Clayton v Clayton: Court of Appeal reminder that trusts are not always sacrosanct

Tuesday 7 April 2015

Authors: Jarrod Walker and Hugh Magee

​In a recent high profile relationship property case, Clayton v Clayton [2015] NZCA 30, the Court of Appeal held that a power of the trust’s settlor to appoint and remove trust beneficiaries was “relationship property” for the purposes of the Property (Relationships) Act 1976 (the Act). The value of the power was deemed to be the same as the value of the trust assets – in effect “busting” the trust.

The decision may yet be appealed to the Supreme Court. However, pending the outcome of any appeal, the decision has potentially significant implications for many other trusts in New Zealand which may have similar features to those in the case. The decision represents another means by which parties to a relationship split may pursue assets held in a trust. The decision will also be of interest to creditors looking to pursue the assets in a trust under which a debtor has an interest.

Context – “trust busting” in the Courts

The Clayton case is another in a long line of cases where attempts to “bust” a trust were made. “Trust busting” is a colloquial term given to the practice of looking through ownership of assets in a trust and attributing ownership of those assets to a person other than the trustee, more often than not the settlor of the trust. The effect of “busting” a trust is usually to treat the trust assets as belonging to the trust settlor, thereby rendering the assets available to a claimant such as a spouse (in the context of a relationship property dispute) or a creditor (in a bankruptcy context).

In the relationship property context, courts have generally relied on the broad powers afforded under the Act to set aside or alter dispositions of property to a trust. Section 44 provides a court a power to set aside a disposition of assets where the disposition was intended to defeat the rights of the other party to sharing of relationship property, while section 44C permits a court to make orders with respect to relationship property disposed of to a trust where the disposition has the effect of defeating the other party’s rights. Similar powers exist under section 182 of the Family Proceedings Act 1980, which permits a court to vary the terms of a pre or post-nuptial settlement.

However, allegations of trusts being “shams” or “alter ego trusts” have also been made before New Zealand courts by parties seeking access to assets otherwise out of their reach. The concept of a “sham” at law is a well-established one and in the trust context it operates where a settlor and a trustee did not intend that the trust would take effect according to its terms and there was an intention to deceive others. The effect of a successful challenge is that the trust is regarded as never having existed, with the result that the assets are available to a claimant.

The concept of a trust being merely the “alter ego” of a person (again usually the trust’s settlor) has previously been recognised in New Zealand courts, with the consequence that the trust assets are then available for equal sharing under the Act. The concept has fallen out of favour with New Zealand courts in recent years and it is now unlikely to be applied.

Attacks have also been made on trusts on the basis of the so-called “bundle of rights” doctrine. This treats the rights of one spouse under a trust (for example, their rights as trustee, protector and/or beneficiary and, importantly in the current context, powers of appointment held as settlor or “principal family member” or otherwise) as a “bundle of rights” which are themselves capable of being treated as relationship property for the purposes of the Act. It is not clear that this has ever been a separate cause of action in its own right. However, there are features of the decision in Clayton which suggest that this decision is the latest manifestation of the doctrine.

The argument that a trust is “illusory” is less common in New Zealand. It was a feature of the lower court decisions in the Clayton case and its overlap with the concept of sham was commented on by the Court of Appeal in its decision.

Background to the Clayton case

To turn, then, to the facts of the case at hand. Mr and Mrs Clayton separated in 2006 after 17 years of marriage. Mr Clayton was a successful businessman involved in the sawmilling and timber processing industry. His interests in the business assets were held through several trust and company structures.

One of those trusts was known as the Vaughan Road Property Trust. It was settled during the marriage of the Claytons. Mr Clayton was the settlor and the trustee of the trust, while he, together with his wife and their two children, were “Discretionary Beneficiaries”. The children were also the “Final Beneficiaries” of the trust. Mr Clayton was nominated in the trust deed as the “Principal Family Member” and in that capacity held a power to remove any person as a Discretionary Beneficiary as well as to appoint any person to become a Discretionary Beneficiary. He also held the power to remove and appoint trustees of the trust. The trust deed gave wide powers to the trustees and permitted the trustees to act despite the possibility of a conflict between the trustee’s interests and those of a trust beneficiary.

After their separation, Mrs Clayton argued that the trust assets were relationship property subject to the equal sharing principle in the Act. The dispute was first heard in the Family Court. It held that the trust was “illusory” on the grounds that the wide powers granted to the trustees by the trust deed negated the ability of trust beneficiaries to ever call the trustees to account, and that the manner in which the trust was administered indicated that it was simply a “convenient structure” for commercial purposes and carried few of the “hallmarks of a trust”. It therefore regarded the property in the trust as relationship property and available for sharing in accordance with the Act.

