Sham and illusory trusts—lessons from Clayton v Clayton

Sham and illusory trusts—lessons from Clayton v Clayton Abstract This article examines the reasoning in Clayton v Clayton [2016] NZSC 29, and some of the issues it raises but does not answer, and suggests some approaches to the drafting of discretionary trust deeds to resist claims that the terms do not establish a valid trust, that is the trust is illusory. Introduction The decision in Clayton v Clayton [2016] NZSC 29, results from a matrimonial property dispute in New Zealand, in which, among other things, it was contended that a trust was a sham or illusory so that the property held by the settlor/putative trustee was held beneficially by him. By the latter term it was contended that because of the powers held by the husband, no trust had been established and he held the property beneficially. The classification of certain trust like relationships as illusory trusts seemed to have been an esoteric backwater. If you were to consult the indices of a number of standard works on trusts you would find that some have an entry ‘Illusory trusts’,1 but that entry is lacking in others.2 That may indicate it is not necessarily a topic, or a classification of trusts, that has appeal or relevance for all text writers, or at least for their indexers. On the contrary, sham trusts have been much discussed. The facts of Clayton v Clayton Mr Clayton was a successful and wealthy businessman. His assets were not held in his name but in various trusts and entities. One of the trusts Mr Clayton had established was the Vaughan Road Property Trust (VRPT). The property held by Mr Clayton as trustee of VRPT was valuable. After the marriage of Mr and Mrs Clayton had broken down, Mrs Clayton sought a property settlement taking into account the value of the VRPT property. She mounted a three-pronged attack: The trust was a sham. The trust was illusory. The trust’s assets were relationship property, or alternately Mr Clayton’s powers were relationship property having a value equivalent to the assets of the trust. The relevant provisions of the Deed are contained in an appendix to the judgment of the Supreme Court of New Zealand. In brief, Mr Clayton was the settlor and trustee. The discretionary beneficiaries included Mr Clayton, his wife and their two daughters. The daughters were the final beneficiaries who took on the Vesting Day absent the exercise of discretion in favour of other beneficiaries. Mr Clayton was the ‘Principal Family Member’. He had a number of powers in that capacity, including to add or remove beneficiaries, to appoint and remove the trustee and to appoint a successor to exercise those powers. As trustee, Mr Clayton had unfettered discretions, including: to resettle the trusts; to distribute income and capital before or as at the Vesting Day to any beneficiary, including himself; he could exercise his powers despite any conflict of interest; and he was entitled to be indemnified against liabilities incurred by him as trustee save for those arising from his own dishonesty or a wilful and knowing breach of trust. Mr Clayton as trustee, with his consent as Principal Family Member, could vary or revoke any of the provisions of the trust deed so long as that did not infringe the rules against perpetuities. What the Courts decided The case was first heard by the Family Court and then successively appealed to the High Court, Court of Appeal and the Supreme Court of New Zealand.3 The parties reached a settlement before the Supreme Court handed down its decision, but the Court considered it appropriate to deliver its judgment ‘given the importance of the issues’. The findings of each court on the issues are set out below. Court  Sham?  Illusory?  Synonymous?  Relationship Property?  Supreme  NO  NOT DECIDED  NO  YES  Court of Appeal  NO  NO  YES  YES  High  NO  YES  NO  NOT NECESSARY TO DECIDE  Family  NO  YES  NO  NOT NECESSARY TO DECIDE  Court  Sham?  Illusory?  Synonymous?  Relationship Property?  Supreme  NO  NOT DECIDED  NO  YES  Court of Appeal  NO  NO  YES  YES  High  NO  YES  NO  NOT NECESSARY TO DECIDE  Family  NO  YES  NO  NOT NECESSARY TO DECIDE  Court  Sham?  Illusory?  Synonymous?  Relationship Property?  Supreme  NO  NOT DECIDED  NO  YES  Court of Appeal  NO  NO  YES  YES  High  NO  YES  NO  NOT NECESSARY TO DECIDE  Family  NO  YES  NO  NOT NECESSARY TO DECIDE  Court  Sham?  Illusory?  Synonymous?  Relationship Property?  Supreme  NO  NOT DECIDED  NO  YES  Court of Appeal  NO  NO  YES  YES  High  NO  YES  NO  NOT NECESSARY TO DECIDE  Family  NO  YES  NO  NOT NECESSARY TO DECIDE  This table is necessarily oversimplified and, to an extent, misleading. The Family Court and the High Court found (but for different reasons) that because the VRPT was illusory, the assets of the VRPT were assets held by Mr Clayton beneficially and those assets were relationship property. The Court of Appeal having found the VRPT was neither a sham nor illusory, then found that certain powers of Mr Clayton under the trust deed were relationship property having the effect of bringing the net value of the assets of the VRPT into the pool of relationship property. The Supreme Court reached the same conclusion that certain (but different) powers of Mr Clayton were relationship property which made it unnecessary to decide whether or not the VRPT was illusory. They said that was a question of some complexity on which the Court did not have a concluded unanimous view. The Courts below Although this article will largely confine itself to an analysis of the judgment of the Supreme Court, the judgments of the courts below reveal two approaches. In the Family Court, Munro J took what has been called the ‘irreducible core’ approach. She found that clause 11—the trustees had an unfettered discretion, there was no requirement for due consideration and the power could be exercised even though it might be contrary to the interests of present or future beneficiaries—coupled with clause 19.1(c)—permitting the trustees to deal with itself as trustee of another trust despite any conflict of duty negate the ability under this deed for the beneficiaries to call the trustee to account in the exercise of his discretion. The beneficiaries therefore have no rights under this deed against the trustee. She relied on the well-known passage in Armitage v Nurse4 … there is an irreducible core of obligations owed by the trustees to the beneficiaries and enforceable by them which is fundamental to the concept of a trust. If the beneficiaries have no rights enforceable against the trustees there are no trusts. In the High Court Rodney Hansen J disagreed. He considered that the provisions relied upon by Munro J did not erode the core obligations. The trustee was not excused from acting honestly and in good faith, he was merely relieved of the obligation to act impartially between beneficiaries. As has been said in other circumstances,5 in any event in a discretionary trust the duty of impartiality is meaningless, so relief from that duty does little more than restate the law. The test he relied upon was whether on a proper construction of the deed Mr Clayton retained such control that he did not intend to give or part from control over the property sufficient to constitute a trust. This can be called the ‘no sufficient disposition’ approach. The provisions he relied upon to find there was no sufficient disposition were: that Mr Clayton was a beneficiary and had power to appoint and remove trustees; the trustees had full discretionary power to pay income and capital to beneficiaries; the deed conferred on trustees the full powers of an owner, including unfettered discretions to exercise all powers and discretions and to deal with the trust property; and, critically, a trustee who was a beneficiary could exercise any power or discretion in his own favour. He concluded that Mr Clayton had effectively retained all powers of ownership, he was able to deal with trust property just as he would if the trust had never been created. The Court of Appeal found the VRPT was neither a sham nor illusory, as noted they considered those terms to be synonymous. It found that clause 7.1 created a general power of appointment and that power was relationship property. The Supreme Court The Supreme Court disagreed with the Court of Appeal as to the power in clause 7.1; they found it was neither property nor relationship property, but concluded Mr Clayton’s powers as a whole were relationship property. As I have noted the Supreme Court did not come to a concluded unanimous view as to whether the VRPT was an illusory trust. The relevant portion of their judgment is set out below. The extract is long, but the reasoning raises a number of issues for further consideration. [122] The Court of Appeal overturned the finding that the VRPT was an illusory trust. It saw that finding as inconsistent with the findings made by Rodney Hansen J that the VRPT was not a sham trust, that Mr Clayton had core obligations as Trustee to act honestly and in good faith, and that other beneficiaries could enforce those core obligations. It also saw the terms sham trust and illusory trust as synonymous and their legal definitions as overlapping. It saw both as