Boxing Day

Bad Management of Family Trusts Can Lead to Problems

 

Trusts are created for a variety of reasons, some being protection against means-testing (aged care fees, etc), asset protection from creditors and defence mechanisms from relationship claims.  But all too often, a Trust's structure fails when tested in a court of law.  Why does this occur? 

 

As Family Trust professionals we often see Trust structures vulnerable to attack due to the way the Trust has been managed.  Principally this occurs because:

 

• Trustees lack an understanding of what the Trust has been created for;
• Trustees fail to comprehend what their duties and obligations are; and
• Poor administration practices.

 

An example of a successful attack on a Trust was found in Prime v Hardie.  This case involved a property which had been purchased by a Trust.  There were only two Trustees, one a Husband and his friend.  The Husband, Wife and their two children resided in the home.

 

The Husband embarked on another relationship and decided he didn't want to live with his Wife anymore.  Nor did he want to share any assets, including the property which he viewed as his own, despite being purportedly Trust property.  He managed to persuade his Wife to move out of the home with the children by telling her he had been offered a job in Australia and wanted the family to move with him.  As an inducement, he offered to take the family on a trip to Europe.

 

The wife duly packed up the home and made arrangements to rent the house out.  She and the children moved into a motel and waited for the husband to collect them and take them on the wonderful promised holiday.  After two days of anxious waiting, the Husband telephoned and advised his wife there was no job in Australia and he wasn't going to take them on holiday ' in fact he was leaving without them.  The Wife tried to return to the home, but was told by the Husband that she could not do this as the home had been rented out by the Trust. 

 

Proceedings were taken by the parties to the Court who found the Trust was effectively the Husband's 'altered ego'. In New Zealand the terms 'sham trust' or 'constructive trust' are far more common. The finding was because the Husband had to a large extent treated the assets of the Trust (eg: the home) as if it were his own. The special relationship of Trustee acting for the Beneficiaries interests was ignored by the Husband. In the Court's view, the terms of the Trust were not being considered as exhibited by the Husband's behaviour.

 

The moral of this story (ignoring the shocking behaviour of the Trustee) is that dealing with Trust assets as if they are personal property rather than Trust property, can lead to a Court finding such assets are personal property very quickly.

 

Legal Consequences

 

When a Trust structure fails, assets can become available to meet creditors' claims, including property relationship claims.  They become taxed as personal or partnership property (potentially), rather than Trust property. This can have far reaching consequences, including tainting and large differences in tax liabilities arising from the differences between the way Trust and individuals get taxed. Further, assets become available to relationship property claims and in the net for means tested government benefits.

 

Additionally, Trustees can become personally liable for the losses the Trust and its Beneficiaries sustain.  This is because Trustees are charged personally with the responsibility of meeting their duties and obligations.  At law, Trustees enjoy a right of indemnity to be reimbursed from the Trust fund for all costs and expenses reasonably incurred in undertaking their duties.  This right can be lost however, if Trustees do not meet their equitable duties and obligations imposed on them under the trust deed and under statute and common law. 

 

Loss of this right can occur regardless of whether a monetary or asset loss has transpired and irrespective of whether a Trustee has acted with the best intentions or not.  When Trustees lose their right of indemnity, they can become personally liable to meet any loss the trust has suffered and they may have to sell their own personal assets to meet such loss. Many Trustees acting for friends and family do not understand that Trustees can become personally liable for obligations of the Trust.

 

 

Follow the Rules

 

Ensuring a Trust structure is strong rests with the Trustees.  If Trustees follow these simple rules, attacking a Trust becomes more difficult:

 

• Be acquainted with the purpose and terms of the Trust;
• Adhere to that purpose and those terms;
• Having regular meetings to review the assets and liabilities of the Trust and to ensure those assets are appropriateto meet the purpose for which the trust was created;
• Act diligently and prudently when dealing with trust assets;
• Don't treat trust property as if it is your own;
• Discuss with all Trustees the transactions the Trust is going to undertake before action is implemented;
• Minute all transactions the Trust engages in; and
• Obtain professional advice with respect to transactions Trustees are not sure of or have queries in respect of.

 

The Solution

 

Having a Professional Trustee like Janet Xuccoa from Gilligan Rowe + Associates Ltd can assist enormously in ensuring the FamilyTrust structure doesn't fail.    This is of course, if the Professional Trustee understands their role and undertakes that role diligently.  Professional Trustees discuss with all the other Trustees what transactions the Trust is proposing to undertake and checks cash flow, asset and liability ratios before agreeing to the Trust engaging in those transactions.  Also, our Professional Trustees advises on the need to pass Resolutions noting the affairs of the Trust and recommends annual reviews be undertaken.

 

Having a Professional Trustee is not without some cost, but it is a relatively low cost.  The Professional Trustee at our firm of chartered accountants for example charges $250 plus GST per annum for holding the position.  Additionally, work undertaken by the Professional Trustee is charged on a time and cost basis.  When considering these costs, it can appear expensive to have a Professional Trustee, but we believe the benefits a Professional Trustee can confer on a Trust, can far outweigh the costs involved if the Trust ultimately fails when tested.