Why you may need to rethink …

Are you a trustee, or the director of a company that acts as a trustee, of a discretionary trust?

If you are, do you actually know what you are doing?!

The Problem

I’m the trustee of a discretionary trust, and that means I can do whatever I want, right?

The answer to this question is no, you cannot do whatever you want as the trustee of a discretionary trust. Certainly, you will usually have very wide powers.  But those powers are not without limitations.

There are some points to be made in this regard.

The Trust Deed

The trust deed of the relevant discretionary trust is the critical limiting factor in determining the extent of your powers as a trustee. This is the document that sets the framework of the trust, including the trustee’s powers. The trustee must act within that framework.  If not, it will be acting without authority, and that can have very serious ramifications for the trustee, as noted further below under the heading ‘Costs’.

And it may be even more basic than that. In her paper to the recent 2024 SA STEP Trust Symposium, Carolyn Sparke KC of the Victorian Bar recalled, in a discussion of these issues, a matter in which she was involved where the trust deed required the trustees to be re-appointed every two years. This had never happened, which meant that the trustees had actually been acting completely without power for a number of years.

The Exercise of Your Powers

OK, so you have the power to do something under the trust deed.  But wait… that is not the end of it. How you actually exercise that power can be critical. Even though the power may be expressed as discretionary, such as the power to distribute the income of the trust amongst the beneficiaries, you still have to exercise that power properly.

Owies case  is relevant in this regard.

This 2022 Victorian Court of Appeal decision  upholds the view that trustees cannot treat discretions given to them in the trust deed as being completely unfettered or unqualified.  In her aforementioned article, Carolyn Sparke KC says, on the basis of Owies case, that, when making decisions about distributions from a trust, “a ‘good’ trustee will:

  1. ensure it is fully informed about the needs of relevant beneficiaries, in each year in which income distributions are being made and when capital distributions are being made;
  2. overlook personal antipathy;
  3. not make formulaic distributions year after year;
  4. not make distributions which are purely tax-driven;
  5. actually give ‘real and genuine consideration’ to the needs and claims of the relevant beneficiaries;
  6. hold proper meetings and keep notes of the decision made; …
  7. consider whether to record in the meeting minutes, what matters were taken into account.”

Your failure to act in a proper way in exercising your discretion as trustee can lead to a Court deciding that your decision must be set aside. It may even lead to you being removed as a trustee, particularly if the Court feels that you may simply continue to exercise your discretion improperly.

Costs

Your failure can also have devastating cost consequences.  If a trustee unsuccessfully defends, in court proceedings, a decision it has made because it acted out of self-interest or it otherwise acted unreasonably,  it may be unable to seek the indemnity it would normally enjoy  and be found to be effectively personally liable for the costs of the court proceedings and any other costs incurred by the trust as a consequence of the trustee’s actions.

South Australia

Just some thoughts about my home state in this context, in particular in the context of its unique position as the only state in Australia that does not have a perpetuity period (that is, the trust can ‘live on’ indefinitely).  The consideration of the competing interest of beneficiaries becomes more problematic the longer the trust continues, given the probable ever-increasing number and diversity of those beneficiaries over time.

It is always important to consider the following issues when drafting a discretionary trust deed, but it is arguably more important in SA to draft a trust deed that:

  • clearly defines the purpose and intent of the trust over future generations so as to provide clear guidelines to the trustee from time to time as to the exercise of its discretion; and
  • provides a trust structure to support those purposes and intentions, such as ‘silos’ within the trust that can facilitate the division of trust assets with separate sub-trustees so as to better manage the micro decision-making processes of the trust.

Concluding Thoughts

Discretionary trusts are helpful for wealth conservation in a family dynamic where there are significant assets or significant risk of attack on particular assets. They are also useful for marshalling property for the purpose of investment and long-term benefit to a family and its succession.

Dissension amongst beneficiaries is, however, not uncommon and is often grounded in how the trustee’s decisions are made.

Establishing consensus between trustee and beneficiaries about the efficacy and purpose of the trust and, in any event, fully, fairly and reasonably considering the competing interests of beneficiaries when decisions are made, can often help avoid dissent and simplify the operation of the trust, thus reducing the personal risk of the trustee.

Bottom line, seek legal advice when you have important decisions to make so as to ensure that your decisions are as unimpeachable as possible. You probably guessed we would say this but, seriously, if you could see what we see, you would know why we do!  Please let us know if we can help.

This article was written by Jeremy Duffy, with contributions from Michael Perkins and Annabelle Wason

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