The Supreme Court, Trusts, alter egos and shams

The case of Kain v Hutton is well known for its statements on the validity of resettlements and advances.  It is not well known for something that is far more important than these topics namely, whether typical discretionary Trusts in which one person has the power to appoint and remove trustees and beneficiaries are valid at law.  

New Zealand is a very Trust-friendly environment and there may well be more Trusts per capita here than in any other country.  A very large number of them are discretionary Trusts in which one person – usually the settlor – retains the power to appoint and remove Trustees and beneficiaries.

One of the Trusts in Kain v Hutton [2008] 3 NZLR 589 (which I will call “the Ponui Trust”) was settled by a Mrs Couper who held the power to appoint and remove the Trustees and beneficiaries.  She appointed herself one of its three Trustees.

Blanchard J – speaking for himself, Elias CJ, McGrath J, Anderson J – and probably Tipping J - held that Mrs Couper’s “ability to appoint and remove Trustees and discretionary beneficiaries” gave her “complete ongoing control of the Trust.”  He said that: 

“It put her in effective control of [the Ponui] shares with the ability to take the benefit herself …”

These statements were made in the context of a Trust that had three Trustees, one of whom was an accountant and supposedly an independent Trustee.

It is implicit in what the Court said that Mrs Couper could remove and presumably replace any Trustee who would not co-operate with her wishes.  It was also explicitly said that “if she saw fit” she could arrange to take all of the Trust assets for herself.

The highest court in New Zealand does not therefore appear to consider that in the law of Trusts there are any fiduciary or other restraints that will prevent a person with such powers from appropriating the Trust’s assets personally “if he or she sees fit”.

The Supreme Court’s statements on this are not dissimilar to Justice Chambers’ statement in Walker v Walker [2007] NZFLR 772, where he said that a husband’s powers of appointment “formed a very valuable package as together they confer control of [a Company]”.  As a consequence of this judgment, claims are now being made for, what is commonly called, the “bundle of rights”.

Such a belief is also the sub-text of statements that are regularly made by Judges that a Trust is “his Trust” or “her Trust” ie a Trust that is under the “effective control” of a particular man or woman.

It is said in Lewin on Trusts that “If the beneficiaries have no rights enforceable against the Trustees there are no Trusts.”  In the case of the kind of Trust described by the Supreme Court, what rights do the discretionary beneficiaries have?  In practice they have no meaningful rights.  If they have a right to see the Trust Deed, or financial statements of the Trust, these “rights” are irrelevant as the appointor can “if he or she sees fit” take all of the Trust’s assets for himself or herself.  Neither the existence of a so-called independent Trustee or the unanimity rule are a safeguard that will apparently prevent this outcome.

Was the Supreme Court right when it said these things?

For practical purposes, it must be assumed that the Court was right since all Judges in the Family Court, the High Court and the Court of Appeal are bound by what the Supreme Court has said.  The Supreme Court has also sanctioned the validity of such Trusts even though the presence of “effective control” of the Trust assets by a person is usually given as the very hallmark of invalidity.  For example, in an Australian case – Ashton it was said that “this Court is not bound by formalities designed to obtain advantages and protection for the husband who stands in reality in the position of the owner.”  Similarly, in another Australian case – Stein – the Full Court of the Family Court said that:  “In our view, the Company [the Trustee of the Family Trust] is a mere puppet of the husband” and could be disregarded.  In another case in 1995 the Federal Court in Australia has said that the formal legal structure of the Trusts under consideration were an “empty pretence”, and it could be disregarded. 

Is this a variant of the alter ego Trust?

The theory of the alter ego Trust is that the assets of a Trust over which a person has effective control are to be treated as that person’s property.  Although the alter ego doctrine met with an unsympathetic audience from the Court of Appeal in Official Assignee v Wilson [2008] 3 NZLR 45, the doctrine appears to be back in a variant form.  Following Justice Chambers’ decision in Walker that powers of appointment in a Trust are relationship property which may have the same value as the value of the underlying assets of the Trust, the Supreme Court has given credence to the Walker analysis since it asserts that a person who has the powers of appointment has “effective control” and can effectively do whatever he or she wants with the assets of the Trust. 

This is not an alter ego Trust in the traditional sense but it amounts in substance to the same thing.  Instead of the assets of the Trust being the appointor’s property, the powers of appointment are held to be the appointor’s property and they presumably have a similar value to the value of the Trust’s assets.

Are sham Trusts back? 

In Official Assignee v Wilson the Court of Appeal indicated its dislike for the concept of the alter ego Trust but said that “a finding of effective control may help establish that a Trust is a sham”.  By this analysis a finding of “effective control” is evidence of a sham Trust rather than an alter ego Trust.

Many people would say that a “Trust” over which an appointor has “effective control” and who can take all its assets “if [he or she] sees fit” is not a Trust at all.  It has, however, been extremely difficult to prove the existence of a sham Trust because traditional doctrine says that it must be shown that none of the Trustees intended the Trust to be a genuine entity.  This is known as the “common intention” test.

As a result of the Supreme Court’s decision in Kain v Hutton there may no longer be a need to have regard to the intentions of any non-appointor Trustees concerning the genuineness of a Trust.  Their views are essentially irrelevant since the appointor is deemed to be in “effective control” of the Trust and can do with its assets as he or she likes.  On this analysis, the sham Trust doctrine would appear to be a more potent remedy to invalidate discretionary Trusts than has been understood in the post Official Assignee v Wilson era.

A most unsatisfactory outcome

This is a very unsatisfactory state of affairs.

On the one hand the Supreme Court’s ruling on “effective control” points to the invalidity of such Trusts under the alter ego and sham Trust doctrines.

On the other hand, the Supreme Court implicitly approved of the validity of the Ponui Trust, so that no lower Court is likely to say that the existence of appointor powers in a discretionary Trust gives rise to a an alter ego or sham Trust.

This topic is of real significance to a large number of people in New Zealand since if the “Trusts” to which they are parties are invalid there may be serious adverse consequences.