hinging on the settlor’s intention to create a trust that was valid and enforceable. The Court said once the Court accepts a valid trust has been established (with no sham), it should not be able to be treated as non-existent because the Trustee has wide powers of control over the trust property. In short, “[t]here is either a valid trust or there is not”. [123] We will come back later to the distinction between a sham and an illusory trust. For the present we observe that a finding that a trust deed is not a sham does not seem to us to preclude a finding that the attempt to create a trust failed and that no valid trust has come into existence. That would lead to a finding that the trust is illusory, to use the terminology adopted in the Courts below. For our part we do not see any value in using the “illusory” label: if there is no valid trust, that is all that needs to be said. [124] Given the extent of the powers held by Mr Clayton under the VRPT deed, there are two alternative lines of analysis concerning the VRPT’s validity. First, it can be argued that the VRPT is not a valid trust because Mr Clayton, having reserved such broad powers to himself in the VRPT deed, cannot be said to have disposed of the property settled under the VRPT deed in favour of another.124 Equally, the breadth of those powers can be said to bring into question whether the irreducible core of Trustee obligations referred to in Armitage v Nurse apply to Mr Clayton.125 However, this does not deny the possibility that a valid trust may come into existence at some time in the future, for example, if Mr Clayton were to be replaced by a new Trustee who was not the Principal Family Member and/or a beneficiary. 124 Knight v Knight (1840) 3 Beav 148, 49 ER 58 (Ch) at 68 per Lord Langdale. 125 The argument that the VRPT is not a valid trust is supported by the observations of Associate Professor Palmer and Professor Peart in their paper “Double Trouble – the power to appoint and remove Trustees and the power to appoint and remove beneficiaries” (Paper presented to NZLS CLE Trusts Conference, June 2015) 33 at 50–51. See also Nicola Peart and Jessica Palmer “Clayton v Clayton: A step too far?” (2015) 8 NZFLJ 114 at 117. [125] Second, it can be argued that, even though the VRPT is effectively defeasible, in the sense that the VRPT powers in substance give Mr Clayton power to bring the VRPT to an end, there is no reason in principle why it should not be regarded as a trust and required to be administered in accordance with the VRPT deed until the exercise of the VRPT powers in that manner. In TMSF, the Privy Council found that the settlor’s powers to revoke the trust were such that the settlor could be regarded as having rights tantamount to ownership.126 It made no finding about the status of the trust in the period before the revocation powers were exercised, because it was not required to do so in order to resolve the issue before it. However, there was nothing in the judgment to indicate that the trust was invalid in the period before the power to revoke it was exercised. 126 Tasarruf Mevduati Sigorta Fonu v Merrill Lynch Bank & Trust Co (Cayman) Ltd [2011] UKPC 17, [2012] 1 WLR 1721 [TMSF] at [59]. [126] It should be acknowledged that the power of revocation was not a power held by the trustee in that case, so there was no question but that the trustee’s fiduciary obligations continued until the power of revocation was exercised. That can be contrasted with the present case, where the VRPT powers are, for the most part, powers held by Mr Clayton as Trustee. [127] Determining which of these two lines of analysis is correct is a matter of some complexity on which the Court does not have a concluded unanimous view. In light of that, we do not intend to determine the issue because the settlement of the proceedings makes it unnecessary to do so and, given the very unusual terms of the VRPT deed, the issue is unlikely to arise in future cases. Is there a distinction between a sham trust and an illusory trust? [128] The answer to this question is academic, given our earlier findings. As noted earlier, a sham is a pretence: the terms of the document do not represent what the party or parties really intended. A finding of sham in this case would involve the Court assessing the subjective intention of Mr Clayton and concluding that the VRPT deed did not conform with his real intention. [129] As we have already said, we do not find the term “illusory trust” helpful. What the Family Court and High Court meant by that term was that no trust was created. In such a case, the document as executed does represent the terms to which the party or parties intended to agree but, despite their subjective intention to create a trust, they failed in their attempt to do so. [130] In the present case, Mr Clayton intended to create a trust on the terms recorded in the VRPT deed. The issue would be whether the powers held by Mr Clayton are so broad that what he intended to be a trust was not, in fact, a trust. As already noted, we are not determining that issue. [Some footnotes omitted or edited to incorporate references to earlier footnotes] The result was the Court: found Mr Clayton’s powers, as enumerated, were relationship property having a value equal to the net assets of VRPT; VRPT was not a sham trust; and did not determine whether VRPT was an illusory trust. A number of observations may be made as to the Supreme Court judgment: They found there was a distinction between a sham trust and an illusory trust, although they found no value in the latter label, ‘if there is no valid trust, that is all there needs to be said.’ The ‘irreducible core’ and the ‘no sufficient disposition’ approaches are conflated; The possibility of an emerging trust is specifically acknowledged; A power of revocation held by a trustee would be a strong indicator of an illusory trust, if such a finding were to be made; A power of revocation may not invalidate a trust before it is exercised; The subjective intention to create a trust must yield to whether as a matter of construction of the deed, a trust was created. Perhaps the most salient point is that of the four courts in the hierarchy, only the Court of Appeal found that the VRPT was NOT illusory, and then on the basis (with respect correctly found to be erroneous by the Supreme Court) that the VRPT could not be illusory because it was not a sham trust. Each of the courts that were not prepared to find the VRPT was not illusory followed well established principles, it was not a new judicial adventure. It is instructive to note the emphasis placed by the Supreme Court in its consideration of whether or not the VRPT was an illusory trust. First, at [124], the court refers to both the ‘no sufficient disposition’ and ‘irreducible core’ approaches, but without analysing any specific provisions and then says the argument that the VRPT is not a valid trust is supported by observations in a paper by two academic writers. But the court immediately follows that by saying a valid trust may come into being in future, if, for example, Mr Clayton was replaced by a new trustee who was not the Principal Family Member and/or a beneficiary. The clear implication is that it was only the combination of powers held by Mr Clayton as trustee and as Principal Family Member, and that those powers could be exercised in his favour as a beneficiary, that may lead to invalidity. Then, at [125], in putting forward the opposing argument, the Court focusses on the ability of Mr Clayton to bring the trust to an end, presumably with the result that Mr Clayton would once again become the beneficial owner of the assets, but says there is no reason in principle why the VRPT should not be regarded as a valid trust until the powers are exercised. The judgment in Clayton raises the possibility that a valid trust may subsequently arise when different people occupy the relevant offices—an emerging trust. In so doing the Court has also left open the possibility that an initially valid trust may become invalid if the offices are initially occupied by different people but one person comes to occupy them all—emerging invalidity. Both of these ‘doctrines’ are discussed below. The focus of the Court on the retention or grant of extensive powers tends to suggest that the ‘no sufficient disposition’ approach was paramount in considering whether the VRPT was a valid trust. Despite the focus in Clayton on the no sufficient disposition approach, I submit that in an appropriate case a trust may be found to be illusory because the irreducible core of trustees’ duties are not present. While there is clear overlap between the two approaches, it does not follow that they are the same. They may have different consequences where the property is transferred to a third party to be held on the terms of the deed. In a ‘no sufficient disposition’ case the settlor retains beneficial ownership, and would do so despite the legal title passing to a person named as ‘trustee’. In an ‘irreducible minimum’ case it may be arguable that the person in whom legal title is vested does not have any equitable estate impressed on the legal title, so that person has full ownership free of any resulting trust to