Discretionary Trusts – Not without limitations – “Real and Genuine Considerations” needed by trustee
Real and Genuine Considerations
The Victorian Supreme Court of Appeal in its decision in Owies v JJ Nominees Pty Ltd [2022] VSCA 142 made it clear that trustees of family discretionary trust must give ‘real and genuine consideration’ to all circumstances of beneficiaries when exercising their power regarding income of the trust. The decision serves as a warning to trustees that if they ‘do as they please’ the court has the power to invalidate income distributions and remove trustees of discretionary trusts where the trustee has failed to give appropriate consideration to the interests of all beneficiaries.
Background
A family discretionary trust was established by a couple John and Eva in 1970. JJE Nominees Pty Ltd was the trustee of this trust. The couple’s children (Michael, Paul and Deborah) were listed as primary beneficiaries of the trust (John and Eva were listed as additional members of the class of general beneficiaries). It should be noted that two of the children (Deborah and Paul) had become estranged from their parents for a significant period of time including for most of the years the proceedings related to (2015-2019).
The trustee had absolute and uncontrolled discretionary power to distribute income (net) of the trust in each financial year. In default of an appointment of income or a resolution to accumulate, the trust deed provided that the net income would be held on trust for each of the children in equal shares.
John and Eva were the directors of the trustee from its registration until their passing in 2020 and 2018 respectively. In 2019 John’s share in the trustee was transferred to Michael. It should also be noted in 1998 Michael and Paul were appointed as directors of the trustee also and removed in 2013 however neither Paul or Michael took any part in the management of the trust and did not actually act as directors. A third-party Mr Sampson was appointed director of the trustee in 2020.
For the financial year ending 30 June from 2011 to 2019 the trustee distributed all net income of the trust. For financial years ending 30 June 2011 – 2018 a pattern revealed by the distributions showed that 40% of the income went to each of John (father) and Michael (child), with the remaining 20% to Eva (mother). For financial year ending 30 June 2019 all income was distributed to John and a distribution of capital, in the form of a residential unit, was distributed to Deborah.
Paul’s circumstances:
- Paul graduated from university in 1983 and worked in the finance.
- Paul was financially independent and had his own business in 1994.
- In 2013, Paul has discussed the trust with his father wanting to know more about the trust and its structure. He requested a copy of the trust deed and information regarding assets of the trust. These requests were unanswered hence he wrote to the trustee in 2013 alleging breach of the trust and concerns on its administration.
- In response, the allegations were denied by the trustee.
Deborah’s circumstances:
- Deborah had numerous medical conditions during her life causing her to be unwell for a majority of her lifetime.
- In 1994 she was diagnosed with Crohn’s disease and she had to switch to part time work (medical doctor and consultant).
- Her taxable income ranged between $39,000 – $44,000 between 2013-2017.
- Her medical expenses exceeded $20,000 per annum.
Proceedings were brought by Deborah and Paul against the trustee seeking various remedies relating to the administration of the trust. For the purposes of this article, we will focus on the order to remove the trustee of the family trust, on the basis that the trustee had breached its fiduciary duty to give ‘real and genuine consideration’ when exercising a discretionary power to distribute income of the trust.
It should be noted regarding the distributions, the trustee’s accountant and tax advisor gave evidence that as the end of the financial year approached, Eva would speak with him regarding distributions and advise on the percentage distributions to be recorded in the minutes. The trial judge found that during the relevant period, the trustee did not make any enquiry of either Paul or Deborah as to any need they may have for a distribution of income. He noted that it was the trustee’s case that in the relevant years the trustee was informed about Paul and Deborah’s circumstances through the knowledge which the directors of the trustee had, which knowledge was imputed to the trustee.
Findings of the Supreme Court of Appeal
In the proceedings, Deborah and Paul successfully argued that the income distributions for the 2015 to 2019 years were voidable on the basis that the distribution decisions of the trustee of the Trust were made on the basis of no real and genuine consideration of Deborah and Paul as potential recipients of distributions. Note an aggrieved beneficiary must apply to a Court for a declaration that a particular transaction was void.
