the formation of a family trust to protect family assets and gain income tax advantages, thereafter chose to ignore the legal implications of his trusteeship and simply regarded the assets of the Trust as part of his overall assets which were available to him to do as he wished. He was able to do so because it is quite obvious that his co-trustees failed to exercise their responsibilities as trustees. Having originally determined on 1 June 1994, when first opening the ASB account, that two trustees were required to operate the account, at some point, possibly on 7 July 1994, they authorised anyone to sign. Thereafter it appears to be clear that in practice Mr Davidson was the sole signatory. It is equally clear that the other trustees did not choose to peruse bank statements forwarded to the trust.”

In a warning which should cause a person to be wary about accepting appointment as a trustee in circumstances where he/she may not be kept fully informed about the affairs of the Trust, Chambers J said in his judgment that he thought it:

“. . . distinctly arguable that it did not matter that [the two innocent trustees] were not aware of what Mr Davidson was doing. There is an argument that the contract with ASB was breached when Mr Davidson . . . failed to notify the Bank of the occurrence of a Cancellation Event . . . Mr Davidson made a statement in connection with a facility which he knew was not to be true and accurate: that was the statement that the Trust sought the initial standby letter of credit, when he knew that the other trustees knew nothing of it. He had the obligation to notify the Bank of that untrue statement; that obligation was breached; the Trust’s contract with the Bank was thereby breached; because of joint and several liability, the Trust is liable for loss flowing from his breach.”

This case can be seen as a means by which the Courts will control the casual use of Trusts. The imposition of liability on trustees who are deliberately kept in ignorance by a co-trustee should lead to a tighter and more appropriate management of trust affairs.

4. Interest of beneficiary in trust assets

A person who wishes to benefit another via a Trust should ensure that the benefit does not become vulnerable to expropriation as relationship property in the hands of that person.

If the donor establishes a Trust and settles property on it, distributions from the Trust derived from the settled property or assets otherwise acquired by the Trust will be the beneficiary’s separate property: s.10 PRA.

If instead of creating a Trust and settling property on it the “settlor” had made a gift to the person concerned or had sold property to the person with a gift back, the property transferred is more at risk of being categorised as relationship property since it may be used in ways which will cause its status to be changed from “separate property” to “relationship property”.

In determining whether property of a spouse/partner is separate property it should be noted that separate property can be converted into relationship property and revert back to separate property. This occurred in Thompson . In that case the husband owned a house at the time of the his marriage. He and his wife occupied it as their matrimonial home. It was sold seven years after the marriage and some of the proceeds of sale were advanced to a Trust which bought a property in which they next lived. Potter J held that the past use of the house as a matrimonial home was spent when it ceased to be used by the husband and wife for that purpose and the sale proceeds of that house became the husband’s separate property.

In RHR v AMMR John Hansen J considered a clause in a Will by which a father declared that trustees were to hold trust property on trust for his children and it referred to an intention that his son would have an entitlement to “an absolute vested interest”. The husband’s interest was held to be “property” for the purposes of the PRA and the wife made claims to it by virtue of s.9A and s.17 of that Act - she claimed that an increase in the value of the separate property was attributable to (a) her actions, and (b) a claim that she had “sustained” the value of the separate property.

In general terms it is preferable that a settlor who decides to create a Trust should give the beneficiaries a discretionary rather than a vested interest in it since the Courts have not yet assessed any interest of a discretionary beneficiary as having a particular value.

By contrast, the creation of a life interest can be valued by conventional principles:

“The value of a life interest can be determined in the same way as a leasehold or any other interest in land by the application of ordinary valuation principles . . .”.

The fact that a spouse/partner may have a quantifiable interest in a Trust does not make that interest relationship property since section 10 of the PRA provides that property received from a Trust which was settled by a third person will be the separate property of the beneficiary. However, a donor who wishes to make provision for a married child, should in my opinion generally try to convey the benefit in such a way as will make it less likely that any benefit which the child receives will be intercepted as relationship property of the child. Vested interests in a Trust may be taken into account in the context of applications for spousal maintenance whereas discretionary interests are less likely to be so.

The attitude of the Courts to the categorisation of a discretionary interest can be seen from the following cases:

(a) In Nation v Nation the Court of Appeal said:

“In general terms, under a discretionary trust a discretionary beneficiary has no legal or equitable interest in the assets of the Trust unless the trustees have exercised their discretion in favour of the particular beneficiary.”

The qualifying words “in general terms” are, I suspect, intended to cover situations where either the alter ego doctrine or the concept of sham trusts are successfully invoked so as to treat the assets of the Trust as being the assets of a person who may be described as a discretionary beneficiary.

(b) A year earlier, Tipping J, giving the judgment for the Court of Appeal in Johns , didn’t qualify the proposition:

“Few citations are necessary to support the view that a so-called discretionary interest in Trust property does not constitute a legal or equitable interest in that property . . .”.

(c) In B v M Allan J left open the possibility that an interest as a discretionary beneficiary may constitute “property” for the purposes of the PRA:

“In summary, the interests of the parties as discretionary beneficiaries are limited. It is arguable that their rights and interests as discretionary beneficiaries may fall within the definition of the term ‘property’ in the ‘Act’ but it is not necessary to decide that point for present purposes. There is no evidence of the value of those interests, nor the interests of the parties as final beneficiaries. There is no warrant for simply treating the assets of the Trusts as those of the parties and dividing it between the parties.”

(d) In Q v Q Judge Fitzgerald held that a wife’s discretionary interest “does not create for her a right or interest in the trust property and does not therefore qualify as ‘property’ under the Act either. It is a mere expectancy.”

(e) In Thompson v Thompson Potter J held that life interests which were created in a Trust were relationship property. The assets of the Trust had derived from the husband’s pre-marriage separate property. The debt which the Trustees owed to the husband in return for the transfer of the property to the Trust was held to be relationship property, being a debt acquired by the husband for the common use and benefit of both him and his wife.

In the controversial case of Q v Q Judge Fitzgerald held that an increase in the value of trust property of $3.9m “was attributable in part to the application of relationship property and also in part to Mr Q’s direct and indirect contributions . . .” and said that:

“The increases are therefore relationship property under ss.9A(1) and (2)”.

He directed that the entire increase in the value of the trust property ($3.9m) was relationship property and that the husband was entitled to half of it.

5. Debts due from Trusts to settlors

It will often be the case that a person will transfer property to a Trust in return for a debt which the Trustees owe to him/her. The debt will usually be relationship property in the hands of a spouse/partner but the property which is transferred to the Trust becomes the property of the Trustees alone.

As Priestly J said in Walker v Walker:

“Debts owing to individual family members by Family Trusts or private companies are a common incidence of family financial structures. Transferring assets to a family Trust in consideration of a debt from the Trust to the transferor is legitimate and widespread. Gift duty is avoided. The debt is a fixed sum. The Trust is the sole beneficiary of future capital gains. The motivation of such transactions varies. Creditor protection, taxation advantages and securing family wealth for future generations are obvious motives. The transferor divests him or herself of the asset but retains the value of the consideration as creditor. The paltry annual gifting allowance may reduce the debt, but the creditor retains the security and comfort of the ability to demand repayment of some or all of the debt if the need arises.”
[My emphasis.]

In Yu Ping Gao v Elledge Judge Robinson held that a family home and family chattels which had been settled on a Trust were relationship property:

“In any event s.10(4) provides that the family home and family chattels are relationship property unless designated separate property by an agreement executed by the parties. No such agreement has been executed in this case.”

