In earlier articles I briefly analysed and discussed some of the benefits that family trusts and testamentary trusts can play in a well-thought-out estate plan.
This article considers the current treatment of family trusts[1] and discretionary testamentary trusts (referred to in this article collectively as 'trusts') in connection with property disputes arising from relationship breakdown, and illustrates that the commercial asset protection benefits that trusts offer in other settings are more limited when considering investigation that accompanies such disputes.
Because this subject matter is so broad, I have made this article a ‘grab bag’ of things that readers might think about when assessing the likely impact on trust administration of relationship breakdown.
Any decision involving trusts – either at the planning stage or post separation – should be accompanied with bespoke legal, accounting and financial advice.
Why understanding trusts is so important … right now
The number of trusts in Australia has been increasing steadily since the 1970s, and in particular since the 1990s. Furthermore, about 80% of trusts in Australia are discretionary. There is accordingly a reasonable prospect that a future relationship breakdown may involve a consideration of the division of trust assets.
Why trusts are so popular
There are many reasons why trusts are so often used in a financial structure:
- The flexibility of trusts may allow a trustee to allocate future income between a class of beneficiaries in a flexible and tax-effective manner.
- trusts can offer asset protection:
- against the insolvency of a trustee, a beneficiary or an appointor; and
- against beneficiary vulnerability; and
It is also often generally assumed that trusts can offer asset protection against the financial consequences of relationship breakdown, and that assets within a trust structure, possibly owned by one party to a relationship prior to the commencement of the relationship, will be preserved for that party subsequent to the termination of the relationship.
That assumption is not always correct. It is generally more difficult to protect assets from the risk of future relationship breakdown using trusts than it is to protect assets from the risk of future beneficiary insolvency.
However, there remains merit in considering the extent of the protection that can be achieved on a case-by-case basis, and forward planning accordingly.
Trusts and relationship breakdown – the court’s power
The relationship between property claims arising from relationship separation and the status of trust assets is a complex area of the law. By way of a very brief summary:
- The court has the power, when considering property claims under the Family Law Act 1975 (Cth) (FLA), to make such order as it considers appropriate to alter property interests with respect to the property of the parties to a marriage or de facto relationship.
- Assets that are held within a trust structure may, depending on the circumstances, be determined by the court to be:
- property of the parties – and therefore capable of adjustment between the parties
- financial resources of one of the parties, and therefore not capable of direct adjustment between the parties but a capable of having an impact on the adjustment of other assets deemed to be property of the parties; or
- neither property nor financial resources.
The critical assessment therefore is whether the assets owned by a trust will be regarded by the court as property of the parties or not.
If the court regards trust assets as property of the parties it will effectively “look through” the trust structure on a case by case, and will then have power to make orders dividing those assets between the parties.
The Court’s power under the FLA is not unfettered, and its determination will be formulated on a case-by-case basis.
Trusts and relationship breakdown – the court’s approach
Recent Family Law decisions dealing with the treatment of trust assets confirm the broad powers that the court has to:
- investigate the status of trust property; and
- to make orders in respect of the trust assets in appropriate factual circumstances.
Some of the themes that emerge from the case law follow:
Trust control
The manner in which a trust is controlled is critical to the court’s characterisation of trust assets. For example:
- Where a wife had voluntarily relinquished control of the trust, but retained a degree of control of the trust, the court concluded that the trust assets should be treated as property of the marriage;[2] but
- Working in businesses controlled through trusts without control, but with promises of future benefits, was insufficient for a finding to be made that trust assets were property[3]
The purpose of a trust
The identifiable purpose of a trust (which trustee discretion must be aligned with) is also critical to the court’s characterisation of trust assets. For example:
- The will of a wife’s deceased father contained a wish that she be provided with an income of $150,000 per annum. The wish was not legally enforceable, but the court accepted that there was a reasonable likelihood that the wife would receive the funds if she requested them because of her close relationship with the estate executors. The trust assets were determined to be financial resources to that extent.[4]
The source of trust assets
The court will also look at the source of trust assets when determining the characterisation of those asset. The greater the proximity between the parties’ mutual endeavours and the trust assets, the more likely the assets will be regarded as property of the parties.
Summary
Whilst the court proceeds on a case-by-case basis in assessing the status of trust assets:
- control over trust assets exerted by a party to the relationship; and
- a trust purpose aligned with the benefit of the relationship; and
- Trust assets sourced from the endeavours of the parties to the relationship
are more likely to result in the court determining that trust assets are available for distribution between the parties.
Conversely:
- lack of control over trust assets by the parties
- a trust purpose aligned with a benefit independent of the parties; and
- Trust assets sourced independently from the parties
are more likely to result in the court determining that trust assets are not available distribution between the parties.
Case study
The following case study[5] demonstrates some of the above considerations.
The husband and a sister were equal shareholders of the trustee of a testamentary trust (Trust) established under the Will of the husband’s father. There were three directors of the corporate trustee at arm’s length to the husband.
The husband and his three siblings received income from the trust. There was no history of distributions of trust capital.
It was accepted that the purpose of the Trust was to pass the capital to the testator’s six grandchildren upon each of them attaining the age of 25 years.
The wife sought to have the trust assets treated as the husband's assets, on the basis that if he could convince his sister to appoint him as director of the corporate trustee, he would have control of the trust.
The court rejected the wife’s arguments because:
- The husband did not control the trust; and
- the trust assets were not, and would not become the husband’s - but were genuinely held for the benefit of the deceased’s grandchildren.
Conclusion
It can appear that the court often ignores trust structures when determining property disputes arising from relationship breakdown.
Whilst that is not the case, case law demonstrates the breadth of the powers that the court wields in investigating trusts in the context of such claims, and whilst those powers are not exercised without reason, their use continues to evolve, and the outcome of a particular matter can be difficult to predict.
Investors utilising trusts will benefit from ensuring that their advisors:
- have a thorough understanding of trust law; and
- have given consideration to trust control, beneficiary rights, and trust purpose in each case.
As with other aspects of commercial life, specific and expert legal, accounting, and financial advice is recommended when considering using trusts within a financial structure, so that benefits can be maximised and pitfalls avoided.
Greg Russo is a succession law specialist and principal of Greg Russo Law.
Disclaimer
The information given by Greg Russo and Greg Russo Law in this article is given in good faith but is of a general nature only and it is not intended that this article will be acted or relied upon in the absence of individual legal, advice. Each person's requirements and circumstances will be different and accordingly, each person should engage professional assistance according to their own particular needs. Copyright in this document is owned by Greg Russo Law.
[1]‘Family Trusts’ are a subset of the wider class of ‘Discretionary Trusts’ being Trusts in which the Trust administrator, the Trustee, generally has a wide discretion to distribute Trust income and capital amongst a wide class of beneficiaries And by extension discretionary Testamentary Trusts
[2] Beeson & Spence [2007] FamCA 200
[3] B Pty Ltd v K (2008) FLC 90-380
[4] Hall V Hall [2016] HCA 23
[5] Peat & Northup [2020] FamCA 1123