The Victorian Court of Appeal’s decision in Owies v JJE Nominees Pty Ltd [2022] VSCA 142 (Owies) will surprise many trustees of discretionary trusts and their advisors. Effectively, the Court found that the decision of the corporate trustee (controlled by the parents of the family) of a discretionary trust to not properly consider two of their children (who were estranged from them), when making annual income distributions from the trust, was voidable (and potentially void).

While this decision could be said to be somewhat confined to its facts, it is likely to have significant ramifications going forward in relation to how the determination of annual income (and capital) distributions from discretionary trusts are made (and challenged).

Background

This case involved distributions from the trustee of a discretionary trust known as the Owies Family Trust (Trust). The Trust was established by a couple (John and Eva) in 1970. The Trust was a generally typical discretionary trust (from the 70’s), although it did have a narrow class of beneficiaries - its primary beneficiaries were the couple’s three children (Michael, Deborah and Paul), while the general class of beneficiaries were certain relatives of the primary beneficiaries. As a result, the beneficiary class in the years in question was less than 10 people. John and Eva were the controllers of the Trust during their lifetimes including as directors of the corporate trustee and as appointors and guardians of the Trust.

John and Eva were estranged from 2 of their children (Deborah and Paul) for significant periods of time, including for most of the years in question (2015 to 2019). During that time, the trustee of the Trust distributed income to John (40%), Michael (40%) and Eva (20%), except for the 2019 year when 100% of the income was distributed to John and a distribution of capital, in the form of a residential unit, which was distributed to Deborah.

Issues for the Court

Deborah and Paul successfully argued that the income distributions for the 2015 to 2019 years were voidable on the basis that the distribution decisions of the trustee of the Trust were made on the basis of no real and genuine consideration of Deborah and Paul as potential recipients of distributions. This issue will be considered in this article. Other issues decided by the Court included that the trustee was not required to give reasons for its decision, the resolutions were voidable rather than void but as no application was made to set them aside, they couldn’t be set aside and that the trustee of the Trust was removed by the Court.

No real and genuine consideration

While the Court acknowledged that it could not overturn a trustee decision that is unreasonable (unless its grossly unreasonable) and the trustee is not required to distribute on a needs basis (although it is required to adopt a needs based analysis of beneficiaries), the Court effectively reached its decision in favour of Deborah and Paul (“by the back door”) by finding there was no real and genuine consideration of Deborah and Paul.

The Court based its decisions on long standing legal principles. Some of the notable quotes from the decision include:

• “The exercise of a discretion in these terms 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” (from Karger v Paul [1984] VR 161).

• “Where a trustee exercises a discretion, it may be impugned on a number of different bases such as that it was exercised in bad faith, arbitrarily, capriciously, wantonly, irresponsibly, mischievously or irrelevantly to any sensible expectation of the settlor, or without giving a real or genuine consideration to the exercise of the discretion. The exercise of a discretion by trustees cannot of course be impugned upon the basis that their decision was unfair or unreasonable or unwise. Where a discretion is expressed to be absolute it may be that bad faith needs to be shown” (from Attorney-General (Cth) v Breckler (1999) 197 CLR 83).

• “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” (from Finch v Telstra Super Pty Ltd (2010) 242 CLR 254).

• “In the case of some trusts, the number of potential objects might be very large and a requirement to undertake a detailed analysis of the identity and needs of each would be unworkable.”

• “The trustee must not simply proceed to exercise the power in favour of such of the objects as happen to be at hand or claim his attention. He must first consider what persons or classes of persons are objects of the power within the definition in the settlement or will. In doing this, there is no need to compile a complete list of the objects, or even to make an accurate assessment of the number of them: what is needed is an appreciation of the width of the field, and thus whether a selection is to be made merely from a dozen or, instead, from thousands or millions. ... Only when the trustee has applied his mind to the ‘size of the problem’ should he then consider in individual cases whether, in relation to other possible claimants, a particular grant is appropriate. In doing this, no doubt he should not prefer the undeserving to the deserving; but he is not required to make an exact calculation whether, as between deserving claimants, A is more deserving than B” (from Re Hay’s Settlement Trusts [1981] 3 All ER 786).

• “One cannot ordinarily decide a question of fact in good faith and give it real and genuine consideration without conducting some investigation and in some cases that will entail making an inquiry of a person who is willing to provide information and is in the best position to do so. It is not a matter of natural justice but bona fide inquiry and genuine decision making” (from Telstra Super Pty Ltd v Flegeltaub (2000) 2 VR 276).

