Owies v JJE Nominees Pty Ltd [2022] VSCA 142 on a trustee’s duty to act on a real and genuine consideration.

The desirability of discretionary trusts as vehicles for investment and managing family wealth is not unknown. A 2017 Labor proposal to reform the taxation of discretionary trusts noted that their number in Australia nearly doubled between the late 1990s to over 642,000.[1] Their prevalence between 2017 and now has only increased[2].

Discretionary trusts typically confer on the trustee great flexibility in dealing with the trust income and corpus. In the market for off-the-shelf discretionary trusts, for example, providers generally offer templated documents with pro forma clauses that afford the trustee maximal discretion and flexibility. Owies v JJE Nominees Pty Ltd [2022] VSCA 142 (‘Owies’) is a reminder, however, that a trustee’s discretion, no matter how wide or absolute, is not unbound, and brings into focus a fundamental duty of all trustees to act on a real and genuine consideration of the trust’s discretionary objects.

Background

Owies concerned a dispute between the three adult children – Michael, Deborah and Paul – over the administration of the Owies Family Trust, a trust established by the parents, John and Eva Owies. Amongst other issues, Deborah and Paul argued that the trustee had failed to give a real and genuine consideration to their relative positions.

In the primary decision at trial concerned distributions of income for each financial year between 2010 and 2019. In none of those years did Deborah or Paul, who for much of that time were estranged from their family, receive any allocations of trust income. Moore J held that:

• on a defence of limitation made by the trustee, the income years in issue were confined to the years 2015 to 2019 inclusive;

• the trustee had failed to give proper consideration to the positions of Deborah and Paul in 2015 and 2016 and to the position of Deborah in 2018; and

• Deborah and Paul’s pleadings as to 2017 and 2019 for both Deborah and Paul were rejected, and for 2018 in relation to Paul.

Deborah and Paul appealed, arguing that the judge erred in concluding that the trustee had given real and genuine consideration to their positions and that the trustee had sufficient information as to their circumstances so as to be able to give them real and genuine consideration in making a decision concerning the trust income.

Decision

The Court of Appeal held that the trustee had not given real and genuine consideration to the positions of Deborah and Paul for 2017 and 2019. In its decision the Court relied upon the decision in Scott v National Trust for Places of Historic Interest or Natural Beauty[3] in which Robert Walker J said:

“Trustees must act in good faith, responsibly and reasonably. They must inform themselves, before making a decision, of matters which are relevant to the decision.”

The Court further cited Karger v Paul[4] in which McGarvie J said:

“…the exercise of a discretion…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.”

The terms of the trust deed for the Owies Family Trust provided that the exercise of a discretion by the trustee was absolute and uncontrolled. The Court of Appeal noted, however, that this discretionary power is not without some bounds. A trustee is subject to constraints, which an individual is not, when disposing of their own property. A trustee’s discretion cannot be exercised capriciously, wantonly, irresponsibly or mischievously or irrelevantly to any reasonable expectation of the settlor

The Court of Appeal at [97] held that:

“Although the validity of the outcome of an exercise of power is not to be assessed by notions of fairness and reasonableness, the process must be one in which the trustee is able to exercise the power in a manner that is just, in the sense of it not being arbitrary or capricious, and it must accord with the purpose of the trust.”

Allocating income – a three-step process

The allocation of trust income by a trustee is in effect a three-step process:

Step 1

inform themselves on matters relevant to making a decision as to the allocation of income, including taking measures to inform themselves on the position and circumstances of the trust’s beneficiaries and discretionary objects, and to give real and genuine consideration to those circumstances.

Step 2

Establish a basis on which to deal with the income i.e. formulate reasons for allocating or accumulating (if the trust’s terms allow) income, which may or may not be stated by the trustee (noting that a trustee is under no obligation at law to state its reasons and it is not common practice to do so).

Step 3

Resolve to allocate the income to the trust’s beneficiaries.

In Owies, given the nature of the trust, the Trustee was required to have sufficient information about the discretionary beneficiaries in order to exercise the discretionary power to allocate income or capital in good faith.

The case highlights that when distributing income, the starting point must be the nature and purpose of the trust.

In this respect, the Trustee should be desirous of making provision for the primary beneficiaries and the general beneficiaries.

The primary beneficiaries of the Owies Family trust revolved around the three children. As noted at [111] of the judgement, the Trustee would generally be informed about the differing circumstances, needs and desires of each beneficiary.

The trust’s default income allocation provisions, that is, that it defaulted to the children in the event of the Trustee not exercising this power, was relevant to the nature and purpose of trust.

 The Trustee, in not properly applying this three-step process, made no relevant enquiries of the beneficiaries who missed out – Deborah and Paul. The distributions for the 2017 and 2019 years were voidable, but no order was sought that the distributions be set aside. Therefore as an alternative, the Trustee was removed.

Giving real and genuine consideration to the position and circumstances of the trust’s beneficiaries – a fundamental duty of all Trustees, is one which is easy to overlook, particularly when, other factors such as tax minimisation are present, or the class of potential beneficiaries is open and considerable in size.

The decision in Owies raises the question – how can it be ascertained if there has been a real or genuine consideration given to the exercise of a discretion unless the trustee gives its reasons?

 The Court of Appeal in Owies at [95] did note that in cases where the potential objects are large “the requirement to undertake a detailed analysis of the identity and needs of each [beneficiary] would be unworkable.”

Further stating that in these circumstances, “having considered whether or not to exercise the power and understood the range of objects that might benefit, the trustee is required to give adequate consideration as to how to exercise the power.”

Taking action towards a trustee’s best practices and procedures

As will be the case for all discretionary trusts, the facts and circumstances in Owies were unique. The decision does however reaffirm the fundamental duty of all trustees to give a real and genuine consideration to the positions and circumstances of the trust’s beneficiaries. The case highlights the need for all Trustees to be proactive in informing themselves of these circumstances, and to do so in a manner that is demonstrable.

Trustees – and by extension – settlors, may look to adopt initial policy documents on establishment of a trust that provide some guidance as to the nature and purposes of the trust and the reasons for which the trust is established.

It may also be good practice for trustees to develop general policies of income allocation and processes which the trustee may rely upon in the future – policies which themselves do not amount to a trustee stating reasons for how it reached a determination, but can be relied upon to indicate that the trustee acted in good faith and on a genuine consideration.

Additionally, on an annual basis the trustee, when considering allocations of income accrued to the Trustee during the course of an accounting period, is bound, it seems, to make due enquiry as to the income, needs and expectations of the key beneficiaries in order to exercise the discretion to allocate on a proper legal basis.

If you need guidance on developing a proper process in relation to annual allocations of income and if you wish to manage risk in the allocations of income in circumstances which may be controversial given the competing needs of the beneficiaries when compared to the wishes of the Trustee, please contact us for legal assistance.

---

[1] https://parlinfo.aph.gov.au/parlInfo/download/library/partypol/5445589/upload_binary/5445589.pdf;fileType=application%2Fpdf#search=%22library/partypol/5445589%22

[2] https://www.afr.com/wealth/personal-finance/ato-turns-screws-on-bogus-payments-by-family-trusts-20221208-p5c4vh

[3] [1998] 2 All ER 705, 717.

[4] [1984] VR 161, 163-4