Trusts are settled for many reasons. While there is no one primary reason for settling a trust, creditor protection is perhaps the most commonly cited reason; perhaps because the settlor is carrying on a risky venture; perhaps because the settlor wishes to ward off the nebulous risks beneficiaries may incur.
Which is all fine. But what actually happens if a beneficiary is bankrupted? Does a trust provide a perfect solution?
The adequacy of a trust to protect bankrupt beneficiaries depends in part on what side of the equation you are looking. Consider the case of Erceg v Erceg, the main issue if which was whether a discretionary beneficiary’s right to trust information was a property right that vested in the Official Assignee on the beneficiary’s bankruptcy.
Some legislative history. Pursuant to s 101 of the Insolvency Act 2006 all of a bankrupt’s property vests absolutely in the Official Assignee upon the bankrupts bankruptcy. See section 101, which provides:
101 Status of bankrupt’s property on adjudication
(1) On adjudication,—
(a) all property (whether in or outside New Zealand) belonging to the bankrupt or vested in the bankrupt vests in the Assignee without the Assignee having to intervene or take any other step in relation to the property, and any rights of the bankrupt in the property are extinguished; and
(b) the powers that the bankrupt could have exercised in, over, or in respect of any property (whether in or outside New Zealand) for the bankrupt’s own benefit vest in the Assignee.
Note that s 101 is subject to s 104, which specifically provides that any property owned by a bankrupt as trustee does not comprise part of the bankrupt’s estate.
For the purposes of the Insolvency Act “property” is defined to mean “property of every kind, whether tangible or intangible, real or personal, corporeal or incorporeal, and includes rights, interests, and claims of every kind in relation to property however they arise”. In Erceg at  Courtney J notes that the definition of property is “very wide and clearly intended to have the broadest reach possible, capturing all interests in and rights broadly connected with property.”
Some trust law – a beneficiary’s right to information flows, not from a beneficiary’s future interest in trust property (a proprietary right) but from the court’s inherent jurisdiction to enforce a trust. See Schmidt v Rosewood at  where the Privy Council states:
“… the more principled and correct approach is to regard the right to seek disclosure of documents as one aspect of the court’s inherent jurisdiction to supervise, and if necessary to intervene in, the administration of trusts. The right to seek the court’s intervention does not depend on entitlement to a fixed and transmissible beneficial interest.”
In Erceg (note that the decision has been appealed to the Court of Appeal, which heard the matter on 17 September 2015 but has reserved its decision) a disgruntled beneficiary who was a discharged bankrupt sought orders requiring trustees of a trust that had since been wound up to provide trust documents. The application was by way of summary judgment. The application was defended by the trustees.
In the first instance it was necessary for the court to determine whether Mr Erceg had standing to bring the proceedings. This required the court to assess whether his rights to seek trust information constituted property for the purposes of s 101 of the Insolvency Act.
The court determined that Mr Erceg’s interests as a final beneficiary were property for the purposes of s 101 and that these rights vested in the Official Assignee. However, perhaps surprisingly, the court also found that these rights did not automatically re-vest in Mr Erceg upon his discharge from bankruptcy. Accordingly, Mr Erceg did not have standing to bring the proceedings as a final beneficiary despite his discharge from bankruptcy.
This begs the question as to what happens to a bankrupt’s interests as a final beneficiary following the bankrupt’s discharge from bankruptcy (where the trust in question has not vested during the term of the bankruptcy).
The answer to this question can be found in Trustee Executors v Official Assignee, which states somewhat succinctly at  that:
“The [Insolvency Act] also allows for an annulment of the adjudication of a bankrupt in certain circumstances including where the court is satisfied that the bankrupt’s debts have been fully paid and that the [Official Assignee’s] costs have been met.The effect of an annulment is that all property of the bankrupt vested in the [Official Assignee (OA)] on bankruptcy and not sold or disposed of, revests in the bankrupt. If there is no annulment, any property that has vested in the OA remains available to the OA despite the bankrupt’s discharge.”
[References to s. 3, 138, 147, 149, 290, 304, 309 and 311 of the Insolvency Act and reference to Official Assignee v Probert deleted from quote]
Nevertheless the next question for the court, related to a discretionary beneficiary’s right to trust information. In this regard it was correctly recognised that a discretionary beneficiary has no more than an expectancy or hope that a trustee will exercise a discretion in the beneficiary’s favour and it was accepted that there is no property right or interest in this. However, a discretionary beneficiary does have the right to seek trust information (deriving not from any property right but from the court’s inherent jurisdiction to enforce trusts – as confirmed in Schmidt v Rosewood).
[Editor’s note: given that rights to trust information are not property rights the basis on which the case was developed appears curious].
The Court considered that the right to seek disclosure to documents relating to the administration of a trust is a right in relation to property – and accordingly vested in the Official Assignee. Given the history prior to the decision in Schmidt v Rosewood whether or not this is correct deserves due consideration. The right while referred to generally as a right belonging to beneficiaries, as its exercise is contingent on the court’s discretion to enforce the proper management of a trust (as discussed at length in Erceg where Courtney J said she would not have been minded to exercise her discretion) – can this properly be considered a property right?
However, if the court is correct; any bankrupt beneficiary who does not have his or her bankruptcy annulled has no rights to trust information during or following the discharge from bankruptcy.
The logical next question is what of the beneficiary’s rights to consideration – and the consequences of a distribution in favour of the beneficiary?
Food for thought.
Also see Bankrupt Beneficiaries, three years or forever in the Law News 3 July 2015
- Erceg v Erceg  NZHC 594
- Schmidt v Rosewood Trust Limited  2 AC 709
- Trustee Executors v Official Assignee  NZCA 118
- Official Assignee v Probert HC Palmerston North CP216/90, 12 November 1990 at 6–7; aff’d Probert v Official Assignee CA328/90, 19 June 1992.
- Insolvency Act 2006