The treatment of trust assets and trusts in family law financial disputes

For decades, Australian advisors have promoted the merits of discretionary trusts as a form of “asset protection” to their clients. The general notion is that the asset protection arises from the fact that beneficiaries of a discretionary trust do not legally own the property of the trust and the trust itself is therefore not affected by claims against or the bankruptcy of its beneficiaries. However, this general notion about asset protection should not be conflated with a belief that the assets of a discretionary trust are immune from family law property settlement claims. For example, just because a wife is the beneficiary of a discretionary trust that holds valuable assets, this does not automatically mean that the trust’s assets will not be treated as the wife’s property for the purpose of a property settlement claim brought by her husband in the family law courts.

The question of whether the assets of a discretionary trust should be treated as a party’s “property” for the purpose of their property settlement dispute is answered primarily by looking at the degree of control and influence that party has over the trust and the source and origin of the assets of the trust. If the assets of a trust are determined by the family law courts to be property of a party, then it is available for division between the parties in the court proceeding for property settlement orders. Family lawyers often refer to the totality of the property available for division in property settlement disputes as being the “property pool”.

Whether the assets of a discretionary trust form part of a property pool depends upon the facts and circumstances of each particular case, including the terms of the relevant trust deed. Typically, discretionary trusts will form part of a property pool where a party holds the role of appointor, trustee or beneficiary at the same time, particularly when they are the only appointor and trustee, due to the high degree of control that they self-evidently possesses in that scenario.

Factors considered by the court

When considering the degree of control and influence a party has over a trust, the family law courts will have regard for:

1. the benefits derived from the trust by the party such as drawings, loans, salaries, payment of expenses, use of motor vehicles etc;
2. the history of the party’s treatment of trust property;
3. the history of distributions made by the trust;
4. the past exercise of powers and the party’s involvement in variations or amendments to the trust deed;
5. the degree of affiliation and interests in the trust including the trustee (or directors of a corporate trustee), the appointor, the guardian etc;
6. the capacity of the party to borrow on trust funds;
7. how the trust property was acquired; and
8. the contributions made by the party (financial and non-financial) to the trust property.

It is not sufficient to say that the assets of a trust do not form part of the property simply because:

1. a spouse (or de facto spouse) party is not specifically named as a beneficiary in the trust deed. For example, the fact that a wife has the husband’s name removed or excluded as a specified beneficiary in the trust deed will have no bearing on whether or not the assets of the trust form part of the property pool (and in many typical trust deeds the husband will be captured under the definition of a default class of beneficiary anyway); and/or
2. a third-party family member, such as a parent or sibling, is the appointor or trustee of the trust. As indicated above, the family law courts will look behind the named roles of a trust and look at the actual reality of who is making decisions and who is deriving benefit from the trust.

Roles within a discretionary trust

It is worth considering how each of the different roles involved in the operation of a discretionary trust are likely to be viewed by the family law courts for the purpose of determining the property pool.

Appointor

The appointor of a trust (sometimes referred to as the “principal” in trust deeds) has the power to remove the trustee at any time and to appoint a new one. The power to remove a trustee and replace a trustee with another is generally regarded by the family law courts as indicating the trust is under the control of the person with that power. Where one of the parties has effective control of a trust in property settlement proceedings, the court has the power to deal with the property of the trust as though it were the property of the parties.

Trustee

A trustee of a trust has no proprietary interest in the assets of a discretionary trust other than bare legal title which is of no practical value.¹ Where the trustee is a company and one or both of the spouses own shares in that company, those shares are likely to have no value for the purpose of the property pool, if the company’s only activity is operating in its capacity as a trustee.

Beneficiary

The beneficiary of a discretionary trust (who does not control the trustee directly or indirectly) has a right to due consideration and to due administration of the trust. These rights are technically considered “property” for family law purposes, however, they are difficult to value when the beneficiary has no present entitlement and may never have any entitlement to any part of the income or capital of the trust. For this reason, these rights have historically been considered to have no practical value in property settlement proceedings. However, there is an emerging case law on this point that departs from this preconception.

