Australia: Owies v JJE Nominees: The trustee's consideration of beneficiaries in income distributions and the written reasons conundrum – When is a trustee not acting in the best interests of the beneficiaries and can be replaced by the court?

The landmark Victorian Supreme Court appeal case of Owies v JJE Nominees Pty Ltd (2022) VSCA 142 (Owies) has highlighted issues relating to the exercise of the power of trustees in discretionary trusts to allocate trust income with absolute discretion and the duty of the trustee to consider beneficiaries. In our view the law has not been changed by Owies, but the requirement to consider beneficiaries has been highlighted.

Note that most ( almost all ) family discretionary trust deeds do not provide for any beneficiary to have a right to income when the trustee does not exercise a discretion to distribute as was the case in the Owies trust deed . A normal family discretionary trust Deed will only grant a default right to a beneficiary to capital upon the eventual winding up of the trust. In most instances the Trust Deed will mean that the Trustee retains the income itself when it does not make a decision to distribute. This is normally overcome by the trustee making an income making decision each year and often with a default beneficiary or beneficiaries in the end of year trust distribution minute itself.

Regardless of the odd facts in Owies, the beneficiaries of a trust do need to be considered by the trustee with good faith and genuine consideration regardless of there not being an entitlement to certain beneficiaries when the trustee does not make a decision

Where the beneficiaries have been considered then the Court will only interfere with an income determination when the powers have been exercised without good faith and real and genuine consideration.

The onus is on the beneficiaries to prove that the discretionary power was not exercised in good faith, upon real and genuine consideration and was not in accordance with the purposes of the power for which it was conferred. Note that if the beneficiary is successful in proving its case then the decision of the trustee will become voidable but not void. The beneficiaries will need to further seek at trial the relief they seek from the Court. The Court will not have power to create an order as to whom and how much the income should be distributed without acting upon the beneficiaries' application. (Owies – para 148).

The highlighted duty to consider these beneficiaries must be read in conjunction with what reasons should be reduced to writing by the trustees to show that they have considered this. The exercise of a discretion by a trustee which does not set out reasons will not be reviewed by a Court when a trustee had not disclosed its reasons as the Court has no power to assess their adequacy.( Karger v Paul (1984) VR 161 , 165-6 ( (McGarvie J ) ) and note that this is long established principle which is recited in the Owies decision.

The absence of written reasons does not however restrict the fact that the trustee must have given the matter properly informed consideration and then exercise real and genuine consideration in its decision. This is described below in the earlier decisions of Re Londonderry Settlement and Re Hay's Settlement which are referred to in the Owies decision and discussed below. In particular, it should be noted that the primary decision of which beneficiaries and of what class the Trustee must be considering and for the unusual Owies facts it was clearly the default beneficiaries. Most Trustees of discretionary trusts will have no such specific class when making their income distribution resolution at the end of a financial year. The consideration of the takers in default of the capital on vesting will not be a correct substitution.

Genuine consideration it should be noted will require more than just following last year's distribution as this may indicate no genuine consideration.

The other unusual fact compared to many family discretionary trust arrangements is that one should consider with Owies that the Trust was established by the parents of the default beneficiaries. The parents were continually given large distributions throughout the lifespan of the trust. These facts should be remembered when the Court made its final decision on whether good faith and genuine consideration was being exercised in both the income distribution decision and also whether the Trustee should be removed.

This article will cover:

• The evidential burden on beneficiaries when trustees do not provide reasons for their distributions and exceptions to this rule;
• The manner in which the income section the Owies trust deed was drafted compared to contemporary trust documents and the unique consequences that follow from it;
• How the corporate trustee was removed and how the strained relationship between the directors of the corporate trustee and beneficiaries played in the removal action; and
• How the failure of one of the power of attorneys to register for shares invalidated the appointment of one of the directors.

