A recent Federal Court decision may have significant implications for the asset protection outcomes achieved through discretionary trusts. The Court’s rationale seems likely to be challenged — but it is an interesting development that professional advisors must monitor.


The new development

If the trustees of a discretionary trust are the ‘alter egos’ of the trust’s beneficiaries (or otherwise subject to their effective control), then a receiver order could be made over the trust’s property.
Background

The case, ASIC v Carey, arose out of the ongoing litigation over the collapse of the Westpoint group.

At ASIC’s request, the Court appointed receivers over the property of a number of directors and companies in the Westpoint group (pending the outcome of further proceedings).

ASIC sought:

* generally, to expand the range of property of those directors to which receivers could be appointed under the Corporations Act 2001 (Act).
* in particular, for the order to include property held by third parties who were trustees for any trust of which the defendants were beneficiaries. Ambitiously, ASIC sought to argue that the defendant’s interest as beneficiaries of these trusts amounted to “property” for the purposes of the Act.

The judge accepted the traditional view — contrary to ASIC’s ambition, but then made an important leap in his reasoning.
The Decision: an “expectancy” becomes something like “property”

The law The Corporations Act defines “property” as:

any legal or equitable estate or interest (whether present or future and whether vested or contingent) in real or personal property of any description and includes a thing in action.

The traditional view Generally speaking, a beneficiary of a discretionary trust would not traditionally be considered to hold an interest that amounted to ‘property’. Instead, in most cases, a beneficiary would have an “expectancy” which is not sufficiently certain or proprietary in nature to amount to “property”.

The new leap The judge stated that if the beneficiary effectively controls the trustee’s power to make distributions, then the beneficiary has something approaching a proprietary interest in the trust property for the purposes of the Act.

That is, if the trustees of the discretionary trusts were ‘alter egos’ of their beneficiaries (or otherwise subject to their effective control), then the beneficiaries would have an interest for the purposes of the definition. If so, then a receiver order could be made over the trust’s property.

Situations in which the leap may be taken By way of example, the judge stated that in the case, he was willing to consider an application to extend the receiver orders to cover “expectancies” in the following circumstances:

1.

Facts A family trust with:
* a defendant as a beneficiary, and a director and a secretary of the trustee company (along with his wife), and
* a trust deed that conferred wide discretion to distribute to one beneficiary to the exclusion of others.

Judge’s reasoning The defendant had effective ownership of the trust property for the purposes of the Act.
2.

Facts A trust:
* with a defendant as current trustee and a member of an open class of beneficiaries (with other family members and a range of charities); and
* in which the defendant had a discretion to distribute 39% of the income or capital to any beneficiary.

Judge’s reasoning The defendant had effective ownership of at least 39% of the trust property for the purposes of the Act.
3.

Facts A trust with:
* a defendant as one of an open class of beneficiaries
* the defendant having the power to remove and appoint new trustees.

Judge’s reasoning The defendant had at least a contingent interest in the property of the trust, if not a general power of selection that approached ownership of trust property for the purposes of the Act.

Implications

Importantly, French J explicitly cited and approved Family Court cases in which – for years – the court’s have looked through formal trust structures (ignoring the legal niceties of trusts law) to make family settlements according to who had de facto ownership of the trust property.

Some thoughts on the implications of the case:

* The decision is a significant departure from accepted wisdom concerning trusts and property law.
* The decision was interlocutory in nature and substantive orders affecting the property of the parties have not yet been made.
* The decision is arguably limited in application to interpreting section 9 of the Act – yet the reasoning could be applied in other circumstances.
* The decision is of a single judge and may be challenged.

In summary, this is an important decision and developments in the area, including any appeal, should be carefully monitored by professional advisors.

You read the decision in full at Australian Securities and Investments Commission (In the Matter of Richstar Enterprises Pty Ltd) v Carey (No 6) (2006) FCA 814;

From an article by Julian Smith and Michael Lyon of Maddocks.

We believe that should this decision be confirmed the effects may spread well beyond asset protection issues. Discretionary trusts have long been defendable against accusations of only being structures for tax avoidance on the basis that they are step up for asset protection purposes.

Should trusts prove to be ineffective against creditors, it would not be surprising to find them in the sights of the Tax Office too.

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