This appears to be wrong since the house and family chattels were the property of the Trust and not the property of the parties. The decision in that particular case could however have been justified on the grounds that the so-called “Trust” was not a trust at all. Its asset was an apartment in which the husband and wife lived. It was transferred to a Trust of which a daughter of the husband from an earlier marriage was the sole trustee. The Trust Deed recorded that:

“At the request and cost of the Beneficiaries the Trustee will transfer the Property to the Beneficiaries as and when the Beneficiaries require.”

“Until the Property is transferred to the Beneficiaries the Trustee will deal with the Property as the Beneficiaries require.”

“Nothing in this Deed shall entitle the Trustee to beneficial ownership of the Property or to deprive the Beneficiaries of the rights of beneficial ownership including the right of possession of the property . . .”.

It appears that in substance the property had not been transferred to the Trustee since the husband and wife retained virtually full control over the apartment. In this way, the so-called Trust was missing one of the “three certainties” of a Trust namely certainty of the settlor’s intention to create a Trust.

In Begum v Ali Judge Fitzgerald was dismissive of a Trust in circumstances which were not dissimilar to those in Yu Ping Gao v Elledge and held:

“I find it impossible to avoid a conclusion that the Trust and the transfer were devices not seriously intended for the purposes referred to in the Trust Deed itself and to that extent amounted to no more than a fiction.”

This decision was appealed to the High Court. Rod Hansen J dismissed the appeal . Here too, it appears that the Court was not satisfied with the genuineness of the settlor’s intention to create a Trust, and with ample justification.

6. Language which conflicts with Trust documentation

It is not uncommon for trustees to speak of trust assets as “their” property. Such language is likely to be considered critically in cases where the alter ego doctrine and the sham trust doctrine are invoked. In Q v Q Judge Fitzgerald commented on the contention that the trading name for an orchard owned by a trust was the name of the parties:

“I do not think too much should be read into such matters or that it is of great significance that the children and third parties did not distinguish between the Trust as a separate legal entity from either or both of the Qs. It would be quite natural for such people to identify the farm and the orchard with the Qs who lived there and handled virtually all of the dealings with third parties directly themselves.”

7. Requests by Settlors to Trustees – whether “substantial or effective control” of Trustees by settlor

It is also common for a settlor to request trustees to make particular distributions. If the trustees are under “the substantial or effective control” of the settlor this will defeat the notion that there is, in truth, a Trust. But:

“if trustees generally exercise their discretion in good faith, they are not under the substantial or effective control of the settlor even if they in fact decide to go along with the settlor’s request . . . In order to establish substantial or effective control it is necessary for the Court to conclude that [the trustees] went along with the request from [the settlor] without applying their minds to the matter in question, ie without exercising a bona fide discretion.”

“It cannot be sufficient simply to show that, in practice, trustees have gone along with a settlor’s wishes. Such an event might of course be evidence that the trustees had abdicated their fiduciary responsibilities and come under the control of the settlor. It would often be equally consistent with trustees having exercised their fiduciary responsibilities properly but having decided that each request of the settlor was reasonable and in the interests of one or more of the beneficiaries so that it could be accepted.”

“[Counsel] argued that because [the settlor] made a number of significant requests, no request was ever refused, no request was made other than with [the settlor’s] approval and it was difficult to see that any significant transaction would have been effective without [the settlor’s] approval, this showed that [the settlor] was in substantial or effective control. He accepted that, in the majority of genuine discretionary Trusts, it was likely that the trustees would not in fact have to turn down a request from a settlor. He further accepted that the mere fact the trustees had not refused a request from the settlor would not have itself proved substantial or effective control. He said that one had to have regard to the number and nature of the requests. He accepted, that, if his argument were right, many discretionary Trusts might well be found to be in the substantial or effective control of their settlor but he submitted that this would not matter as piercing the veil could only take place if there was mis-use as well.”

8. Trusts settled by third parties – s.10(1)(a) PRA

I referred earlier to s.10 of the PRA with its provision that property received by a beneficiary of a Trust settled by a third person will not be relationship property.

It appears that the drafters of section 10 may have assumed that a Trust is “settled” on a single occasion but this may not be so. It is established law that where property is transferred on later occasions to the trustees to be held on the terms of the Trust Deed, this creates further trusts in respect of that property. Each separate transfer gives rise to the creation of a separate Trust.

Thus, if a parent establishes a Trust during his/her lifetime and settles property on it for a child, and the parent later dies and the child becomes a Trustee and decides to settle further property on the Trust, the child may be the “settlor” for the purposes of section 10 with the consequence that distributions from the Trust to that person may have a relationship property component.

If this analysis is correct (and it is logical that it should be so) there will be some difficult accounting calculations to determine the extent to which a particular distribution derived from a part of the Trust corpus which was settled by the child but not by others.

It is not appropriate to add to the length of this paper by referring in detail to the argument whether an interest in a Trust held by a spouse who settled a Trust is itself relationship property or whether that argument “has no practical significance except in relation to actual distributions or appropriations by trustees in favour of a beneficiary/spouse”. If a Trust has received settlements from several people at different times, it is my opinion that the property which was settled by the spouse/partner should be the focus of attention, rather than the property which has been settled by third parties.

If “settlor” is to be interpreted by reference to the income tax legislation a person who provides money or services for less than market value to a Trust will be deemed to be a settlor in relation to that Trust.

9. Constructive Trust imposed over Trust assets

Settlors should be aware that the destiny of assets settled on a Trust may not be determined solely by the wording of the Trust Deed but also by the possibility that a Court may determine that the Trust assets are the subject of a constructive trust. In Prime v Hardie Salmon J imposed a constructive trust upon assets of an express Trust. The family home (and its predecessor) was owned by a Trust and he held that Ms Prime had a reasonable expectation that she would acquire an interest in the property.

A similar argument failed in B v M where Allan J said:

“That argument is not tenable. There is no room for the imposition of a constructive trust. The parties have elected to organise their affairs by establishing express Trusts. Their rights fall for determination under the applicable legislation, or under the terms of those express trusts.”

By contrast, in Q v Q Judge Fitzgerald held that if the husband had not succeeded in establishing that his wife’s

“rights and interests were property under the Act and that he was entitled to share equally in the value in the increases in value that accrued during the marriage, I would have imposed a constructive trust over the assets of the Trust to achieve a like result.”

It might be thought that a Court would be reluctant to declare a constructive trust over assets of an express trust in circumstances where some of the trustees had no knowledge of the conduct which was said to have given rise to the entitlement to impose a constructive trust but this did not appear to give rise to difficulty in Q v Q. There were four trustees in that case: Mrs Q, her sister, their mother and a Mr TC. It appears from the judgment that the sister, mother and Mr TC may not have been aware of any expectations which the husband was acquiring.

What can a parent do to avoid property being made the subject of a constructive trust at the behest of a child’s spouse/partner?

The first action is to ensure that the Trustees are actively involved in the administration of the Trust and have a good understanding about what is happening. In Q v Q three of the four Trustees paid little, if any, attention to the administration of the Trust. The Judge said:

“Throughout most of the marriage there is little evidence of any act of direct involvement by the Trustees . . . . No formal meetings were held and no Minutes kept of any informal meetings if they ever occurred.”

Trustees who neglect their role in this way may find themselves exposed to claims from other beneficiaries whose interests have been diminished as a result of the erosion of Trust assets through their negligent failure to monitor the affairs of the Trust properly.

10. The Hastings-Bass principle

A strand of law which has the potential for much greater exploitation is the Hastings-Bass principle. In accordance with this principle, if trustees, despite diligent and informed deliberation become aware that they have made a disadvantageous decision, they may be able to obtain an order from the Court which will allow them to reverse the decision – and all the taxation consequences which follows in its wake.