the transferor, because the transferor always intended legal title to pass without creating any equitable obligations. Illusory or Sham? In North America, it appears the terms are considered synonymous and the New Zealand Court of Appeal so found in Clayton,6 although that finding was overturned by the Supreme Court. At one level, what constitutes a sham trust and what an illusory trust appears to be the same because in each case what appears to be a valid trust is found not to be one because there is no intention of creating a trust. I submit that the correct position requires a more detailed consideration of the intention: A sham trust is one where as a matter of construction the terms of the document would establish a valid trust, but the intention of the relevant parties is that they will not be bound by those terms, but hold the property for or at the direction of the settlor. An illusory trust is one where the intention of the parties is that they will be bound by the terms of the document, but as a matter of construction those terms do not establish a valid trust. This position accords with the decision of the Supreme Court in Clayton, the extra judicial writings of Justice Pagone7 and a recent, and I suggest important, decision of the Family Division of the England and Wales High Court.8 The recent decision of Birss J in Mezhprom Bank v Pugachev9 contains an extended discussion of sham and illusory trusts, the decision in Clayton and numerous other cases, texts and articles. The judge found, in effect, that the trusts in question were illusory, although he found that word to be ‘unhelpful’ preferring to consider the true effect of the trusts, but if they were not then they were shams. I make one further comment. In sham trusts, what is important is the subjective intention of the parties not to be bound by the terms of the document; that subjective intention must be established by cogent evidence to override the intention expressed in the document. In an illusory trust, the parties may have had a subjective intention to establish a trust, but it is their objective intention as established by construction of the document in light of any admissible evidence that is determinative. Having said that, it must be admitted that the presumption that a revocable debtor’s mandate does not give rise to a trust in favour of the creditors appears to give weight to the subjective intention of the debtor despite that presumption being expressed as a matter of construction. To avoid getting bogged down on issues concerning sham trusts, or the more contentious issue of emerging sham,10 I will confine this article to illusory trusts as defined above with some reference to the possibility of a doctrine of an emerging trust (the Odette to the Odile of emerging sham?). Is there a doctrine of emerging trust or emerging invalidity? The Supreme Court noted it could be argued that the VRPT was not a valid trust because of the powers reserved by Mr Clayton to himself. That resulted from the combination of powers held by him as trustee and as Principal Family Member and his status as a beneficiary. The Court then did not deny the possibility of a valid trust subsequently coming into existence if a new trustee was appointed who was not the Principal Family Member and/or a beneficiary. I must confess I have grave difficulty with this concept, unless it be taken that Mr Clayton, by removing himself as trustee, then, but only then, divested himself of beneficial ownership, despite the same terms of the trust deed being as binding on him as his successor. My difficulty increases if Mr Clayton ceased to be a trustee by involuntary act, including death. The difficulty can be expressed in a different way: if Mr Clayton was not the initial trustee or Principal Family Member, but subsequently was appointed to those offices; could it then be said that the trust, although initially valid, became illusory and invalid because of the combination of powers then held by him? And what if he, and his predecessor, had been exercising their powers in accordance with the deed for the benefit of the other named beneficiaries? What lessons does Clayton have for practitioners and drafters of trust deeds? The Supreme Court considered that ‘given the very unusual terms of the VRPT deed, the issue [whether a trust is illusory] is unlikely to arise in future cases.’ In my experience, it is not at all unusual for Australian discretionary trust deeds to provide: The same persons are the trustees or control a corporate trustee and are also named as holding an office variously called the Appointor, Guardian, Protector or Principal (for convenience hereafter ‘the Principal’); The trustees, and the Principal if different, are beneficiaries; There is an extremely widely defined class of discretionary beneficiaries; The Principal can remove and appoint the trustees; The trustees, sometimes only with the consent of the Principal, can: Appoint and remove beneficiaries; Amend all or any of the trusts terms and conditions of the trust deed, I note many powers of amendment are expressed in terms permitting a trustee to revoke add to amend or vary the trusts terms and conditions; Appoint capital and income to any beneficiary, by definition including themselves, both before and as at the vesting date; Exercise an unfettered discretion in respect of management or dispositions; Resettle the trust fund or transfer the trust fund to another trust fund if similar or if any of the beneficiaries have an interest in it; Enter into self-dealing transactions and retain benefits such as director’s fees where they are appointed because of interests held as trustee; Be indemnified against any liability save that arising from dishonesty or wilful commission of a breach of trust. Together these provisions mirror those that were contained in the VRPT trust deed. The provisions in the VRPT trust deed which are not usual in Australian deeds in my experience are those identified by Munro J in the Family Court, namely clause 11, in particular paragraphs (a) and (b) entitling the trustee to exercise discretions even though: (a) the interests of all Beneficiaries are not considered by the Trustees; (b) the exercise would or might be contrary to the interests of any present or future Beneficiary; and paragraph (c) of clause 19.1 permitting a conflict of interest and duty when acting as trustee of another trust. It may be that it was these clauses that the Supreme Court found very unusual. Possible applications In Australia, as in New Zealand, there is no need to resort to the concept of illusory trust in matrimonial property proceedings, because in similar circumstances a court can find that the powers held by a spouse are matrimonial or de facto property and thus brought within the pool of assets.11 Alternatively, the alter ego principle can be applied to find that the trust assets are within the pool or are a financial resource. There are two obvious areas where the concept may be relied upon. First, the invalidation of a trust as illusory could be used in insolvency proceedings where the result will be that the assets are the property of the debtor divisible between their creditors. The exposition and doctrinal basis of illusory trusts is not confined to matrimonial property. Although, so far as I am aware, that argument has not been successful to date, there is the decision of French J, as he then was, in In the Matter of Richstar Enterprises Pty Ltd (ACN 099 071 968) Australian Securities and Investments Commission v Carey (No. 6) [2006] FCA 814 where he held, in interlocutory proceedings, that he would appoint receivers of property held by trustees of trusts because the trustee is effectively the alter ego of the relevant beneficiary or otherwise subject to his or its effective control, the beneficiary has at least a contingent interest within the meaning of that term as used in the definition of ‘property’ in s 9 of the [Corporations Act 2001]. In my opinion, Richstar should be seen as dependent on something approaching a sham, in that it appeared that there was an understanding between the trustee and the beneficiary that the trust would be administered for the benefit of that beneficiary or as he directed. Of course, it is also highly dependent on the extended definition of ‘property’ in the Corporations Act. The second area of application arises on transition to the next generation. Where family assets are held in a family trust and not directly by the parents, then they are beyond the reach of applications under the Family Provision Acts, with the exception of New South Wales where they may be caught as notional property. If a child or other dependant is locked out of benefit from a family trust by formal exclusion or a pattern of distributions to others, then it will be in their interest to have the trust declared illusory and the trust assets held on a resulting trust for the parents who donated them or funded their acquisition. The assets may then fall into residue in which the child participates or be available to satisfy a successful family provision application. One issue that will cause evidentiary problems in the Australian context arises from taxation considerations and the