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General

No hiding from the terms of the trust

One of the most fundamental pieces of advice to all intending or new trustees should always be to know the trust instrument, typically a deed of trust. It sets out the terms of the trust including the obligations and responsibilities of trustees, as well as clarifying some of the things they can and cannot do, especially when it comes to the decisions trustees must make regarding distributions (or otherwise) of income and capital, because there is no hiding from the terms of the trust.

The recent case of Enright v Enright is a salutary lesson why this is such valuable advice.

The case concerned a trust established by a man named Jack Enright who grew up in Central Otago. He met his wife, Jean, in Canada and they moved to New Zealand in the 1960s where Jack worked in a number of jobs before getting involved in building and in property development. Jack and Jean had 6 children. Jean died of cancer in 1974 and Jack in 2014.

Evidence presented to the Court differed markedly between the children, although it appears that Jack fell out with all of his children except Tony (the first named defendant Shane Anthony Enright).  There were claims that Jack was strict and domineering and a devout Catholic, which led to differences with some of his children’s life choices. Several of the children referred to being disavowed by their father. The five children other than Tony (including the executor of one of them), were the plaintiffs in the case.

Jack settled the JJ Enright Trust (the Trust) in 1974 after the death of Jean, naming his six children as discretionary beneficiaries, but before falling out with five of them.  Later, Jack named his sixth son Tony as the sole capital beneficiary of the trust.

Tony’s siblings, who were not aware of the Trust, sued the trustee and the Trust’s solicitor for breach of trust and fiduciary duty, knowing receipt and unjust enrichment.

Jack’s later co-trustee Mr Thomson resisted the proposition that he had bent to Jack’s will, but did consider that Jack, “by his tireless efforts for the trust, had earned the moral right to make that decision”.  See [28].

Mr Thomson was of the view that he had no obligation to advise the income beneficiaries of their status as beneficiaries.

In September 2007 the trust capital, valued then at $4m, but later $11m, was transferred to Tony.

Jack was later unaware of steps he had taken, which raises issues of capacity that were not addressed in the judgment.

Interpretation of the Deed

The first exercise undertaken by the court was the analysis of the trust deed to establish the terms of the trust.  The approach taken in this was regard was to confirm the role of the court as interpretive, not re-writing. The scale of the exercise is apparent from the words of Palmer J (at [14]: “the full horror of the drafting of key clauses of the Trust Deed is reproduced…[below]”.

Some consideration was given to the strict interpretation of executed trusts and the interpretation of executory trusts, which are interpreted in accordance with the settlor’s intention.

The more modern approach is set out in Congregational Christian Church of Samoa (Westmere) Trust Board v Tilaima, where Andrews J summarised the substantive propositions in Baragwanath J’s elegant prose in Inglis v Dunedin Diocesan Trust Board as follows at [105]:

(a) The purpose of a Trust must be derived from its deed.
(b) Where there is no express intention, extrinsic evidence is admissible.
(c) Factors to consider include the language of the deed, its nature and the circumstances both of its execution and at the present time.
(d) The Court’s role is interpretation, not creation.
(e) Past practice based on error cannot justify breach of trust.

As noted at [46]:

“The Supreme Court has observed that the scope for resort to background knowledge is itself, to some extent, dependent on context. Similarly, as Clifford J observed in Bulley v Attorney-General, there may be a difference in context between a will or trust, which is usually a unilateral document, and a contract where a common intention must be sought, though in that case the trust deed was the outcome of the interactions of several parties. As Kós J held in New Zealand Māori Council v Foulkes, “similar principles should apply to the construction of trust deeds as the construction of contracts.”

The interpretive exercise was important due to the distinction between income and capital beneficiaries.

