There are many common misconceptions about trusts, how they operate and what rights and entitlements the potential beneficiaries have. A recent decision of the New South Wales Court of Appeal, Lewis v Condon  NSWCA 204 (4 July 2013), provides a salient reminder of some basic principles and the great strength of trusts for asset protection purposes. Kenthurst Investments Trust In 2001, the Kenthurst Investments Trust (Trust) was created. Colleen, her daughters Louise and Melissa, and her grandchildren were beneficiaries. Colleen was the appointor, with the power to remove existing trustees and appoint new trustees. Appinville Pty Limited (Appinville), a company controlled by Colleen’s accountant Mr Fraser as sole director and shareholder, was the trustee. The Trust was a discretionary trust. Its terms included that:
- trust assets were held for such of the beneficiaries at the distribution date as the trustee should determine in its absolute discretion; and
- the distribution date was 1 January 2040 or such earlier date as the trustee might in its absolute discretion determine
Trust acquires the Property On the same day the Trust was created, Appinville entered into a contract to purchase land at Kenthurst (Property) as trustee of the Trust. Challenger Mortgaged Investments loaned the majority of the purchase price to Appinville. The loan was secured by a registered mortgage over the Property, guaranteed by Colleen. The balance of the purchase price came from Paris King Investments Pty Ltd, a company controlled by Colleen. Mr Fraser gave evidence that he met Colleen in 2001 through a mutual contact and she said to him:
"I’m in a complicated Court case. I’ve found a property which I want to buy, but I want to keep it away from my own name in the short term because of the Court case. I want to put it in a trust. I will be a beneficiary. The case might be over by Christmas, so it will be a short term thing, and then the property will be transferred back into my name.”
The Court case in question was long-running proceedings in the Family Court between Colleen and her former husband, Michael.
Subsequent events, including Colleen’s bankruptcy After Appinville acquired the Property, Mr Fraser forwarded to Colleen correspondence related to the loan from Challenger and assumed that she made payments. He did not prepare any financial statements or tax returns for the Trust, nor was he aware of any such documents being in existence. The proceedings between Colleen and her former husband were settled in 2006 and the Court made orders by consent. They included an order that the parties do all things necessary to transfer the Property from Appinville to Colleen, as well as an acknowledgment that Colleen would hold the Property as trustee of a family discretionary trust. Colleen did not become the registered owner of the Property until 2009 when it was transferred to her for $1.00. In 2010, ANZ loaned over $700,000 to Colleen, secured by a registered mortgage over the Property. She used the funds in part to pay personal expenses. Colleen defaulted on the ANZ loan and was made bankrupt in 2012. Her trustee in bankruptcy, Mr Condon, lodged a caveat and applied to have the Property transferred to him. He said that the Trust was a sham and that Colleen was the sole beneficial owner of the Property. Colleen’s daughter, Louise, commenced court proceedings to challenge this position taken by the bankruptcy trustee. Beneficial ownership arises where property rights belong to a person even though legal title of the property belongs to another person.
Was the Trust a sham? A sham has been judicially defined as “steps which take the form of a legally effective transaction but which the parties intend should not have apparent, or any, legal consequences.” That is, while professing to be one thing the parties in fact intended it to be something different. Because it requires a finding of intent to deceive, strong evidence is required to establish a sham.
Colleen’s trustee in bankruptcy, Mr Condon, argued that although the terms of the 2001 deed which established the Trust indicated that Appinville held the Property beneficially for various potential beneficiaries which included Colleen, in actual fact it held the Property on a bare/resulting trust for Colleen alone. In other words, the argument was that the terms of the Trust were a sham. With a bare trust, the trustee has no active duty beyond conveying the property to the beneficiary at some future time determined by the trust. A resulting trust arises where a voluntary payment is made by A to B in circumstances which do not suggest that a gift was intended. B is deemed to hold the payment on resulting trust for A.
