Does a discretionary trust protect beneficiaries?

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Dominique Perry of Townsends Lawyers provided a two-part overview on whether a discretionary trust protects beneficiaries. It is the first of the series.

One of the supposed advantages of a discretionary trust is that it protects the assets of the primary beneficiary (ies) of the trust from attacks by their creditors, because although those beneficiaries may control the assets, they do not actually own them ( they ‘belong to the trustee of the trust).

At one point, it looked like the courts were going to overturn that principle.

Let’s take a look at what happened in several court cases:

Richstar Case

The case of Australian Securities and Investments Commission Richstar Enterprises Pty Ltd (ACN 099 071 968) v Carey (No 6) [2006] FCA 814 (“Richstar”), was of some concern with respect to discretionary trust assets.

The question before the Court was whether a receiver could be appointed for the property held in trust. S1323 of the Corporations Act allows the court to appoint a receiver over the property of a person concerned.

The Court concluded that trusts whose “the defendant concerned is the effective controller, enjoying at least a possible interest ” was beneficial ownership of the trust property. “

This case raised major concerns about the protection of assets under discretionary trusts from creditors when a bankrupt beneficiary exercised de facto or legal control over the trust. Specifically, the combination of control of the trust and being the beneficiary of the trust allowed the court to appoint a receiver and freeze the assets of the trust.

The concern was somewhat alleviated by an analysis of the differences between the Bankruptcy Act and the Corporations Act. In particular, the Bankruptcy Act stipulates that the property of a bankrupt at the time the person becomes bankrupt passes to the trustee in bankruptcy. However, property held in trust for another is specifically excluded. Section 4A of the Act specifically sets out the circumstances in which a bankrupt controls a trust. Arguably, the Act recognizes that the bankrupt’s potential interest in a discretionary trust (contingent on the trustee making a distribution of the trust in favor of the bankrupt) is not transferable to a bankruptcy trustee.

Smith case

Since the concern of Richstar, we have seen courts reluctant to follow the case.

In the case of Black-smith, the question was whether the property that belonged to a discretionary trust could be considered to belong to a person, who was also the sole shareholder and director of the trust company, to allow the property to be given by will of that person .

The Court discussed the analysis between beneficial and beneficial ownership and concluded that the willor was not the beneficial owner (beneficiary) of the trust assets.

With respect to Richstar, it was noted that the Court in that case: “Did not say that it followed from the defendant’s position as beneficiary of discretionary trusts and their control over the trustees that this amounted to beneficial ownership as opposed to effective control ”.

In Smith, the judge said: “I don’t understand ASIC v Carey (# 6) (i.e. Richstar) to establish that because a beneficiary of a discretionary trust controls the appointment or dismissal of the trustee or controls the exercise of the power of the trustee and may ascribe trust property to himself, that the holder of such power is the beneficial owner of the trust property, regardless of the terms of the trust deed ” The reasoning above in Smith was applied by the same judge in a later case in 2008.

Fordyce case

In the case of Fordyce, we see once again the reluctance of a court to follow Richstar. In this case, there were three trust structures and the bankruptcy trustee requested the appointment of a receiver to liquidate the trusts.

The bankruptcy trustee relied on the Richstar case indicating that “the right of the bankrupt as the general beneficiary of a discretionary trust should be property under the Bankruptcy Act vested in the trustee in bankruptcy.

She stood at Fordyce that the “the legal or de facto control of the beneficiaries / trustees over the discretionary trust trustee in the context of bankruptcy, does not alter the character of the beneficiary’s interest as the property of the bankrupt if the beneficiary goes bankrupt.

The Court was based on principles of general law according to which the interest of a beneficiary in a trust is a simple discretionary interest being a right to be considered and a right to enforce the good administration of the trust. being a personal right that does not pass to the trustee in bankruptcy.

In other words,

  • the right of a bankrupt as a general beneficiary does not belong to the trustee in bankruptcy as the property of the bankrupt, and the right of a beneficiary to be considered and to enforce the proper administration of the trust is a personal right that does not pass to the trustee in bankruptcy;
  • a validly created trust does not alter the interests of a bankrupt beneficiary by reason of his actions or influence by causing the trustee to make distributions of income; and
  • distributions from a trust to a bankrupt will fall into the bankrupt’s assets as property subsequently acquired.

Conclusion

The discretionary trust did not die as a vehicle to protect the assets of a beneficiary even though that beneficiary is also the trustee or director of the trust trustee and therefore controls the assets of the trust and the distributions of the trust. .

Next month, in Part 2 of this series, we’ll take a look at whether the discretionary trust protects the beneficiary’s assets from a family court order effectively dividing those assets with the beneficiary’s estranged spouse.


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