decision in Truesdale v Federal Commissioner of Taxation [1970] HCA 27; (1970) 120 CLR 353. That decision led to family discretionary trusts being established by a settlor who settles a nominal sum to establish the trust which is then ‘fed’ by the parents or other true controlling minds. It will not always be easy to determine what funds or assets are the subject of any resulting trust because the true funder may not appear on the face of the trust deed. I question whether a distinction should exist between a person who settles assets and another person who does not, where both have power to bring the trust to an end for their own benefit. If a trust may be invalid because it may be brought to an end by a person for their own benefit, does it matter whether or not that person has contributed any or all of the assets of the trust? What should be done? I have noted above some situations when a decision may be made to attack the validity of a trust. In a sense, it does not matter for the present whether or not a trust in Australia can be found to be invalid because of the powers held by one person similar to those considered in Clayton; the possibility of proceedings, even if eventually unsuccessful, should be sufficient to reconsider the drafting of trust deeds. I have taken it that the founders of a typical family discretionary trust will wish to retain the possibility that they can benefit from the trust if circumstances make that desirable. That immediately raises the possibility of an attack on the basis the trust is illusory. What then can be done to protect the trust from attack? I have noted that the Supreme Court in setting out the opposing analyses as to whether or not the VRPT was illusory, conflated the ‘no sufficient disposition’ and the ‘irreducible core’ approaches while placing greater emphasis on the former. The finding that a trust is illusory depends upon a finding that the reservation, or grant, of powers are such to preclude a trust coming into effect, because as a matter of construction the beneficial interest in the assets is retained by the true settlor. That construction could not stand if it is made clear that beneficiaries have enforceable interests in respect of the trust property. Few trust deeds make explicit whether powers of persons other than the trustee are fiduciary or personal. Indeed, there is a tendency to include specific provisions negating some fiduciary duties. That of course will not matter is the irreducible core of duties continue to exist. It must be remembered that the fons et origo of a discretionary trust is that the trustee may exercise a discretion to favour one beneficiary or one class of beneficiaries over any others. It cannot negate the intention to establish a trust that the trustee has such a discretion. I suggest that instead of negating or confining trustee’s duties, it should be made explicit that the trustee must act honestly and in good faith and is bound to give due consideration to the interests of beneficiaries before exercising a discretion, but may, if a beneficiary, also consider the trustee’s own interests. I submit it would then be clear that person named as the trustee exercises the powers as a fiduciary and is a true trustee. Further, the powers exercisable by a Principal should be categorized as those that are fiduciary, such as appointing or removing a trustee, and those that are personal, such as withholding consent to discretionary distributions making clear in each case the extent of the constraints on the exercise of the power. In my submission, if that is done then there is no room for a conclusion that enforceable interests have not been created in favour of all beneficiaries. If that is so, then there has been a sufficient disposition and the irreducible core of trustee obligations will be present. Some other considerations It has been suggested that there are some ‘trusts’ that do not take effect immediately, but only on death of the settlor and consequently take effect as Wills and must be executed with the same formalities as a Will. There may also be taxation consequences because the property would form part of the estate at death. Such trusts may arise where the settlor retains the right to income and enjoyment during their lifetime and the rights of other beneficiaries are postponed until the settlor’s death. In Australia, such trusts would have adverse taxation consequences. Of course, if there is such a thing as an emerging trust, then on death of a putative trustee who had reserved such powers so that there was no sufficient disposition during his lifetime, then it is conceivable a valid trust would emerge on his death, particularly if combined with cessation of the powers held by him as Principal. Would it then be arguable that the trust did not take effect as a Will, but ‘emerged’ on his death? My final comment concerns so-called ‘capricious trusts’. I am indebted to an essay by Professor John H. Langbein entitled ‘Burn the Rembrandt?’12 Professor Langbein cites a number of cases where testators have given eccentric directions to destroy money, brick up a house or erect statues of the testator or his family. In these cases, the courts have labelled the trusts as capricious and invalidated them as not being in the interests of the beneficiaries. This, he considers, adds a further core element that a trust must benefit the beneficiaries. The thesis of his essay is that principle applies to investment directions such as retaining an interest in a business or company. I do not propose to enter into that debate, but merely to raise the prospect that an attack on a trust might be mounted on the basis it was capricious, rather than it was a sham or illusory, because it was not to benefit the beneficiaries—other of course than the beneficiary holding the powers to bring the trust to an end for their own benefit. If that were successful, then the result might be to strike down the capricious elements leaving the balance of the terms and the trust in place. Grahame Young is a barrister practising in Perth, Western Australia. The major focus of his work is in the structuring and restructuring of corporate and family groups, taking into account taxation, equity, trusts and succession, corporate and property law. He is the author of ‘Duties Legislation Western Australia’. Footnotes 1. For example, JD Heydon & MJ Leeming, Jacobs’ Law of Trusts in Australia (8th ed, LexisNexis Butterworths 2016) (Jacobs) and D Hayton, Underhill and Hayton Law of Trusts and Trustees (19th ed, LexisNexis 2014). In WA Lee et al, The Law of Trusts, Thomson Reuters looseleaf, there is no entry in the index but there is a discussion of some classes of illusory trusts at [5.930] ff. Similarly, in GW Thomas, Thomas on Powers (2nd ed, OUP 2012) (Thomas) there is no index entry, but a valuable discussion at 15.35–15.41 and 16.54–16.56. 2. For example, J Mowbray et al, Lewin on Trusts (18th ed, Thomson Reuters and supp 2012); GE Dal Pont, Equity and Trusts in Australia (6th ed, Thomson Reuters 2015). I understand, but have not been able to verify myself, that there is no entry for ‘Illusory trusts’ in the index of the third edition of Waters’ Law of Trusts in Canada but it appears in the fourth edition. 3. I understand the Family Court decision is MAC v MAC (NZFC, 2 December 2011) but I have been unable to find the decision online. Fortunately, the High Court decision [2013] NZHC 309 has comprehensive extracts. The Court of Appeal decision is [2015] NZCA 30. In addition to the decision on the VRPT, the Supreme Court also handed down another decision between the same parties on the same day concerning the Claymark Trust, [2016] NZSC 30, but it not relevant to this article. 4. [1998] Ch 241per Millett LJ at 253–254. 5. Edge v Pensions Ombudsman, cited in Thomas at 10.154. 6. The Court of Appeal noted that in the United States the term ‘illusory trust’ is used instead of ‘sham’ relying on Scott and Ascher on Trusts and that Waters’ Law of Trusts in Canada explains ‘illusory trusts’ under the heading of ‘sham trust’. Professor Donovan Waters, in a comment on a blog written by Anthony Grant, a New Zealand barrister, and quoted in his subsequent blog, suggests a trust will be described as ‘illusory’ in circumstances that clearly amount to a sham. 7. Sham Trusts Revisited a paper presented at the STEP Asia Conference in Hong Kong in October 2014 and re-presented at the South Australia STEP Trusts Symposium in March 2015. 8. ND v SD [2017] EWHC (Fam) 1507 (21 June 2017) at 176ff. 9. [2017] EWHC 2426 (Ch). 10. In ND v SD supra, Roberts J had no doubt. She said at [244] ‘a trust which is not initially a sham cannot subsequently become a sham.’ On the other hand, Kirby J in Raftland Pty Ltd v Federal Commissioner of Taxation [2008] HCA 21; 243 CLR 516 at [149] stated that a sham could develop over time citing Marac Finance Ltd v Virtue [1981] 1 NZLR 586 at 588. 11. Kennon v Spry [2008] HCA 56; 238 CLR 366. 12. Boston University Law Review, Volume 90 (2010) 375 © The Author(s) (2017). Published by Oxford University Press. All rights reserved. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Trusts & Trustees Oxford University Press

Sham and illusory trusts—lessons from Clayton v Clayton