Facts

As a refresher, the Owies Family Trust consisted of John and Eva who were general beneficiaries and their children, Michael, Deborah and Paul who were the primary beneficiaries of the trust. From 30 June 2011 to 30 June 2018, the corporate trustee distributed the income of the trust in the following manner:

• 40% to John
• 40% to Michael; and
• 20% to Eva.

In 2019, 100% of the income was given to John, and Deborah received the South Yarra trust property. Deborah and Paul had taken issue with the way the trust income was distributed given that from 2011 to 2018, they did not receive any of the trust's income. As a result, they commenced legal action against the corporate trustee and Michael who at the time was the director of the corporate trustee along with Mr Sampson.

Trustee's Reasons for Distribution

Re Hay's Settlement provides the steps that trustees must go through when exercising their discretionary powers. First, where there is a class of beneficiaries identified by the trust deed, the trustee must consider which persons or classes of persons are within the definition of this class. Second, in relation to the possible claimants, they must consider whether each distribution/grant is appropriate. Further, this consideration must also be made in good faith. A failure to follow this may invalidate the distribution and the court may set it aside.

This case highlights the evidential issues that beneficiaries of a discretionary trust have in applying to set aside the exercise of a trustee's power. It is established law that trustees of a discretionary trust are not required to give reasons when they exercise their powers under the trust. The rationale for this is provided in Re Londonderry's Settlement with the main reason being that any reasons provided may embitter relations between beneficiaries and trustees alike and subject trustees to embarrassment, arguments and quarrels, especially in the context of family trusts.

Unless the trustee provides the reasons voluntarily, the courts cannot examine them and the onus is on the beneficiaries to prove that the discretionary power was not exercised in good faith, upon real and genuine consideration and was not in accordance with the purposes of the power for which it was conferred as noted in Karger. Further, per Curwen v Vanbreck, no adverse inferences may be drawn from the trustees' refusal to provide reasons.

To prove that a trustee did not exercise their discretionary powers in accordance with the rules set out in Re Hay's can only be determined through the conduct of the trustee. The onus was satisfied here despite the corporate trustee's refusal to provide reasons for their distributions. The following reasons were relevant in establishing a lack of real and genuine consideration:

• No enquiries were made of Paul and Deborah as to their circumstances. The evidence provided by the applicants showed that Deborah's financial and personal circumstances were egregious and it would have been beneficial if some of the trust income was provided to her;
• The income was substantial each year, amounting to hundreds of thousands of dollars. There was no reason for the distributions to be apportioned 40:40:20 and to exclude Paul and Deborah from the distributions;
• The interests of the directors of the trustee did not correspond to the best interests of the beneficiaries. The administration of the trust was continually placed in the hands of John and Eva whose interests were in contrast with Deborah and Paul. As a result, the corporate trustee's discretion was fettered by the intention of John and Eva;
• There was a history of antipathy between the directors of the corporate trustee and Paul and Deborah. The evidence showed that Deborah was cut off from the rest of the family and Paul's enquiries about the trust and intention to seek a copy of the trust deed was continually rejected; and
• The uniformity of the distributions each financial year indicated that no consideration was given to the circumstances of Paul and Deborah. There was no reason for the distributions – especially in a discretionary trust – to settle in the pattern of distributions described. The judge viewed the pattern of distributions as "extreme" and the 2019 distribution as "remarkable" given that 100% of the distributions was given to John.

Hence, despite the difficulties in proving that a trustee's distributions are invalid when they fail to provide reasons for such distributions, the conduct of the trustee in exercising its discretion may provide a valid means for beneficiaries to challenge the distributions as exercised in bad faith or wholly lacking real and genuine consideration.

It is further worth noting the grounds whereby a trustees decision may be questioned by a Court as stated by the High Court in the Attorney – General ( Cth) v Breckler (1999) 197 CLR 83 ( Breckler) which is stated in Owies at para 87 :

Where a trustee exercises a discretion it may be impugned on a number of different bases such as that it was exercised in bad faith , arbitrarily , capriciously , wantonly , irresponsibly, mischievously ,or irrelevantly to any sensible expectation of the settlor, or without giving a real or genuine consideration to the exercise of the discretion. The exercise of a discretion by the trustees cannot of course be impugned upon the basis that their discretion was unfair, unreasonable, or unwise. Where a discretion is expressed to be absolute it may be that bad faith needs to be shown. The soundness of the exercise of a discretion can be examined where the reasons have been given, but the test is not fairness or reasonableness.

