Tara (00:51):
Welcome back to the Art of Estate Planning Podcast. This episode is the second in our series about family law protection of discretionary and testamentary trust.
(01:07):
So we covered Kennon and Spry in episode 75. So as I mentioned in that episode, nearly all of the subsequent cases refer to Kennon and Spry as the original high court authority about the meaning of property of the parties to the relationship under Section 79 of the Family Law Act when it comes to assets in discretionary trust. So as promised, nearly all of the subsequent decisions refer to it. So go and back and listen to episode 75 if you haven't had a chance to. What I want to do in this episode is look at some of the cases after Kennan and Spry. So we're going to start off with a 2010 case of Pittman & Pittman. Then we will look at a 2012 case, Morton & Morton, and also another 2012 case, Harris and Harris. So a recap from Kennon and Spride. It confirmed by the high court that the family court has expansive powers to look through a trust structure to find the true situation or facts of how that trust and the assets are being used.
(02:27):
They can set aside and unwind transactions. They can declare trusts to be shams and ignore them, and they can even bind third parties to orders and alter third party ownership. So their trust busting powers are really expansive. I also want to reiterate from episode 75 that out of Kenan and Spry and the subsequent judgments, they have emphasised the importance of a couple of key factors. And you'll see how the court has given weight to those key factors in the judgments we're going to talk about today. So those factors are the control of the trust. So looking at the appointor and trustee roles, the purpose of establishing the trust, the source of trust assets, the range of beneficiaries and whether the parties to the relationship are beneficiaries, the history of income and capital distributions, and whether the parties to the relationship have benefited from the trust, and whether there is an intention to mislead third parties through share more puppet arrangements.
(03:42):
So let's have a look. There's a lot of decisions I want to talk about since Kennon and Spry, but let's sort of go through it in chronological order and I've picked a few key decisions that I think really enlightening and give us a lot of information and insight about how we might structure our trust for clients to maximise the protection of that trust in a family court. Now, you'll see from the judgments and the factual circumstances considered, it's also got to be workable. The most protection would be that your clients have got no involvement in the trust, but that almost defeats the purpose of the trust sometimes. So we've got this real balancing act of how can we structure it to create protection without it being contrived, but also that the clients can actually live and work with this structure. So let's start with Pittman & Pittman.
(04:41):
I'll put the citation for all of the cases in the show notes. So Pittman & Pittman is a 10-year relationship and together they had an $8.6 million property pool. The family trust in question had a $250 million asset base. So we are talking big bucks and a lot is at stake for our applicant here to try to bring in the respondent's interest in the trust as property. The property pool of eight million up to 250 million is a big difference. So yeah, big end of town, big bucks. So we had one family trust with a corporate trustee. It was established by the respondent's dad before their relationship. And the control of that is basically the respondent was ... Well, let's say the appointors was the respondent, the respondent's mom, and the respondent's two brothers at the date of the decision. The shareholders of the corporate trustee were the respondent, the respondent's mom, and the brothers.
(05:58):
The directors of the corporate trustee was one of the brothers and the accountant. So let's just think about this, the day-to-day decisions about the trust, the decisions to distribute. Income and capital of the trust is being made by the respondent's brother and accountant. They're the directors. But as a shareholder, the respondent could change the directors or vote at least with the other shareholders to change the directors, and they could also vote with the other appointers to change the trustee. But he's one of four appointors, so he can't pass that motion on his own. The respondent's mom and the two brothers became the joint appointers and guardians after the father's death. So they really took on that role as part of a succession plan and an intergenerational wealth transfer. But importantly, there were some major changes to the deed. So it started off as a discretionary trust, but they buried the deed to create fixed entitlements.
