Confident or cautious: A review of the trustee’s obligation to consider all potential beneficiaries

As part of a discretionary trust structure, the trustee has significant powers in respect of the administration of the trust. Generally, the trustee has discretion to decide which beneficiary will receive distributions of the income and capital of the trust.

While it is generally accepted that trustees have absolute discretion in the case of discretionary trusts, recent case law suggests that trustees cannot abuse this power and use it to deliberately exclude particular beneficiaries (including certain family members that they may wish to exclude as part of estate planning exercises).

The cases of Re Owies¹ and Re Marsella² comment on the scope of a trustee’s obligations in such situations and remind us of the importance of exercising discretion in good faith, with genuine consideration of all potential beneficiaries, and in accordance with the purpose for which the power was granted under the terms of trust.

If not properly undertaken, the consequences of a failure to meet these thresholds not only spells breach of duty on behalf of the trustee but also has the potential to jeopardise the validity of decisions which can result in them being set aside, and the trustee being removed from their role.

Both Re Owies³ and Re Marsella⁴ had corresponding family provision applications on foot.⁵  While assets held in trusts do not strictly form part of a deceased person’s estate, these cases highlight a likely trend that this type of attack against a trustee and on a trust may become more common by family provision applicants.  

Re Owies Family Trust [2020] VSC 716

Re Owies Family Trust [2020] involved a dispute between three adult siblings over the operation of a discretionary trust established by their parents in 1970. This trust was controlled by a corporate trustee, JJE Nominees Pty Ltd, of which the parents were named Directors. The assets held under the trust had an estimated value of $23 million, inclusive of an apartment in Melbourne where one of the siblings lived. Three deeds of variation had been executed between 2002 and 2017, all of which sought to change the Guardian and Appointer roles previously held by the father and mother. Two siblings brought an action against JJE Nominees Pty Ltd and the eldest sibling, Michael. Amongst other matters, these claims: 

 

a)   challenged the distribution of income between 2010 and 2019, a timeframe which generally saw consistent distributions in favour of the mother, the father and Michael in a 20:40:40 split; and

b)   sought to remove Michael and the trustee on the basis that they were not fit to undertake their duties in these roles.

With respect to income distributions, the Court initially found that trust income was validly distributed as the trustee had given adequate consideration to the other two siblings on all occasions except 2015 and 2016, and towards one of the siblings in 2018. On these occasions, the trustee failed to make sufficient enquiries regarding the financial circumstances of the parties prior to distribution meaning the application of the standard distribution pattern of 20:40:40 was not only improper but evidenced a lack of genuine consideration on the part of the trustee. Nevertheless, the trustee was not removed as the court concluded that these incidents were insufficient to strip confidence in the trustee’s administrative capabilities.

Appeal

On appeal, however, the court upheld submissions to remove the trustee based on failures to act impartially and to give genuine consideration to all potential beneficiaries. These failures, paired with the damaged relationships between the beneficiaries and those responsible for the trust’s administration, were persuasive in concluding that it was not in the best interests of the beneficiaries for the trustee to continue in this role.

With respect to income distributions, the court found that the trustee had failed to genuinely consider the financial needs of the beneficiaries in its 2017 and 2019 distributions. The trustee’s distribution of the entirety of the income in 2019 to the elderly father living in residential care paired with a general failure to enquire about the financial positions of the other beneficiaries was a decisive factor in finding this conclusion.

Although these distributions were held to be voidable, the decisions could not be set aside because the legal representatives did not seek a particular order to do so. If this order had been sought initially, it is likely that the trustee’s decisions could have been reversed.

Marsella v Wareham (No 2) [2019] VSC 65

In 2003, Helen Marsella (‘Marsella’) established a self-managed superannuation fund (‘SMSF’). She was married and had two children from her previous marriage, one of which was a co-trustee of the SMSF. Marsella died in 2016, upon which her daughter (‘Wareham’) became the sole trustee of the fund, and Marsella’s husband became the sole executor of her estate despite not being a co-trustee of the fund. At the time of death, Marsella did not have a valid, binding death benefit nomination. In 2017, Wareham appointed her husband as co-trustee and used her discretion to pay the death benefit directly to herself, thereby excluding her brother and stepfather. Marsella’s husband challenged the distribution on the basis of bad faith, asserting that there was a clear failure to genuinely consider the circumstances of eligible beneficiaries. He also submitted that there was a conflict of interest flowing from the fact that the trustee has a general power of appointment.