Clause 3(ii) – Default Beneficiaries

Attention should also be drawn to the way the income clause of the trust was framed. In particular, clause 3(ii) read with clause 4 acknowledges that any of the income that is not used for charitable purposes or for the benefit of the General Beneficiaries which include the parents and children, the Trustees will hold the income on trust for the children in equal shares.

Clause 3

(ii) the Trustees shall hold so much of the income of the Trust Fund as the Trustees shall not pay apply or set aside pursuant to the powers contained in paragraph (i) of this Clause in trust for the persons successively described in paragraphs (a) (b) and (c) of Clause 4 hereof as though each date on which such income becomes subject to the Trusts hereof were the Vesting Day specified in the Schedule

Clause 4

As from the Vesting Day the Trustees shall stand possessed of the Trust Fund and the income thereof in trust for such charitable purposes and/or for such of the General Beneficiaries for such interests and in such proportions and for one to the exclusion of the other or others as the Trustees may with the consent of the Guardian by instrument in writing revocable or irrevocable before the Vesting Day appoint PROVIDED ALWAYS that the Trustees shall not without such consent revoke any revocable appointment AND PROVIDED FURTHER that if there is no Guardian alive the Trustees shall have no such power of appointment and in default of and subject to any such appointment in trust –

...

What this means is that in default of appointment of income or a resolution to accumulate, the deed provided that the net income will be held on trust for each Michael, Deborah and Paul in equal shares. It must be acknowledged that modern trust instruments rarely to never incorporate default beneficiaries. Rather, in most cases the discretionary trust deed will only grant a default right to the trust's assets in the event of the winding up of the trust. As a result, the manner in which the trust was created is highly unusual.

Removal of the Trustee

In deciding to remove a trustee from their position, the Court noted the following passage from Miller v Cameron (1936) 54 CLR 572:

The jurisdiction to remove a trustee is exercised with a view to the interests of the beneficiaries, to the security of the trust property and to an efficient and satisfactory execution of the trusts and a faithful and sound exercise of the powers conferred upon the trustee. In deciding to remove a trustee the Court forms a judgement based upon considerations, possibly large in number and varied in character, which combine to show that the welfare of the beneficiaries is opposed to his continued occupation to the office.

Here, the continued management of the trust by the corporate trustee was opposed to the welfare of the beneficiaries, Deborah and Paul. The court found that the trustee has over a number of years failed to act impartially and failed to give real and genuine consideration to the interests of Deborah and Paul as seen through the failure of the trustee to make any distributions to Deborah and Paul from 2011 to 2018. The following reasons provided demonstrated how the continual management of the trust by the corporate trustee was opposed to the interests of Deborah and Paul.

The relationship between the primary beneficiaries and directors of the corporate trustee were "irreconcilably damaged". For example, although the trial judge found that Mr Sampson had acted in good faith in regard to the invalid variations, this was no basis to conclude that he would act in good faith in the future. The court found that Mr Sampson had continually aligned himself with John, Eva and Michael. This is shown in the December 2017 proposal which reflected the wishes of the parents for Michael to retain his control of the trust. Additionally, he had complied with Eva's instructions not to provide trust documents to Paul even though he knew that Paul was entitled to such documents. As a result, his discretion was constantly altered by the interests of the parents and Michael.

The relationship with Michael and the remaining primary beneficiaries was even more strained. The court said the silent call made to Deborah by Michael because he did not believe she had been in hospital was quoted to be "disturbing and reveals a high degree of suspicion". In conjunction with the fact that the trust was principally for the benefit of Michael, Eva and Paul, it was contrary to the welfare of the primary beneficiaries that Michael and Mr Sampson remain in control given their relationship with the other primary beneficiaries. Hence, the trustee was removed on this basis.

