The Law and the Sea of Ethics
Just when you thought you were comfortable about the advice you have been giving for years about trustees exercising absolute discretions vested in them along comes a case that questions everything you thought you might know.
Or at least it jolts you out of your comfort zone.
The law about a trustee who in terms of a trust instrument has a wide, absolute and unfettered discretion to make a decision (usually about what beneficiaries might receive) is reasonably settled.
Generally speaking, there are limited grounds for a disappointed beneficiary to challenge the decision of a trustee.
This is presumably the reason Daniel Katz of Katz v Grossman [2005] NSWSC 934 fame (having lost his case about his sister and brother in law being appointed trustees of his father’s SMSF) did not challenge their not surprising decision to pay 100% of a $1M death benefit to his sister leaving him with nothing (more on this below).
Not that it might be readily apparent to Joe Blow (nor is it always evident) but the law floats on a sea of ethics. The Court has an inherent jurisdiction to supervise the administration of trusts and intervene if the circumstances are warranted.
The difficulty is that a disappointed beneficiary needs a fair bit of bad behaviour by a trustee (and compelling evidence of that bad behaviour) to help their cause and cannot go to a Court cap in hand and just say “I don’t like the decision”. This is what is called ‘high risk litigation’.
The oft quoted principles applicable in Australia were concisely set out by the Victorian Judge, McGarvie J. in Karger v Paul where his Honour held (my highlighting):
In my opinion the effect of the authorities is that, with one exception, the exercise of an absolute and unfettered) discretion ... will not be examined or reviewed by the courts so long as the essential component parts of the exercise of the particular discretion are present. Those essential component parts are present if the discretion is exercised by the trustees in good faith, upon real and genuine consideration and in accordance with the purposes, for which the discretion was conferred. The exception is that the validity of the trustees' reasons will be examined and reviewed if the trustees choose to state their reasons for their exercise of discretion. In this context | consider that the test of acting honestly is the same as the test of acting in good faith: compare: all Holl (1881) 7 QBD 575, at pp. 580-1, per Bramwell LJ. It was argued for the plaintiff that gross negligence may of itself amount to an absence of good faith. I do not agree. Honest blundering and carelessness do not of themselves amount to bad faith: Jones v Gordon (1877 2 AC 616, at pp. 628-9, per Lord Blackburn. Again do not agree with the argument for the plaintiff that there is any conceptual territory which lies between good faith and bad faith. An act which falls short of good faith is done in bad faith.
On Karger v Paul the High Court in Finch v Telstra Super [2010] HCA 36 observed:-
“There is no doubt that under Karger v Paul principles, particularly as they have been applied to superannuation funds, the decision of a trustee may be reviewable for want of "properly informed consideration". If the consideration is not properly informed, it is not genuine. The duty of trustees properly to inform themselves is more intense in Superannuation trusts in the form of the Deed than in trusts of the Karger V Paul type ... It would be bizarre if knowingly to exclude relevant information from consideration were not a breach of duty. And failure to seek relevant information in order to resolve conflicting bodies of material, as here, is also a breach of duty. ... Whether or not it will be decided hereafter that, ... the duty of a superannuation trustee in forming an opinion of the present type is a duty to form a fair and reasonable opinion, or even a duty to form a correct opinion, there is because of the importance of the opinion and its place in the total and permanent disability payment) scheme a high duty on the Trustee to make inquiries for "information, evidence and advice" which the Trustee may consider relevant. The existence of that duty in a more intense form than exists under Karger v Paul principles in their standard application is further support for the correctness of Byrne J's decision.”
Along comes Marsella
Litigation is uncertain.
This could be greatest understatement of all time.
The factual background to the Victorian Supreme Court decision in Re Marsella [2019] VSC 65 (delivered on 15 February 2019) is remarkably similar to that in Katz v Grossman. The practical result was, however completely different.