In the recent case of Sieff & Others v Fox & Other Trustees received advice concerning the taxation consequences of a decision. The advice was wrong and the Trustees applied to the Court for permission to be voided. Lloyd LJ granted the application, saying:

“It seems to me that, for the purposes of a case where the Trustees are not under a duty to act, the relevant test is still that stated in Re Hastings-Bass namely whether, if they had not misunderstood the effect that their actual exercise of the discretionary power would have, they would have acted differently. In my judgment that is correct on authority starting with Re Hastings-Bass and on principle. Only in a case where the beneficiary is entitled to require the Trustees to act, such as Kerr’s case or Stanard’s case should it suffice to vitiate the Trustees’ decision to show that they might have acted differently.”

The Hastings-Bass principle has recently been applied with success in A et al v Rothschild Trust Cayman Ltd. The plaintiff who was both the settlor and one of the beneficiaries of two Trusts was a Canadian resident. When he became concerned that he was spending so much time in the USA that he might become resident there for tax purposes he sought advice from a tax specialist and was advised that he could avoid that outcome if the Trusts were restated. The advice was acted upon but it became apparent that the advice was wrong and that the tax consequences of the restatement would achieve the very consequence that the settlor intended to avoid. Chief Justice Smellie explained the rationale of the Hastings-Bass principle:

“It seems that the fundamental rationale . . . is that because trustees exercise fiduciary powers vested in them for the benefit of the beneficiaries, trustees can only properly exercise such powers after they have given due consideration and weight to all relevant circumstances. The existence of the fiduciary duty vested in trustees which governs the exercise of their fiduciary powers, requires them to inform themselves of all matters relevant to their decisions . . . and in arriving at their decision in exercise of their discretionary powers, trustees are obliged to take account of all relevant but no irrelevant factors . . .Thus were trustees act on decisions taken under a mistaken or seriously flawed misunderstanding as to the nature of the benefit to be derived or conferred as a consequence of their decision, they cannot be said to have exercised their discretion properly for the benefit of the beneficiaries and so acting within the powers vested in them. Having acted so improperly their actions may be set aside by the Court as being void, or according to other expressions of developing case law to be examined, voidable.”

The Sieff and Rothschild Trust cases have significant implications in the area of relationship property. If trustees distribute money to a beneficiary in the mistaken belief that the money will remain the beneficiary’s separate property, and it later eventuates that their belief was mistaken, there may be circumstances which will enable them to seek to avoid the decision and so stop the property from being intercepted as relationship property.

These decisions show that there are distinct advantages for a person to make errors in the capacity as a Trustee rather than in an individual capacity or corporate capacity since the Hastings-Bass principle is confined to decisions made by Trustees. The contractual law of mistake has none of the flexibility of the Hastings-Bass principle.

11. Compensation for property disposed of to a Trust – s.44C PRA

A person who transfers assets to a Trust in the belief that the asset will no longer be his/her property will confront section 44C of the PRA which enables the Court to grant compensation to a spouse/partner on the basis that the transfer had the effect of defeating a spouse’s right under the Act. The section has been considered in a number of cases.

In Stewart the parties owned a property at Puhoi which was registered in the wife’s sole name. During the course of the marriage the property was transferred to a Trust at a value of $85,135. This modest sum reflected the value of a lease which had been given to the wife for her life which was valued at $159,864. At the time of separation the property had an agreed value of $245,000. At the time of trial it had a value of $360,000. It was held that the relationship property pool had diminished by $115,000 ($360,000 less $245,000) and the wife was ordered to compensate the husband for this diminished value.

The transaction was undertaken to shield the couple’s assets from potential creditors. Judge Ryan referred to the potential remedies which were available to the husband:

“Section 44C(2) gives me three remedies with which to compensate Mr Stewart. I can order Mrs Stewart to pay him a sum of money ‘whether out of relationship property or separate property’ or I can order Mrs Stewart to transfer to him any property, whether that be relationship or separate property. Where neither of the aforementioned remedies are available, I can make an order requiring the Trustees of the Tiffany Trust to pay to Mr Stewart income from the Trust for a specified period. In this instance the Trust has no income. Therefore, regardless of whether I am able to make either of the earlier orders, I cannot make an order against the Trustees.”

The next case was P v P. Trusts were formed to acquire the family home for $2.1m, a consultancy practice of $1m, consulting rooms for $350,000, some additional real estate, boats and a motor vehicle. The Trusts were formed to protect the husband’s assets and to provide a degree of tax relief.

The “dominant submission” of counsel for the wife was the effect that the wife should be compensated because the Trusts had taken away from the “relationship property pool” assets that would otherwise have been relationship property and thereby defeated her claim. She relied on the Stewart decision. To this Judge Strettell said that the intention of the parties at the time of the creation of the Trusts was the primary consideration.

“Whilst it may be accepted that had the Trusts not been created, the income of the respondent would have otherwise been relationship property. There is, however, nothing unlawful or unusual in what has been done. This arrangement was undertaken on the advice both from the applicant’s father and from the parties’ accountant. Moreover it is a practice not uncommonly used by those in medical or professional practices.”

This decision was appealed to the High Court and the Family Court decision was upheld. It was argued that the purchase by a Trust during the course of the marriage of a bach, boats and a vehicle should be considered as dispositions of relationship property but this was rejected:

“We agree with the Family Court Judge but s.44C does not accommodate the approach advocated by counsel. For whatever reason the holiday home and other assets were purchased directly by the Trust and did not involve dispositions by one or the parties to the Trust. These assets are beyond the scope of s.44C.”

This case sent to the Court of Appeal. That Court made it plain during the course of the hearing that it disagreed with the decision being appealed and counsel for the husband consented to the appeal being allowed.

The limited power which s.44 gives in respect of the Trust were revealed in C v C. Ten years after their marriage the parties established a Family Trust on the suggestion of an accountant. They and their future children were the discretionary beneficiaries and there were two Trustees. The family home was transferred to the Trust together with other property. The wife applied for an order under s.44C(2)(a) that the Trust should pay income to her, and an order was made that the Trustees should pay her $80 per week in respect of the debt due back to the parties of $207,000. Her share of $207,000 would be 50%, ie $103,500. At the rate of $80 per week it would take approximately 25 years to repay the debt to her. The Judge contemplated that the Trustee would sell some properties to accelerate the debt repayment but the Trustee was not present at the Court and there was no evidence from it of its intentions.

The Trustee was not represented at Court and therefore did not give evidence concerning its ability to pay the sum of $80 per week. It seems that the Court assumed that the Trust had the ability to pay that sum in circumstances where the wife had asked the husband to provide her with an income from the Trust of that amount and he “appears to have agreed with this suggestion but has done nothing to implement it”.

s.44C(1) requires as a pre-condition to the making of an order for the payment from a Trust that the disposition “must have the effect of defeating the claim or rights of one of the spouses”. In making the order Judge Ullrich QC must have been satisfied that the consensual transfer of the family home to the Trust had the effect of defeating the wife’s claim of rights.

In Nation v Nation the husband and wife separated after a 28 year marriage. In the year before separation a Trust was established and this acquired the farm on which the husband had worked throughout his life. He had received it in part from a Trust and the balance from his family. It was held that the disposition of the farm to the Trust had the effect of defeating the claim or rights of the wife and the case was remitted to the Family Court to determine the sum which she should receive.

“In this instance, there was a disposition to the Trust . . . of relationship property – a half interest in the farm (which had been acquired from the estate of E C Nation) . . . .”.

