Discretionary trusts – trustees cannot do as they please

Discretionary trusts are a commonly used investment vehicle in Australia. These trusts, often arising in the context of family arrangements, offer attractive flexibility because trustees have discretionary powers to choose which beneficiaries receive trust income.

However, the recent case of Owies v JJE Nominees Pty Ltd [2022] VSCA 142 is a timely reminder that trustees of discretionary family trusts ‘cannot do as they please’ despite having absolute discretion in the distribution of trust income and capital.

The case confirms that a trustee is required to take positive actions to properly inform itself of the circumstances of potential beneficiaries before exercising its discretionary power to allocate any, none or all of the trust’s income.

The Owies Family Trust was established by John and Eva Owies who were appointors and directors of the Trust’s corporate trustee, JJE Nominees Pty Ltd. John and Eva along with their three children (Michael, Deborah and Paul) and a small group of family relatives were the beneficiaries. Michael, Deborah and Paul were also the principal beneficiaries. The trust deed conferred absolute discretionary powers on the trustee to distribute the income and capital of the Trust in any financial year. If no distribution was made, the income of the Trust was to be held for the children in equal shares.

John and Eva had a strained relationship with Deborah and Paul and there were lengthy periods of time when the parents and children had little to no contact. Both Paul and Deborah faced financial need especially Deborah who had numerous medical conditions which required expensive medical treatment. In contrast, John, Eva and Michael were financially well off. In each of the financial years 30 June 2011 to 30 June 2018, JJE Nominees Pty Ltd made the following distributions:

• 40% to John;
• 40% to Michael; and
• 20% to Eva.

In 2019, 100% of the net income went to John whilst Deborah received a capital distribution of residential property.

Deborah and Paul commenced proceedings arguing that JJE Nominees Pty Ltd had failed to give real and genuine consideration to their circumstances in the years 2015-2019. At first instance the Supreme Court found that the trustee had failed to give proper consideration in the years 2015, 2016 and 2018. On appeal, the Victorian Court of Appeal held that:

• the trustee had failed to give real and genuine consideration to Deborah and Paul’s circumstances for all financial years;
• despite this, the distributions were void and not voidable because no orders were sought to set aside these distributions; and
• JJE Nominees Pty Ltd was to be replaced as trustee by an independent trustee.
  

Whilst trustees often are given uncontrolled and unfettered discretion, this discretion must be exercised in the context of the trustee’s fiduciary obligations. This requires trustees to exercise discretion in good faith, upon real and genuine consideration of the beneficiaries’ circumstances and in accordance with the purposes for which the discretion was conferred[1].

The Court held there was not real and genuine consideration because:

• the trustee made no enquiries of Paul and Deborah. Ad hoc family conversations between the parents and the children in some years was not enough to suggest that these conversations were included in the deliberations of the trustee;
• there was no obvious reason why the trustee would favour Michael, John and Eva at the expense of Deborah and Paul who had a demonstrable need for income. Whilst financial need does not necessitate a distribution, the failure to do so each year pointed to a lack of due consideration for Deborah and Paul;
• there was a conflict between the interest of John and Eva and the best interests of beneficiaries which caused the trustee to not have an independent mind;
• there was a history of antipathy between Eva and her children which was reflected in the trustee’s actions; and
• the 2019 distribution to John was ‘extreme’ because he had no need for income.

Whilst the decision was based on specific facts, it reinforces that trustees have a duty of inquiry even if their discretionary power is expressed in absolute terms. A trustee is required to take positive actions to properly inform itself before exercising discretion and this obligation is not simply removed by ‘information barriers’ such as a breakdown in family relationships or geographical distance. The size and scale of the trust and the purpose of the trustee’s power are also important factors in determining the extent of this obligation.

1. Annual income distributions are not a ‘tick the box’ exercise – distributions should be made carefully and according to proper process.
2. Trustees should be aware of the potential beneficiaries of the trust and in particular, any default beneficiaries.
3. Fixed formulae for distributions for financial year should rarely be used especially where the circumstances of beneficiaries are changing from year to year.
4. Trustees should ensure that an enquiry process for the main beneficiaries is well established and commences weeks or months preceding the end of the financial year. Conversations between family members may not be enough.
5. Trustees should consider documenting evidence of the enquiry process
   
   

[1] Karger v Paul [1984] VR 161.

This article provides general commentary only. It is not legal advice. Before acting on the basis of any material contained in this article, seek professional advice.

Author: Peter Makestas

Position: Associate

Practice: Transactions

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