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University of Otago Law Theses and Dissertations |
Last Updated: 13 April 2024
Unlimited Self-Benefit ‘Trusts’? A Fiduciary-Centric Analysis of the Illusory Trust Doctrine.
Jonathan McLeay
October 2023
A dissertation submitted in partial fulfilment of the requirements of the degree of Bachelor of Laws (Honours) at the University of Otago – Te Whare Wānanga o Ōtākou.
Acknowledgements
Firstly, I would like to thank Professor Jessica Palmer for challenging me and guiding me in the completion of this dissertation. You have never failed to make me a priority amongst your incredibly busy schedule and for that I am profoundly thankful.
Secondly, to my family. To Mum and Dad you have constantly encouraged me and looked out for me in all my endeavours. Thank you for your kind words, proofreading and prayers. To Will and Lucy, your friendship and support as siblings is greatly cherished and I will miss you dearly next year.
Thirdly, to my friends. You all make day to day life in Dunedin so much fun. The lunches, dinners, Bible studies and adventures with all of you have energised me and spurred me on in the completion of this dissertation. Special thanks to Ben, George, Hayley and Matson for being such incredible flatmates.
Fourth, to the community at Leith Valley Church. You have been my home away from home for the last five years and I am deeply thankful for the many ways you have blessed me over the years. A bonus shoutout to my Junior Youth crew, long days in the library are more bearable when I get to spend Fridays and Sundays hanging out with you.
Finally, to Lydia. Thank you for sticking by me through all the highs and lows of the year. Your support means the world to me and I genuinely could not have done this without you.
Table of Contents
Introduction
It is tempting to frame this dissertation with a wide-reaching statement about the pervasiveness of the modern discretionary trust and how the effects of that spark moral outrage in many. One such example is the following quotation from a paper by the Tax Justice Network entitled Trusts: Weapons of Mass Injustice. Here, the prevalence of trusts is said to have resulted in:1
...one set of rules for the rich and powerful, and another set of rules for the rest of us. The time has come for our societies to start pushing back against this system, which worsens inequality, facilitates endless crimes and market abuses, and undermines democracy.
Ultimately though, this dissertation does not seek to make a moral claim. Instead it addresses one element of the legal complexity that has arisen from the development of trusts in such a way as to seemingly threaten their fiduciary character. This is a problem that is confronting courts in common law jurisdictions but has not yet been solved.2 Overlying this issue is the emerging concept of an illusory trust. This doctrine is one means through which courts may address particularly egregious attacks on trust fundamentals by declaring that a deed which claims to be a trust is in fact not a trust at all.3 While the dissertation draws on material from throughout the common law world, it has a particular focus on the New Zealand context especially in light of the Trusts Act 2019.
The illusory trust question is often asked when the presence of a valid trust has the effect of limiting another party’s rights in relation to the property held on trust.4 Property held on discretionary trust is distinct from property beneficially owned and therefore does not form part of an individual’s property pool.5 In many cases, this means property held on trust cannot be accessed by an individual’s creditors or ex-partner and will be assessed differently by tax and other public authorities.6 This is the case when it comes to discretionary trusts because no one person has a fixed interest in the trust property. Instead the discretionary beneficiaries
1 Andres Knobel Trusts, Weapons of Mass Injustice (Tax Justice Network, February 2017) at 6.
2 Mark Bennett “The Illusory Trust Doctrine: Formal or Substantive” (2020) 51 VUWLR 193 at 219-211.
3 Graham Virgo “Abuse of Trust” in Richard Nolan, Tang Hang Wu and Man Yip (eds) Trusts and Private Wealth Management: Developments and Directions (Cambridge University Press, Cambridge, 2023) 285 at 294.
4 See for example Clayton v Clayton [2013] NZHC 309, [2013] 3 NZLR 236.
5 Law Commission Dividing relationship property – time for change? (NZLC IP41, 2017) at 431, n 32.
6 See Chapter I.
have only a mere hope or expectation that they receive trust property.7 However, this position often appears to be completely arbitrary when one party retains effective control over the assets.