It was held that this was relationship property:

“In our view the wife’s claim was defeated. She has been ‘denied’ by the disposition, a claim to an equal share of one-half of the equity in the farm, valued as at the date of the hearing . . . . The wife would have been entitled to make that claim had it not been for the sale to the . . . . Trust by the husband. Instead, she has a claim to an equal half share of one-half of the interest free debt owed to the husband by the . . . Trust. The amount of the debt has remained constant from the time of the sale to the time of the hearing, while the value of the farm has increased significantly. Her potential claim has been defeated to the extent of the difference in the value between the amount of her share of the debt and the value of the share of the equity in the farm in which she would have had a claim. The meaning of the word ‘defeat’ is mechanical; it does not turn on bad faith or on improper motive.

There has been some concern in the legal profession as to how far, if at all, orthodox discretionary Trusts may be reached under this legislation. It is important to distinguish between the prospective claim against an interest in a Trust; and the operation of s.44C.

In general terms, under a discretionary Trust a discretionary beneficiary has no legal or equitable interest in the assets of the Trust until the trustees have exercised their discretion in favour of the particular beneficiary . . . .

In an instance such as the present . . . the husband . . . has put that asset beyond the usual reach of the statute, and substituted an asset which is frozen in value because it is a debt instrument and no interest accrues on it. He has thereby ‘defeated’ the wife’s claim in that respect. This is not a case where an asset has been exchanged for another asset of similar worth, with equal scope for increase in value and risk of loss of value. The section provides that the husband can be required to compensation the wife – on a personal basis – in cases where the wife’s claim is ‘defeated’.

The decision in Begum v Ali illustrates the operation of s.44 in circumstances where property was blatantly transferred to a Trust to defeat the claim of a spouse. During the course of a marriage the husband established a Trust into which the home in which the parties lived was transferred. The wife had no knowledge of the formation of the Trust and neither she nor her daughter were included as beneficiaries. Judge O’Donovan held:

“My view, . . . is that any disposition by the first respondent of the Norfolk Street property to the second respondent was made ‘in order to defeat the claim of rights of the applicant’.”

In the result the property was vested in the parties as tenants in common in equal shares.

In Q v Q it was held that a husband was entitled to an order under s.44C in circumstances where relationship property had been disposed of to a Trust. Among the factors was the husband’s and the wife’s unpaid labour. It is not easy to understand how unpaid labour can constitute “relationship property”.

In JCW v KFW a husband established a Trust two days before his marriage and transferred various assets into it including his residential home. The wife argued that the transfer was a disposition which was made “in order to defeat [her] claim or rights” for the purposes of s.44. To this Judge Mather said:

“The words ‘in order to defeat’ connote an intention on the part of the party disposing of the property which logically must be assessed at the time of the disposition. As indicated below, I think the test is rather different when the Court is required to have regard to the effect of a transaction rather than the intention of the disposing party at the time. Accordingly the focus must be on KW’s intention at the time of the disposition.”

The intention was to protect the husband pre-marriage assets for the children of his first marriage and this was said to be appropriate.

In Blackburn v Schierling the wife gifted $40,000 to a Trust. Judge Doogue held that the wife had received legal advice concerning the gifting of the sum and:

“On the evidence available to the Court there was nothing to establish that the value of the Trust was actually increased by this transaction. There is insufficient evidence to fulfil the requirements of s44C.”

This decision has been criticised on the basis that it ought not to matter that the Trust had not increased in value as a result of the transaction. Against that criticism it should be noted that the gifting of $40,000 to the Trust did not require the payment of the monies concerned but merely the completion of gift declarations.

In concluding my comments on s.44C I was to refer to the orders which can be made against trustees.

Apart from the order which was made in C v C that a trustee should pay $80 per week to a spouse the only other order which has been made against a Trust was a direction that a husband was to instruct a trustee “to execute a form of security for the monies outstanding under the terms of this judgment.” This order was made in Stewart. The wife was ordered to pay monies to the husband and was allowed to continue to occupy the former matrimonial home, now owned by the Trust, for a period of time to enable her to raise the money to pay the husband the monies which she was directed to pay him. If the sum of money was not paid by a specified date she was directed to pay interest at a specified rate until the sum was paid. Judge Ryan said:

“If required, Mrs Stewart is to instruct [her co-trustee, a practising solicitor] in his capacity as trustee of the Tiffany Trust to execute a form of security for the monies outstanding under the terms of this judgment.”

Although the common-sense practibility of this order is readily understandable it is not clear whether such an order had a sound jurisdictional basis. Any security would be provided for the husband’s benefit. The judgment does not record whether the husband was a beneficiary of the Trust. It seems that he may not have been one since the house had been transferred to the Trust to defeat claims which were liable to have been made against him by his creditors. If he was not a beneficiary it seems strange that a Court could order a professional trustee to encumber a trust asset (the house) with a liability in favour of a non-beneficiary. And even if he had been a discretionary beneficiary of the Trust, the Trustees had made no determination in his favour and could not properly have agreed to encumber the Trust for a debt which was associated with him.

12. Application to remove trustees

12.1 One of the concerns which a settlor might have concerning Trusts is the possibility that in the event of future conflict an application will be made for the removal of trustees who are said to be partisan to a beneficiary. It might be understood by those who have attended some recent relationship property seminars that such orders will easily be made. The case of Cuthbert v Humphries shows that such orders may not be so easy to obtain. In that case the plaintiff alleged that a corporate trustee had engaged in forgery, back-dating and the wrongful transfer of assets through the lawyer who controlled it. She further contended that the trustees of three Trusts were in breach of their fiduciary duty by failing to act objectively and fairly taking account of all potential beneficiaries’ interests. She went so far as to allege that the three Trusts were shams. The allegations were denied and the application to remove the trustees was dismissed. The Court was referred to the Court of Appeal’s decision in Kain v Hutton where the Court of Appeal held that beneficiaries’:

“anxieties would be best addressed by enquiries as to management, the taking of accounts, the examination of conduct by reference to Trust powers and relevant deeds of trust and legal principles, rather than by way of piecemeal interlocutory litigation in which a party sought to remove trustees.”

12.2 The long-running litigation in Kain v Hutton involved an application to remove trustees. Pankhurst J held that it was appropriate for the Court to appoint new trustees.

“Whenever it is found ‘inexpedient, difficult or impractical so to do without the assistance of the Court . . .’ there is also an inherent jurisdiction to remove, being an incident of the Court’s general supervisory power in equity to supervise the administration of Trusts for the welfare of their beneficiaries . . ..

In broad terms trustees may be removed for cause or, equally, on account of hostility between the beneficiaries and the trustees such as to make removal necessary. This latter situation has been defined as one where continuation of the trustee in office would be likely to be detrimental to the Trust because the trustee is out of sympathy with the beneficiaries.

He held that the trustee, Mr Couper:

“. . . is so out of sympathy with the beneficiaries of those Trusts as to make his continuation in office untenable. The case for retention of a professional trustee is overwhelming.”

13. Resettlements

13.1 The advent of family changes, changes in taxation regimes, and other events, can restrict the ability of Trusts to achieve a settlor’s intention. It is common to resettle the assets of a Trust on a new Trust which has greater flexibility to achieve the settlor’s intentions. In this context it is desirable that the initial Trust should have a term which expressly authorises resettlements. Where there is no such express power trustees often resort to Pilkington’s case but there are significant constraints on the use of that case as justification for a resettlement.

14. s.182 Family Proceedings Act

Any person who is considering whether to establish a Trust should be aware of the recent jurisprudence on section 182 of the Family Proceedings Act. This section empowers the Court to:

“enquire into . . . any ante-nuptial or post-nuptial settlement made on the parties and make such orders with reference to the application of the whole or any part of the property settled or the variation of the terms of any such agreement or settlement, either for the benefit of the children of the marriage or of the parties to the marriage or either of them, as the Court thinks fit”.

