Is Your Family Trust Watertight

Posted on Friday, June 21 2013

NZ Family Trust: Potential Claims When Relationships End

 

As property investors many of you will have assets held in Trusts, which you may assume render those assets immune from relationship property claims. However given that there is a currently a lack of coherent and principled development between trust and relationship property law in New Zealand, it is a minefield to negotiate. For that reason special care needs to be taken when both initial asset protection structures are being implemented and when obtaining advice following a relationship breakdown. This article highlights the need for specialist advice in both setting up and the administration of trusts and what possible challenges are now able to be made in the relationship property context when a marriage, civil union or de facto relationship fails.

Key Principles of New Zealand Trust Law

Unlike a company, a trust is not a legal entity with a separate personality. A trust is essentially a relationship of one or more persons (the Trustees) holding property for the benefit of others (the Beneficiaries). The Trustee must have legal ownership of the trust property in order for it to be held subject to the trust. The trust involves obligations imposed on Trustee towards the Beneficiaries.

The type of trusts most commonly encountered in New Zealand are discretionary family trusts. Essentially these entail a private express trust governed by a written Trust Deed. Properly created and maintained the standard discretionary trust in New Zealand is a highly effective structure for ring fencing of assets, ie. protecting them from claims by creditors of the legal holders of the assets (the Trustees) and from creditors of those on whose behalf they are held (the Beneficiaries).

Estate Planning and Relationship Property Law

Properly running a trust involves significant time and effort and where independent trustees are involved can entail high expense. Consideration needs to be given as to what you want the trust for. Whether seeking to set up and run a trust or defending an attack being made on the trust, attention should be given to the following matters:

• The correct number of trustees pursuant to the trust deed.

• Making and recording resolutions for decisions which have been passed by the trustees.

• Proper systems for the trust expenditure. Although one or both spouses may have the chequebook from which a wide variety of expenses are paid, this often leads to trustee approval being overlooked. Best practice is that the expenditure should be approved by all of the trustees and recorded by a formal deed of resolution.

• If spouses intend to hold their joint assets through a trust consideration should be given to allowing for an effective “winding up” of the trust in the event of a relationship breakdown. This will allow property to be resettled without recourse to the Courts.

• If a person wishes to protect against claims under section 182 of the Family Proceedings Act 1980, a Trust Deed should not include reference to a future spouse as a beneficiary of the trust (see comments re: Section 182 below).

• If the power of appointment is held by spouses jointly during their lifetime unfairness can arise where a couple separates soon before the death of one party. The survivor is left with the ability to remove any trustees that may oppose his or her desires. Best practice is to include a provision in the spouses respective wills to transfer their power of appointment to a third party.

Contracting Out Agreements under the Property Relationships Act 1976 (“PRA”)

Under the PRA, the presumption that relationship property will be divided equally between spouses regardless of their contribution applies. Many people seek to avoid this by entering into a pre-nuptial or “Contracting Out” Agreement pursuant to Section 21 of PRA. If you wish to comprehensively protect your assets being subject to this presumption, an agreement is required as a trust alone is insufficient.

The unprecedented use of family trusts in New Zealand over the past 15 years has meant that when relationships break up much of the property that has been acquired during the relationship is not held personally by either spouse, but instead in the family trust.

Prior to the abolition of gift duty any debt back owed to either of the parties personally was classified as relationship property. Since the abolition of gift duty it is likely that most debts have now been forgiven which means that under PRA, it is neither relationship nor separate property. Consequently, trusts are increasingly coming under more scrutiny in the Courts.

Trust Busting

Contrary to popular belief, there are no trust busting clauses under PRA. Property settled on a trust prior to a relationship is generally safe from claims under this act. However properties settled on a trust during a relationship may be subject to challenge if the transfer of property to a trust was intended to avoid, or have the effect of avoiding, a potential claim being made by a spouse (sections 44 and 44C PRA).

