How Do Courts Deal With Discretionary Trusts and Divorce?
A trust is an obligation to deal with assets for the benefit of either a class of persons called “beneficiaries” or for a charitable purpose. This obligation is binding on a person called a “trustee”, the legal owner of the trust assets. Ownership of the trust assets is transferred to the trustee from a “settlor”, the person responsible for creating the trust. Where the trust assets are dealt with for the benefit of beneficiaries, the beneficiaries are the equitable owners of the trust assets. This empowers them to enforce the trust obligation against the trustee.
There are different types of trust. The type most often encountered in the context of property proceedings under the Family Law Act is the discretionary trust. This type of trust empowers a trustee to allocate trust assets to beneficiaries at the trustee’s discretion.
In general, assets held under a discretionary trust for the benefit of a party to property proceedings are not “property” for the purpose of those proceedings. Accordingly, the court does not have the power under the Family Law Act to alter that party’s interest in the trust assets. A beneficiary under a discretionary trust has no more than mere expectation that the trustee may distribute trust assets or income for their benefit. There are, however, circumstances where assets held under a discretionary trust may be property for the purpose of proceedings under the Family Law Act. Such circumstances arose in the High Court case of Kennon v Spry (2008) 238 CLR 366.
When Is Trust Property Included in the Asset Pool?
In Kennon, the husband had created a discretionary trust in 1968. He was the settlor, trustee and a beneficiary. In 1983, the husband varied the trust to exclude himself as a beneficiary. The husband’s marriage to his wife began to deteriorate in 1998. During that same year, the trust was varied yet again to exclude both the husband and wife as capital beneficiaries. By 2001, the parties had separated. In 2002, the husband had set up four trusts – one for the benefit of each of his four daughters. One quarter of the capital and income of 1968 trust was transferred to each of the four trusts.
The wife sought to have the instruments that created the trusts set aside. She succeeded. Accordingly, the main issue for High Court to determine was whether the trust property was “property of the parties to the marriage”. If the trust assets answered that description, then they could be divided between the parties under an order of the court. Otherwise, they would not be included in the asset pool.
In Kennon, a majority of the High Court found that the trust assets should be included in the asset pool. The crux of the decision related to the degree of control that the husband had in relation to the trust property and the nature of the property was acquired. Property acquired by either party is “property of the parties to the marriage” for the purpose of making property orders under s79(1). Nor does it cease being property of the parties to the marriage in circumstances where:
• one of the parties declares a trust with respect to that property;
• the relevant party is the trustee of the trust;
• that party could have vested trust property in the other party during their relationship; and
• the relevant party is the only person with an interest in the trust property.
The Court’s Expanding Powers
Kennon is the leading example of the court’s power to dismantle trusts where one of the parties to the dispute exercises the required degree of control over the trust property. This is significant because it confers broader on courts in dealing with discretionary trusts and divorce. Prior to Kennon, trust property was included in the asset pool only if one of the parties could vest it in the other party at the time of trial. The decision in Kennon, on the other hand, includes trust property that could have been vested in the other party at any time during the course of the relationship.