(07:12):
So in 2001, the trust was amended to make the respondent, the respondent's mother, and the two brothers as nominated beneficiaries. They also changed it so that they could no longer change or appoint any further appointers and guardians. And if the current appointers and guardians wanted to change a trustee, they had to act unanimously. Importantly, the whole of the trust fund was revocably appointed in favour of the nominated beneficiaries and equal shares, and the net income of the trust was also irrevocably appointed in favour in equal shares. They also amended the vesting date to be the first of when any two of the nominated beneficiaries have died or such other date as the trustee may appoint to be the vesting date or the date of expiry of the perpetuity period. So basically when two of the nominated beneficiaries have died, the trust vests, the capital is basically created into four equal parts going to each of the respondent, respondent's mom, and the two brothers.
(08:32):
They then later, the next year, amended the vesting date irrevocably to be the day immediately before the date of the first to die of the respondent or the respondent's brothers. And then on that date, they reiterated such of the respondent, the respondent's mom, and the two brothers who were living on the vesting date will be entitled to the capital irrevocably in equal shares. Okay. So we've gone basically from a fully discretionary trust to sort of fixed entitlements. The other thing we'll also note in terms of the analysis is the respondent did receive significant income and capital distributions. He didn't have to work anymore. He just lived off the income from the trust. So what was the outcome? Let's have a look at what the trial judge held, and then this decision or the final decision is an appeal from her reasonings. The evidence is that the trust exists for the benefit of the respondent, the mom, and the siblings.
(09:43):
The history of the trust and the subsequent amendments since the death of the respondent's father confirmed that intention. So looking at purpose, it's for the whole family. In terms of control, the respondent himself doesn't have any sole control, right? They also, in terms of the source of the assets, it's clear that this is from the respondent's father for the whole family, but they've got a problem in terms of who the beneficiaries are and the distribution. So at paragraph 32 of the full court judgement , they recite what the trial judge said. So after the father's death, the four family members were made irrevocable appointors and guardians, and they became equal shareholders in the trustee company. In 2001, amendments were made to ensure the four family members received income and capital from the trust. And then in 2002, the trust was amended ostensibly to ensure that those four family members received their entitlement sooner rather than later by amending the vesting date to be immediately following the death of one of the three brothers.
(10:54):
This is not a case where the husband is a beneficiary under a family trust without any level of control or expectation of receiving his entitlement. It is clear that the husband's father intended the four family members to be in control of the trust to the extent of their personal entitlement. On the wording of the trust, the husband is an irrevocable beneficiary of income and a revocable beneficiary of the capital of the trust. They also took into the fact that the trial judge noted the husband certainly does not have the fullest power of disposition over either the property and the income of the trust. He has a fixed entitlement to the profits and a right to the corpus. He has an irrevocable right to the income, and if there is no profit, there is no distribution. However, historically, he has received regular distributions. He agreed that he could confidently expect to receive a quarter share of the profit distributions of the trust in the future.
(11:58):
And then she notes in the 2007, 2008 year, this was approximately 4.1 million. He accepted the profit distributions were likely to be more substantial in the future. So what did the full court hold? They agreed that the husband's interest in the trust should have been held to be property of the parties to the marriage. We consider that the interest was property because whatever the original nature of that trust and the husband's interest in it, the various amending instruments have resulted in a situation where the husband has irrevocable entitlements, not only to income, but also to capital. So that's at paragraph 63 of the decision. At 64, it's stated, "It is true there is a possibility, perhaps described as a theoretical possibility, that the husband's one quarter share of the capital might ultimately be diluted by the appointment of other beneficiaries, but he would still be entitled to some share in the capital.
(13:04):
It is only the value of his share that might change, and indeed it might increase on his mother's death." So here, the conversion of the discretionary trust to a fixed trust creating that certainty was fatal to the respondent's argument that he was a mere beneficiary and he didn't have a set expectation in the trust. Let's move on to another decision two years later, 2012, Morton and Morton. So in this decision, we had a 12-year relationship. The parties to the relationship had a $3.6 million property pool, and there was a family trust with an extra million dollars in it, and the applicant wife was arguing that half of that family trust was to be brought in as property of the parties. Now, the family trust was controlled jointly with the respondent's brother. So the respondent and his brother were both appointers, shareholders of the corporate trustee, and directors of the corporate trustee in equal shares.
