Challenging the Control of Discretionary Family Trusts – reflections on Owies v JJE Nominees Pty Ltd [2022] VSCA 142

Overview

The recent decision of the Victorian Supreme Court of Appeal in Owies v JJE Nominees Pty Ltd [2022] VSCA 142 provides a clear and stark warning that the trustee of a discretionary family trust cannot simply ‘do as they please’ and that a Court may invalidate income distributions and remove trustees of discretionary trusts where a trustee has failed to give appropriate consideration to the interests of all beneficiaries.

Facts

In 1970, John and Eva (via the Settlor) established a discretionary family trust. The Trust Deed named ‘the children of John and Eva’ as the primary beneficiaries, with John and Eva being listed as additional members of the class of general beneficiaries.

The trustee was conferred with ‘absolute and uncontrolled’ discretionary powers to distribute the net income of the trust in each financial year. In default of a distribution or decision that the trustee accumulate the income, that income would be held on behalf of the children in equal shares (known as a ‘default distribution clause’).

John and Eva had three children, Michael, Paul and Deborah. The case ultimately concerned a breakdown in family relations and the trustee preferencing the interests of Michael (and John and Eva) over those of Paul and Deborah.

For the income years ended 30 June 2011 to 30 June 2018, the trustee resolved to distribute the income of the trust in the following proportions: 40% to John, 40% to Michael and 20% to Eva. In the income year ended 30 June 2019, the trustee resolved to distribute 100% of the income to John.

This case involved Paul and Deborah seeking orders 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 estate.

Findings

In summary, the Victorian Supreme Court of Appeal concluded that:

1. the trustee had breached its fiduciary duty by failing to make any real or genuine considerations in respect of whether a distribution of income should be made to either of Paul or Deborah for various income years;
2. the breach of trust in failing to give real and genuine consideration to the exercise of the power rendered the distributions made to John, Eva and Michael voidable. It should be noted, however, no order was sought that those distributions be set aside; and
3. given the history of breaches, antipathy and lack of trust between the siblings, the trustee should be removed as trustee and replaced with an independent trustee.

Analysis

This case is a stark reminder that trustees, even trustees of discretionary family trusts, cannot ‘do as they please’. The case challenges the traditional notion that beneficiaries of a discretionary trust face an extremely uphill journey in taking action against a trustee of a discretionary trust.

Real and Genuine Consideration

‍Of paramount importance when exercising a discretionary power is that the trustee must act in good faith, responsibly and reasonably. They must inform themselves, before making a decision, of matters which are relevant to the decision.

The Court determined that the trustee fundamentally failed to do this for the years 2015 to 2019 inclusive. In reaching this conclusion, the Court took a holistic approach to its analysis noting that:

1. the trustee made no enquiries of Paul or Deborah;
2. Eva, as a director and the controlling mind of the trustee, had a strained relationship with each of Paul and Deborah, which was reflected in their dealings with the trust;
3. whilst the income was substantial in each year, Deborah received no distribution from the trust (despite Deborah’s health and financial situation being perilous);
4. there appeared to be a policy of distributions with a settled ratio, other than in 2019 when John received 100% of the income (of roughly $1 million) despite being aged 96, living in a residential care facility with no need for income due to his not so insignificant wealth. This strongly pointed to a lack of due consideration of beneficiaries’ positions (particularly Deborah’s); and
5. the purpose of the trust, as provided by the trust deed, was to provide for the children of John and Eva (i.e. Paul, Deborah and Michael). This was reflected by the recitals in the trust deed and the fact that each of the children were primary beneficiaries and default beneficiaries under the trust.
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Trustee and Reasons for Decisions

Unless required under the Trust Deed, trustees are not required to give reasons for their decisions when exercising their discretionary powers. This principal is often relied on where a beneficiary seeks to challenge the decision of a trustee. No adverse inference could be drawn as a result of a trustee not providing reasons to explain the exercise of its discretionary power.

Despite this, the Court determined in this case, that where the trustee elected not to explain its reasons, it left “the stark pattern of distributions to speak for itself”. In essence, the Court held that no reasonable person acting would have made the decisions made by the trustee, and for that reason could infer that the trustee failed to give real and genuine consideration when exercising its power to appoint income.

