When a marriage or relationship breaks down and there are significant assets in trust structures, bitter disputes and attempts to access those trusts can result. The issues often focus on whether the trust was established as a sham or for some other improper purpose. However, a recent Court of Appeal case has created some media and professional consternation with its finding that assets placed in trusts might be scrutinised and unravelled in different ways as well.

The relationship property case of the Clayton family has led the Court of Appeal to hold that the power to appoint and remove trustees and beneficiaries of a trust can be considered ‘property’.(1)  The court considered that the person holding the power could be considered the effective owner of the trust property under two conditions:

  • if the power practically means that the person holding the power could make himself or herself the sole trustee and beneficiary of the trust; and
  • if the power is not constrained by any obligation to consider the interests of others.

For assessing financial impact, the value of the power is the value of the trust property. The Court of Appeal also rejected the High Court's earlier classification of a trust as not being a sham, but still illusory. It held that there is no real distinction between an illusory trust and a sham trust. Finally, it considered that in relationship property cases, the court can draw an adverse inference against a party who fails to provide full and frank information about his or her property.

Sham and illusory trusts

The first two issues concerned a trust called the Vaughan Road Property Trust. Mr Clayton settled the trust during his marriage to Mrs Clayton. He was the sole trustee and, as the principal family member, he was a discretionary beneficiary. Mrs Clayton and the couple's children were discretionary beneficiaries.

The Family Court considered that the trust was illusory because the trust deed empowered the trustee to act – notwithstanding a conflict of interest – to amend the administrative and management provisions (with the principal family member's consent) and to use the trust as a commercial vehicle.(2)  The judge was influenced by the fact that Mr Clayton's business advisers effectively dealt with the trust property as a commercial enterprise, without any regard to the beneficiaries' interests.

The High Court considered that the trust was not a sham because the trustee was still under an obligation to act honestly and in good faith.(3)  Further, the power to change the administration and management of the trust was not tantamount to ownership. However, the combination of several provisions in the deed meant that Mr Clayton effectively retained all powers of ownership. Those provisions empowered the trustee to pay all of the Vaughan Road Property Trust's property to a beneficiary to deal with the property as if the trustee were the beneficial owner and to self-deal. Therefore, the trust was illusory.

The Court of Appeal held that the concept of an illusory trust is the same as that of a sham trust. Both refer to an arrangement that looks like a trust, but in reality has no effect, such that there was no actual intention to create a trust. The evidence established that there was no sham, because Mr Clayton genuinely intended to create a trust for legitimate business purposes. Even though the deed gave the trustee broad exemptions, he was still subject to enforceable fiduciary obligations to act honestly and in good faith. Therefore, Mr Clayton did not effectively have full ownership of the property and the trust was valid.

Powers of appointment and removal as property

During the course of the hearing, the court raised with counsel the issue of whether the power to appoint and remove trustees and beneficiaries is property. The court considered that the issue arose in light of the Privy Council decision in Tasarruf Mevduati Sigorta Fonu v Merrill Lynch Bank and Trust Co (Cayman) Ltd.(4)  A similar power – the power to revoke a trust – was considered property in that case.

Mr Clayton held the power in his capacity as the principal family member, not in his capacity as trustee. The power was not constrained by the deed or any of the fiduciary obligations that Mr Clayton would owe the beneficiaries if he were acting as the trustee. The trust deed enabled Mr Clayton to self-deal. The power and lack of restriction on self-dealing meant that Mr Clayton could make himself the sole trustee and discretionary beneficiary of the trust – in effect, the owner of the property. The court held that in those circumstances, the power of appointment was a property right. However, the decision did not consider the obligations of Mr Clayton as trustee to the final beneficiaries of the trust.

The court stressed that this property right did not invalidate the Vaughan Road Property Trust. It simply added the power to the pool of property owned by Mr Clayton personally. The value of the power was the value of the property that would be received if the power were exercised (ie, the net assets of the trust).

The court's reasoning relied in part on the broad definition of 'property' under the Property (Relationships) Act 1976. However, it explicitly stated that the rule applied irrespective of legislative intervention. The case is unlikely to be confined to a relationship property context and is likely to have important implications for trusts law generally, particularly where the holder of the power is personally insolvent.

Evidence in relationship property proceedings

In a further claim, Mrs Clayton alleged that some property had been given to post-separation trusts in order to defeat her claim to it. However, she had difficulty tracking the property because Mr Clayton provided inadequate information. The court accepted her submission that parties to relationship property proceedings must make full and frank disclosure of all relevant information and that it can draw the appropriate inferences when information is not disclosed. In doing so, the court may rely on the information that has been disclosed, its experience of relationship property cases and the inherent probabilities from the non-disclosure.

Ultimately, while not struck down as a sham (or illusion), the trust assets are now in play for distribution between husband and wife. It is understood that Mr Clayton has sought leave to appeal to the Supreme Court.