By Domenic Festa (Accredited Tax Specialist and Chartered Tax Adviser)

 

Key Takeaways

  • No need for rash action as a result of the decision.
  • In the usual case, beneficiaries named are those who are intended to benefit immediately after establishment, not at some future time as was likely to be the case in Owies.
  • When establishing a trust, serious consideration should be given as to the beneficiaries that are named, any beneficiaries included as default beneficiaries and beneficiaries included within a class of what might be considered primary beneficiaries.
  • Where familial bonds are broken, which provides the trustee’s usual source of information, obtain professional advice to take appropriate steps to satisfy the trustee’s obligations. This will require an appropriate means of seeking information with confirming evidence.

Consideration

The decision in Owies v JJE Nominees Pty Ltd [2022] VSCA 142 (Owies) by the Victorian Court of Appeal was concerned with the exercise of discretion by trustees of discretionary trusts to make distributions of income and/or capital. It has caused some to suggest the end of a trustee’s unfettered discretion and to make wholesale changes to beneficiaries of discretionary trusts.

The case involved distributions from the trustee of a discretionary trust known as the Owies Family Trust (Trust). The Trust was established and controlled by the parents, however they were not specifically named as beneficiaries. Instead, the parents three children were named as the primary beneficiaries and also default beneficiaries. The parents were included as general beneficiaries only. The parents became estranged to two of the children (Paul and Deborah), and no distributions were made to those estranged children for a number of years. In most years, distributions were made in fixed percentages to the father – 40%, other son – 40% and mother – 20%.

Basic Principles

The principles applied in the case are not new, rather Owies case referred to and applied the principles from the decisions in Karger v Paul [1984] VR 161, Attorney-General (Cth) v Breckler (1999) 197 CLR 83, Wareham v Marsella (2020) 61 VR 262; [2020] VSCA 92 and Finch v Telstra Super Pty Ltd (2010) 242 CLR 254.

The key principles as outlined in Karger and adopted in Owies are that with one exception, the exercise of a discretion will not be examined or reviewed by the courts so long as the essential component parts are present.

The exercise of a discretion cannot be challenged upon the basis that it is unfair, unreasonable, unwise or not sound. The exception is where reasons have been given by the trustee in which case the court will determine the soundness of the exercise of discretion by the trustee.

The essential component parts are:

  • exercised in good faith,
  • upon real and genuine consideration, and
  • in accordance with the purposes for which the discretion was conferred.

In very brief terms:

  • Good faith requires that the trustee has sufficient information about the objects of the power in order to exercise the power.
  • Real and genuine consideration requires that the trustee not act irresponsibly, capriciously or wantonly. To satisfy this requirement the trustees must consider what persons are beneficiaries to understand the width of the field, it being said that only when the trustee has applied his mind to the ‘size of the problem’ should he then consider individual cases. For individual cases, the trustee needs to obtain information of the circumstances and needs of beneficiaries.
  • Purpose requires that the exercise of discretion be made by reference to the nature, scope and purpose of the discretion. In determining the purpose of the discretion, one must have regard to the terms of the trust deed, the purpose for establishing the trust, the main beneficiaries, and any special characteristics attributable to a class of beneficiaries.

In addition, it is necessary that the above requirements are satisfied each time the discretion is exercised (that is, annually for income distributions), and a trustee does not divest itself of this responsibility by adopting a universal rule or by acting under the dictates of another such as the principal, appointor or guardian.

Some Suggestions

Some have suggested that the decision requires the following conclusions:

  • the case marks the end of the unfettered discretion for trustees of discretionary trusts;
  • removing estranged persons as beneficiaries of the trust;
  • where an estranged person is a default beneficiary, removing them from that position and incurring the consequent liabilities for state duties and, if applicable, CGT;
  • limiting the number of beneficiaries to those that might be considered in a particular year (which goes against the flexible nature of a discretionary trust as having a broad class of beneficiaries to accommodate a varying range of circumstances);
  • distributing the assets of the trust to the individuals as capital distributions (again, which goes against the purpose of a discretionary trust in many situations as a structure established for asset protection).