Distributions Voidable

The Court confirmed that where a trustee does not undertake real and genuine considerations before exercising its discretionary power to distribute income, that distribution will be voidable (but not void), provided the trustee’s breach is sufficiently serious as to amount to a breach of fiduciary duty.

As the transactions were voidable (and not void) an aggrieved beneficiary must apply to a Court for a declaration that a particular transaction was void. It appears that Paul and Deborah had not sought an order declaring the distributions void, and the Court refused to allow the applicants leave to amend their pleadings to cover this ground. This highlights the importance of ensuring an applicant’s pleadings at first instance cover all possible relief sought from the Court.

Removal of Trustee

The power of the Court to remove a trustee is discretionary and will only be used in circumstances which “afford a ground upon which the jurisdiction may be exercised”. The grounds upon which the jurisdiction may be exercised are to ensure the welfare of the beneficiaries, and includes ensuring:

1. the protection of the interests of the beneficiaries;
2. the security of the trust property;
3. an efficient and satisfactory execution of the trusts; and
4. the faithful and sound exercise of the powers conferred upon the trustee.

As noted earlier, the Court in this case determined that it was necessary to remove the trustee because over a number of years it failed to act impartially, it failed to give real and genuine consideration to the interests of Paul and Deborah, and the relations between the controlling minds of the trustee and Paul and Deborah were irreconcilably damaged.

Takeaway and Questions

The purpose of the trust in question was to provide for the primary beneficiaries in an even handed and impartial way. This case is a stark reminder that trustees, even trustees of discretionary family trusts, cannot ‘do as they please’. The case also challenges the traditional notion that beneficiaries of a discretionary trust face an extremely uphill journey in taking action against a trustee of a discretionary trust.

In exercising its discretionary powers, the Court of Appeal made clear that the controlling mind of the trustee must set aside all personal emotions and make all reasonable enquiries to ensure that it is acting in good faith and with real and genuine consideration. A failure to do so risks the trustee breaching its fiduciary duty, having the distributions being declared void and being removed as trustee. These principles apply even in the context of a discretionary family trust and even where the trust deed makes clear that the trustee’s powers are absolute and uncontrolled.

The case also raises a number of somewhat compelling and difficult questions, including the following

1. how far does the need for a trustee to give real and genuine consideration extend? Does this obligation depend on how wide the class of beneficiaries are, or on the ‘purpose’ of the trust?
2. in Commissioner of Taxation v Carter [2022] HCA 10, the High Court held that a beneficiary disclaiming a present entitlement after the end of an income year is not effective for tax purposes – as they are ‘presently entitled’ at 30 June. How would voidable transactions be treated from a tax perspective and would the Commissioner still be within time to amend assessments as a result of a voidable transaction??
3. in this case, trust distributions were routinely lent back to the trust by John and Eva (for several millions of dollars). Could section 100A of the Income Tax Assessment Act 1936 (Cth) apply to such transactions or would such dealings be ‘ordinary family dealings’?
4. the trust deed explicitly stated that the trustees powers are “absolute and uncontrolled”. Can and should additional provisions be inserted into such trust deeds to better ‘protect’ the discretionary nature of a trustee’s discretionary power? (for example, provisions regarding the obligation to survey the class of beneficiaries)
5. assuming that the trust deed permitted the trustee to declare that certain persons were excluded from benefit under the trust (‘exclusion power’), what if the trustee had previously exercised that exclusion power to exclude Paul and Deborah from benefitting under the trust?
6. would the result have been different if the primary beneficiaries were John and Eva, rather than the children of John and Eva? Would the result have been different if the trust deed contained no default distribution clause?
7. would the result have been different if the trustee resolved to accumulate the income of the trust, rather than to make any distribution at all?
8. in this case, the trust funds and income generated was very substantial. How significant was the size of the income distribution in each year and would the result have been different if the funds were question were more modest?

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This article in no way constitutes legal advice. It is general in nature and is the opinion of the authors only. You should seek legal advice tailored to your individual circumstances before acting on anything related to this article.