In December 2010 the High Court granted interim asset preservation orders in respect of assets owned by the trustees of the KA3 and KA4 Trusts and former Hanover director Mark Hotchin.
The trustees of the KA3 and KA4 trusts challenged the High Court’s refusal to strike out certain aspects of the Financial Market’s Authority (FMA) claim, specifically:
- whether the trustees hold property on behalf of associates of Mr Hotchin, and
- the tenability of the FMA’s claim that the KA4 Trust is a sham.
The appeal was unsuccessful, meaning that substantive arguments will be heard in due course. While this represents another interim victory for the FMA, the matter is far from over. The decision, although not the last word on the matter, does highlight again, the need for considered and measured trust management. Yet again, we are presented with a trust where, as a by-stander, and admittedly without all the facts, you still have to ask – what were they thinking? Before the navel gazing, a bit more background.
Property held on behalf of beneficiaries
The first issue before the Court of Appeal relates to whether it is reasonably arguable that property can be held on behalf of discretionary beneficiaries. A fair question. A discretionary beneficiary has a right to be considered, and not much more. Final beneficiaries, well, that is a different matter. However, the question here needs to be framed not just by reference to trust law, but also the legislative frame-work. The legislation in question is the Securities Act 1978 and the provision in question provides for orders transferring funds where “… any person [is] holding money, securities or other property on behalf of the relevant person or an associated person of the relevant person.” (s 60 H(1)(f)).
The High Court took a purposive view looking at what the legislation was aiming to achieve. The counter argument is that on plain reading the legislation can’t apply as a discretionary beneficiary has no property rights so property cannot be held on their behalf. The Court of Appeal has followed the High Court reasoning at this stage.
The substantive hearing on the point will be interesting.
The second issue relates to whether it is reasonably arguable that the KA4 Trust is a sham. The facts in support indicate a poorly managed trust and clear breaches of trust. Whether that amounts to a sham will be for the court to determine. The difficulty to overcome, as is so often the case with sham arguments, is the need to evidence that a trust was not intended, only that it should look like one. While there are certainly aspects of the trust “magic cloak” to protect the assets, arguably that relates more to the settlor / trustee’s naivete than any planned fraud.
Consider evidence put forward in support of a sham:
- the settlor retained significant control (that would put perhaps the majority of modern discretionary trusts in the sham box)
- when the trust was settled Mr Hotchin was sole settlor and trustee (but he wasn’t a beneficiary)
- the subsequent trustee was directed and owned by an associate of Mr Hotchin (again, not uncommon)
- the trustee largely did what Mr Hotchin wanted (poor execution of trustee obligatons, possibly delegation, but sham?)
- absence of documentation (again, so common, that perhaps a better sign of a sham would be appropriate documentation).
While the arguments are not well developed, given the early stage of proceedings, the factors pointed to are common to so many trusts that the outcome of the sham arguments will be of considerable interest.
KA No 4 Trustee Limited and KA No 3 Trustee Limited v The Financial Markets Authority  NZCA 370