Without reading the Marsella decision line by line you cannot gain a true understanding about the result (which is obvious he laughed with the benefit of hindsight). I am sure the lawyers acting for the Trustees (who lost) must have been feeling fairly confident at the outset (but gradually started feeling ill as things unfolded).
In Katz v Grossman:-
- the deceased was survived by a son and a daughter;
- his will provided that his estate assets were to pass equally to his two children;
- part of the deceased's wealth included about $1 million in an SMSF;
- on death, the SMSF was in the control of the daughter;
- the daughter caused the deceased's superannuation death benefit to be paid directly to her, and not to the deceased's estate;
- the son did not receive half the superannuation as intended by the deceased.
Katz v Grossman was about whether or not the Trustees had been appointed properly and not the exercise, by the trustees, of an absolute discretion.
Certainly (and rightly or wrongly) since 2005, the accepted view has been that, the trustee of an SMSF has a discretion to determine how death benefits are to be paid, including the discretion to pay the benefits to themselves.
In Re Marsella:-
- The Fund was established by deed in 2003 with deceased and her daughter from her previous marriage, as individual trustees;
- The deceased was the sole member and founder of the Fund until her death on 27 April 2016 and her member account was about $490,000.
- The deceased was also survived by her husband of 32 years who was her sole Executor;
- Importantly, the deceased did not make her husband a co-trustee;
- The daughter was left as sole trustee of the Fund and appointed her husband a co- trustee and they resolved to pay the daughter the whole of the death benefit;
- The husband got nothing;
- The husband submitted that the daughter (and her husband) did not exercise good faith and real and genuine consideration in relation to the dependants of the deceased and submitted that the death benefit payment should be set aside;
- The daughter (and her husband) submitted that the trust deed afforded them with an absolute and unfettered discretion to make the payment to the daughter, arguing that they were not required to provide reasons for their decision. Further, that under the trust deed, the trustees had a general power of appointment, which was tantamount to ownership, and for that reason, the trustees could properly decide to pay the whole of the death benefit to the daughter.
Re Marsella differs from Katz v Grossman in that the case was fairly and squarely about the actual exercise of the discretion and not about how trustees got to be there in the first place.
What went wrong for the trustees?
- McMillan J held that the daughter (and her husband) in their capacity as trustees failed to exercise their discretion with a real and genuine consideration of the interests of the Fund's beneficiaries.
- In particular, the Court singled out the daughter's behaviour for criticism, stating at [56] that her arbitrary distribution of benefits in the Fund to herself was carried out with '… ignorance of, or insolence toward, her duties.' and at [57] also stated that her conduct was beyond 'mere carelessness' or 'honest blundering'.
- Consequently, the Court held that the daughter (and her husband) were to be removed as trustees commenting at [79]: “In the context of an improper exercise of discretion, and significant personal acrimony between the first defendant and plaintiff, the defendants are to be removed as trustees of the fund.”
What made it easier for the husband in this case was that the husband had commenced a family provision case against the estate and the daughter had started separate proceedings claiming the family home where the husband lived was held on trust for her and was not an asset of the estate.
The Court in the family provision case handed down Judgment in June 2018 (giving the husband a flexible life interest in the home). In the process, the Court made a number of findings regarding the relationship between the husband and daughter, namely, that upon the death of the deceased the daughter exhibited a marked negative attitude toward the husband, that their relationship had broken down irretrievably and that the daughter’s evidence “tended to be jaundiced by her negative feelings toward the plaintiff (husband)”. Subsequent to this judgment, the daughter discontinued the trust proceeding.
None of this helped the daughter in that the Court was on notice about the unhappy and litigous relationship of the parties. It certainly helped the Court draw an inference that the daughter and her husband acted arbitrarily (and that consequently they acted in bad faith).
What should a Trustee do?
Re Marsella is an example of what trustees in these circumstances should not do.