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Abstract This article examines the reasoning in Clayton v Clayton [2016] NZSC 29, and some of the issues it raises but does not answer, and suggests some approaches to the drafting of discretionary trust deeds to resist claims that the terms do not establish a valid trust, that is the trust is illusory. Introduction The decision in Clayton v Clayton [2016] NZSC 29, results from a matrimonial property dispute in New Zealand, in which, among other things, it was contended that a trust was a sham or illusory so that the property held by the settlor/putative trustee was held beneficially by him. By the latter term it was contended that because of the powers held by the husband, no trust had been established and he held the property beneficially. The classification of certain trust like relationships as illusory trusts seemed to have been an esoteric backwater. If you were to consult the indices of a number of standard works on trusts you would find that some have an entry ‘Illusory trusts’,1 but that entry is lacking in others.2 That may indicate it is not necessarily a topic, or a classification of trusts, that has appeal or relevance for all text writers, or at least for their indexers. On the contrary, sham trusts have been much discussed. The facts of Clayton v Clayton Mr Clayton was a successful and wealthy businessman. His assets were not held in his name but in various trusts and entities. One of the trusts Mr Clayton had established was the Vaughan Road Property Trust (VRPT). The property held by Mr Clayton as trustee of VRPT was valuable. After the marriage of Mr and Mrs Clayton had broken down, Mrs Clayton sought a property settlement taking into account the value of the VRPT property. She mounted a three-pronged attack: The trust was a sham. The trust was illusory. The trust’s assets were relationship property, or alternately Mr Clayton’s powers were relationship property having a value equivalent to the assets of the trust. The relevant provisions of the Deed are contained in an appendix to the judgment of the Supreme Court of New Zealand. In brief, Mr Clayton was the settlor and trustee. The discretionary beneficiaries included Mr Clayton, his wife and their two daughters. The daughters were the final beneficiaries who took on the Vesting Day absent the exercise of discretion in favour of other beneficiaries. Mr Clayton was the ‘Principal Family Member’. He had a number of powers in that capacity, including to add or remove beneficiaries, to appoint and remove the trustee and to appoint a successor to exercise those powers. As trustee, Mr Clayton had unfettered discretions, including: to resettle the trusts; to distribute income and capital before or as at the Vesting Day to any beneficiary, including himself; he could exercise his powers despite any conflict of interest; and he was entitled to be indemnified against liabilities incurred by him as trustee save for those arising from his own dishonesty or a wilful and knowing breach of trust. Mr Clayton as trustee, with his consent as Principal Family Member, could vary or revoke any of the provisions of the trust deed so long as that did not infringe the rules against perpetuities. What the Courts decided The case was first heard by the Family Court and then successively appealed to the High Court, Court of Appeal and the Supreme Court of New Zealand.3 The parties reached a settlement before the Supreme Court handed down its decision, but the Court considered it appropriate to deliver its judgment ‘given the importance of the issues’. The findings of each court on the issues are set out below. Court  Sham?  Illusory?  Synonymous?  Relationship Property?  Supreme  NO  NOT DECIDED  NO  YES  Court of Appeal  NO  NO  YES  YES  High  NO  YES  NO  NOT NECESSARY TO DECIDE  Family  NO  YES  NO  NOT NECESSARY TO DECIDE  Court  Sham?  Illusory?  Synonymous?  Relationship Property?  Supreme  NO  NOT DECIDED  NO  YES  Court of Appeal  NO  NO  YES  YES  High  NO  YES  NO  NOT NECESSARY TO DECIDE  Family  NO  YES  NO  NOT NECESSARY TO DECIDE  Court  Sham?  Illusory?  Synonymous?  Relationship Property?  Supreme  NO  NOT DECIDED  NO  YES  Court of Appeal  NO  NO  YES  YES  High  NO  YES  NO  NOT NECESSARY TO DECIDE  Family  NO  YES  NO  NOT NECESSARY TO DECIDE  Court  Sham?  Illusory?  Synonymous?  Relationship Property?  Supreme  NO  NOT DECIDED  NO  YES  Court of Appeal  NO  NO  YES  YES  High  NO  YES  NO  NOT NECESSARY TO DECIDE  Family  NO  YES  NO  NOT NECESSARY TO DECIDE  This table is necessarily oversimplified and, to an extent, misleading. The Family Court and the High Court found (but for different reasons) that because the VRPT was illusory, the assets of the VRPT were assets held by Mr Clayton beneficially and those assets were relationship property. The Court of Appeal having found the VRPT was neither a sham nor illusory, then found that certain powers of Mr Clayton under the trust deed were relationship property having the effect of bringing the net value of the assets of the VRPT into the pool of relationship property. The Supreme Court reached the same conclusion that certain (but different) powers of Mr Clayton were relationship property which made it unnecessary to decide whether or not the VRPT was illusory. They said that was a question of some complexity on which the Court did not have a concluded unanimous view. The Courts below Although this article will largely confine itself to an analysis of the judgment of the Supreme Court, the judgments of the courts below reveal two approaches. In the Family Court, Munro J took what has been called the ‘irreducible core’ approach. She found that clause 11—the trustees had an unfettered discretion, there was no requirement for due consideration and the power could be exercised even though it might be contrary to the interests of present or future beneficiaries—coupled with clause 19.1(c)—permitting the trustees to deal with itself as trustee of another trust despite any conflict of duty negate the ability under this deed for the beneficiaries to call the trustee to account in the exercise of his discretion. The beneficiaries therefore have no rights under this deed against the trustee. She relied on the well-known passage in Armitage v Nurse4 … there is an irreducible core of obligations owed by the trustees to the beneficiaries and enforceable by them which is fundamental to the concept of a trust. If the beneficiaries have no rights enforceable against the trustees there are no trusts. In the High Court Rodney Hansen J disagreed. He considered that the provisions relied upon by Munro J did not erode the core obligations. The trustee was not excused from acting honestly and in good faith, he was merely relieved of the obligation to act impartially between beneficiaries. As has been said in other circumstances,5 in any event in a discretionary trust the duty of impartiality is meaningless, so relief from that duty does little more than restate the law. The test he relied upon was whether on a proper construction of the deed Mr Clayton retained such control that he did not intend to give or part from control over the property sufficient to constitute a trust. This can be called the ‘no sufficient disposition’ approach. The provisions he relied upon to find there was no sufficient disposition were: that Mr Clayton was a beneficiary and had power to appoint and remove trustees; the trustees had full discretionary power to pay income and capital to beneficiaries; the deed conferred on trustees the full powers of an owner, including unfettered discretions to exercise all powers and discretions and to deal with the trust property; and, critically, a trustee who was a beneficiary could exercise any power or discretion in his own favour. He concluded that Mr Clayton had effectively retained all powers of ownership, he was able to deal with trust property just as he would if the trust had never been created. The Court of Appeal found the VRPT was neither a sham nor illusory, as noted they considered those terms to be synonymous. It found that clause 7.1 created a general power of appointment and that power was relationship property. The Supreme Court The Supreme Court disagreed with the Court of Appeal as to the power in clause 7.1; they found it was neither property nor relationship property, but concluded Mr Clayton’s powers as a whole were relationship property. As I have noted the Supreme Court did not come to a concluded unanimous view as to whether the VRPT was an illusory trust. The relevant portion of their judgment is set out below. The extract is long, but the reasoning raises a number of issues for further consideration. [122] The Court of Appeal overturned the finding that the VRPT was an illusory trust. It saw that finding as inconsistent with the findings made by Rodney Hansen J that the VRPT was not a sham trust, that Mr Clayton had core obligations as Trustee to act honestly and in good faith, and that other beneficiaries could enforce those core obligations. It also saw the terms sham trust and illusory trust as synonymous and their legal definitions as overlapping. It saw both as hinging on the settlor’s intention to