• “An obvious, but unstated, premise on which the trustee would be expected to discharge its duties is that it would generally be informed about the differing circumstances, needs and desires of each beneficiary as an incident of the familial bonds that underpin the trust and explain its purpose. It is not to be supposed that, when those familial bonds become strained or broken, the purpose of the trust to provide for the family as a whole would change or that the trustee would be relieved of the obligation to properly inform itself.”

Why did the Court find there was no real and genuine consideration?

The Court found here that there was no real and genuine consideration (and the trustee income distributions were voidable) for the following reasons:

• The trustee (i.e., the parents) made no enquires of Paul and Deborah. This was because in some years there was no contact with them and in others there was minimal contact and no evidence of enquires.

• The distributions went in the same proportions each year (exempt 2019) to John (40%), Michael (40%) and Eva (20%), with the Court noting that “there was no obvious reason why the trustee would favour Michael, John and Eva in this way” and “Deborah’s health and financial situation were parlous. Although need was not a qualifying factor for a distribution, the purpose of the trust was to make provision for the beneficiaries in the context of a family settlement. Deborah had strong claims to a favourable exercise of the discretion. That does not mean that a distribution had to be made to her; but the failure to do so, and the repetition of the same formula in each year up to and including 2018, strongly points to a lack of due consideration of her position”.

• Although the trustee was required to consider the wishes of the guardian (John and in the event of his death, Eva) in making a decision to distribute income, “the trustee was required to exercise an independent mind, and the interests of John and Eva did not correspond to the best interests of the beneficiaries”.

• “There was a history of antipathy between Eva and Paul, and Eva and Deborah, that found reflection in the dealings with the trust”.

• It could be inferred “from the outcome of the 2018 distributions that the trustee had, by that time, reached a policy of distributions with a settled ratio that was inconsistent with a continuing obligation to consider the distribution of income for each accounting period”, “the failure to give real and genuine consideration to Paul and Deborah is made more obvious by the extreme nature of the distribution that was made in 2019” and “the distribution in 2019 is so extreme and without any evident justification that it provides an additional factor that demonstrates that the trustee exercised its discretion under cl 3 without real and genuine consideration of the position of Paul and Deborah”.

So what does this case mean for distributions going forward?

As noted above, many parents (and their advisers), who set up discretionary trusts primarily and ultimately for themselves, would be surprised to learn that making income distributions to themselves and a child they have contact with (and not to children that they don’t have contact with) would be making determinations without real and genuine consideration. To the contrary, they would most likely say that they did consider their estranged children and definitively decided not to make distributions to those estranged children.

However, this case makes it clear that this is not enough. The trustee must actively inform itself of the beneficiaries of the trust – if not all of them, then at least the key beneficiaries. This could include writing to such beneficiaries each year to enquire about their situation and needs. Although it does beg the question if the trustee did make such enquiries and still did not make distributions to the beneficiaries “in need”, would the Court still overturn the decision on the basis that the decision was “grotesquely unreasonable” (to use quote used in Cowies).

While in a “happy families” situation, this issue may not arise (as no beneficiaries will challenge the decision), in cases where there is a potential disaffected beneficiary, the controllers of trusts could consider:

• Excluding/removing the disaffected beneficiary as a beneficiary of the trust (although that decision could be found to be void on the basis of no real and genuine consideration);

• Having a wider/broader class of beneficiaries (although there still appears to be an obligation to consider the “core beneficiaries”);

• Not having the disaffected beneficiary as a primary/default beneficiary – here, the Court appeared to put some weight on the fact that the children were the primary beneficiaries (as compared to the parents);

• Going through a formal claim staking process each year – enquiring about the beneficiaries’ situations and needs (although if distributions where not made to beneficiaries in need would the court still overturn the decision on the basis that the decision was “grotesquely unreasonable”);

• Taking the assets of the trust out to the individuals as capital distributions, so that they are no longer subject to the trust (although that decision could be void on the basis of no real and genuine consideration or that there was a conflict of interest).

In summary, distributions by trustees of discretionary trusts are not a “tick the box” exercise, even for annual income distributions. Careful thought, and processes, should be put in place to ensure that the trustee exercises real and genuine consideration for each distribution.

Phil Broderick
Principal
M +61 419 512 801 | T +61 3 9611 0163  
E: pbroderick@sladen.com.au           

Philippa Briglia
Senior Associate
T +61 3 9611 0173
E pbriglia@sladen.com.au