(14:19):
They also had a corporate beneficiary that the respondent's brother was the sole director of, and it had another sum of about 700,000. So maybe we're talking about like a 1.8 million all up in that trust structure. So the applicant argued because the two brothers each had a 50% share of the corporate trustee and sort of intended to equally benefit themselves from the trust, that a 50% interest in the trust should be treated at the respondent's property. But the respondent argued that neither he nor his brother had control. Neither of them had a better right than the other in their standing as director's shareholder appointor. So they had a veto power for each other. No one brother could drive through any kind of decision. So it was held that the trust assets were not property of the parties, wasn't right to say that 50% should be deemed as property of the parties none of the trust assets.
(15:25):
So there's some really interesting comments out of this decision, and it's actually not a very long one. So I'd almost encourage you to just print it out and read it, but I'm going to read out a few for you. Okay. So firstly, at paragraph 33, it's acknowledged that respondent and husband are not the only beneficiaries. The beneficiaries are extensive in that they include but are not limited to the respondent, his brother, their mother, any grandchildren, remote relatives, any company or trust, et cetera, et cetera. So they're basically just saying, "This is a fully discretionary trust." It appears the applicant seeks to appoint to the respondent in his capacity as director of the trustee company as having control of the trust, yet his brother is appointed and acts in an identical capacity. I must also emphasise the fact that the brothers are in fact also joint appointers with power to remove and appoint a trustee.
(16:24):
Neither has a better right in this regard than the other. They are the beneficiaries of the trust, but they are merely two beneficiaries among several other and potentially many other beneficiaries. And then at paragraph 38, "Notwithstanding the evidence before me shows there is a close, warm, and loving relationship between the brothers and that there has been a good deal of intermixing of funds, not only their own personal funds, but funds from various entities which they have created and which have subsequently died commas, so being wound up. There is not sufficient evidence before me to convince me that the husband has that sufficient control over the entities to which I have referred to make me believe that they are in fact his property. Consequently, I shall take them into consideration as a financial resource and a matter which will be taken into consideration as section 752.
(17:20):
So financial resource, not property of the parties. At paragraph 43, this is where they follow Kennon and Spry. So I am more than satisfied of the evidence before me and taking into consideration the authority of Kennon and Spry and the principles applicable there too, unless I am satisfied that a person has control of a trust and control is underlined in case you're interested. In other words, that it is his alter ego, I do not believe that it can be suggested that any interest that the husband may have in Morton Trust in this case as a beneficiary is in fact property. So this is where this alter ego concept is starting to be coined in the subsequent decisions, and it's also reiterating those factors from Kennon and Spry. So here, control was really given a lot of weight and the husband or the respondent didn't have control.
(18:22):
They then go on to talk about the corporate beneficiary and the corporate trustee, and again, just saying," There is not sufficient evidence to convince me that the husband alone has control. "So yeah, I really find this outcome or decision really reassuring that where we do not have one person in control, provided it's not a sham and there's not a puppet type arrangement, that it is really hard for an applicant to be successful in arguing that the assets of the trust. So if you've done my course, The Essential Guide for Testamentary Trust for Australian Lawyers, we talk a lot about how do we structure the control of a testamentary trust to achieve the objectives of the family, but also for family protection.
(21:18):
The last decision I want to cover in this episode is the decision of Harris and Harris. In this case, Mrs. Harris argued that there was a sham in place.
(21:31):
So I really wanted to highlight this. We don't have a lot of these sham cases and this one's quite interesting. So 20-year relationship between the parties, they had a $4.2 million property pool and then there was a family trust with about $1.5 million and it actually carried on a business and both Mr. And Mrs. Harris worked in that business during the relationship. After the relationship broke down, Mrs. Harris stopped working in that business, but Mr. Harris continued. Mr. Harris's dad actually settled up the trust. He created it six years before the relationship started. The dad was the appointer. On his death, Mr. Harris's mom became the appointor and was still the appointor at the date of this case. The beneficiaries are Mr. Harris's parents and then their general lineal descendants, and it is a discretionary trust. Mrs. Harris herself was not a beneficiary, but she did actually receive distributions from the trust.
