TRUST BASICS
*What are trusts?
*What are they used for?
*types of Trusts
*Trusts in practice and their use in – business
- family trusts
- discretionary trusts
- testamentary trusts
What are trusts?
1. A trust exists where the owner of property is obliged to deal with that property for the benefit of some other person or persons, or for some purpose recognised by law. The trust has three necessary elements:
2. A trustee can be a beneficiary of the trust of which he or she is trustee, provided he or she is not the only one. The object of a trust need not be a human beneficiary. Property can be held on trust for some purpose recognised as charitable at law.
There is also said to be a fourth element:
3. Trusts fall into two broad groups, although the second group contains two elements often treated separately:
1. Express trusts
These are trusts arising from express declaration, which can be effected by some agreement or common intention held by the parties to the trust. Trusts for charitable purposes are usually express trusts.
2. Trusts arising by operation of law
These will be either:
(a) resulting trusts, which may arise from a failure to dispose of the entire beneficial interest in property under a settlement or other instrument creating a trust, or upon the purchase of property by one person in the name of another where there was no intention to make a gift; or
(b) constructive trusts, which are trusts imposed by the court irrespective of the intentions of the parties, in circumstances where it would be unconscionable for the legal titleholder to deny the beneficial interest claimed by another party.
This paper is concerned with the basics of express trusts.
The three elements of the trust:
The trustee, the trust property and the object or beneficiaries.
The Trustee
4. A trust is not a separate legal entity.
5. The relevant legal entity in dealing with the rest of the world is the trustee.
6. The trustee must be a legal entity, a person or a corporation. There can be more than one trustee of any given trust. A number of people can act as trustees of the same trust, as a committee or unincorporated association. Under the general law there was no restriction on the number of persons who might be appointed trustees. For private trusts there is a statutory limit of four as the maximum number of persons who can be appointed trustees of the one trust in all states, except South Australia and Tasmania (Trustee Act 1925 (NSW) s 6(5)(b); Trusts Act 1973 (Qld) s 11 (in Queensland and Attorney-General may approve the appointment of more trustees); Trustee Act 1958 (Vic) s 40; Trustees Act 1962 (WA) s 7(2)(a).
7. A trustee must be validly appointed. Usually the trustee will be appointed in the deed of trust under which the trust is established. It is prudent to have some machinery in the trust to enable the appointment of a new trustee, and the removal of the existing trustee, should that become necessary.
8. It is usual to include a power of appointment in an express trust so that any vacancy in the office of trustee can be filled easily. The power of appointment is sometimes conferred on the original trustees and sometimes on third parties. The circumstances in which such a power of appointment can be exercised will depend upon the terms of the trust. Trustee legislation throughout
9. The court has an inherent power to make orders appointing new trustees, either in substitution for or in addition to the existing trustees, where it is inexpedient, difficult or impractical for a new trustee to be appointed without the assistance of the court. That power has been enshrined in statutory form in all states. (Trustee Act 1925 (NSW) s6(4); Trusts Act 1973 (Qld) s12(1); Trustee Act 1936 (SA) s14(1); Trustee Act 1898 (Tas) s13(1); Trustee Act 1958 (Vic) s41(1); Trustees Act 1962 (WA) s 7(1)).
10. Where a trustee enters into some engagement or incurs some liability on behalf of the trust, the trustee is entitled to be indemnified out of the trust assets, the trust estate if you like, for such liability.
11. The trustee’s entitlement to this indemnity is subject to some qualifications.
(a) the liability must be one which is authorised by the trust instrument.
(b) the liability must be incurred in the course of carrying out the trust, and not in the trustee’s personal capacity.
(c) the right of indemnity will be lost if the liability is incurred in breach of trust or otherwise fraudulently or by some unlawful conduct.
Gatsios Holdings v Kritharas Holdings (in Liquidation) [2002] NSWCA 29
although there is another view that says that the trustee’s right of indemnification against the trust estate is confined to liabilities and expenses which have been properly incurred in the carrying out of the trust.
Nolan v Collie & Merlaw Nominees Pty Ltd (in liq) [2003] VSCA 39 (
(d) A trustee will not lose its right of indemnity for breach of trust unless the breach alleged has some connection with the basis of the claim for indemnity.
Re Staff Benefits Pty Ltd [1979] 1NSWLR 207
(e) The right of indemnity out of the assets of the trust has been confirmed by statute (see Trustee Act 1925 (ACT) s59(4); Trustee Act 1925 (NSW) s59(4); Trustee Act (NT) s 26; Trusts Act 1973 (Qld) s72; Trustee Act 1936 (SA) s 35(2); Trustee Act 1898 (Tas) s 27(2); Trustee Act 1958 (Vic); Trustee Act 1962 (WA) s 71.)
(f) A trustee’s right of indemnity from the assets of the trust does not cease upon formal termination of the trusteeship of any particular trustee.
Kemtrong Industries Pty Ltd v Commissioner of Stamp Duties (Qld) [1984] 1 Qd R 576. The right of indemnity, and the lien over the trust assets that goes with it, will also survive the vesting or winding up of the trust and the transfer of the trust assets to a beneficiary: Rothmore Farms Pty Ltd v Belgravia Pty Ltd [1999] FCA 745.