Such an enquiry may only be made “on or within a reasonable time after the dissolution of a marriage”. An application which was filed two years and four months after the dissolution of the marriage was held to be “within a reasonable time after the dissolution of the marriage” on the basis that the wife had not been aware of the statutory time limit and she had experienced “difficulties” following the collapse of the marriage and been advised that it was “better to leave the Trust issues until later”.

Some recent cases have shown the extent to which the Courts will use the section to modify Trusts.

The case of Chrystall shows the potential power of this section. The husband’s father owned land and wanted to divest it into Trusts for each of his three sons to avoid estate duty. Six years before the husband and wife separated (after a marriage of 22 years) a Trust was created by which the wife was a discretionary beneficiary as to housing and income and the husband was a beneficiary with both discretionary and fixed entitlements as to income and capital.

“It was perfectly clear for many years that the [husband’s] share of the farm business was to be appropriated and vested in his Trust and the principal farm property had in fact been subdivided and its separate units were being separately farmed by the three sons long before the formalities had been completed.”

The husband was one of the trustees of the Trust.

The husband’s counsel argued that the settlement was not “post-nuptial” because it had not made “of or in relation to the marriage”; it had been made on one of the parties and not both; and it had not been made “because of or in relation to the marriage” but solely for the purpose of avoiding estate duty.

Judge Inglis QC concluded:

“I reach the conclusion that the settlement was in character and was intended to be a post-nuptial settlement on the parties for the purposes of s.182 . . . . It is idle to suggest that benefit to the [wife’s] and [husband’s] family unit was not the central focus of the settlement.”

After 22 years of marriage the wife would otherwise have been left with a half share of a small amount of matrimonial property ($21,323). The value of the Trust assets was not clear as the Court did not accept that the husband had disclosed their true value. The Trust’s 1991 accounts recorded that it had net assets of $611,832. The Judge described this as “unduly conservative”. In that financial year the Trust had a net income of $37,345.

The Judge directed that the Trust:

“ . . . has a sufficiently strong capital base to enable it without undue hardship to the [husband] or the two children of their marriage, who are now independent, to acquire a home of reasonable quality for the use of the [wife]. It is the Court’s intention to order pursuant to s.182(1) that a sufficient proportion of the settled property be applied for that purpose, the home to be purchased and maintained by the Trust. That will involve the application of both capital and income. In addition it is the Court’s intention to order that a capital sum be allocated from the settled property and paid to the applicant. The Court’s intention is that the Trust should not be required to allocate more than $175,000 of capital for these purposes. The capital sum to be paid to the applicant is likely to amount to a minimal proportion of the Trust assets. The Trust will of course retain ownership of the home purchased for the [wife’s] use.”

In Gallagher The Court was concerned with a Trust which had net assets of between $350,000 - $360,000 and the trustees were directed to make a payment of $17,500 to a wife who was in materially poorer circumstances following the separation than the husband. Judge Strettell identified the following four factors as being relevant when exercising the Court’s discretion:

Whether the wife had an expectation in terms of the Trust itself.
Whether the Trust property was previously matrimonial property.
Whether the wife was a beneficiary under the Trust.
Whether the wife might have an expectation of spousal support (and he held that after eight years from separation it was too late for this).
The wife in that case had received various assets pursuant to matrimonial property litigation but had not been as prudent as the husband had been with the assets which she had obtained.

In Williamson v Williamson Judge Inglis QC ordered that a trust deed should be amended pursuant to the section to delete the husband’s power to appoint trustees. The husband had settled the Trust but was not a beneficiary. The wife proposed that three people should be appointed as trustees. The husband said that they would be “affected by an agenda”, a proposition with which the Judge appeared to agree:

“It is likely to be an agenda sympathetic to the Trust land remaining in the family, one of the objectives of the original settlement. It cannot be right to assume that persons of their calibre will be incapable of acting independently for the benefit of the Trust estate, or of resisting pressure.”

The Judge held that NZ Guardian Trust should be appointed as trustee (subject to its agreement) and that the three people recommended by the wife should be appointed as advisory trustees.

The advantages of appointing NZ Guardian Trust – a professional corporate trustee – were described in the following way:

“There are two obvious disadvantages in the appointment of a professional corporate trustee. The first is one of cost. The Trust income is modest. The second disadvantage is that the proper administration of the Trust in this case requires a relatively specialist knowledge of the practice and economics of farming in this particular area, so as to place the trustee or the trustees in a position where judgment on such matters can be exercised independently of those operating the farming enterprise.”

It was emphasised that while the Court could appoint new trustees, and modify the power of appointment, it could not direct how the new trustees were to act:

“It is as well to make it quite clear, except to the extent that the Court has directed that the deed of trust be amended, the Court has no power to control the way in which the trustees choose validly to exercise their powers.”

In Kain v Hutton Pankhurst J said that a Court would not likely interfere with a decision of trustees:

“Bad faith must be shown. An onus lies upon the person seeking review of the decision. Where a discretion is at large, its exercise in a particular way will frequently be unimpeachable. But where it is established that there has been no proper consideration of the issue or that the Trust is enacted for an ulterior motive, then review of their decision is warranted. (Para 226.)

The Judge accepted that the following four factors should be taken into account when deciding whether to modify a Trust under s.182:

The onus is on the applicant to show grounds why the settlement should be departed from; since he was the settlor the onus must surely be a heavy one.
The purpose of s.182 is to provide relief where the dissolution of the marriage has altered circumstances so that the expectations at the time of the settlement are no longer appropriate.
The discretion is limited by the need to intervene only to the extent shown to be necessary.
The position of the children of the marriage and the grandchildren, all of them beneficiaries under the settlement, should as far as possible not be detrimentally affected by the marriage breakdown, a point implicit in s.182(1).

It can be noted that a claim under section 182 does not create a caveatable interest in land owned by a Trust.

The decision of Judge Clarkson in T v T reveals a major constraint upon the operation of s.182. She held that the section only applies “in respect of the property settled when the Trust was created”. Many Trusts are settled with a nominal sum and property is acquired later. For such Trusts, the power of modification under s.182 is ineffective since it is confined to the nominal sum which was settled on the Trust at its creation.

I have referred earlier to the jurisprudence which holds that each time a property is settled on a particular Trust there is a new settlement and a new Trust is created at that time. It seems unlikely that Parliament understood this: as drafted, section 182 appears to contemplate that a Trust is “settled” at its creation and that there cannot be a sequence of “settlements” or “settlors” during the course of its life.

In B v F Judge Ryan ordered the trustees of a family Trust to make payment to a wife “forthwith in the sum of $145,000”. They were also ordered to make provision for the future support of the dependent children of the parties by making an “immediate payment to [the wife] in the sum of $28,000”; “to make specific provision to meet the arrears of child support owing by [the husband] under the various formula assessments, namely $9,103.85” “and to pay interest at the rate of 12% per annum”.

It appears that the only asset of the Trust was the home which it owned so that the trustees would have had to sell the house. The trustees were served with the proceeding but took no formal steps to be represented.

The background to this decision is that the husband had been married before and entered into a pre-nuptial agreement before his second marriage by which it was declared that the home would be his separate property if the second marriage collapsed. Before the marriage collapsed he transferred the property to a Trust with a debt due back to himself. The parties separate two years later. Judge Ryan held that the pre-nuptial agreement had become unfair and unreasonable in that it attempted to exclude the operation of sections 16 and 9(3) of the Matrimonial Property Act. He held that the family home was matrimonial property as it was acquired by the Trust.