The High Court agreed that the trust was illusory but on a different basis from the Family Court. It did not accept that the terms of the trust eroded the trustee’s core obligations owed to the beneficiaries. It instead concluded that Mr Clayton retained control over the trust assets to such a degree that he was able to deal with trust property as if the trust had never been created, and that as a consequence the trust could be regarded as “illusory”. The High Court was influenced by the fact that there was no clause in the trust deed preventing self-dealing, thereby effectively conferring on him an unfettered discretion, as the sole trustee, to distribute trust property to himself (as a beneficiary). This contrasted with another high profile case in which the validity of a trust was challenged on similar grounds, Financial Markets Authority v Hotchin, where such aprovision was included in the trust deed.

Court of Appeal decision in Clayton

The Court of Appeal confirmed the requirements for the existence of a sham trust and held that the trust in this case was not a sham. It found that Mr Clayton genuinely intended to create the trust for legitimate business purposes. It also rejected the High Court’s conclusion that the trust could be disregarded on the basis that it was “illusory”. Importantly, the Court of Appeal held that there was no separate concept of an “illusory” trust, but that the concept was the same as a sham.

However, the Court of Appeal was of the view that Mr Clayton’s power to appoint and remove beneficiaries amounted to “relationship property” for the purposes of the Act. The Act contains an extended definition of “property” for this purpose, which includes “any other right or interest”. The Court based its decision not on the more ambiguous “bundle of rights” doctrine, but on a 2011 decision of the Privy Council, Tasarruf Mevduati Sigorta Fonu v Merrill Lynch Bank and Trust Co (Cayman) Limited. That case was a decision on appeal from the courts of the Cayman Islands, and as such is not binding on New Zealand courts. However, it is persuasive authority.

In the TMSF case the Privy Council held that a power of revocation given to the settlor of a trust was “property” for the purposes of applicable bankruptcy laws (with the practical effect that the assets of the trust were available to the bankrupt settlor’s creditors). Traditionally, a mere power, such as a power of appointment in a trust deed, has not been regarded as property in itself. However, the Privy Council was of the view that the distinction between a power and property has not been preserved in all contexts and for all purposes. It noted that for many purposes the law regards the holder of the power as being the effective owner of the property subject to the power. The Court of Appeal applied the reasoning of the Privy Council in this regard with the result that the power was a property right in Mr Clayton’s hands.

Importantly, the Court of Appeal noted that Mr Clayton held the power in his capacity as nominated “Principal Family Member”, and not as trustee. Trustees owe fiduciary duties to beneficiaries and cannot act in an unrestrained manner. Although Mr Clayton was a trustee, the power was given to him in his separate capacity as “Principal Family Member”. As such, his ability to exercise the power was not fettered by any fiduciary duties such as those that would constrain the exercise of a power by trustees. Mr Clayton would have been entitled, by virtue of the power, to remove all beneficiaries other than himself, and then (in exercise of his separate wide power of distribution of trust assets held as the sole trustee) to distribute all the trust assets to himself.

The Court of Appeal was of the opinion that the value of the power was equal to the value of the trust assets themselves. The effect of this decision was that the power, with value equal to the trust assets, was treated as relationship property and was available for equal sharing under the Act.

Comment

The Court of Appeal’s decision in Clayton is a welcome clarification of the scope of the “sham” doctrine in the trusts context. Pending any different outcome should the case be appealed to the Supreme Court, the Court of Appeal’s confirmation that there is no separate cause of action of “illusory” trust is also welcome.

If the case is appealed to the Supreme Court, the views of that court (our highest) on certain issues would be welcome. The Court of Appeal placed considerable reliance on the Privy Council decision in TMSF. TMSF itself had judicial precedent, and similar reasoning has been applied recently in another English case, JSC Mezhdunarodniy Promyshlenniy Bank & Another v Sergei Viktorovich Pugachev. However, Mr Clayton’s power was not the same as that in TMSF. The power in that case was a power to revoke a trust. Upon revocation of a trust, trust assets either revert to the trust settlor or are to the order of the settlor by the trustee. Here, the power was only to alter the class of discretionary beneficiaries (not, it should be noted, the “Final Beneficiaries” of the trust). The Court of Appeal was of the view that there was no practical distinction between the powers in those cases. Further argument and judicial reasoning on this point would be helpful.

The extent to which the reasoning in the case may be applied to similar fact situations may become apparent over time. The Clayton case had somewhat unusual facts. Mr Clayton held the power solely, and was also the sole trustee of the trust. Whether the reasoning of the Court of Appeal could apply where the power is held jointly (for instance by a settlor and a third party such as a solicitor), or by one person where that person habitually acts on instructions from the settlor, is uncertain.

The potential application of the reasoning in a bankruptcy context is also unclear. The finding of the Court of Appeal was that the power itself was relationship property, having a value equal to the value of the trust assets. Whether this would give a creditor in a bankruptcy sufficient grounds to claim against the trust assets remains uncertain.

These questions may yet be determined in future cases.

If you would like to discuss the potential relevance of the Clayton case to your personal and family affairs please contact the authors or your usual Bell Gully adviser.​​


Disclaimer

This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

For more information
  • Jarrod Walker

    Partner Auckland
  • Hugh Magee

    Solicitor Auckland
Related areas of expertise
  • Trusts, asset and estate planning