(22:38):
So some not quite perfect compliance with the trustee there and maybe some tax issues, but we'll put that to the side. There was some change to the structure. So initially there was a corporate trustee where the husband and wife were both directors of the corporate trustee. Three years after their separation, as the appointor, the husband's mom changed the trustee and appointed a new company and the directors of that company were the mom, the husband's friend, and the husband's son, who was an adult from the first relationship. So when you look at it, the husband had no control a particular point. And we saw the husband's mom exercising her control through the appointal role to change the trustee. So the trial judge held that the trust was the respondent's property. Also, around the time of the separation, the husband set up a company where shares were owned solely by the husband and it received distributions in lieu of the husband receiving direct distributions.
(23:56):
Now, again, also another issue because it was not technically a beneficiary of the trust, but that's to the side of the family court issues. So the wife claimed basically that the trust is the husband's alter ego, and his mom was merely acting as a figurehead in her role as a pointer and also director. It's also, I think, interesting or relevant to note that the husband and then the company that he controlled did receive significant distributions from the trust. So let's look at the decision. So this is an appeal decision. Justice Bell initially held that the assets of the trust would be regarded as property of Mr. Harris and therefore included in their calculation of property to the parties of the marriage under Section 79. So the husband is appealing that decision. To rebut that, the wife argued actually there is full control here by the husband.
(25:00):
Mom is really just sitting there doing everything that the husband is telling her to. So there was evidence there in terms of the husband's engagement with the accountant, some acts about a share transfer that never went ahead. They also acknowledged, we observe in passing that there appears to be no dispute that the husband was the manager of the actual business, which was conducted by the trust, but the issue raised in the case was whether the husband had sufficient control of the trust itself, such that its assets could be regarded as his assets. So I think that is useful to know because it can be very muddying to a layperson when they look at the day-to-day operations versus the control of the legal entities. So the wife did try to sort of put forward that the trust is the alter ego of the husband. And they do, I sort of mentioned in the Kennan and Spry case, everyone attributes the alter ego concept to that judgement , but they don't actually use that terminology.
(26:12):
But as I've just said, in Morton & Morton, they bring forward the concept of alter ego. And they do also in this decision, Harrison Harris, they use the phrase alter ego. So for instance, the wife believes that the company is the alter ego of the husband, and as a result, he is the alter ego of the trust. Some instances is that the husband dismissed the accountant who had been responsible with the husband's father for the creation of the original trust and replaced him with someone else. The new accountant received directions from the husband about shareholdings and directors and how to make the distributions each year. So let's have a look at paragraph 54 of the judgement , which talks about what the trial judge held. The matters that I have looked at in relation to the trustee being the husband and the husband being the trustee is that he has quite clearly, he says, with the approval of his mother, varied the distributions received by the grandmother with the advice of accountants who were accountants for the company at the time.
(27:18):
Once again, it appears to me that he has complete control over the amount of funds to be distributed, notwithstanding his allegations that he consults deeply with his mother, but I do not accept the fact that he does so. He accepts the recommendations of his agents, the company accountants, and is able to manipulate the payments to his own devices. I note that the subsequent to separation, the distributions of substantial amounts to the wife cease and she was brought back down to a lower rate. So just sort of putting forward the evidence of why what they think is truly happening here, so reiterating from Kennan and Spry, they can ignore what's on paper and really cut through all of that to get to the source of how is this trust being used by the family? Who is the key decision maker and who's in control? Now, on appeal, the trial judge's decision was actually reversed on the basis that, firstly, they said it is not easy to identify with absolute precision the matters which have caused the trial judge to conclude that the assets of the trust should be treated as the assets of the husband.
