The benefits of using discretionary family trusts as investment or business vehicles are often stated to include increased asset protection (including against estate challenge claims) and flexibility as to distributions which can be tax effective. From an estate planning point of view, the focus with respect to family trusts is typically on the controlling roles of trustee, appointor and guardian, on the basis that those controllers will determine which of the beneficiaries can benefit from the assets and income.
The broad legal principle behind those reasons are that a trustee’s discretion is generally not able to be challenged by beneficiaries (whether those beneficiaries are in the general class or default beneficiaries). However, nothing is as simple as it seems and the question of the extent of trustee discretion and the overlay of their fiduciary obligations requires more detailed consideration.
Secondly, many trustees do not record their reasons for decisions on the basis that they are not obliged to and only if they are recorded can they be compelled to be provided and be subject to dispute.
Owies – the Case and the Judgement
The decision of the Full Court of Appeal in Victoria in Re Owies*, arose in the context of a dispute amongst family members post the death of the parents about how the trust had been and was to be administered. During the lifetime of the parents who established the trust, they held the various controlling roles and it could be said treated the trust as “theirs”. Their succession planning included making various amendments to the deed that resulted in one of their 3 children assuming the role of appointor and guardian.
The trust had also been administered so that for various years there was a pattern of income distributions (40% to Dad, 20% to Mum and 40% to Michael, one of the three children), and in one year 100% to Dad. There was also a capital distribution of the property to one of the other 2 children. The deed provided for the trustee to have “absolute discretion” as to income distribution but provided that the 3 children were the default beneficiaries.
Following the death of Mum and Dad, the directors of the Corporate Trustee had been the son who had received the distributions and the parents’ long-term solicitor.
The matter brought before the Court
Post the death of Mum and Dad, the 2 disgruntled children brought the matter before the Court and were ultimately successful in arguing that:
- The variations of the deed which purportedly put the “good” son in control were invalid. The amendment power in the deed did not allow the changes to the role of appointor and guardian.
- The exercise of the trustee’s absolute discretion was a breach of trust in various of the financial years, because the trustee failed to give due and proper consideration of all of the beneficiaries. They relied on the fact that the trustee had made no enquiries of the circumstances of the 2 disgruntled children and therefore could not have made a properly informed and genuine decision.
- The trustee should be removed and replaced with an independent trustee.
The court decision
In coming to their decision in respect of the lack of due and proper consideration, the Court found that the Trustee should have informed itself as to the size and nature of the trust, the nature of the relationships, and the purpose of the power as well as the circumstances of relevant beneficiaries, which cannot be assumed to be static.
The Court took into account a number of factors including:
- That the 3 children were the default income beneficiaries, which “reinforces the default structure of the trust deed as one providing for the benefit of the children in equal proportions”
- There was no evidence that the Trustee made enquiries of the circumstances of the disgruntled beneficiaries, or that the information they did have was part of the deliberations of the trustee.
- The 100% distribution to Dad in one year was noted as “remarkable”, given that he was 96 years old at the time and in residential care. The Court found this distribution was “so extreme and without any evident justification that it provides an additional factor that demonstrated it exercised its discretion… without real and genuine consideration” of the 2 disgruntled children.
The removal of the trustee and appointment of an independent trustee
In deciding to remove the trustee and appoint an independent trustee, the court said it was satisfied that the trustee had, over a number of years:
“failed to act impartially, failed to give real and genuine consideration to the interests of two of the primary beneficiaries, and relations between the beneficiaries and those involved in managing the trustee are, at least from this vantage point, irreconcilably damaged, such that it is not in the best interests of the beneficiaries for the trustee to continue in office”.
Amongst other reasons, the Court specifically cited the fractured relationship, antipathy and “total lack of trust” between the siblings as factors that favored removal of the Trustee to protect the welfare of the beneficiaries as a whole.
Notably, even though the 2 disgruntled children were successful in many respects, the Court found that the actual distributions made by the Trustee were voidable and not void. That meant that the distributions made in the past stood and because it was not sought to be set aside in the original claim, the 2 disgruntled children could not do so as part of the appeal.
Has the Game Changed?
The law has not changed as a result of this decision but it is an example of why reliance on broad principles can be dangerous.
While it is true to say that the controllers of a family trust have a broad discretion, it is equally important to consider the terms and purpose of the trust as well as how it is being administered to assess whether or not it can achieve the goals of the parties involved.
Changes to consider in respect of the establishment and operation of family trusts
In practice, the game will need to change in respect of the establishment and operation of family trusts, if the claims brought in Re Owies are to be avoided. For example:
- Reconsider the default beneficiaries in a trust. Individuals as a default for tax purposes might be recommended, but will also feed into decisions such as this. A default as to accumulation may be preferred.
- Consider the purpose recited in a trust. Is it to provide for the beneficiaries? Could it be capital retention for longer term generations?
- Consider the terms of a Trustee exercising their discretion:
- Trustees ought seek information from “main” beneficiaries at least, before exercising their discretion.
- There should be evidence of the seeking and receipt of relevant information and that it has been considered by the Trustee.
- Unchanging patterns of distribution and giving 100% to one person may well lead to adverse inferences, in the absence of clear evidence of consideration of the position of each party.
- The general position of a trustee not recording their reasons may need to be reconsidered to balance a justification of their decision as against the risk of those reasons then also being challenged.
- Family members exercising control of family trusts are well advised to be aware that family dynamics and behaviors will be considered by the courts when assessing whether the removal of a trustee will be beneficial for the welfare of the beneficiaries of a trust as a whole. This may embolden other disgruntled beneficiaries to bring court proceedings for removal of a trustee if they feel the trustee is not acting impartially or suspect that their decisions are imbued with bad faith.
Implications for Advisors
Professional advisors involved in addressing the administration and succession of family trusts will need to take note of this decision and consider the impact on various aspects including:
- When family trusts are being established consider and advise on the implications of the default beneficiaries, as well as the purpose of the trust, the breadth of the amendment power. If you are ordering off the shelf, consider who is giving that advice or might be held responsible for it.
- Ensuring deeds of variation are valid. This case is another in a long line of deeds of variation being rendered void.
- The preparation for and documenting of trustee deliberations and decision as to income resolutions each year, particularly where there is the potential for disgruntled beneficiaries. A pro-forma document printed and signed on 30 June may not cut it. The enquiry process may take some time and would need to begin the weeks or months preceding the end of the financial year.
- Estate planning advice should not be reduced to “the controller gets the trust”; it is not as simple as that. In addition, the larger the trust and the higher the risk of dispute, the greater the case for involving independent trustees as part of the succession process.
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*Owies v JJE Nominees Pty Ltd  VSCA 142