See [50], where Palmer J observed that:

“Modern discretionary trusts tend to be drafted to avoid the earlier mysterious legal distinction between income and capital. The law has held tax and accounting treatments as potentially relevant but not determinative of the distinction between capital and income in trust law.  A modern approach to interpreting a trust deed using the terms “capital” and “income”, drafted in today’s world of comprehensive accounting standards, might simply invoke those standards as the default context which gives them meaning. Not necessarily so with a deed from 1974. I later outline more of the case law in applying it. For the moment, a sufficient taste of the legal context is provided by Ronald Young J in Wong v Burt:

The essential duty of a trustee on receiving money from a company is to ascertain the intention of the testator as to the division of the funds between capital and income where there are different capital and income beneficiaries. Typically, consideration of the relevant provisions in the trust will be appropriate. The trustees will need to keep in mind their duty to the life tenant(s) and the remaindermen and the need for impartiality. It is also clear that trustees are not obliged to follow either tax law as to the classification of income and capital, or accountancy classification of income and capital.”

The trust deed in the Enright case provided (at clause 3) that the trustees had a duty to divide the residual income amongst the settlor’s children.  This did not happen.

The judgment considers that facts regarding the income that was derived, and how this was dealt with by the trustees, at some length.  The judgment is detailed and warrants reading to appreciate the nuances and the relevant law.

As determined by Palmer J at [57]:

  • the trustees held the residue of the annual income on trust after payment of costs and expenses (clause 2)
  • the trustees were required to divided the residue among Jack’s children at their discretion
  • the share of each child was to be determined on the balance date
  • in the absence of such apportionment within six months of the balance dated the income was deemed to have been apportioned among and vested in the children.

The reason for the deemed apportionment was to avoid income being taxed at the higher trustee rate.  Expert evidence was given on this point.

The conclusion with respect to the income was “that the reserved income vested in the capital beneficiaries as at the date of reservation.”  The nature of this vested interest was “a future interest contingent upon survival until the date of distribution and upon other conditions on the capital beneficiaries as explained next.” The fact of vesting had various implications, including on the duty of the trustees to disclose the interest.

A number of other clauses of the Trust Deed were also relevant to the capital of the Trust. So, for example, the capital beneficiaries were stated to be the children living at the date of distribution. The shares and proportions in which the capital vested were to be those appointed by Jack as settlor by deed or by will. Accordingly, from 1974 until 1985 (when Jack executed a deed purporting to remove the five children as capital beneficiaries), all six children were capital beneficiaries as at the date of distribution. As Palmer J analysed matters:

“[68] …Their future interests in the capital, including the reserved income, vested in them, contingent upon their survival and subject to divestment because Jack might alter the shares and proportions of vesting (as he did). They would have all shared equally in the capital as tenants in common, with the odious exception, according to the Deed, that Cathie as a daughter would have received half the share of her brothers.

[69] But, on 12 August 1985, Jack appointed Tony as sole capital beneficiary. From that date, the capital vested in Tony, subject to the possibility that Jack could divest him of it by revoking his Deed and appointing the capital to the children in different proportions in either a new deed or in his Will. The Deed did not provide explicitly it was revocable. Clause 6 explicitly admitted of the possibility that such a deed could be revocable or irrevocable. But, unless it was explicitly made irrevocable, I consider a Court exercising its supervisory jurisdiction over the Trust would have very likely upheld a revocation. So, while the other children were discretionary capital beneficiaries after August 1985, Tony had a vested interest in the capital from then, subject to the contingency of surviving until the date of distribution and subject to possible divestment by Jack revoking the deed apportioning the capital to Tony and making a new deed.”

In 1969 Jack had incorporated a company, Southern Lakes Holdings Limited (SLH), which later undertook property developments. In about 1987 the Trust purchased 98% of the shares of SLH from Jack, with a debt back to Jack. Later, SLH purchased the Dunstan Burn Station surrounding the town of St Bathans where Jack grew up. Jack moved there but the property required substantial investment. According to Tony’s evidence, all revenue and reserves from SLH were re-invested in the development of the Station. SLH borrowed from the Trust and from the Southland Building Society to acquire another adjoining property. Evidence was given to the Court that without injections of funds from Trust income the Station would have risked failure.

Accordingly, the court had to answer the question whether income had vested in the beneficiaries and, as a consequence, whether it could be traced to SLH. This meant that four other issues needed to be determined:

(a) Did the trustees reserve income annually by the time required under the Trust Deed?

(b) Did the trustees’ reservation breach their duty of impartiality?