The decision went to appeal and the appeal was dismissed. Keane J held that the fact that the applicant had ceased to be a discretionary beneficiary on the dissolution of the marriage did not prevent her from being able to assert a claim under s.182.

In Cuthbert v Humphries & Others there was an interlocutory application to remove the trustees and to seek an order for the interim distribution of relationship property. Both applications failed.

Ms Cuthbert alleged that a corporate trustee had engaged in forgery, back-dating and the wrongful transfer of assets through the lawyer who was said to control the Trusts. She also contended that the trustees of the three Trusts were in breach of their fiduciary duties by failing to act objectively and by failing to take account of all potential beneficiaries’ interests and claimed that the three Trusts were shams.

The allegations were all denied. Justice Williams refused to remove the trustees and he referred to the Court of Appeal’s decision in Kain v Hutton where it had held that beneficiaries’ “anxieties would be best addressed by enquiries as to management, the taking of accounts, the examination of conduct by reference to Trust powers and relevant deeds of trust and legal principles, rather than by way of piecemeal interlocutory litigation” in which a party sought to remove trustees.

B v M concerned the failed marriage of a lawyer who was a partner in an Auckland law firm earning a substantial income. The matrimonial home was owned by two mirror Trusts. The wife applied to modify the Trusts under s.182. Allan J said:

“In its terms, the application seeks an order directing that the Court re-settle upon the wife, for her benefit, such portion of the Trusts’ property as the Court deems just and appropriate, but little or no attention was paid in argument to that aspect of the application. The application also seeks an order varying the terms of the Trusts for the benefit of the wife ‘as this Court thinks fit’”.

Justice Allan refused to make any order pursuant to this request. He noted that the husband and wife were not the only beneficiaries of the Trust and directed that:

“If the matter is to be further argued . . . then counsel should give their attention to the question of whether it is necessary to have the children separately represented. Like the parties, they are both discretionary and final beneficiaries and it would be necessary in considering the making of any order under s.182 to take into account their interests.”

In JCW v KFW a Family Court Judge was asked to modify a Trust which had been established to hold the separate property assets of a husband prior to his marriage. Judge Mather held that as the assets which had been transferred to the Trust were all his separate property, the wife had not established a basis for a claim under s.182.

15. Significance of a Memorandum of Wishes

A settlor may prefer to leave property via a Trust in the expectation that the trustees will implement his/her wishes via a Memorandum of Wishes. Such confidence may be misplaced. In Bishop O’Regan J accepted a submission that trustees were not bound in act in accordance with a Memorandum of Wishes and held that no cause of action based on the failure to comply with a memorandum was tenable.

It may also be noted that O’Regan J struck out a claim based upon an allegation that the trustees had failed to consult a beneficiary when they had re-settled Trusts and excluded her as a beneficiary in the new Trusts:

“There is also a claim based on failure to consult the plaintiff or notify her of her exclusion. Neither failing can impugn the decision to exclude her, and claims based on those failings are also untenable.”

Although O’Regan J struck out the claim that the trustees had failed to consult with the beneficiary about her exclusion from the re-settled Trusts, he did not strike out a claim that they had acted in breach of fiduciary duty in excluding her as a beneficiary on the re-settlement. It was alleged that in excluding her they “had exercised their powers of exclusion in an arbitrary, capricious and unreasonable manner and for an improper purpose, failing to take into account relevant considerations and failing to consult with her and to notify her of her exclusion” In the alternative it was alleged that they had failed to turn their minds to the question of whether she should be excluded, failed to take into account that she was the only child of the settlors, and her need for support from the Trust, failed to take into account the Memorandum of Wishes prepared by the settlors and failed to consult with her and inform her of the decision. Of this claim O’Regan J said:

“While the plaintiff will have some evidential mountains to climb in support of her claim that the trustees acted capriciously or out of spite, I do not consider the pleading, as currently drafted, can be said to have no reasonable cause of action.”

In the Kain litigation there was a question whether a statement of wishes should be complied with by replacement trustees. Pankhurst J said:

“The legal reference to a statement or letter of wishes is clear, namely the trustees must take serious account of the settlor’s wishes but always appreciating that the ultimate decision is theirs. It follows that trustees may properly decide to act contrary to the settlor’s wishes after taking account of all the relevant circumstances. . .

In short, I do not think that a professional trustee would be assisted by a direction in the terms contemplated.”

Nor can a settlor expect that trustees will always take all relevant factors into consideration before reading decisions. Chisholm J recently said:

“[Trustees] must inform themselves, before making a decision, of matters which are relevant to the decision. These matters may not be limited to simple matters of fact but will, on occasion (indeed quite often) include taking advice from appropriate experts . . . It is however for advisers to advise and for trustees to decide . . .

In an imperfect world trustees . . . do often make decisions which are based on less than complete information and less than full analysis and discussion, and there is real difficulty in formulating the test for determining when a decision is so flawed as to be invalid . . . To impose too stringent a test may impose intolerable burdens on trustees who often undertake heavy responsibilities for no financial reward; it may also lead to damaging uncertainty as to what has and has not been validly decided.”

A settlor should therefore be aware that trustees may act in ways which defeat his/her intentions and leave a proposed beneficiary with no effective recourse.

16. Failure of Trustees to take all relevant factors into consideration

Nor can a settlor cannot expect that trustees will always take all relevant factors into consideration before reading decisions. Chisholm J recently said:

“[Trustees] must inform themselves, before making a decision, of matters which are relevant to the decision. These matters may not be limited to simple matters of fact but will, on occasion (indeed quite often) include taking advice from appropriate experts . . . It is however for advisers to advise and for trustees to decide . . .

In an imperfect world trustees . . . do often make decisions which are based on less than complete information and less than full analysis and discussion, and there is real difficulty in formulating the test for determining when a decision is so flawed as to be invalid . . . To impose too stringent a test may impose intolerable burdens on trustees who often undertake heavy responsibilities for no financial reward; it may also lead to damaging uncertainty as to what has and has not been validly decided.”

17. Alter ego doctrine

Settlors who consider that the most effective way to implement their wishes is by the use of a Trust must take care to avoid their intentions being defeated by the operation of the alter ego doctrine. Much has been written about this in recent times and the following notes are therefore brief.
Justice Salmon held in Prime v Hardie that a Trust was Mr Hardie’s alter ego:

“He was the principal (although not the only) beneficiary. He borrowed the money which enabled the Trust to purchase its assets. He paid the interest on the mortgages and rates and insurance. In the 1998 financial year his personal Income Tax return showed an apparently fictitious rental received from Rahopara Street, $3,600 and deductions for interest, depreciation and other items resulting in a loss of $10,975 which he claimed as a tax deduction against his personal income.”

In circumstances of such abuse it was clearly appropriate for the Court to disregard the form of the Trust and to treat the Trust asset as the defendant’s.

Similarly in Glass v Hughey Priestley J said that an express Trust was Mr Hughey’s alter ego:

“As an additional and alternative route to the same result, I find that the Trust has for all intents and purposes been disregarded by the husband so far as his operation of International [a Company] is concerned and, so far as the wife’s claim is concerned should be regarded as a sham or more particularly the husband’s alter ego.”

One of the factors which caused Priestley J to determine that the Trust was the husband’s alter ego was the fact that he was entitled to acquire ownership of the Trust’s primary asset by a contract in which the shareholding of the asset (a Company) would be transferred to him. “Trusts” established in this way run the risk that they are not only vulnerable to defeat via the alter ego doctrine but also by the Court making a determination that there was no sufficient evidence of a “Trust” in the first place since the subject matter of the Trust was ultimately controlled by someone other than the trustees.