create a trust that was valid and enforceable. The Court said once the Court accepts a valid trust has been established (with no sham), it should not be able to be treated as non-existent because the Trustee has wide powers of control over the trust property. In short, “[t]here is either a valid trust or there is not”. [123] We will come back later to the distinction between a sham and an illusory trust. For the present we observe that a finding that a trust deed is not a sham does not seem to us to preclude a finding that the attempt to create a trust failed and that no valid trust has come into existence. That would lead to a finding that the trust is illusory, to use the terminology adopted in the Courts below. For our part we do not see any value in using the “illusory” label: if there is no valid trust, that is all that needs to be said. [124] Given the extent of the powers held by Mr Clayton under the VRPT deed, there are two alternative lines of analysis concerning the VRPT’s validity. First, it can be argued that the VRPT is not a valid trust because Mr Clayton, having reserved such broad powers to himself in the VRPT deed, cannot be said to have disposed of the property settled under the VRPT deed in favour of another.124 Equally, the breadth of those powers can be said to bring into question whether the irreducible core of Trustee obligations referred to in Armitage v Nurse apply to Mr Clayton.125 However, this does not deny the possibility that a valid trust may come into existence at some time in the future, for example, if Mr Clayton were to be replaced by a new Trustee who was not the Principal Family Member and/or a beneficiary. 124 Knight v Knight (1840) 3 Beav 148, 49 ER 58 (Ch) at 68 per Lord Langdale. 125 The argument that the VRPT is not a valid trust is supported by the observations of Associate Professor Palmer and Professor Peart in their paper “Double Trouble – the power to appoint and remove Trustees and the power to appoint and remove beneficiaries” (Paper presented to NZLS CLE Trusts Conference, June 2015) 33 at 50–51. See also Nicola Peart and Jessica Palmer “Clayton v Clayton: A step too far?” (2015) 8 NZFLJ 114 at 117. [125] Second, it can be argued that, even though the VRPT is effectively defeasible, in the sense that the VRPT powers in substance give Mr Clayton power to bring the VRPT to an end, there is no reason in principle why it should not be regarded as a trust and required to be administered in accordance with the VRPT deed until the exercise of the VRPT powers in that manner. In TMSF, the Privy Council found that the settlor’s powers to revoke the trust were such that the settlor could be regarded as having rights tantamount to ownership.126 It made no finding about the status of the trust in the period before the revocation powers were exercised, because it was not required to do so in order to resolve the issue before it. However, there was nothing in the judgment to indicate that the trust was invalid in the period before the power to revoke it was exercised. 126 Tasarruf Mevduati Sigorta Fonu v Merrill Lynch Bank & Trust Co (Cayman) Ltd [2011] UKPC 17, [2012] 1 WLR 1721 [TMSF] at [59]. [126] It should be acknowledged that the power of revocation was not a power held by the trustee in that case, so there was no question but that the trustee’s fiduciary obligations continued until the power of revocation was exercised. That can be contrasted with the present case, where the VRPT powers are, for the most part, powers held by Mr Clayton as Trustee. [127] Determining which of these two lines of analysis is correct is a matter of some complexity on which the Court does not have a concluded unanimous view. In light of that, we do not intend to determine the issue because the settlement of the proceedings makes it unnecessary to do so and, given the very unusual terms of the VRPT deed, the issue is unlikely to arise in future cases. Is there a distinction between a sham trust and an illusory trust? [128] The answer to this question is academic, given our earlier findings. As noted earlier, a sham is a pretence: the terms of the document do not represent what the party or parties really intended. A finding of sham in this case would involve the Court assessing the subjective intention of Mr Clayton and concluding that the VRPT deed did not conform with his real intention. [129] As we have already said, we do not find the term “illusory trust” helpful. What the Family Court and High Court meant by that term was that no trust was created. In such a case, the document as executed does represent the terms to which the party or parties intended to agree but, despite their subjective intention to create a trust, they failed in their attempt to do so. [130] In the present case, Mr Clayton intended to create a trust on the terms recorded in the VRPT deed. The issue would be whether the powers held by Mr Clayton are so broad that what he intended to be a trust was not, in fact, a trust. As already noted, we are not determining that issue. [Some footnotes omitted or edited to incorporate references to earlier footnotes] The result was the Court: found Mr Clayton’s powers, as enumerated, were relationship property having a value equal to the net assets of VRPT; VRPT was not a sham trust; and did not determine whether VRPT was an illusory trust. A number of observations may be made as to the Supreme Court judgment: They found there was a distinction between a sham trust and an illusory trust, although they found no value in the latter label, ‘if there is no valid trust, that is all there needs to be said.’ The ‘irreducible core’ and the ‘no sufficient disposition’ approaches are conflated; The possibility of an emerging trust is specifically acknowledged; A power of revocation held by a trustee would be a strong indicator of an illusory trust, if such a finding were to be made; A power of revocation may not invalidate a trust before it is exercised; The subjective intention to create a trust must yield to whether as a matter of construction of the deed, a trust was created. Perhaps the most salient point is that of the four courts in the hierarchy, only the Court of Appeal found that the VRPT was NOT illusory, and then on the basis (with respect correctly found to be erroneous by the Supreme Court) that the VRPT could not be illusory because it was not a sham trust. Each of the courts that were not prepared to find the VRPT was not illusory followed well established principles, it was not a new judicial adventure. It is instructive to note the emphasis placed by the Supreme Court in its consideration of whether or not the VRPT was an illusory trust. First, at [124], the court refers to both the ‘no sufficient disposition’ and ‘irreducible core’ approaches, but without analysing any specific provisions and then says the argument that the VRPT is not a valid trust is supported by observations in a paper by two academic writers. But the court immediately follows that by saying a valid trust may come into being in future, if, for example, Mr Clayton was replaced by a new trustee who was not the Principal Family Member and/or a beneficiary. The clear implication is that it was only the combination of powers held by Mr Clayton as trustee and as Principal Family Member, and that those powers could be exercised in his favour as a beneficiary, that may lead to invalidity. Then, at [125], in putting forward the opposing argument, the Court focusses on the ability of Mr Clayton to bring the trust to an end, presumably with the result that Mr Clayton would once again become the beneficial owner of the assets, but says there is no reason in principle why the VRPT should not be regarded as a valid trust until the powers are exercised. The judgment in Clayton raises the possibility that a valid trust may subsequently arise when different people occupy the relevant offices—an emerging trust. In so doing the Court has also left open the possibility that an initially valid trust may become invalid if the offices are initially occupied by different people but one person comes to occupy them all—emerging invalidity. Both of these ‘doctrines’ are discussed below. The focus of the Court on the retention or grant of extensive powers tends to suggest that the ‘no sufficient disposition’ approach was paramount in considering whether the VRPT was a valid trust. Despite the focus in Clayton on the no sufficient disposition approach, I submit that in an appropriate case a trust may be found to be illusory because the irreducible core of trustees’ duties are not present. While there is clear overlap between the two approaches, it does not follow that they are the same. They may have different consequences where the property is transferred to a third party to be held on the terms of the deed. In a ‘no sufficient disposition’ case the settlor retains beneficial ownership, and would do so despite the legal title passing to a person named as ‘trustee’. In an ‘irreducible minimum’ case it may be arguable that the person in whom legal title is vested does not have any equitable estate impressed on the legal title, so that person has full ownership free of any resulting trust to the transferor, because the transferor