These provisions mean that transfers to a trust by one spouse during the course of the relationship could be the subject of a claim for compensation by the other. However, the claim is not against the assets of the trust. It is a claim for compensation which has to come from the other spouse’s separate property or share of relationship property. Thus, the power of the Court to tap into trust assets is constrained under PRA.

Application to vary a Trust – Section 182 Family Proceedings Act 1980

This is another piece of legislation which is also often referred to as a “trust busting” provision. It only applies to married and civil union couples, whereas the PRA also applies to de facto couples. Section182 enables the Court to make wide ranging orders in respect of nuptial trusts upon the breakdown of the relationship.

Other Remedies

Given that trust property is neither relationship nor separate property, the Courts have developed what is now known as a “bundle of rights” claim on the basis that the controlling spouse’s interests and powers in the trust are “property” capable of division under PRA. Although this is a relatively new concept being deployed it has had some measure of success following the leading Court of Appeal decision, Walker v. Walker [2007] NZFLR 772.

A constructive trust claim may also be made on the basis that the claimant has made valuable contributions to the trust assets and reasonably expects an interest in them.

Additionally, the Family Court can declare a trust to be a sham, where a valid trust was constituted but the actual dealings were a pretence.

Similarly illusory/no intention trusts were found to exist in a recent case concerning the assets of trusts in Financial Markets Authority v. Hotchin HC Auckland [2012] NZHC 323, in which it was held that the Trust Deed provided for retention of control by Mr Hotchin personally such that in reality no trust was ever constituted. In effect, Mr Hotchin had retained all powers of personal ownership.

In another recent case, Clayton v. McGloskey Nominees Limited [2013] NZHC 301, a “self-benefit” clause in favour of a trustee who was a beneficiary, enabling the trustee to exercise any power of discretion vested in the trustee in his favour, was fatal. The entire trust was held to be illusory giving his former spouse the ability to pursue claims in the Family Court.

Where a trust is found to be a sham or illusory, the assets are then held on what is known as a “resulting trust” for the settlor. This means that the property is then able to be classified under the PRA and potentially available for division through Family Court proceedings.

Golden Rules to protect your assets from challenges following relationship breakdown

1. Create a trust before you meet your future partner.

2. Ensure that the trust deed is drafted in such a way as not to be susceptible to the illusory trust doctrine. Best practice is:

a. for there to be one or more trustees including an independent trustee;
b. for no beneficiary to be a trustee and for the settlor not to be a trustee;
c. there should be a prohibition on self-dealing for trustees who are also beneficiaries;
d. The power of appointment should rest with someone other than the settlor/trustee/beneficiary.

3. Throughout the life of the trust ensure that it is run as a separate entity and that trust assets are kept entirely separate from other assets. Do not intermingle income earned from employment or other sources with trust assets;

4. It is important to educate the trustees to run the trust as a trust for the benefit of all beneficiaries.

5. Good record keeping is essential.

6. A non-beneficiary spouse should not be permitted to contribute to trust wealth through asset contributions or skill or labour without appropriate consideration and a record that he or she acknowledges that such conduct does not provide that spouse with any claim to the trust’s assets.

7. Do not rely on settlement of a trust as a means of avoiding the creation of relationship wealth in a relationship property claims. Have a section 21 contracting out agreement as well but ensure that arrangements are fair over time and review it from time to time to update for fairness and the relationship wealth that may have been created.

Conclusion

It may well be time for you to seek legal advice to review your current arrangements. While it is tempting to try and ignore these matters taking the view that it would only open a can of worms, a future break-up would potentially entail a much larger and more expensive can.

Cushla Webster
Rennie Cox Laywers

www.urbanlegal.co.nz

 

New Zealand Family Trust

 

 
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Expert's Bio

Anne Needham

I have over 30 years experience in providing excellent residential property legal services to clients. I have an established local (NZ based) practice and also an extensive off shore client base having acted for clients dealing with New Zealand property who are located all over the world - the internet and cellphones have made this so very easy! In addition Rennie Cox/Urban Legal has been providing legal services since 1923 and is now a progressive modern law firm providing a wide range of legal services to clients.

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