Registration of Michael for Eva's Shares

Another interesting point to note down was the observation made by the plurality at [31]. The court found that the 2017 variation made by Michael and Mr Sampson was invalid as Mr Sampson was not acting in his capacity as a validly appointed director. Prior to the variation being made on the 17 December 2017, Mr Sampson had been appointed by resolution made by John and by Michael who was acting in his capacity as attorney for Eva. The trial judge held that Michael was not registered for Eva's shares in the corporate trustee and could not vote on her behalf in making Mr Sampson director. Resultantly, Mr Sampson was not validly appointed as a director. Note that this was corrected by a later director appointment procedure, but this is an interesting legal point.

Conclusion – Practical Considerations

A The income distribution decision

Owies has highlighted the duty for a Trustee to make due enquiry of specific relevant beneficiaries if they do exist for that trust or more generally of beneficiaries where they do not. Owies has not been overly helpful in determining who are the relevant beneficiaries from the inevitable long list of beneficiaries in a discretionary trust deed as most trusts do not have a set of beneficiaries who are takers in default of income. You may start with the takers in default for the capital of the trust but you will be probably legally incorrect and a more studied view of the facts by the trustee is needed. Note that there may be none although the prior recipients of income are always worth consideration.

The Trustees should note the rule in Karger that the Court will only examine the Trustee's reasons for an income distribution (or other decision) if and only if the Trustee has provided written reasons for it and therefore the Trustee should make all appropriate enquiries of the needs of beneficiaries but be very careful in writing any reasons for its decision. It is up to the Trustee to make the trust decision and not the Court. The principles expressed in Karger have not been disturbed by Owies.

The key takeaways here are that reasonable enquires need to be made of the beneficiaries before deciding to distribute income, however by providing written reasons, the trustee will be opening up a potential avenue for redress by the beneficiaries should they be dissatisfied with the distribution as seen in this case.

Should the trustee provide written reasons for their distributions and even when they do not, they need to ensure that their reasons if analysed by a Court they would indicate that the powers of the trustee were exercised in good faith and in real and genuine consideration in accordance with the core beneficiaries of the trust. A failure to do so may open up an avenue of redress for beneficiaries regardless of the onus being upon the beneficiary to prove this.

Note that if a beneficiary does show that the trustee has made an unreasonable decision then it is important for the beneficiary to also show the Court where the distribution should have gone.

We note further that under trust law, the beneficiaries will be entitled to very little documentation from the trustee. All they will be entitled to is the trust deed and some trust account information. Litigation may allow further documentation to be discovered.

In accordance with the rules set out in Re Hay's, the following is a useful procedure for a trustee to consider:

1. If there is a class of beneficiaries, ensure that the individuals that can potentially receive the trust distributions are within the criteria of beneficiaries set out in the trust deed;
2. Ensure that the grants to each beneficiary are appropriate. This step necessitates that a reasonable enquiry be made for each potential beneficiary; and
3. Ensure that the power is being exercised in good faith and for the purposes as denoted by the trust deed.

Note that a similar procedure in respect of a capital distribution by a trustee would need to be followed in respect of potential capital entitled beneficiaries.

B The Court Decision to Remove the Trustee

We repeat the quoted positon above and note that in these facts the Court decided to remove the trustee:

"The jurisdiction to remove a trustee is exercised with a view to the interests of the beneficiaries, to the security of the trust property and to an efficient and satisfactory execution of the trusts and a faithful and sound exercise of the powers conferred upon the trustee. In deciding to remove a trustee the Court forms a judgement based upon considerations, possibly large in number and varied in character, which combine to show that the welfare of the beneficiaries is opposed to his continued occupation to the office."

If you are acting as a trustee, or are an advisor to a trustee or are a beneficiary who believes has not been adequately allowed for in an income or capital distribution, you should carefully consider these issues.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.