always intended legal title to pass without creating any equitable obligations. Illusory or Sham? In North America, it appears the terms are considered synonymous and the New Zealand Court of Appeal so found in Clayton,6 although that finding was overturned by the Supreme Court. At one level, what constitutes a sham trust and what an illusory trust appears to be the same because in each case what appears to be a valid trust is found not to be one because there is no intention of creating a trust. I submit that the correct position requires a more detailed consideration of the intention: A sham trust is one where as a matter of construction the terms of the document would establish a valid trust, but the intention of the relevant parties is that they will not be bound by those terms, but hold the property for or at the direction of the settlor. An illusory trust is one where the intention of the parties is that they will be bound by the terms of the document, but as a matter of construction those terms do not establish a valid trust. This position accords with the decision of the Supreme Court in Clayton, the extra judicial writings of Justice Pagone7 and a recent, and I suggest important, decision of the Family Division of the England and Wales High Court.8 The recent decision of Birss J in Mezhprom Bank v Pugachev9 contains an extended discussion of sham and illusory trusts, the decision in Clayton and numerous other cases, texts and articles. The judge found, in effect, that the trusts in question were illusory, although he found that word to be ‘unhelpful’ preferring to consider the true effect of the trusts, but if they were not then they were shams. I make one further comment. In sham trusts, what is important is the subjective intention of the parties not to be bound by the terms of the document; that subjective intention must be established by cogent evidence to override the intention expressed in the document. In an illusory trust, the parties may have had a subjective intention to establish a trust, but it is their objective intention as established by construction of the document in light of any admissible evidence that is determinative. Having said that, it must be admitted that the presumption that a revocable debtor’s mandate does not give rise to a trust in favour of the creditors appears to give weight to the subjective intention of the debtor despite that presumption being expressed as a matter of construction. To avoid getting bogged down on issues concerning sham trusts, or the more contentious issue of emerging sham,10 I will confine this article to illusory trusts as defined above with some reference to the possibility of a doctrine of an emerging trust (the Odette to the Odile of emerging sham?). Is there a doctrine of emerging trust or emerging invalidity? The Supreme Court noted it could be argued that the VRPT was not a valid trust because of the powers reserved by Mr Clayton to himself. That resulted from the combination of powers held by him as trustee and as Principal Family Member and his status as a beneficiary. The Court then did not deny the possibility of a valid trust subsequently coming into existence if a new trustee was appointed who was not the Principal Family Member and/or a beneficiary. I must confess I have grave difficulty with this concept, unless it be taken that Mr Clayton, by removing himself as trustee, then, but only then, divested himself of beneficial ownership, despite the same terms of the trust deed being as binding on him as his successor. My difficulty increases if Mr Clayton ceased to be a trustee by involuntary act, including death. The difficulty can be expressed in a different way: if Mr Clayton was not the initial trustee or Principal Family Member, but subsequently was appointed to those offices; could it then be said that the trust, although initially valid, became illusory and invalid because of the combination of powers then held by him? And what if he, and his predecessor, had been exercising their powers in accordance with the deed for the benefit of the other named beneficiaries? What lessons does Clayton have for practitioners and drafters of trust deeds? The Supreme Court considered that ‘given the very unusual terms of the VRPT deed, the issue [whether a trust is illusory] is unlikely to arise in future cases.’ In my experience, it is not at all unusual for Australian discretionary trust deeds to provide: The same persons are the trustees or control a corporate trustee and are also named as holding an office variously called the Appointor, Guardian, Protector or Principal (for convenience hereafter ‘the Principal’); The trustees, and the Principal if different, are beneficiaries; There is an extremely widely defined class of discretionary beneficiaries; The Principal can remove and appoint the trustees; The trustees, sometimes only with the consent of the Principal, can: Appoint and remove beneficiaries; Amend all or any of the trusts terms and conditions of the trust deed, I note many powers of amendment are expressed in terms permitting a trustee to revoke add to amend or vary the trusts terms and conditions; Appoint capital and income to any beneficiary, by definition including themselves, both before and as at the vesting date; Exercise an unfettered discretion in respect of management or dispositions; Resettle the trust fund or transfer the trust fund to another trust fund if similar or if any of the beneficiaries have an interest in it; Enter into self-dealing transactions and retain benefits such as director’s fees where they are appointed because of interests held as trustee; Be indemnified against any liability save that arising from dishonesty or wilful commission of a breach of trust. Together these provisions mirror those that were contained in the VRPT trust deed. The provisions in the VRPT trust deed which are not usual in Australian deeds in my experience are those identified by Munro J in the Family Court, namely clause 11, in particular paragraphs (a) and (b) entitling the trustee to exercise discretions even though: (a) the interests of all Beneficiaries are not considered by the Trustees; (b) the exercise would or might be contrary to the interests of any present or future Beneficiary; and paragraph (c) of clause 19.1 permitting a conflict of interest and duty when acting as trustee of another trust. It may be that it was these clauses that the Supreme Court found very unusual. Possible applications In Australia, as in New Zealand, there is no need to resort to the concept of illusory trust in matrimonial property proceedings, because in similar circumstances a court can find that the powers held by a spouse are matrimonial or de facto property and thus brought within the pool of assets.11 Alternatively, the alter ego principle can be applied to find that the trust assets are within the pool or are a financial resource. There are two obvious areas where the concept may be relied upon. First, the invalidation of a trust as illusory could be used in insolvency proceedings where the result will be that the assets are the property of the debtor divisible between their creditors. The exposition and doctrinal basis of illusory trusts is not confined to matrimonial property. Although, so far as I am aware, that argument has not been successful to date, there is the decision of French J, as he then was, in In the Matter of Richstar Enterprises Pty Ltd (ACN 099 071 968) Australian Securities and Investments Commission v Carey (No. 6) [2006] FCA 814 where he held, in interlocutory proceedings, that he would appoint receivers of property held by trustees of trusts because the trustee is effectively the alter ego of the relevant beneficiary or otherwise subject to his or its effective control, the beneficiary has at least a contingent interest within the meaning of that term as used in the definition of ‘property’ in s 9 of the [Corporations Act 2001]. In my opinion, Richstar should be seen as dependent on something approaching a sham, in that it appeared that there was an understanding between the trustee and the beneficiary that the trust would be administered for the benefit of that beneficiary or as he directed. Of course, it is also highly dependent on the extended definition of ‘property’ in the Corporations Act. The second area of application arises on transition to the next generation. Where family assets are held in a family trust and not directly by the parents, then they are beyond the reach of applications under the Family Provision Acts, with the exception of New South Wales where they may be caught as notional property. If a child or other dependant is locked out of benefit from a family trust by formal exclusion or a pattern of distributions to others, then it will be in their interest to have the trust declared illusory and the trust assets held on a resulting trust for the parents who donated them or funded their acquisition. The assets may then fall into residue in which the child participates or be available to satisfy a successful family provision application. One issue that will cause evidentiary problems in the Australian context arises from taxation considerations and the decision in Truesdale v Federal Commissioner