This is part 2 of a series of papers on the law and practical application of trusts in everyday life. In this article we look at the discretionary trust which is encountered in everyday life — whether used in business, as a vehicle to complete property acquisitions, or as a testamentary trust provision incorporated in your will.
As noted in our earlier paper, the intended audience of this paper are those people who want a general understanding of trusts.
The key persons are:
trustee:
who has the day to day responsibility for the administration of the trust. See below: “Trustee as a fiduciary”; “Trustee’s discretion”; “Trustee’s liability to creditors of the trust and trustee’s right of indemnity”;
settlor:
whose intention it is to create the trust and who provides the initial property to settle the trust (usually a nominal sum of $10.00, but can be other property, eg land or personal property;
beneficiaries:
those persons who will benefit from the trust. See below “Who is included/excluded as a beneficiary of the trust”;
appointor:
this person has the power to replace the trustee and ultimately controls the trust;
guardian or protector:
in some trusts a guardian or protector is appointed, whose consent is required before certain acts of the trustee can be carried out (eg. to amend the trust).
Trustees are fiduciaries — this means the person or entity holding the office of trustee has core duties it owes to the beneficiaries of the trust. The core duties of the trustee as fiduciary are:
• to carry out the terms of the trust honestly and in good faith for the benefit of the beneficiaries;
• to exercise the trustee’s powers in the interests of the beneficiaries;
• not to allow the trustee’s interest to conflict with the trustee’s duty to the beneficiaries of the trust;
• not to profit from their position as trustee of the trust
In its performance of the above duties, the trustee is required to act with “due care, diligence and prudence” and “exercise care in preservation of trust property”. This is above the standard of “reasonable care and skill” that you find in other parts of the law — eg law of negligence.
The trustee of a discretionary trust has broad ranging powers to administer the trust.
The trustee will in most cases be a corporate entity because as a corporate entity it enjoys limited liability when transacting on behalf of the trust. See below under the heading “Trustee’s liability and indemnity”.
Typically, the range of trustee powers may run into several pages of the trust document and include powers to — deal with trust property as the legal owner, to lend money forming part of the trust fund, to borrow, to give security over trust property to secure its borrowings, to give guarantees, etc .
An important decision of the trustee is the discretion to allocate income and capital of the trust amongst the beneficiaries of the trust. That discretion must be exercised in good faith, but that does not mean the trustee has to apportion income and capital between all of the beneficiaries of the trust. The trustee may, in good faith, apportion income and capital of the trust to select beneficiaries without allocating income or capital of the trust to other beneficiaries of the trust.
At law, the trustee as the legal representative of the trust is liable for debts incurred by it on behalf of the trust.
Creditors transacting with the trustee of a trust have no remedy against the beneficiaries of the trust or the trust assets if they are unpaid. In most cases, a creditor will not know if they are transacting with a person or company acting as trustee of a trust.
The result is that a creditor who is unpaid when dealing with a person who is a trustee will have to sue the person or company acting as trustee and rely on the trustee’s indemnity against the trust assets in order to be paid.
The trustee’s indemnity for debts and costs incurred for the benefit of the trust is provided for under the trust document and is also provided for under various State Acts —eg s59(4) Trustee Act 1925 (NSW).
The appointor has the ultimate power to control the trust by removing the trustee and appointing another trustee in its place.
It is not unusual for the appointor(s) to be the principal beneficiaries of the trust, as in most cases the trust will have been established to benefit the principal beneficiaries. The same principal beneficiaries will also likely be the directors of the corporate trustee. This arrangement ensures the trust is carried on for the benefit of the principal beneficiaries and their immediate family.
Typically, the discretionary trust document nominates a person or persons (eg husband and wife) as the principal beneficiaries of the trust, and around whom the trust document defines the other beneficiaries of the trust by reason of their relationship to the principal beneficiaries.
For example, if Jane and Peter are named as the principal beneficiaries, the general beneficiaries are defined according to their relationship to Jane and Peter. This may include, such persons as:
→ children of the principal beneficiaries;
→ spouses of the persons referred to in (a) above;
→ brothers and sisters of the principal beneficiaries;
→ nephews and nieces of the principal beneficiaries;
→ any company in which the principal beneficiaries or any of the persons named in (a) to (d) hold a share or are a director of the company;
→ any trust in which the principal beneficiaries or any of the persons named in (a) to (d) hold an interest as a beneficiary.
Apart from defining the group of beneficiaries, you may need to exclude beneficiaries who would otherwise fall meet the definition of beneficiary for the following reasons — government benefits (eg pension) may be affected by a person’s eligibility to benefit from a trust; adverse tax may follow if the beneficiary is a “foreign person” and not excluded from the trust (eg a surcharge land tax and surcharge stamp duty may apply in respect of property held or acquired by the trust), you also want to exclude persons who by law cannot be beneficiaries (eg the settlor of the trust).
Trust property is owned by the trustee as the legal representative of the trust.
Apart from any vested interest of a beneficiary (see below), the beneficiaries of a discretionary trust have no interest in trust property and cannot direct the trustee to deal with trust property. The only actions a beneficiary can bring against the trustee are — to have the trustee account for trust property, to have the court direct the trustee to administer the trust in circumstances where the trustee is delinquent in its actions as trustee.
A beneficiary has a vested interest in the discretionary trust if the trustee has allocated income or capital to the beneficiary but has not paid or made a distribution to the beneficiary in respect of its vested interest. In such circumstances, the beneficiary can call on the trustee to distribute to the beneficiary its vested interest in the trust. This is later deal with in article 4 – “Taxation of Trusts”.
The trust document once settled may require amendments over the life of the trust (see below as to how long a trust may remain in place).
Amendments usually take the form of:
→ change of trustee;
→ changes to the beneficiaries of the trust;
→ changes to the powers of the trustee.
Each State of the Commonwealth sets the time when a trust must vest, in other words when the trust must come to an end.
In NSW, a trust must vest on the 80th anniversary of the settlement of the trust.
In many trust documents the vesting date of the trust will be defined as:
→ the date the trustee resolves to vest the trust; or
→ 80 years from the settlement date of the trust.
At A. W. Pitman & Co, lawyers Sydney, we can assist you with advice in relation to discretionary trusts including amending your trust document.
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