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Trusts and relationship property claims

The recent Supreme Court in Preston v Preston [2021] NZSC 154 (see here https://www.courtsofnz.govt.nz/assets/cases/2021/2021-NZSC-154.pdf) shows how dangerous it is for a client with a pre-relationship trust to get married or have a civil union, and to add their spouse as a beneficiary of the Trust. Preston v Preston dealt with s. 182 of the Family Proceedings Act 1980, which empowers a court to vary the terms of a settlement made before or during the marriage, where the parties’ marriage comes to an end.

Mr Preston and Mrs Preston were married for just under five years and had children from previous relationships and no children together. Most of the assets at issue were owned by the Grant Preston Family Trust, which Mr Preston formed before meeting Mrs Preston. The High Court, the Court of Appeal and the Supreme Court all held that “an amendment deed executed in February 2010, which had added Mrs Preston as a discretionary beneficiary to the GPF Trust, was a nuptial settlement for s 182”

In Preston v Preston the Supreme Court held that the purpose of s. 182 is to empower the courts to remedy the consequences of the failure of the premise – a continuing of the marriage or civil union – on which the nuptial settlement was made. They decided that a comparison is to be made between the position under the settlement if the marriage or civil union had continued and the position after the dissolution. The Supreme Court observed that as the purpose of s. 182 is to remedy the disparity. Where the Court is faced with a disparity, the usual course is to make orders to provide that remedy. The Supreme Court held that to depart from this logic would require there to be factors telling against such an outcome, such as where the interests of a dependent child are predominant or where both parties brought considerable assets to the marriage and had maintained some separation in the way those assets were utilised.

Applying these principles, the Supreme Court held there was a clear difference between the direct and indirect benefits Mrs Preston would have continued to receive from the Trust if the marriage was ongoing, compared to her position after the dissolution. The Court, therefore, held that the discretion under s. 182 therefore applied, and orders in Mrs Preston’s favour needed to be made. The Supreme Court took into account that Mr Preston’s children were the final beneficiaries of the Trust; that the main assets had been settled on the Trust prior to the relationship between the parties, and that this was not a lengthy marriage. On that basis, the Supreme Court held that a “modest sum” of $243,000 was to be made to Mrs Preston under s. 182 (plus costs). That sum was approximately 15 per cent of the Trust’s equity.

For the earlier Supreme Court in Clayton v Clayton [2015] 3 NZLR 293 see here: https://www.courtsofnz.govt.nz/assets/cases/2016/sc23_2015claytonvclaytonsubst.pdf 

Illusory trusts

The Supreme Court's decision in Clayton v Clayton was a welcome clarification of the scope of the "illusory trust" concept. There is clearly no such concept. The issue that will arise for determination in future is whether the powers held by the settlor “are so broad that what he intended to be a trust was not, in fact, a trust.”

The implications of the Clayton case for sham trusts 

The decision clarified the law on sham trusts. In essence if a trust is a valid trust on day one, it will be exceedingly difficult for it to be held to be a sham trust due to subsequent “mismanagement.” Please read here:  http://www.rossholmes.com/index.php/sham-trusts

Relationship property and creditor protection implications

The Supreme Court in Clayton disagreed but held, in a decision that will have major implications for many New Zealand trusts, that:

[38] We accept the submission for Mrs Clayton that the property definition in s 2 of the PRA must be interpreted in a manner that reflects the statutory context. We see the reference to “any other right or interest” when interpreted in the context of social legislation, as the PRA is, as broadening traditional concepts of property and as potentially inclusive of rights and interests that may not, in other contexts, be regarded as property rights or property interests. Against that background, we now turn to the power of appointment in cl 7.1 and other relevant provisions of the VRPT deed…. 

[40] TMSF was a case resulting from the bankruptcy (under the law of Turkey) of a Mr Demirel. He had earlier established two discretionary trusts in the Cayman Islands, which, between them, had assets worth more than US$24 million. The discretionary beneficiaries included Mr Demirel and his wife and children. Mr Demirel, as settlor, had a general power to revoke the trusts. The issue before the Privy Council was whether this power of revocation was a property right that Mr Demirel could be required to delegate to the receivers in his bankruptcy, allowing them to exercise the power and obtain access to the assets of the trusts for the benefit of Mr Demirel’s creditors.

[41] Lord Collins of Mapsbury delivered the advice of the Privy Council. Having reviewed the authorities, he concluded:

[59] … The powers of revocation are such that in equity, in the circumstances of a case such as this, Mr Demirel can be regarded as having rights tantamount to ownership. The interests of justice require that an order be made in order to make effective the judgment of the Cayman court recognizing and enforcing the Turkish judgment.