It should be noted that many of the above steps are likely to be found invalid for the same reasons as given in the Owies decision, a failure of real and genuine consideration.

Key bases of decision

The conclusion reached by the court in Owies was that the trustees had failed to give real and genuine consideration to the 2 estranged beneficiaries, and the circumstances were sufficient to warrant the removal of the trustee.

On the surface, the decision might appear surprising in the case of the exercise of discretion in a discretionary trust, which is usually considered unfettered. However, a closer examination reveals the key issues.

The key bases for the decision were:

  1. The purpose of the trust was to provide for the primary beneficiaries (three children) in an even handed, impartial way (para 116).
  2. The three children were default beneficiaries (para 113).
  3. The exercise of all of the powers has to take into account the default position as one providing for the benefit of the children in equal shares (para 113).
  4. While the trustee would ordinarily be informed as an incident of the familial bonds, where those familial bonds had become strained, that source of information did not exist (para 111).
  5. The trustee made no enquiries of Paul and Deborah and there was no direct evidence that any other information found its way into the deliberations of the trustee (para 115).
  6. The inescapable inference is that the trustee was not informed (para 119).
  7. The trustee had applied a uniform payout ratio 40:40:20, with no obvious reason, which was inconsistent with giving real and genuine consideration (para 125).

In essence, the purpose of the trust was to benefit the default beneficiaries, the children, information was not obtained about two of those default beneficiaries and therefore real and genuine consideration was not given for two of the default beneficiaries which was contrary to the purpose of the trust. The court concluded that the trustees were in breach of its duty.

Rash Action

From time to time there are cases that appear to give a surprising result, and initially cause some to consider there is a monumental change in the law, and give rise to what is subsequently found to be a knee-jerk reaction.

A couple of examples:

  1. Hanel & Ors v O’Neill [2003] SASC 409 held that directors of a corporate trustee were personally liable for the debts of a trust where the trust was insolvent or had insufficient assets to meet the liability;
  2. ASIC, Re Richstar Enterprises Pty Ltd v Carey (No 6) [2006] FCA 814 held that a beneficiary that has effective control of the trustee has a proprietary interest that amounts to effective ownership of the trust property (similar to the decisions in the family law context).

Following each of those cases, a number of writers expressed the view that it was the end of the often used strategy of holding assets through discretionary trusts for asset protection.

The decision in Hanel was subsequently rejected in Saffron Sun v Perma-Fit Finance (2006) 24 ACLC 14 which came to the conclusion that the decision in Hanel was plainly wrong.

Following the decision in Richstar, the writer had the strong view that the decision would be limited to its statutory context (preventing the dissipation of assets pending an ASIC investigation). That view was subsequently confirmed with subsequent cases limiting its application to the particular context – ASIC v Burnard [2007] NSWSC 1217, Public Trustees v Smith [2008] NSWSC 397 and Farr v Hardy [2008] NSWSC 996.

The writer expects a similar result with Owies.

Court Orders

It is one thing for a court to conclude that a trustee has been in breach of its duty, but what is of importance is the actual orders made by the Court as a result of those breaches. In this case, the result was:

  1. Prior distributions were not overturned;
  2. There had been a history of breaches of duty by the trustee;
  3. There was evidence of a strained relationship between the current trustees and the three default beneficiaries, with the result that the Court could not be satisfied that the trustees would honour their duty in future. In addition, 2 of the default beneficiaries were not included in the group of current trustees;
  4. The current trustees were removed to be replaced by an independent trustee.

In the writer’s view, the removal of the trustee was made due to the matters in paragraph 12.

Suggestions

No doubt, the decision will encourage litigators to take action where there are disputes between beneficiaries involving discretionary trusts. We anticipate subsequent cases will disappoint those liquidators as occurred in Hanel and Richstar.

NOTE: This article is for general information only and should not be relied upon without first seeking advice from one of our specialist solicitors.