The Supreme Court’s decision in Clayton v Clayton – What does this mean for the family trust?

Friday, June 3, 2016

The law relating to relationship property and trusts has always been complicated, particularly as lawyers try to challenge the validity of trusts when dividing property after a relationship has ended. The latest word from the Supreme Court is in two decisions in respect of one family, in Clayton v Clayton.[1]

Background

Mr and Mrs Clayton began their relationship on 1986, married in 1989, separated in 2006, and divorced in 2009. They had two daughters together.

Shortly before they married, the Claytons signed a contracting out agreement. Under that agreement, Mrs Clayton was to receive a maximum of $10,000 for each year of marriage up to a maximum of $30,000. At the time, Mr Clayton owned a small timber supply business and a block of land near Rotorua. By the time they separated, Mr Clayton had built up a significant sawmilling and timber processing business.

The Claytons’ assets were primarily held in a number of trusts, settled during and after their relationship. For the purposes of the court proceedings, the principle claims were against the Vaughan Road Property Trust (VRPT) and the Claymark Trust. These trusts were each established by Mr Clayton during the marriage. He was the sole settlor, principal family member and sole trustee of the more extreme VRPT. He was also the settlor and one of two trustees of the more conventional Claymark Trust.

After the Claytons’ relationship ended, the contracting out agreement was set aside by the Family Court, deciding that giving effect to the agreement would cause serious injustice. Court proceedings then turned to the extent to which Mrs Clayton could claim assets held in the trusts.

Challenging the trusts

In relation to the VRPT, Mrs Clayton claimed that the trust was either a sham trust or an illusory trust, and therefore the assets of the trust still belonged to Mr Clayton and could be taken into account in the division of relationship property.

In the alternative, if the VRPT was valid, then Mrs Clayton claimed that the rights and powers held by Mr Clayton under the trust deed themselves amounted to property within the definition of the Property (Relationships) Act 1976 (PRA).

Mrs Clayton also argued that the Claymark Trust was set up during the marriage and that she had an expectation of benefit under the trust, and that the Claymark Trust was therefore a nuptial trust in terms of section 182 of the Family Proceedings Act 1980 (FPA).

Sham v illusory trust

In deciding whether the VRPT was a sham trust, the Supreme Court reiterated its finding in Ben Nevis,[2] that “a sham is a pretence: a document that does not evidence the true common intention of the parties.” They decided that:

“We do not consider that Mr Clayton’s reliance on his advisors in relation to the VRPT and his lack of knowledge of the legal ramifications of the trust structure and the terms of the trust deed itself leads to the conclusion that the VRPT deed is a sham. Mr Clayton’s reliance on his advisors does not indicate any lack of intent on his part to create a trust, nor does his lack of knowledge of the legal detail.”

Mr Clayton had intended to create a trust when he established the VRPT, and therefore it is not a sham.

The Supreme Court also noted that despite submissions to the contrary:

“there is no basis to extend the sham concept to encompass a trust created under a document that was not intended to be a pretence but that the Court considers is otherwise reprehensible in some way.”

The Supreme Court went on to consider whether, as claimed, the VRPT was an illusory trust. They said that:

“we observe that a finding that a trust deed is not a sham does not seem to us to preclude a finding that the attempt to create a trust failed and that no valid trust has come into existence. That would lead to a finding that the trust is illusory, to use the terminology adopted in the Courts below. For our part we do not see any value in using the “illusory” label: if there is no valid trust, that is all that needs to be said.”

The Supreme Court decided that “the issue would be whether the powers held by Mr Clayton were so broad that what he intended to be a trust was not, in fact a trust.” Nevertheless, because they concluded elsewhere in the judgment that the powers held by Mr Clayton were relationship property, they did not need to determine whether or not the VRPT was illusory.

The VRPT was therefore a valid trust.

Are the powers to manage a trust “property”?

The Supreme Court also looked at the extent of control that Mr Clayton had over the VRPT, through the powers that he exercised, and whether these powers were property within the definition of the PRA.

Property is defined[3] as including real property, personal property, any estate or interest in any real property or personal property, any debt or any thing in action, and any other right or interest.

The Supreme Court noted that:

“the PRA must be interpreted in a manner that reflects the statutory context. We see the reference to ‘any other right or interest’ when interpreted in the context of social legislation, as the PRA is, as broadening traditional concepts of property and as potentially inclusive of rights and interests that may not, in other contexts, be regarded as property rights or property interests.”

In respect of the VRPT, Mr Clayton had the following powers:

  • in his capacity as “Principal Family Member”, a power of appointment under clause 7.1 to appoint or remove discretionary beneficiaries;
  • in his capacity as Trustee, a power:
  • under clause 6.1(a) to pay or apply all or any part of the capital of the trust to any one or more of the discretionary beneficiaries (allowing him to pay or apply the entire trust capital to himself);
    • under clause 10, to bring forward the vesting date (which, if exercised together with the power to appoint all trust capital to himself, would give Mr Clayton both legal and beneficial ownership of the capital, and bring the trust to an end);
    • under clause 8.1, to resettle the trust fund on the trustees of another trust, if one or more of the discretionary beneficiaries is a beneficiary of that trust (which would allow the resettlement on a trust of which Mr Clayton is the sole beneficiary);
    • under clause 11.1, to exercise any power or discretion without considering the interests of all beneficiaries; and
    • under clause 19.1, the authority to exercise any power or discretion notwithstanding any conflict between the interest of the Trustee and the duty of the Trustee to the beneficiaries; and
  • in his capacity as Trustee who is also a beneficiary, a power under clause 14.1 to exercise any power or discretion in his own favour.