[60] There is no invariable rule that a power is distinct from ownership. Nor, (as the cases on the rule against perpetuities show) is there an invariable rule that any departure from the distinction between power and property is effected solely by legislation. As Lord St Leonards said (and Hoffman LJ approved), “To take a distinction between a general power and a limitation in fee is to grasp at a shadow while the substance escapes”, and in Re Triffitt’s Settlement[1958] Ch 852at 861 Upjohn J said that “where there is a completely general power in its widest sense, that is tantamount to ownership”.…

[62] In the present case the power of revocation cannot be regarded in any sense a fiduciary power, and the defendants do not suggest otherwise. The only discretion which Mr Demirel has is whether to exercise the power in his own favour. He owes no fiduciary duties. As has been explained, the powers of revocation are tantamount to ownership.

[42] Having found that the power of revocation was “tantamount to ownership”, the Privy Council ordered Mr Demirel to delegate the power of revocation to receivers representing TMSF’s interests as a judgment creditor…..

[44] We agree with the Court of Appeal that, if Mr Clayton had a non-fiduciary power as Principal Family Member to make himself the sole beneficiary under the VRPT deed, the effect of the exercise of that power would be analogous to the revocation of the VRPT, justifying the application of the same analysis as in TMSF….

[80] We consider that, taking an approach that recognises the statutory context of the PRA, the VRPT powers are properly classified as “rights” that give Mr Clayton an “interest” in the VRPT and its assets….

[86] As the VRPT powers, which we have found to be property, were “acquired” by Mr Clayton after his relationship with Mrs Clayton began (when the VRPT was settled in 1999), they are relationship property under s 8(1)(e) of the PRA. Counsel for the VRPT Trustee suggested applying this analysis would lead to an unfair outcome, because the property transferred to the VRPT included the two Vaughan Road blocks, which Mr Clayton owned before the relationship began, and which were therefore separate property. He argued that the strict application of s 8(1)(e) of the PRA to the powers under the VRPT deed would, in substance, convert separate property into relationship property.

[87] We do not see any basis for such a concern in this case. We accept that the Court of Appeal found that the property held in the VRPT was not relationship property.86 But it is clear that its only reason for doing so was because the property in the trust was held on trust by Mr Clayton, not that it was Mr Clayton’s separate property. The alleged unfairness would arise only if the underlying assets of the VRPT would, if they had not been settled on the VRPT, have been Mr Clayton’s separate property.

[88] The Family Court Judge accepted a concession from Mrs Clayton that the value of Mr Clayton’s separate property when the relationship began was $500,000. She found that, as both s 9A(1) and s 9A(2) applied, the increase in value of that separate property over and above that $500,000 was relationship property, to be shared equally…. The Family Court’s finding was upheld in the High Court. It was not challenged in the Court of Appeal.

[89] In those circumstances, we see no basis for the allegation of unfairness. If the underlying assets of the VRPT were all such that they would have been separate property but for having been settled on trust, it may have been necessary to consider whether s 13 of the PRA should be invoked…..

[131] For the reasons given, we conclude that the Court of Appeal erred in determining that cl 7.1 of the VRPT deed was a general power of appointment and that power was relationship property. But we find that the VRPT powers are relationship property, the value of which is equal to the value of the net assets of the VRPT. The practical outcome is the same. We formally allow the appeal and quash the Court of Appeal’s finding that the power of appointment under cl 7.1 of the VRPT deed is relationship property having a value equal to that of the net assets of the VRPT. We substitute a finding that the VRPT powers are relationship property having a value equal to that of the net assets of the VRPT. For the avoidance of doubt, we record the VRPT powers are Mr Clayton’s power as Principal Family Member under cl 7.1 and his powers as Trustee under cls 6.1, 8.1 and 10.1, in light of cls 11.1, 14.1 and 19.1(c).

It is therefore clear that for creditor protection reasons trusts should not contain a non-fiduciary power permitting a settlor or beneficiary to make themselves the sole beneficiary under the trust deed, as such a power will be tantamount to ownership and will vest in the Official Assignee in the event of their bankruptcy. Our trusts do not contain such powers. 