It reinforces the need for trustees to seek, obtain and rely on reliable specialist advice before doing anything. Here the accountant for the Fund recommended to the daughter that she should obtain specialist advice. At 55 McMillan J noted (my highlighting):-
“This evidence does not indicate that any misapprehensions the first defendant was under were otherwise resolved and is more than outweighed by the totality of the evidence. In this regard, the Court accepts the plaintiff’s submission that they are formulaic. Further, while the Court notes that the first defendant obtained legal advice and the advice of Mr Hayes, she did not obtain specialist advice as suggested by Mr Hayes and did not seek to resolve uncertainty surrounding the fund deed, in the context of a significant financial decision, that is, distributing the amount of $490,000.”
And at 57:-
“The ill-informed arbitrariness with which the first defendant approached her duties also amounts to bad faith. The dismissive tenor of the correspondence from Hill Legal, the willingness to proceed with the appointment and distribution in the context of uncertainties and significant conflict and the lack of specialist advice despite the recommendation of Mr Hayes, all support the conclusions that her conduct was beyond ‘mere carelessness’ or ‘honest blundering’. This conclusion is reached without reference to the lack of evidence deposed by the defendants personally.”
The three key points that you can take from this case (which has always been the case) are:-
- Trustees must exercise their discretion with good faith and give real and genuine consideration;
- Trustees must exercise their powers in accordance with the purpose for which the power was conferred;
- Trustees must not act in conflict of their duty.
What should a Trustee consider?
To successfully resist a challenge a trustee must consider the deceased's children and spouse, including:
- their relationship with the deceased;
- their relationship with the trustee and particularly whether there is any ongoing conflict;
- the financial circumstances of each potential beneficiary;
- how the deceased has already provided for the respective beneficiaries under their will or other estate entities such as family trusts; and
- the potential conflict in the trustee paying themselves.
Window dressing
It is clear (to me at least) that simply trying to give the appearance that a trustee is acting properly by making inquiries and inviting submissions and information about personal circumstances will not cut the mustard.
The process must be real. The process must be genuine.
Writing silly or terse letters (as happened here) only makes things worse. One of the letters from the Trustee’s solicitors actually said the husband was not a beneficiary of the fund.
Re Marsella will encourage many more disappointed beneficiaries and all the more reason to get your house in order well before there is a problem.
Planning for dispute
It is very common for more recent spouses to go to war with step-children after the step-childrens’ parents have died.
In giving advice about what to do the first port of call is to analyse thoroughly how death benefits are to be paid in terms of the deed and from their investigate:-
- who will be the trustees after death;
- who will be the possible beneficiaries after death;
- what the chance of dispute is;
- how much is involved and what are the other circumstances of the beneficiaries.
Then there are various things that can be recommended including:-
- Separate SMSFs;
- BDBNs;
- Removal of certain classes of dependants from the Deed. (There is no requirement to include all SIS Act dependants);
- Locking in who the trustees will be (amending the deed and/or corporate trustee constitution);
- Removing the discretion from the Trust Deed altogether.
Discretionary Trusts
It goes without saying that when the trustee of a discretionary trust is exercising a discretion exactly the same principles apply.
Watch this space.
About Paul Radford
Paul is the partner in charge of the Connolly Suthers Succession Law Department.
His focus is on personal estate planning, business succession planning, superannuation (including SMSFs), estate administration and estate litigation. He has also acted in many contentious partnership, company as well as estate and trust disputes.
A majority of Paul's time is devoted to estate planning and estate and superannuation litigation. Practice in this area demands a broad understanding of commercial and structuring issues as well as the family and personality issues involved.
Qualifications/Affiliations
- Bachelor of Laws (Queensland University of Technology) 1988
- Admitted as a Solicitor in 1988
- Diploma in Superannuation Management (Macquarie University) 1995
- Queensland Law Society Accredited Specialist Succession Law 2003
- Member - Society of Trust and Estate Practitioners 2010
- Diploma in Financial Planning (IEG) 2016
- Self Managed Super Funds (RG146) Accredited 2016
- SMSFA - SMSF Specialist Advisor (SSA) 2017