Importantly, when considering the nature of a party’s interest held in a discretionary trust involving third parties, regard ought to be had to the following statement of the High Court of Australia in Kennon v Spry (2008) 238 CLR 366:

“The preceding conclusion does not involve some general extension of [the family law courts property settlement power] which would require that it be hedged about with protective discretions of uncertain application to prevent its intrusion into trust arrangements affecting assets foreign or extraneous to those acquired by the parties to the marriage in their own right. So if the husband were trustee of a charitable trust or executor of the will of a friend or client the mere legal title to the assets of such trusts, because of their origins and character, could not be regarded as part of the husband's property as a party to the marriage within the meaning of the Family Law Act.”

Trusts as third parties in a property settlement court proceeding

Since the Family Law Act 1975 was introduced, the powers of the family law courts to deal with third party interests have been extended including by virtue of:

1. its original jurisdiction to deal with companies, officeholders and shareholders under the Corporations Act 2001; and
2. its third party powers under Part VIIIAA of the Family Law Act 1975. This includes, subject to certain protections afforded to third parties in the legislation, the power to:
   • override anything in a trust deed or other instrument;
   • make a property settlement order binding a third party; and
   • make an injunction binding a third party, restraining it from doing a certain thing it would otherwise be entitled to do freely.

Whether it is necessary to involve a third party in family law litigation is not a choice—a third party’s involvement in a proceeding is mandatory if certain circumstances are met. In practice, this is not always immediately obvious and it is up to a spouse party in a family law dispute to carefully consider whether those circumstances are met in a given matter. Rule 3.01 of the Federal Circuit and Family Court of Australia (Family Law) Rules 2021 provides that:

"A person whose rights may be directly affected by an issue in a proceeding, and whose participation as a party is necessary for the court to determine all issues in dispute in the proceeding, must be included as a party to the proceeding”.

When it comes to discretionary trusts, when a spouse party brings a property settlement claim that, if successful, will affect the trust in some material way, it is usually the case that the trustee/s of the trust will need to be joined to the court proceeding before that claim can be determined by the court. The main reasons for the trustee/s needing to be joined are that they are the person/s with power to control the trust and because trustees in general have fiduciary duties to act in the best interests of beneficiaries (which includes defending the assets of the trust against claims). Examples of trustees of discretionary trusts needing to be joined to a proceeding include:

1. where there are multiple trustees of a discretionary trust who must make distribution decisions by majority and where orders are sought by a spouse party compelling those trustees to make certain decisions that will benefit their property settlement outcome;
2. where a decision made by a trustee—for example a significant transaction is entered into to dispose of trust property or a significant distribution is made to an arm’s-length beneficiary—is challenged by a party who seeks that the family law courts unwind that decision;
3. where injunctive relief is sought that would restrain the ability of a trustee to make certain decisions.

Protecting trust interests during litigation

There are a range of strategies that trustees can employ when joined or threatened with being joined to a family law proceeding, including strategies that:

1. require the party making the claim affecting the trust to, at their own expense, properly plead their case;
2. limit the trustee’s involvement in the court proceeding to the bare minimum, including with respect to their involvement in the disclosure/discovery process and being dragged through years of litigation until a trial between the two spouse parties; and
3. maximise the prospect that legal costs can be recovered by the trustee against the spouse party, if the spouse party’s claim against the trust is ultimately unsuccessful;

The law relating to the joinder of third-parties to family law litigation is complex and specialist family law advise at the earliest opportunity is essential.

Practical considerations for trust structures

Discretionary trusts continue to be valuable wealth management and asset protection tools. However, their treatment in family law disputes is often misunderstood. The family law courts are concerned with the practical reality of control, influence, and benefit as opposed to the formal structure of a trust or the titles recorded in a trust deed. As a result, trust assets may in some circumstances be treated as property available for division between parties to a family law dispute, notwithstanding that those assets are held by a trustee and not by a spouse personally.

Equally, where orders sought in a property settlement dispute may affect the rights, powers or obligations of a trust, the trustee and other relevant parties may need to be joined to the proceedings. This can expose trustees and beneficiaries to significant cost, complexity and litigation risk, even when they are not themselves parties to the underlying relationship breakdown.

For families, trustees and advisers, the key lesson is that trust structures should be considered well before any dispute arises. Careful drafting, governance and administration of trusts remain important, but they are not a substitute for obtaining specialist family law advice where a relationship breakdown has occurred or is anticipated. Early advice can assist in identifying potential risks, protecting trust assets and ensuring that all affected parties understand their rights and obligations before positions become entrenched.

¹Karllson & Karllson [2014] FamCA 571 per Dawe J at [28].