The Supreme Court said that:

“These provisions mean that Mr Clayton is not constrained by any fiduciary duty when exercising the VRPT powers in his own favour to the detriment of the Final Beneficiaries. The fact that he cannot remove the Final Beneficiaries does not alter the fact that he can, unrestrained by fiduciary obligations, exercise the VRPT powers to appoint the whole of the trust property to himself.”

They went on to record that a “general power of appointment is usually viewed as tantamount to ownership and can be treated as property for particular purposes.” The Supreme Court decided that while the power under clause 7.1 was not on its own a general power of appointment which would allow Mr Clayton to effectively revoke the trust:

“the combination of powers and entitlements of Mr Clayton as Principal Family Member, Trustee and Discretionary Beneficiary of the VRPT amount in effect to a general power of appointment in relation to the assets of the VRPT.”

These powers were therefore considered to be property, and as the trust was established during the relationship and the powers were acquired at that point, the property was relationship property, to be divided between Mr and Mrs Clayton.

The Supreme Court also acknowledged that if the assets of the VRPT were such that they would have been separate property but for having been settled on the trust, it may have been necessary to consider whether section 13 of the PRA applied. This section provides for unequal division of property in accordance with contributions to the marriage in cases of extraordinary circumstances that make equal sharing repugnant to justice. The Court concluded there was clearly no basis to do that in this case, as the assets would have been relationship property but for their ownership by the VRPT.

The Supreme Court distinguished the VRPT from a trust with similar provisions in Financial Markets Authority v Hotchin[4]. In Hotchin, the trust had a prohibition on self-dealing, and the power to appoint and remove was held by a trustee rather than a non-trustee.

Having decided that the powers in the trust are property, the Supreme Court carried on to deal with the question of the value of the powers. It decided that:

“As Mr Clayton can appoint the assets of the VRPT to himself at any time, we see no reason to differentiate the value of the power to do this from the value of the assets to which the power relates. Indeed, some cases relating to general powers of appointment say that the power gives the donee of the power an interest tantamount to ownership of the assets to which the power relates. Treating the VRPT powers as having a value equal to that of the assets to which they apply can be seen as consistent with that approach to general powers of appointment.”

The value of the powers was therefore equal to the value of the net assets of the trust in this case, although the Court observed:

“We leave for another case what would the position be if the VRPT powers were less extensive: both the issue as to whether the powers were property and, if so, how they would be valued”

This argument, that powers under a trust deed can sometimes equate to a property interest, could also have potential future application in the creditor/debtor context. If a creditor who is owed money can establish that the debtor has control of a family trust to the extent that the assets in the trusts name could be viewed as a property interest in his hands, then failure of the debtor to pay his or her debts may result in an application for bankruptcy whereby all of the debtor’s property, including control of that family trust, could potentially pass to the Official Assignee on bankruptcy.

Section 182 of the FPA – Nuptial settlement

Mrs Clayton challenged the more conventional Claymark Trust in a different way, claiming that it was a nuptial settlement. If that is the case, then pursuant to section 182 of the FPA, the court may make any orders it chooses to in respect of the property settled on that trust. This is a true “trust busting” provision. The Supreme Court’s decision has clarified and potentially extended the section’s application and this is possibly the most important practical aspect of the decision.

The lower courts had all held that the Claymark Trust was set up for business purposes, and therefore was not a nuptial trust. They also held that because the Claytons had entered into a contracting out agreement, Mrs Clayton had no expectations from the trust at the time that it was settled.

The Supreme Court disagreed with the courts below and found that there was a nuptial settlement. They considered there to be a two-tiered approach: first whether there was a nuptial settlement, and secondly whether, and how, the court should exercise its discretion to make orders.

In considering whether or not there was a nuptial settlement, the Supreme Court referred to the Court of Appeal’s decision of Ward v Ward,[5] which the Supreme Court said decided that:

“to come within the term ‘settlement’ as used in s 182, any arrangement must be one that ‘makes some form of continuing provision for both or either of the parties to a marriage in their capacity as spouses, with or without provision for their children’. It was also made clear that discretionary family trusts can be settlements for the purposes of s 182.”

They went on to say that:

“the requirement that the settlement be for both or either of the parties ‘in their capacity as spouses’ as meaning only that there must be a connection or proximity between the settlement and the marriage. Where there is a family trust (whether discretionary or otherwise) set up during the currency of a marriage with either or both parties to the marriage as beneficiaries, there will almost inevitably be that connection.”