(28:31):
So at paragraph 59, so far as the relationship between the husband and the trustee is concerned, it is important to observe that while the husband was and remains a director and minority shareholder in the original trustee, he is neither a director nor a shareholder in the new trustee. It is also important to observe that the trial judge made no reference in his reasons to this change of trustee, nor did he provide any examination of the husband's relationship with the current trustee. So they're sort of saying that change of trustee is actually really important and we need to look at the current control structure. So paragraph 65 of the appeal decision, in the present case and on the basis of the material before us, the husband appears to be no more than such a beneficiary of such a trust. He is not the appointer of the trust, nor does he hold any position in the current trustee company.
(29:28):
On the assumption that the use of the word directly by the chief justice in Kenan and Spry was referring to the strict legal position, it therefore cannot be said that the husband directly controls the current trustee, nor could it be said that he directly controlled the previous trustee on the assumption that the reference by the chief justice to indirect control of a discretionary trust by a beneficiary was a reference to a puppet situation in the sense that the person with legal control All of the trust is a puppet of a beneficiary. That could be the situation in the present case. In the sense that is of the mother who is the appointor of the trust and one of the three directors of the trustee company holding two shares in that company with each of the other two directors holding one share each, being the puppet of the husband.
(30:21):
The difficulty, however, for the wife on this appeal is to be able to point to any evidence which would support a finding that the husband's mother is his puppet and that it is through her or perhaps otherwise that he exercises de facto control of the trustee company and the trust. So they then go on to say at paragraph 72, "It will be clear from what we have said so far that we do not consider that his honours conclusion that the assets of the trust should be treated as the assets of the husband can be supported on the basis of his findings, nor indeed on the basis of any of the evidence before him to which we have been referred. On the evidence to which we have been referred, the best that we could do would be to determine that the trust is a very significant financial resource for the husband.
(31:16):
So the husband got up on rejecting that the mom was his puppet because remember the onus of proof is on the person attacking the trust. So in this case, the wife trying to bring it in. So this is why I'm so passionate about using testamentary trusts, but particularly to protect inheritances to adult children because it shifts the onus of proof. If you're an adult child and you receive an inheritance from your parents or from anywhere and you receive it directly, it's intermingled in the assets of the relationship and there's no argument. It just becomes the property of the parties. Whereas if you inherit those assets through a testamentary trust, your spouse has to then argue and follow the factors that we talked about, like looking at control, the purpose of the assets, the source of the assets, who the beneficiaries are, the history of distributions, to then mount a case that the trust is your alter ego and that there's enough of those factors to justify bringing the trust assets in as property of the party.
(32:34):
So the owners of proof basically ships. If you've received an inheritance directly, you're really scrambling to try and say," Well, it's not included. "Whereas if it's in a trust, the owners is on them. And I'm actually looking at Harris and Harris around paragraph 11. It actually talks about the fact that the wife did receive an inheritance from her parents. They used that money to buy a house. And then I think they sold the house and then they bought another house and the husband lives in that house now. And because she received that inheritance directly, firstly, when it's received directly, it's so much more likely to be intermingled and mixed in with the relationship assets. So you can't even sort of trace it. It's not ring fenced. And yeah, there's no argument. So she's lost her inheritance to this property pool. Whereas where you have the structure of a trust holding the inheritance, you've got separate bank account, duties over that trust.
(33:42):
It's ring fenced. It's got to be reported in separate financials. It's much less likely to just be intermingled and not being able to be traced anymore either. So I'm getting ahead of myself in terms of the takeaways from these decisions, but I do think these are helpful. Morton & Morton and the fact that by both being controllers, neither one of them really had any sway or was able to have control over the trust. Harris and Harris looking at the analysis of what do you need to prove a sham? And then also Pittman & Pittman really reiterates the importance of discretionary entitlements. As soon as you get away from a beneficiary being able to say," I don't know what I'll receive year to year. I could receive 0% or 100%. "My entitlement is totally at the discretion of the trustee. Once you have certainty about your entitlement, it's very easy for the court, the applicant to point to that and then say," Great, we can value this.
(34:50):
We know what the set share is and we have a certainty of expectation. "So I hope you found these cases useful. There's a lot more to talk about. We're going to keep going with the series, so keep an eye out for that. And I look forward to bringing more cases to you soon. Thanks for listening.