of Taxation [1970] HCA 27; (1970) 120 CLR 353. That decision led to family discretionary trusts being established by a settlor who settles a nominal sum to establish the trust which is then ‘fed’ by the parents or other true controlling minds. It will not always be easy to determine what funds or assets are the subject of any resulting trust because the true funder may not appear on the face of the trust deed. I question whether a distinction should exist between a person who settles assets and another person who does not, where both have power to bring the trust to an end for their own benefit. If a trust may be invalid because it may be brought to an end by a person for their own benefit, does it matter whether or not that person has contributed any or all of the assets of the trust? What should be done? I have noted above some situations when a decision may be made to attack the validity of a trust. In a sense, it does not matter for the present whether or not a trust in Australia can be found to be invalid because of the powers held by one person similar to those considered in Clayton; the possibility of proceedings, even if eventually unsuccessful, should be sufficient to reconsider the drafting of trust deeds. I have taken it that the founders of a typical family discretionary trust will wish to retain the possibility that they can benefit from the trust if circumstances make that desirable. That immediately raises the possibility of an attack on the basis the trust is illusory. What then can be done to protect the trust from attack? I have noted that the Supreme Court in setting out the opposing analyses as to whether or not the VRPT was illusory, conflated the ‘no sufficient disposition’ and the ‘irreducible core’ approaches while placing greater emphasis on the former. The finding that a trust is illusory depends upon a finding that the reservation, or grant, of powers are such to preclude a trust coming into effect, because as a matter of construction the beneficial interest in the assets is retained by the true settlor. That construction could not stand if it is made clear that beneficiaries have enforceable interests in respect of the trust property. Few trust deeds make explicit whether powers of persons other than the trustee are fiduciary or personal. Indeed, there is a tendency to include specific provisions negating some fiduciary duties. That of course will not matter is the irreducible core of duties continue to exist. It must be remembered that the fons et origo of a discretionary trust is that the trustee may exercise a discretion to favour one beneficiary or one class of beneficiaries over any others. It cannot negate the intention to establish a trust that the trustee has such a discretion. I suggest that instead of negating or confining trustee’s duties, it should be made explicit that the trustee must act honestly and in good faith and is bound to give due consideration to the interests of beneficiaries before exercising a discretion, but may, if a beneficiary, also consider the trustee’s own interests. I submit it would then be clear that person named as the trustee exercises the powers as a fiduciary and is a true trustee. Further, the powers exercisable by a Principal should be categorized as those that are fiduciary, such as appointing or removing a trustee, and those that are personal, such as withholding consent to discretionary distributions making clear in each case the extent of the constraints on the exercise of the power. In my submission, if that is done then there is no room for a conclusion that enforceable interests have not been created in favour of all beneficiaries. If that is so, then there has been a sufficient disposition and the irreducible core of trustee obligations will be present. Some other considerations It has been suggested that there are some ‘trusts’ that do not take effect immediately, but only on death of the settlor and consequently take effect as Wills and must be executed with the same formalities as a Will. There may also be taxation consequences because the property would form part of the estate at death. Such trusts may arise where the settlor retains the right to income and enjoyment during their lifetime and the rights of other beneficiaries are postponed until the settlor’s death. In Australia, such trusts would have adverse taxation consequences. Of course, if there is such a thing as an emerging trust, then on death of a putative trustee who had reserved such powers so that there was no sufficient disposition during his lifetime, then it is conceivable a valid trust would emerge on his death, particularly if combined with cessation of the powers held by him as Principal. Would it then be arguable that the trust did not take effect as a Will, but ‘emerged’ on his death? My final comment concerns so-called ‘capricious trusts’. I am indebted to an essay by Professor John H. Langbein entitled ‘Burn the Rembrandt?’12 Professor Langbein cites a number of cases where testators have given eccentric directions to destroy money, brick up a house or erect statues of the testator or his family. In these cases, the courts have labelled the trusts as capricious and invalidated them as not being in the interests of the beneficiaries. This, he considers, adds a further core element that a trust must benefit the beneficiaries. The thesis of his essay is that principle applies to investment directions such as retaining an interest in a business or company. I do not propose to enter into that debate, but merely to raise the prospect that an attack on a trust might be mounted on the basis it was capricious, rather than it was a sham or illusory, because it was not to benefit the beneficiaries—other of course than the beneficiary holding the powers to bring the trust to an end for their own benefit. If that were successful, then the result might be to strike down the capricious elements leaving the balance of the terms and the trust in place. Grahame Young is a barrister practising in Perth, Western Australia. The major focus of his work is in the structuring and restructuring of corporate and family groups, taking into account taxation, equity, trusts and succession, corporate and property law. He is the author of ‘Duties Legislation Western Australia’. Footnotes 1. For example, JD Heydon & MJ Leeming, Jacobs’ Law of Trusts in Australia (8th ed, LexisNexis Butterworths 2016) (Jacobs) and D Hayton, Underhill and Hayton Law of Trusts and Trustees (19th ed, LexisNexis 2014). In WA Lee et al, The Law of Trusts, Thomson Reuters looseleaf, there is no entry in the index but there is a discussion of some classes of illusory trusts at [5.930] ff. Similarly, in GW Thomas, Thomas on Powers (2nd ed, OUP 2012) (Thomas) there is no index entry, but a valuable discussion at 15.35–15.41 and 16.54–16.56. 2. For example, J Mowbray et al, Lewin on Trusts (18th ed, Thomson Reuters and supp 2012); GE Dal Pont, Equity and Trusts in Australia (6th ed, Thomson Reuters 2015). I understand, but have not been able to verify myself, that there is no entry for ‘Illusory trusts’ in the index of the third edition of Waters’ Law of Trusts in Canada but it appears in the fourth edition. 3. I understand the Family Court decision is MAC v MAC (NZFC, 2 December 2011) but I have been unable to find the decision online. Fortunately, the High Court decision [2013] NZHC 309 has comprehensive extracts. The Court of Appeal decision is [2015] NZCA 30. In addition to the decision on the VRPT, the Supreme Court also handed down another decision between the same parties on the same day concerning the Claymark Trust, [2016] NZSC 30, but it not relevant to this article. 4. [1998] Ch 241per Millett LJ at 253–254. 5. Edge v Pensions Ombudsman, cited in Thomas at 10.154. 6. The Court of Appeal noted that in the United States the term ‘illusory trust’ is used instead of ‘sham’ relying on Scott and Ascher on Trusts and that Waters’ Law of Trusts in Canada explains ‘illusory trusts’ under the heading of ‘sham trust’. Professor Donovan Waters, in a comment on a blog written by Anthony Grant, a New Zealand barrister, and quoted in his subsequent blog, suggests a trust will be described as ‘illusory’ in circumstances that clearly amount to a sham. 7. Sham Trusts Revisited a paper presented at the STEP Asia Conference in Hong Kong in October 2014 and re-presented at the South Australia STEP Trusts Symposium in March 2015. 8. ND v SD [2017] EWHC (Fam) 1507 (21 June 2017) at 176ff. 9. [2017] EWHC 2426 (Ch). 10. In ND v SD supra, Roberts J had no doubt. She said at [244] ‘a trust which is not initially a sham cannot subsequently become a sham.’ On the other hand, Kirby J in Raftland Pty Ltd v Federal Commissioner of Taxation [2008] HCA 21; 243 CLR 516 at [149] stated that a sham could develop over time citing Marac Finance Ltd v Virtue [1981] 1 NZLR 586 at 588. 11. Kennon v Spry [2008] HCA 56; 238 CLR 366. 12. Boston University Law Review, Volume 90 (2010) 375 © The Author(s) (2017). Published by Oxford University Press. All rights reserved.

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Trusts & TrusteesOxford University Press

Published: Mar 1, 2018

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