(g) In addition to the right of indemnity out of the assets of the trust, a trustee is also entitled to an indemnity from the beneficiaries, at least in cases in which the beneficiaries are presently entitled to ascertainable interest in the assets of the trust (so this right cannot apply in the case of a discretionary trust).
(h) In pursuing a trustee for recovery of some liability incurred by the trustee in carrying out the trust a creditor can be surrogated to the trustee’s right of indemnity and can bring proceedings directly against the beneficiaries.
Countryside (No 3) Pty Ltd v Bayside Brunswick Pty Ltd (SC(NSW), Brownie J, 20 April, 13 May 1994, unreported),
(i) The liability of the beneficiaries to indemnify the trustee can be excluded by the terms of the trust deed.
McLean v Burns Philp Trustee Co Pty Ltd (1985) 2 NSWR 623
(j) By the same token the protection given to trustees, particularly in terms of their right of indemnity or recourse to trust assets, can be enlarged by the terms of the trust instrument. In Gatsios v NKH the trust deed included two clauses, 13 and 15, which appeared to protect the trustee against liability. The two clauses provided:
13. THE Trustee shall not be personally liable for the consequences of any error or forgetfulness whether of law or of fact on the part of any of the Trustee or its legal or other advisor [sic] or generally for any breach of duty or trust whatsoever unless it shall be proved to have been committed made or omitted in personal conscious fraudulent bad faith by the Trustee charged to be so liable and accordingly all persons claiming any beneficial interest in over or upon the property subject to this Settlement shall be deemed to take with notice of and subject to the protection hereby conferred on the Trustees.
15. SUBJECT always to any express provision to the contrary herein contained every discretion vested in the Trustee shall be absolute and uncontrolled and every power vested in it shall be exercisable at its absolute and uncontrolled discretion and the Trustee shall have the like discretion in deciding whether or not to exercise any such power. No Trustee shall be responsible for any loss or damage occasioned by the exercise of any discretion or power hereby or by law conferred on the Trustee or by failure to exercise any such discretion or power or for any loss or damage accruing as a result of concurring or refusing or failing to concur in any exercise of any power or discretion.
At first instance Hamilton J was inclined to the view that the trustee was not entitled to an indemnity under the general law, having engaged in misleading and deceptive conduct in trade or commerce, found in favour of NKH on the basis of these clauses, particularly Clause 13. In the Court of Appeal, Meagher JA< while describing the two clauses as having been drafted with ‘maximum clumsiness’ expressed agreement in broad terms with the finding of Hamilton J and said (at [49]) that, ‘the Trustees’ behaviour would be covered by the last sentence of paragraph 15, if it were necessary to rely on it’. Spigelman CJ agreed with that view.
12. A trustee’s right to indemnity out of the assets of the trust, or against the beneficiaries if available, should not be barred too readily. In many cases creditors of the trustee will be standing behind that indemnity and it will be their only possible means of recovery. In Re Johnson; Shearman v Robinson (1880) 15 Ch D 548, Jessel MR, in explaining the reason why the creditors of a trading trust are entitled to be subrogated to the trustee’s lien for his indemnity gave the same explanation for the trustee’s entitlement to that indemnity. The Master of the Rolls said (at 552):
The trust assets having been devoted to carrying on the trade, it would not be right that the cestui que trust should get the benefit of the trade without paying the liabilities; therefore the court says to him, you shall not set up a trustee who may be a man of straw, and make him a bankrupt to avoid the responsibility of the assets for carrying on the trade: the court puts the creditor, so to speak, as I understand it, in the place of the trustee. But if the trustee has wronged the trust estate, that is, if he has taken money out of the assets more than sufficient to pay the debts, and instead of applying them to the payment of the debts has put them into his own pocket, then it appears to me there is no such equity, because the cestuis que trust are not taking the benefit.
13. Interesting and at the time difficult questions can arise upon the winding up or bankruptcy of a trustee. Strictly speaking a distinction should be drawn at that point between assets held by the trustee as trustee, the trust fund or trust assets, and the personal assets of the trustee. Usually where a trustee is a company, it will only have acted as trustee and the only assets in its possession or control will be trust assets. A distinction will also have to be drawn between debts incurred by the trustee, as trustee, and which are debts in respect of which the trustee is entitled to an indemnity out of the assets of the trust, and the trustee’s personal debts. Once again, if the trustee is a corporation it is likely that it will only have debts falling into the first category.
14. While there has been some controversy on the point, the prevailing line of authority, at least outside
The Trust Fund
15. This simply means the assets which are held by the trustee on trust for the beneficiaries in accordance with the terms of the relevant trust. If there are no trust assets, there can be no trust. But the assets of a trust can comprise a chose in action, such as the benefit of a contract or covenant, or a right to sue to recover the trust property.
16. the trust property must be described with sufficient certainty.