(c) What income was reserved?

(d) Could the income be traced?

For the trustees to have reserve income annually there needed to be evidence that they had done so and that the decisions had been unanimous (the Trust Deed required unanimity). Counsel for the plaintiffs argued that the reservation clause in the Trust Deed created vested interests unless this was defeated by valid exercise of the power to reinvest; however this power was never validly exercised as attested by the lack of any contemporaneous documentation. Palmer J found that “As with any trust, the trustees must actually consider and intend to exercise a discretionary power in order for it to be validly exercised… Given income was not specifically apportioned, if it was not reserved by then it would have vested in the children as income beneficiaries as at the balance date of the Trust.”

As to the trustees’ duty of impartiality, Palmer J cited the 2007 Court of Appeal decision in Kain v Hutton where beneficiary grandchildren had claimed that trustees had reinvested funds in breach of trust without considering their needs, including requests for assistance with their education. The Court of Appeal had held that the trustees were entitled to seek further information about the financial position of the beneficiaries, and in fact had done so in that case, with this providing an evidential basis that they had turned their minds to the matter impartially.

However, Palmer J also cited other cases where impartiality can be more difficult to establish:

“[81] The duty of impartiality can bite harder where there is a life tenant and capital beneficiaries but, even then, trustees still have a wide discretion. In Re Mulligan (Deceased), the High Court emphasised the concept of fairness, the importance  of discretion and the width of competing considerations in any case. Pankhurst J held:

It is elementary that a trustee must act with strict impartiality and endeavour to maintain a balance between the interests of life tenant and remaindermen. Put another way, a trustee must be even-handed as between income and capital beneficiaries.”

Tony gave evidence that he studied the Trust Deed at the time he became a trustee in 1986 (when he was a student). He stated that he agreed with Jack’s view that Trust revenue should be reinvested into the Trust and also that he was aware of the financial situation of his siblings and advised Jack as such.

Palmer J considered that he was unable to determine, on the balance of probabilities, that the plaintiffs had proven that trustee decisions between 1990 and 1993 were not unanimous. However, other periods were more problematic and Palmer J was able to find based on cross examination that there had either not been meetings or that the later co-trustee, solicitor Mr Thomson, had acquiesced with decision he did not necessarily agree with. Further, there was also evidence that the Trust’s accountants were given “standing instructions” that no income was to be allocated to beneficiaries. Accordingly it was found that the trustees had not made valid unanimous decisions. The residual income from 1994 to 2007 was not validly reserved by the trustees and, accordingly, the Court had to determine the amount of income not reserved which came to over $2 million. Further, Palmer J found that SLH could not defeat a tracing claim as a purchaser without knowledge, because of Jack’s own knowledge.

Although these events happened upward of 12 years ago, Palmer J found that there were no limitation issues that would stop the plaintiffs’ claim. The duty of disclosure is a fiduciary duty and so the failure to disclose was also a breach of that fiduciary duty. This also amounted to fraudulent concealment for the purposes of s 28 of the Limitation Act, meaning that time had not started to run for limitation purposes. Only one of the plaintiffs was found to be out of time.

Under s 73 of the Trustee Act 1956 there is a defence for trustees who act honestly and reasonably. Counsel for the defendant trustees asserted this defence but Palmer J found that the trustees did not deserve the benefit of the defence, in part because of Tony’s clear conflict of interest. Moreover, they had made a distribution of income to Jack himself although Jack was not a beneficiary.

Palmer J ruled total compensation to the successful plaintiffs of over $1.7 million.

 

 

 

 

 

 

References:

  • Enright v Enright [2019] NZHC 1124
  • Wong v Burt [2003] 3 NZLR 526
  • Congregational Christian Church of Samoa (Westmere) Trust Board v Tilaima (2010) 3 NZTR ¶20–047
  • Inglis v Dunedin Diocesan Trust [2011] NZAR 1 (HC)
  • New Zealand Māori Council v Foulkes [2014] NZHC 1777, [2015] NZAR 1441
  • Kain v Hutton [2007] NZCA 199
  • Re Mulligan (Deceased) [1998] 1 NZLR 481

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