The court found that the trustees had not acted in good faith. The stepfather’s financial circumstances and longstanding relationship with Marsella outweighed the presumption that Marsella did not intend for him to benefit from the fund. Wareham’s declaration that the potential interests of all potential dependents were adequately considered was insufficient to demonstrate the trustee had not acted arbitrarily. In this case, arbitrary decision-making was equated to an exercise of discretion in bad faith and a lack of genuine consideration was found in light of the following circumstances:

 

a)   the husband’s longstanding personal relationship with Marsella;

b)   litigation between the husband and Wareham including a physical dispute;

c)   incorrect legal statements provided by Wareham upon requests for explanation by husband;

d)   absence of any enquiries made by Wareham as to potential beneficiaries; and

e)   absence of dialogue between trustees as to distribution and lack of evidence surrounding how they reached the decision.

The court further confirmed the existence of a conflict of interest, to which it said that Wareham’s denial of such conflict was not only ignorant but amounted to a mischaracterisation of the circumstances. This fact, paired with Wareham’s arbitrary dealings with the fund property and personal conflicts with her stepfather, necessitated her removal as trustee.

Appeal

On appeal, the court upheld the original decision and confirmed that powers must be exercised in good faith, for the proper purpose and with genuine consideration of the best interests of beneficiaries. The trustee’s failure to seek accurate legal advice from a superannuation specialist when making these distributions was regarded by the court as evidencing a high level of carelessness. The court also confirmed the existence of a conflict of interest and its impact on the impartiality required of the trustee when performing her duties.

The court further found that, given the opportunity to re-formulate a decision with proper legal advice, there was no guarantee that the trustee would have exercised discretion and reached a different outcome. It was the lack of impartiality paired with this overarching risk that informed the court’s decision to remove Wareham as trustee. In view of this decision, it appears that the best practice for the trustee is to invite all potential beneficiaries to provide information as to their circumstances before exercising discretion.

A changing landscape: a guide to exercising discretionary powers

These cases serve to remind trustees of the nature and scope of their obligations when exercising discretionary powers. A trustee’s duty to act in the best interests of the beneficiaries cannot be taken lightly and trustees must continue to err on the side of caution and consult the trust deed to ensure powers are exercised validly.

Specifically, these cases present a list of practical considerations for a trustee when exercising their discretion in relation to annual income distributions:

1. it may not be appropriate to adopt a standard pattern of income distributions each year;
2. the trustee may need to demonstrate that they have genuinely considered all relevant beneficiaries – the extent of beneficiaries would surely include the primary beneficiaries, but we do not know if it would extend further than that (i.e. to secondary or tertiary beneficiaries);
3. in circumstances where the trustee is not in direct or indirect contact with a potential beneficiary or persons proximate to the beneficiary so far as to mean that the trustee would not be deemed to have imputed knowledge of the beneficiary’s circumstances, the trustee may need to write to the relevant beneficiary seeking financial disclosure to ensure they are genuinely considering their circumstances before making a discretionary distribution;
4. at the trust establishment phase, careful consideration must be given to the beneficiaries that are included; and
5. if the trust is already established, a trustee could consider excluding certain classes of beneficiaries. Careful consideration would need to be given to the potential to resettle a trust, however, this may be preferable to giving consideration to a very wide range of beneficiaries every year.

If you have any concerns about safeguarding a trustee’s decision making, please do not hesitate to contact Hamilton Locke.

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¹ Re Owies Family Trust [2020] VSC 716.

² Marsella v Wareham (No 2) [2019] VSC 65.

³ Re Owies Family Trust [2020] VSC 716.

⁴ Marsella v Wareham (No 2) [2019] VSC 65.

⁵ A family provision application is a claim for further provision from a deceased person’s estate.