The alter ego doctrine was asserted without success in the Family Court and High Court in P v P . In that case an expensive home, a medical practice, medical rooms and other assets were transferred to Trusts during the course of a marriage. One of the Trusts had as its trustees a Christchurch barrister (a friend of the husband), a partner in the wife’s father’s law firm, and the husband’s accountant. Judge Strettell held:

“There is no evidence to suggest that they have acted at any time other than bona fide in terms of their obligations as trustees in terms of the Trust Deed. There is nothing in the Trust Deed which favours [the wife] in terms of the exercise of the trustees’ discretion.”

The case went on appeal to the Court of Appeal where the Judges indicated a clear disagreement with the decision under appeal and counsel for the husband consented to the appeal being allowed.

An assertion that the alter ego doctrine was applicable to a Trust was rejected in Q v Q . Judge Fitzgerald said:

“Ms Hollings submits that the reality of the situation in this case is that the Trust has been, and continues to be, used by Mrs Q as, in effect, her own property. Reliance is placed on two recent New Zealand cases of the High Court, Prime v Hardie and Glass v Hughey which draw upon a line of English and Australian cases. Those cases bear no real resemblance to this case and the facts here do not support a finding that the Trust operates, in effect, as Mrs Q’s alter ego. That claim therefore fails.”

In Boys v Calderwood it was contended that Trusts were Mr Calderwood’s alter ego This was rejected by Ronald Young J. There, the settlor had addressed the trustees with language such as “I would like to see” and “I would like this Trust” do various things. In one letter he wrote that insurance policies having a value of $1.5m “are to be transferred …” :

“Firstly, Mr Calderwood … is a beneficiary of some but not all of the Trusts. Secondly, the correspondence I have referred to from Mr Calderwood to the trustees put proposals to the trustees with respect to the Trusts. This was not the action of someone who has used the Trust property as his own. There was, however, as I have recounted, some evidence of attempts to direct trustees by Mr Calderwood. It is not extensive and does not establish that the Trusts are his alter ego. I am not satisfied therefore that the plaintiff can establish that the Trusts are Mr Calderwood’s alter ego.”

The alter ego doctrine was successfully invoked in Begum v Ali . The parties had married in June 1988. They had a child in 1989 and separated eleven years later in 2000. In 1995 a Trust was established into which the home in which they lived was transferred. The wife had no knowledge of the formation of the Trust and neither she nor her daughter were included as beneficiaries. It was held that they had been deliberately excluded from the Trust. Judge O’Donovan held that:

“Since the formation of the Trust there appears to have been a total lack of formality relating to the affairs of the Trust and the reality of the situation is that the first respondent has continued to act as the registered proprietor of the [matrimonial home] and has … acted with regard to it without reference to the trustees whose involvement with the property has been limited to expressions of concern when, from time to time, they have been advised by the mortgagee that instalments have not been paid.

There are no records at all as to the activities of the Trust, except those relating to the formation of the Trust and the transfer of the property to the trustees.

Accordingly to the [husband] and his witnesses, his occupation of the [matrimonial home] has been as a tenant but there appears to be no tenancy agreement and only a very informal arrangement as to the rental to be paid, it apparently being understood that he would be responsible for all outgoings …”

In circumstances where people try to portray the veneer of a Trust to a transaction which is in substance private ownership by the settlor, it is to be predicted that the Courts will declare them invalid.

18. Sham Trusts

A sham Trust is a Trust in respect of which:

“The Court must find that both the settlor and the trustee had the intention that the true position should be otherwise than as set out in the Trust Deed which they both executed.´

The Court went on to say that:

“In relation to a sham, a Trust Deed will not be held to be a sham unless both the settlor and the trustee had the necessary ‘shamming’ intention. On the facts we find that neither Sheikh Fahad nor Abacus [the trustees] had any such intention whether at the time of the original settlement or the addition of 97 Dulwich Village. They both intended that it be a genuine discretionary Trust in the terms of the Trust Deed. Even if our decision in law is wrong and it is sufficient if the settlor alone has a shamming intention, the plaintiff’s case fails because the Court is satisfied that Sheikh Fahad had no such intention.”´

In K v R Judge von Dadelszen held that there was a sham Trust in circumstances where a husband and wife had bought a property in their own names although ostensibly by a Company PKZ Limited, of which they were the shareholders. It was held that the purported Company ownership was a sham.

The following factors led the Court to conclude that the purported ownership of the house by the company was a sham:

The purpose of interposing the Company was to procure a GST refund.
This was achieved by “hoodwinking” the IRD over the amount of the property which was ostensibly used for an osteopathy practice.

If the Trusts had been created offshore, in a jurisdiction which lacks reciprocity with New Zealand, the New Zealand Courts would probably have been powerless to unsettle the Trusts. In Minwalla v Minwalla the English High Court held that a Trust which was set up in Jersey was a sham. The Royal Court of Jersey refused to allow the judgment to be implemented saying that the test for determining whether under Jersey law a Trust was a sham was that both the settlor and the trustees subjectively must have had a common intention that the instrument should not create legal rights and obligations and that both parties have a common intention to mislead. The English Court had not applied that test. The proper law of the Trust was Jersey law and there was therefore no power for the English Court to require the trustees to disregard the Trust Deed.

19. Undue influence by one trustee over other trustees

A decision by a person to settle moneys on a Trust in the expectation that a Trust will be a suitable vehicle for the non-contentious distribution of the Trust income and capital may be frustrated by a trustee who exerts undue influence over other trustees. In such circumstances the undue influence could amount to a breach of trust and give rise to a claim from a beneficiary.

20. Inflexibility of Trust Deed

When a person decides that the most appropriate vehicle for the distribution of wealth is a Trust it is highly desirable that the Deed of Trust should contain a provision which enables the trustees to amend the terms of the Deed. In Wong v Burt the trustees considered that there was an obvious gap in the Deed of Trust and decided to rectify the omission by making a distribution to one of the trustees who would in turn make a distribution to a non-beneficiary. This was held by the Court of Appeal to constitute a fraud on a power for which the trustees were personally liable, notwithstanding their reliance on legal advice that the mechanism which they used to rectify what they considered to be the settlor’s mistake was legitimate.

21. Compensation for lack of interest in family home where home is owned by a Trust

Section 11B of the PRA provides that where neither spouse/partner owns a matrimonial home, the Court may make an order awarding payment from one party to another from the other’s relationship property or separate property.

This section has been invoked in cases where the matrimonial home is owned by a Trust.

In P v P Judge Strettell declined a wife’s application for compensation for the absence of an interest in a family home (which was owned by a Trust), saying:

“There seems little point in making an award for equal share in [other] relationship property given that I have directed that it is the amended Act that applies and hence all relationship property . . . is divided equally.”

Judge Fitzgerald took a similar stance in Q v Q where he said:

“[Counsel for the Trust] submitted that s.11B – which allows for compensation to be paid for the absence of an interest in a family home – is not relevant given the equal sharing provisions of the Act and should have been repealed when the Act was introduced. Here there was no family home in terms of the definition in s.2 of the Act because of the Trust’s ownership of the land. Reference was made to the decision of Judge Strettell in P v P. Both Judge Strettell and the authors of Fisher . . . are of the view that there seems little point invoking s.11B since its effect is limited to the equal division of other relationship property and will normally be divided equally now under the Act anyway. I wonder whether the provision should have provided the Court with the ability to award an unequal share in such part of the relationship property as it thinks just, rather than equal. Otherwise how is compensation to be provided for in a situation such as the present one (were it not for the relief provided for later in this judgment).”