The Court also said that a “generous approach to the issue of whether a settlement is a nuptial settlement is required”, and that the exercise of deciding whether the settlement is nuptial or not is primarily one of construction of the settlement documentation. They noted that if a trust benefits children of the marriage, that is a strong indication of it being a nuptial settlement.

In contrast, if the trust is set up by a third party and there are substantial other beneficiaries apart from the parties to the marriage and their children, then it is more arguable that it is not a nuptial settlement.

The Supreme Court therefore decided that because the Claymark Trust was settled by Mr Clayton during the marriage and just after the birth of the Clayton’s second child, it was a nuptial settlement.

Responding specifically to the suggestion that if the trust was set up for business purposes it would not be a nuptial settlement, the Supreme Court said that:

“counsel were unable to point to any cases where the nature of the assets settled was seen as relevant to the question of whether or not the settlement was a nuptial settlement. Indeed, it would make no sense to have such a restriction. If the aim of a settlement is to provide for the parties to the marriage and their children, then it would not be unusual that income earning (including business) assets form at least part of the settlement.”

The Supreme Court also indicated that a nuptial settlement can include an ante-nuptial settlement; however the test may be more difficult if the settlement is before the marriage and there is no particular spouse contemplated. The Supreme Court did leave it open to be argued that once a marriage has taken place and the spouse identified, there may be the necessary connection with the marriage for it to be classified as a nuptial settlement.

Having determined that the Claymark Trust was a nuptial settlement, the Supreme Court could then exercise its discretion as to whether to make any orders in respect of the assets of the trust. They recorded that:

“Nuptial settlements are premised on the continuation of the marriage or civil union. The purpose of s 182 is to empower the courts to review a settlement and make orders to remedy the consequences of the failure of the premise on which the settlement was made. Each case will require individual consideration.”

The Supreme Court indicated that the subjective expectations of the parties at the date of settlement of the trust was no longer the relevant test. They confined their previous decision in Ward to its own facts and said that the correct application of the test required the Court to make an objective assessment of what the applicant would have received from the trust if the marriage continued and compare it to what the applicant’s current position was now that the marriage is dissolved.

In exercising the discretion the Supreme Court indicated that you need to look at how:

“the applicant, as part of the family unit, would have continued to benefit directly or indirectly from the trust. This of course includes any current distributions to the family that the trust provides, as well as possible future distributions, including in the case of need.”

The Court confirmed that there should be no formulaic or presumptive approach, and that each case will require individual consideration.

In exercising the discretion, particular attention must be paid to the interest of dependent children. Children’s interests, both long term and short term are a primary consideration. For example, distributions to a child have obvious benefits for the parents, as they reduce the parents’ household expenditure.

If the assets in a trust are sourced from a third party or from separate property then that may be a relevant factor in the exercise of the discretion and the quantum of the award but it does not prevent the trust from being classified as a nuptial settlement.

A well thought out contracting out agreement which cross refers to the trust under consideration is always the best way of protecting against a section 182 claim, because section 182 specifically precludes the court from using the section to defeat a contracting out agreement. In Clayton however the Supreme Court was able to use section 182 because the contracting out agreement had been set aside.

Although not required to make an order, as the Claytons settled between themselves shortly before the judgment was released, the Supreme Court said that they would have made orders to split the Claymark Trust equally into two separate trusts.

Where to now?

The principal effect of the Clayton decision is that it will leave a number of more extreme family trusts more vulnerable to attack. Clayton continues the recent growing trend of courts at all levels to try to ensure that assets accumulated by partners during long relationships are shared more equitably whether they are held in trusts or not.

There is now a question of whether that trend has gone too far. One of the consequences of the logic adopted in Clayton is that it is the putting of assets in a trust during the relationship that creates the potential for a claim that otherwise may not have existed, despite the long-standing position that people put assets into a trust to protect them from a claim.

As a result of the Clayton decision, individual outcomes will be more difficult to predict with any certainty and cases are therefore less likely to settle.

Where the parties were married or in a civil union, the chances of bringing a successful claim under section 182 against a traditional succession planning trust which was settled during the relationship has also increased. However, having not kept pace with other legislation, section 182 of the FPA does not apply to de facto relationships.

Work is currently underway to revamp New Zealand trust law with a new Trusts Act, and the Law Commission has commenced a review of the Property (Relationships) Act. Any changes to the legislation could again change the way that trusts are deal with, particularly in the relationship property context. However, any changes could still be a number of years away.

In the meantime, there are a number of things that you can do to prevent Clayton type arguments. Reviewing the terms of your trust is important. Consideration should be given to obtaining a contracting out agreement or reviewing your existing contracting out agreement to ensure that it will stand the test of time.

If you have any questions about the powers contained in your family trust or any other potential for claims on the assets of the trust, contact a member of our trusts team.

 

[1] Clayton v Clayton [2016] NZSC 29 and Clayton v Clayton [2016] NZSC 30

[2] Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289

[3] Section 2 of the Property (Relationships) Act 1976

[4] Financial Markets Authority v Hotchin [2012] NZHC 323

[5] Ward v Ward [2009] NZCA 139, [2009] 3 NZLR 336

 

Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.

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