The major implications of the Clayton case in relationship property cases arise because the clauses mentioned are standard form clauses found in many New Zealand trusts. Clause 6.1 of the trust deed was the normal discretionary power of the Trustee to distribute capital to any of the Discretionary Beneficiaries before the vesting day; clause 7.1 was the power of the settlor to appoint and remove beneficiaries (but not the Final Beneficiaries); clause 8.1 was the normal discretionary power of the Trustees to resettle all or any part of the Trust Fund upon the Trustees of any trust which included any one or more of the Discretionary Beneficiaries; clause 10.1 was the normal discretionary power of the Trustees to distribute capital to any of the Discretionary Beneficiaries on the vesting day; clause 11.1 was the normal clause conferring an unfettered discretion on the Trustees; clause 14.1 was the normal clause that a Trustee who is also a Beneficiary may exercise any power or discretion vested in the Trustees in his, her or its favour; and clause 19.1 (c) was the normal clause permitting a trustee to act notwithstanding a conflict of interest.

In reaching the conclusion that the combination of powers and entitlements of Mr Clayton as Principal Family Member, trustee and discretionary beneficiary of the Trust amounted in effect to a general power of appointment in relation to the assets of the Trust, the Supreme Court stated:

[64] The powers Mr Clayton exercises as Trustee are fiduciary powers and it has been argued that even the cl 7.1 power is constrained by fiduciary obligations. But the freedom given by cl 14.1, cl 11.1 and cl 19.1(c) mean the normal constraints of fiduciary obligations are not of any practical significance in relation to his powers as Trustee. And Mr Clayton can appoint the property of the VRPT to himself without recourse to the cl 7.1 power.

[65] The fact that the VRPT powers are, for the most part, Trustee powers is, on the face of it, a distinction between this case and TMSF, where the relevant power was held by the settlor of the trust, not the Trustee. We acknowledge that but consider that the lack of the normal constraints on Mr Clayton as Trustee means that this distinction is not significant in this case….

[68] We conclude that the combination of powers and entitlements of Mr Clayton as Principal Family Member, Trustee and Discretionary Beneficiary of the VRPT amount in effect to a general power of appointment in relation to the assets of the VRP.

The Supreme Court determined that these powers of appointment were property, and were only relationship property because as detailed in para. 86 they “…were “acquired” by Mr Clayton after his relationship with Mrs Clayton began (when the VRPT was settled in 1999), they are relationship property under s 8(1)(e) of the PRA”

Separate property is defined in s 9 of the PRA as:

9Separate property defined

(1)All property of either spouse or partner that is not relationship property is separate property.

(2)Subject to sections 8(1)(ee), 9A(3), and 10, all property acquired out of separate property, and the proceeds of any disposition of separate property, are separate property.

(3)Subject to section 9A, any increase in the value of separate property, and any income or gains derived from separate property, are separate property.

(4)The following property is separate property, unless the court considers that it is just in the circumstances to treat the property or any part of the property as relationship property:

(a)all property acquired by either spouse or partner while they are not living together as a married couple or as civil union partners or as de facto partners:

(b)all property acquired, after the death of one spouse or partner, by the surviving spouse or partner, as provided in section 84.

(5)Subject to subsection (6), all property acquired by either spouse or partner after an order of the court (other than an order made under section 25(3)) has been made defining the respective interests of the spouses or partners in the relationship property, or dividing or providing for the division of that property, is separate property.

(6)However, where relationship property has been divided on the bankruptcy of a spouse or partner,—

(a)the family home and any family chattels acquired after that division may be relationship property; and

(b)any other property acquired by either spouse or partner after the discharge of that spouse or partner from bankruptcy may be relationship property.

Do these decisions affect settlor’s who have only transferred property to their Trust before the marriage or civil union?

The recent decision in Preston v Preston shows that a married or civil union settlor who has transferred separate property to a Trust formed before a relationship can be adversely affected.

It is now clear that a married or civil union settlor who transfers separate property to a trust formed after a relationship can be worse off than a party who retains separate property in his or her own name or in a company the shares in which are owned by him or her if they add their spouse or civil union partner as a beneficiary of the Trust.

It has always been and still is, essential to have a relationship property agreement before commencing living together with a new partner

In view of the above passages in the Supreme Court’s judgments, it is essential that everyone with a trust, or who may form a trust, enters into a s, 21 agreement before commencing living together with a new partner as a couple, providing, inter alia, that the settlors and trustees powers under the trust deed are not relationship property. That is now the only safe way in which to avoid such results.

In the case of a married or civil union settlor, even a relationship property agreement will not be sufficient to avoid a claim under section 182 of the Family Proceedings Act 1980.