The Beneficiary
17. There must be a valid beneficiary or object of a trust. The beneficiary. Traditionally this requirement has meant that a trust must either be for the benefit of some object or purpose recognised as charitable at law (and I do not propose to engage in a discussion of the meaning of charity in this paper) or in favour of ascertainable persons.
18. The advent of the modern discretionary trust, and the application in those trusts of the machinery of powers of appointment employed in creative ways has stretched the boundaries of this requirement.
19. It had been the law that, to be valid, a trust, where it was not a trust in favour of some charitable purpose, had to be in favour of a person or persons who were “ascertainable” – that meant, in effect, that it was possible to make a list of those persons at the date the trust came into operation (the “list certainty” test).
20. In Re Baden’s Deed Trusts; McPhail v Doulton [1971] AC 424 Lord Wilberforce held that it was not necessary to apply the list certainty test to all trusts and that, at least in the case of a trust in which the trustee was given a power of appointment in the nature of a trust, ie, a power of appointment which the trustee was bound to exercise, it would be enough if it could be said whether a given postulant (ie, nominated possible object) was or was not a member of the intended range of benefit. This has been described as the “criterion certainty” test. The relevant issue is whether a given postulant satisfies the criterion, or the criteria or one of them.
21. In stating this principle Lord Wilberforce was careful to point out that what the courts are concerned with is what he described as “linguistic or semantic” certainty, whether the meaning of the words is clear, whether the criterion or description of the range of objects is sufficiently clear, and not with “evidentiary” certainty, whether a beneficiary can be found, for example. The latter case his Lordship said, could be dealt with as a matter of directions.
Discretionary Trusts
22. These are trusts in which the trustee is given a “discretion” or power to distribute the beneficial interest in the trust estate, usually in such proportions, as to both income and capital, as the trustee shall decide.
23. The “discretion” or “discretions” conferred on the trustee will usually include:
1. a discretion to select from the designated range of objects of the trust those who are to receive benefits of income, capital or both;
2. an accompanying power to decide the amount or proportion of income or capital to be allocated to the selected object or objects; and
3. a power to decide not to allocate benefits to some objects or, indeed, to allocate benefits to one object to the exclusion of all the others.
24. In addition to these powers, there will sometimes be an additional discretion: a power to add to the designated range of objects.
25. In a trust established on such terms, no beneficiary has any entitlement to any specific part of the trust property unless and until the trustee decides to allocate some or all of the income or capital to that beneficiary. Prior to the making of that decision, the rights of the beneficiaries are restricted to a right to be considered for nomination by the trustee and to compel proper administration of the trust: Gartside v IRC [1968] AC 553. The interest of an object of a discretionary trust is thus not an ‘interest in possession’ and can best be described as a ‘mere expectancy’: Pearson v IRC [1981] AC 753. In this context it is better to refer to the ‘beneficiaries’ as ‘objects’ or ‘potential objects’ of the discretionary trust. They do not have any ‘beneficial’ interest in the property of the trust.
26. This “discretion” or power is an example of a common legal device, a power of appointment. This means a power to “appoint” or distribute or allocate property which is not your own. The use of the word “appoint” as the relevant verb can be seen in the history of these powers, which began with feoffments to uses in late medieval England where the common words of limitation used when transferring land to the persons who were to hold the land as feoffees to uses, he terms of the transfer if you like, were usually something like: To XYZ in fee simple to the use of A for life and thereafter to the use of whomsoever A might by deed or will appoint.
27. The discretion to decide the proportions in which the trust fund is allocated, described in Point 3 above, may also be coupled with another power, a power not to distribute at all to the class or range of objects of the power. In a trust set up in this way, the trust will usually be structured so that it is, on its face, a trust in favour of some designated group, say the descendants of a certain person living at a defined date, usually 80 years from the date the trust comes into operation.
28. there are three types of powers of appointment:
(a) General Power of Appointment – a power to appoint to anyone on the world, including yourself, ie, the holder of the power;
(b) Special Powers of Appointment – said to be a power to appoint in favour of a group or class – although these days perhaps better described as a power to appoint in favour of a range of objects identified or described primarily by inclusion;
(c) Hybrid or Intermediate Powers of Appointment – said to be a power to appoint in favour of anyone in the world within the exception of some excluded group or class – these days perhaps better described as a power to appoint in favour of a range of objects identified primarily by exclusion.
29. There is no good reason for the distinction between special and hybrid powers except that, on current authority, Tatham v Huxtable (1950) 81 CLR 639 and Horan v James [1982] 2 NSWLR 376, the inclusion of such a power in a Will is invalid, constituting a delegation of testamentary power.
30. There is a widely held view that this line of authority is wrong but it will need a decision of the High Court to overcome the difficulty. The so-called rule against delegation of testamentary power will not defeat a trust expressed to come into effect of the death of a person which is otherwise created inter-vivos: Gregory v Hudson (1998) 45 NSWLR 573.
31. Discretionary trusts are commonly used as family trusts. They used to have great value in tax minimisation when they could be used to distribute income to children. That loophole has been largely closed, but they remain a useful device for distributing income between spouses, and between spouses and adult children, where there is some advantage to be gained. Used in this way they are commonly referred to as “family trusts”.