22. Case study: solicitor trustee in a conflict concerning future use/sale of family home

The recent case of X v X illustrates some of the complexities which can arise when spouses arrange for the family home and other assets to be held in the Trust. The original trustees were the husband and wife together with a solicitor. Following the husband’s move to work in Australia it was desirable from a tax perspective that he and his wife should cease to be trustees and a second professional trustee was appointed.

When the marriage relationship broke down the trustees proposed to sell the former matrimonial home to the wife and to use the assets of the Trust for the benefit of the couple’s two children. A resolution concerning the proposed benefits for the children was opposed by the husband. The beneficiaries of the Trust were the husband, the wife, their children and some of the parents of the husband and wife.

In an application under s.182 to amend the terms of the Deed of Trust Judge Clarkson directed that the trustees should be represented at Court. Counsel was also appointed to represent the interests of the children.

The husband wished the Trust assets to be settled on two Trusts of which the husband would be a trustee of one Trust and the wife a trustee of the other. The wife, on the other hand, wanted the retention of the single Trust, focused on the needs of the children.

The Judge preferred the retention of a single Trust and made some suggestions to the trustees concerning some modifications to their proposals for the use of the Trust’s assets.

The Trust will continue to be supervised by two professional trustees.

24. Role of counsel for trustees in applications to amend Trust Deeds

I acted as counsel for the trustees in X v X. Because trustees have a duty to act fairly between all classes of beneficiaries I consider that the scope of submissions which trustees can make to the Court is very limited. If the trustees speak in favour of one group of beneficiaries it will almost invariably be to the detriment of others and this will put them in conflict with their obligations to the others.

The Trust assets were owned by the Trust without debt but if this had not been so the financiers would presumably have been given the right to appear.

I have set out below the role which counsel for trustees have adopted in recent cases. It is not clear whether counsel have always appreciated their obligations to be completely even-handed between different classes of beneficiaries.

In Cuthbert v Humphries there was an interlocutory application to remove trustees on the grounds of their alleged forgery, back-dating and wrongful transfer of assets etc. Counsel was appointed to act for a corporate trustee and he made submissions opposing the application for removal.

In Q v Q counsel for the trustees made submissions on the following topics: Whether Mrs Q’s interest as a discretionary beneficiary was “property”.

The alleged inapplicability of the Rule in Saunders v Vautier, because there were other beneficiaries not all of whom were of full age and consenting to a distribution to Mrs Q.
A valuation of the interest which Mrs Q had as a beneficiary. She contended that it was incapable of valuation or in the alternative that it required expert evidence from an actuary and that no such evidence was available to the Court.
The husband’s lack of entitlement to seek compensation for the cost of the house which was on Trust land, saying that the trustees had acknowledged that they would reimburse him for a half share of that improvement, provided it was off-set against his post-separation occupation costs.
Whether either or both of the Q’s had a constructive trust claim against the Trust. (He conceded that they did).
He contended that the husband’s claim for a constructive trust should fail since the Trust had made benefits available to him which exceeded any entitlement to which he might otherwise have had. In this context the Trust called evidence from the family accountant.
He asserted that a claim for equitable relief by the husband was barred by the Limitation Act.

Of note, it does not appear from the judgment whether he made any submissions concerning the interests of the children and the extent to which their interests should be taken into account. Counsel for Mr Q said their interests should be ignored and the Judge referred to those submissions in paragraph 135 of the judgment.

Whether the making of all of those submissions complied with the duty of the trustees to be completely even-handed in their duties to each of the beneficiaries deserves careful consideration.

In Q v Q Judge Fitzgerald made orders in relation to Trust assets without hearing from any representative of the parties’ children, who were beneficiaries under the relevant Trust. The Judge referred to the reasons for the lack of representation:

“Evidence was given that some provision had been made recently for at least one of the boys. Also, there is no evidence that either of the Qs would do anything adverse to their own children’s interests if there was some division of the value of the assets held in trust as a result of any decision the Court makes. As I understand it, that was a reason why separate representation for the children was not considered necessary in these proceedings.”

In X v X counsel for the trustees (who were solicitors) informed the Court that if it considered that it may be appropriate to modify some of the terms of a resolution concerning the distribution of income to the parties’ children, it should do so and the trustees would modify their resolution accordingly. Judge Clarkson adopted these suggestions concerning the modification of their resolution.

Counsel was additionally appointed to represent the interest of the children. The judgment does not record that the children were the final beneficiaries of the Trust but they were. They were also discretionary beneficiaries.

No-one was appointed to represent the interests of the parents of the husband and wife – who were also beneficiaries.

It is clear from the judgment that the representations of counsel for the children had a material impact on the decision of the Court not to vary the Trust.

In Johns v Johns Vautier J indicated that if any orders were to be made varying the Trust under s.33(3)(m) “some consultation with the Department of Inland Revenue may well be necessary”.

23. Variation of Trusts – s.33(3)(m) PRA

A person who settles a Trust in the expectation that his/her wishes will be implemented by the trustees must also contend with s.33(3)(m) of the PRA. This section has not been invoked successfully on many occasions.

The following are some notes about the ambit of the provision drawn from recent cases.

In Johns Vautier J suggested that counsel should give consideration to the amendment of a Trust pursuant to s.33(3)(m) and said that some consultation with the Department of Inland Revenue may well be necessary.
A claim under s.33(3)(m) is not one which entitles the claimant to a matrimonial property caveat against land.
In Thompson v Thompson Potter J said that “It may be possible to direct a sale of [a house in which the spouses lived] having regard to the provisions of s.33 of the Matrimonial Property Act 1976.” This may be contrasted with the decision of Judge Inglis QC in Williamson in the context of an application under s.182 where he said:

“It is as well to make it quite clear, except to the extent that the Court has directed that the Deed of Trust be amended, the Court has no power to control the way in which the trustees choose validly to exercise their powers.”

Similarly, in Chrystall Judge Inglis QC said:

“It is worth repeating that the Court is unable to control the trustees’ exercise of their own discretion on a matter of this kind, and that the present s.182 proceedings are directed not at obliging the trustees to follow any particular policy, but the Trust property or the terms of the Trust Deed.”

Section 33(3)(m) does not confer on the Court an originating jurisdiction. Counsel for the wife in B v M asked Allan J to make an order in that case under s.33(3)(m). To this he said:

“The wife refers to the provisions of s.33(3)(m) of the Act and invites the Court to vary the terms of the Trusts, presumably as an alternative to the s.182 jurisdiction . . .. I agree with [counsel for the husband] that s.33(3)(m) does not confer on the Court an originating jurisdiction. The powers set out in s.33 are plainly conferred for the purpose of enabling the Court to direct the implementation of substantive orders made under ss.22-32 inclusive of the Act. Orders under s.33 may be made only if they are ‘necessary or expedient to give effect or better effect to orders made pursuant to ss.25-32 inclusive of the Act’. . ..”

The vague invocation of s.33(3)(m) is unlikely to be received sympathetically by the Court. In Q v Q counsel for the wife made a request for an order under the section for the Court to vary the terms of a Trust:

“. . . although why or how it should be done is not mentioned. I can see no need to consider the issue at this stage. As was noted by Allan J in B v M, s.33(3)(m) does not confer an originating jurisdiction on the Court. The powers in that section are conferred for the purpose of enabling the Court to direct the implementation of substantive orders made under ss.25-32 inclusive. Orders under s.33 may be made only if they are ‘necessary or expedient to give effect or better effect to orders made under ss.25-32’.”

Copyright Anthony Grant 2006