Can a Trustee’s Discretion Be Challenged?

Taxation and Revenue, Commercial

minutes reading time

DATE PUBLISHED: June 16, 2022

key takeaways

  • Sometimes, beneficiaries of discretionary trusts can feel as if they haven't been given a reasonable amount of influence or control of the distributions or that they haven't received a fair amount.
  • Recently, there has been an increase in cases where a beneficiary has been successful in its case of challenging a trustee's discretion.
  • It's important that trustees are aware of this possibility of challenge and should seek specialist advice in relation to trust administration.

introduction

Discretionary trusts (sometimes referred to as “family trusts”) are a common type of structure used for a number of reasons, including:

  • Asset protection;
  • Inter-generational wealth succession planning; and
  • Tax planning.

Unlike a company where shareholders have fixed entitlements to a distribution of profits, beneficiaries of a discretionary trust don’t have a specific entitlement to a particular share of the income or capital of the trust. Rather, their only entitlement is a right to be considered when the trustee exercises its discretion for any distribution.

As such, the trustee (and the Appointor, who is the person who can appoint and replace the trustee) has a significant amount of power and control over a trust.

With the trustee holding so much power, it is easy to see how family members who are potential beneficiaries of a trust might form the view that they have either:

  • Not received their “fair share” of trust distributions; or
  • Not been given adequate “control” or influence over the trust and its decisions.

Conversely, it is easy to see how family members who are trustees might form the view that they have unlimited and unchallengeable authority over the way the trust is administered and how its income and assets are dealt with.

In our experience, a significant portion of trustees fail to properly consider and protect themselves against the risks posed by disgruntled family members/beneficiaries.

Unfortunately, family disputes are often viewed as unlikely until they actually occur (particularly if the beneficiaries in question are only children now).

Some of the more common risks posed by disgruntled beneficiaries of discretionary trusts include:

  • A challenge to an exercise of the trustee’s discretion – normally, such a challenge relates to a failure to distribute income or capital of the trust to that beneficiary;
    • Taking action based on the maladministration of the trust; and
    • Alleging the trustee has breached its fiduciary duties


challenging trustee discretion

Historically, Karger v Paul[1] provided authority that where the reasons for a trustee’s exercise of discretion were not provided, that decision was generally not reviewable by the court unless it could be shown that:

  • The trustee had not satisfied its requirement to act in good faith;
  • That it had failed to show real and genuine consideration; or
  • That it had not acted in accordance with the purpose for which the discretion was conferred.

For this reason, trustees rarely provide reasons for the exercise of their discretion.

A number of advisors and their clients have taken these principles as providing a near-impenetrable defence where, so long as no reasons were provided, the assumption was that a trustee’s exercise of discretion is impervious to challenge by a beneficiary.


what happens when a challenge is successful?

In recent times, we have seen an increasing number of cases, such as that of Trani[2] and also Marcella[3], which both confirmed that the risk of a challenge succeeding is very real.

In both Trani and Marcella, significant assets of a trust were distributed to the exclusion of a potential beneficiary after control of the trust had been transferred to the next generation of the family. Such distributions were found to have been made without the proper exercise of discretion by the trustee. Although reasons were not given, the court in each case was able to consider other evidence of the trustee’s failures and to make inferences based on the trustee’s behaviour to show that the trustee had:

  • Acted in bad faith;
  • Not shown real and genuine consideration; or
  • Acted for an improper purpose.

The consequences of failing to properly exercise discretion as a trustee may include:

  • Court-ordered equitable remedies (e.g. a constructive trust is declared in respect of amounts the disgruntled beneficiary may be entitled to); and
  • The removal of the current trustee and appointment of a replacement trustee. This may include the appointment of an independent trustee.

This could result in someone losing control of a trust they thought they controlled and had injected their own assets into.

conclusion

It is clear from the potential consequences and abovementioned recent cases that the landscape is changing, and the view that a trustee’s discretion can’t be challenged is wrong. Further, where a successful challenge is made, rather than merely asking the trustee to properly make its decision, the courts increasingly are showing a willingness to remove a trustee on the basis it has acted improperly.

Specialist advice should be sought in relation to a trust’s administration, especially prior to the making of significant distributions, to ensure that it can be shown the trustee has made a real and genuine consideration in connection with the exercise of its discretion.

get in touch with us!

We can assist with a whole host of commercial, structuring and trust matters, including but not limited to:

  • Providing advice on inter-generational wealth transfers (whether planning or actually effecting a transfer). For example, we can advise on how best to transfer the assets or business conducted by a trust to your next generation in a way which does not allow the next generation recipients to unfairly exclude a co-recipient, such as in the case of Trani discussed above;
  • Providing advice on the requirements and obligations under the trust deed and general advice in relation to the administration of the trust;
  • Assisting with documenting the trustee’s actions to show that it has met its obligations;
  • Working with your advisors to document trustee distributions;
  • Advising in relation to the prospects of a potential claim against a trustee for the improper exercise of their discretion (whether from the perspective of the trustee or also the disgruntled beneficiary); and
  • Providing advice on your personal asset protection, taxation and structuring strategies. This may include the establishment of various entities, including companies or trusts, depending on your goals.


If you require any assistance or have any questions,  please fill out the enquiry form below and mention this article for an obligation-free appointment.

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