The Court noted that shams are to be distinguished from transactions entered into for an improper purpose:
There is a clear distinction between a settlement of a property in favour of (say) a spouse intended to operate in its terms, but made with the intent of defrauding creditors, and a sham declaration of trust in favour of a spouse never intended to give rise to the ordinary incidents of a trust. Both are entered into for an improper purpose, but the legal meaning of the former accords with the language of the declaration (although it is liable to be set aside pursuant to statute), while the legal meaning of the latter is that there is no trust at all. The limited notion of what constitutes a sham does not swallow up the large class of other transactions entered into for a purpose regarded as improper by the law. In short, every case of shamming involves a finding of intentional deception as to the effect of a document, but not every case of improper purpose is a sham.”
The Court found that there was insufficient evidence to establish a sham in 2001 when the Trust was created and the Property acquired by Appinville as trustee. The most important evidence was that given by the accountant, Mr Fraser, as to his conversation with Colleen mentioned above. That conversation showed that Colleen wished to establish a trust so that it would appear, for the purposes of the Family Court proceedings with her former husband, that she did not have legal title to the Property; and that she wished to take ownership of the Property after the proceedings had concluded. The Court noted that the Trust terms, including that Colleen was the appointor and could therefore bring the Trust to an end and gain title to the Property whenever she chose, were entirely consistent with these objectives. Although Colleen’s motives in creating the Trust and purchasing the Property through that vehicle may have been improper, that did not mean the Trust was a sham. Mr Condon pointed to, amongst other matters, the fact that Colleen raised funds against the security of the Property for personal purposes in 2010. However, the Court did not consider it safe to rely upon what occurred many years later to make a finding as to the subjective intention at the relevant time, back in 2001. Was there an “emerging sham”? In the alternative, Colleen’s trustee in bankruptcy argued that although the Trust may have been validly created in 2001 it had subsequently become a sham by the time of Colleen’s bankruptcy (an “emerging sham”). The Court also rejected this argument:
''A trust once validly constituted does not change in nature because the trustee and some of the beneficiaries subsequently choose no longer to abide by the obligations of the trust relationship. Such conduct may amount to a breach of trust, and may lead to the removal of the trustee, but does not destroy the proprietary and personal rights and obligations which came into existence when the trust was created.”
In other words, an effective transaction may subsequently change in nature by agreement of all the parties. However, the class of potential beneficiaries of the family discretionary trust in this case was not closed. It included all children and grandchildren of Colleen. All the potential beneficiaries had a right to due administration of the Trust. It was not possible for one of them, Colleen, to unilaterally change the nature of the Trust from being in favour of all potential beneficiaries to her alone. The bankruptcy trustee’s appeal was dismissed and he was ordered to pay Louise’s costs.
- The trustee of a discretionary trust holds the trust assets for all the potential beneficiaries jointly; no one potential beneficiary can claim to have a right of entitlement to the Trust assets. This was the main reason why Colleen’s trustee in bankruptcy failed to claim the Property for her creditors. The fact that Colleen was appointor and, subsequently, also trustee as well as a potential beneficiary of the Trust did not give her, individually, any right or entitlement to the Property which was held by the Trust.
- The purpose for which a Trust was created will generally not affect its legal effectiveness. Colleen did not wish to purchase the Property in her own name as this would have been against her interests in the Family Court proceedings with her former husband. She also wished to avoid land tax. But this did not affect the Trust’s validity.
- To establish that a document or transaction is a sham, and not what it purports to be, requires very strong and cogent evidence. Evidence of the subjective intention of the parties at the time the transaction was entered into is paramount. Evidence of subsequent conduct will be of much less weight.
- The fact that a trustee fails to comply with their duties and treats trust assets as their own shall not be sufficient to alter the trust or bring it to an end. Rather, such conduct may give the potential beneficiaries grounds for recourse against the trustee for breach of duty.
All the above points reinforce just how strong the trust is as a vehicle, particularly from an asset protection perspective!