The Court took a holistic approach and the following reasons indicated there was a lack of real and genuine consideration as to the positions of Deborah and Paul:
- As noted above, no enquiries were made by Eva (who was the controlling mind of the trustee) as to the positions of Deborah and Paul;
- Eva had a strained relationship with Deborah and Paul which was evident in the dealings of the trust;
- Income was substantial each year and Deborah did not receive any despite her health/ financial situation;
- There were no obvious reasons for the apparent ‘fixed’ distribution of 40/40/20 (to Michael, John and Eva) and why these beneficiaries would be favoured given the fact Deborah’s health and financial situation were parlous- in saying this, we note need is not a qualifying factor for a distribution, the purpose of the trust was to make provision for the beneficiaries in the context of a family. Deborah did have strong claims to a favourable exercise of discretion however this does not mean that a distribution had to be made to her; in this regard the failure to do so, and the repetition of the same formula in each year up to and including 2018, strongly points to a lack of due consideration of her position;
- The 100% income distribution in 2019 to John strongly pointed to a lack of due consideration of beneficiaries’ positions given the fact John was 94, living in an aged care facility with no need for the income due to his insignificant wealth; and lastly
- The purpose of the trust per the deed was to provide for the children of John and Eva i.e./ Michael, Paul and Deborah. This was further reflected in the recitals of the deed and the fact that the children themselves were the primary and default beneficiaries of the trust.
Principles
The trust deed provides a power to distribute income and that discretion is broad i.e./ absolute and uncontrolled. It should be noted however that despite the wording the discretionary power is not without bounds. Per Scott v National Trust for Places of Historic Interest or Natural Beauty [1998] 2 All ER 705, it was held that “Trustees must act in good faith, responsibly and reasonably. They 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, whether the experts are lawyers, accountants, actuaries, surveyors, scientists or whomsoever.”
Further, per Finch v Telstra Super Pty Ltd (2010) 242 CLR 254 “The decision of a trustee may be reviewable for want of ‘properly informed consideration’. If the consideration is not properly informed, it is not genuine.
Per General (Cth) v Breckler (1999) 197 CLR 83, “Where a trustee exercises a discretion, it may be impugned on a number of different bases such as that it was exercised in bad faith, arbitrarily, capriciously, wantonly, irresponsibly, mischievously or irrelevantly to any sensible expectation of the settlor, or without giving a real or genuine consideration to the exercise of the discretion. The exercise of a discretion by trustees cannot of course be impugned upon the basis that their decision was unfair or unreasonable or unwise. Where a discretion is expressed to be absolute it may be that bad faith needs to be shown”. It is evident that the test is not fairness or reasonableness.
Per Telstra Super Pty Ltd v Flegeltaub (2000) 2 VR 276 “One cannot ordinarily decide a question of fact in good faith and give it real and genuine consideration without conducting some investigation and in some cases that will entail making an inquiry of a person who is willing to provide information and is in the best position to do so. It is not a matter of natural justice but bona fide inquiry and genuine decision making”.
“An obvious, but unstated, premise on which the trustee would be expected to discharge its duties is that it would generally be informed about the differing circumstances, needs and desires of each beneficiary as an incident of the familial bonds that underpin the trust and explain its purpose. It is not to be supposed that, when those familial bonds become strained or broken, the purpose of the trust to provide for the family as a whole would change or that the trustee would be relieved of the obligation to properly inform itself.”
Lesson
The cases itself makes it clear that the trustee must actively inform itself of the beneficiaries of the trust (at least the key one) and when exercising power act in good faith, responsibly and reasonably. Failure to do so increases the risk that the trustee had breached its fiduciary duty and having distributions declared void. Practically, it is evident that an issue would generally only arise where there is a falling out, bad relationship and therefore a beneficiary might challenge a distribution.