It is often said that, when exercising their discretions, trustees are bound by fiduciary obligations to the beneficiaries.8 Fiduciary obligations ensure that the trustee uses their powers for the benefit of the beneficiaries and not for themselves.9 However, it is now well- established that settlors can make themselves both trustees and beneficiaries of trusts that they settle so long as they are not the sole trustee and beneficiary.10 When a settlor makes themselves both trustee and beneficiary, they are authorising a situation where they act to benefit themselves under the trust, but the law still distinguishes such a situation from ownership.11 One possible justification for this is that a trust which permits self-benefit does not permit unlimited self-benefit.12 On this approach, the relevant limit that remains is an underlying fiduciary duty that still requires some form of selflessness or un-selfishness in administering the trust.13
This dissertation views that claim as lacking substance and attempts to demonstrate that any claim that a trustee permitted to self-benefit is in any way constrained from distributing all of the property to themselves is merely empty rhetoric. Therefore, if the test for an illusory trust is one where enforceable fiduciary duties are needed to separate a trust from ownership, all trusts permitting self-benefit should be considered illusory.
Chapter I sets the scene by considering some of the reasons why trust law has evolved in such a way as for trusts permitting self-benefit to be commonplace. It also examines the nature of trusts where the illusory question has arisen and highlights some common features of those
7 Jessica Palmer and Charles Rickett “The Revolution and Legacy of the Discretionary Trust” (2017) 11 J EQ 157 at 160.
8 Jessica Palmer “Controlling the Trust” (2011) 12 OLR 473 at 479.
9 Tobias Barkley “Is the Trustee-Beneficiary Relationship Necessarily Fiduciary?” (Paper presented at Obligations VII, Hong Kong, 2014) at 2.
10 Trusts Act 2019, s 14.
11 Barkley, above n 9, at 1; Chief Commissioner of Stamp Duties v Buckle [1998] HCA 4; (1998) 192 CLR 226.
12 Bennett, above n 2, at 220.
13 Barkley, above n 9, at 4.
trusts. Finally, it discusses the uncertainty around current formulations for an illusory trust before zeroing in on the fiduciary angle.
Chapter II will examine what it means to be a fiduciary in order to explore what may remain of the fiduciary duty after duties not to conflict and not to self-benefit are excluded. This involves questioning when fiduciary relationships arise to isolate what exactly gives a relationship its fiduciary character. This analysis is then applied to modern discretionary trusts permitting self-benefit.
Chapter III addresses the enforceability question. It canvasses the respective mechanisms available to oversee and enforce a trust and how those mechanisms can give effect to certain trustee obligations with a specific emphasis on the fiduciary duties. This chapter aims to demonstrate that to take a “substance over form” approach, as equity often claims to do, requires recognition that there is no meaningful way to give effect to whatever fiduciary duties remain in a trust permitting self-benefit.14
Chapter IV turns to the applicability of these principles to trusts that have been the subject of recent judicial consideration. By applying the methodology from the dissertation to these trusts, the piece suggests that a fiduciary approach to the illusory trust question would render a substantial number of trusts illusory, not just those at the margin. This may suggest that the real problem is allowing trusts for self-benefit as opposed to any specific structuring of those trusts. The chapter concludes by highlighting some further issues with modern trusts that may still enable settlors to retain control of property they settle on trust even if they were prohibited from being trustee and beneficiary.
14 Harrison v Harrison (2008) 27 FRNZ 202 at [19].
Chapter I: Setting the Scene
When is a purported trust not a trust? For a structure so broad, so flexible and so complex this is a remarkably challenging question for our courts to address. The question has become increasingly important in a landscape where there are plentiful opportunities to use trusts to subvert the law.15 The opportunity for subversion arises because disposing of property to trust means that: 16
“the settlor and/or beneficiaries do not have the kinds of property rights that would make them liable to have that property taken from them to satisfy their debts, or counted as their property for the calculation of tax liability”
Subversion is particularly notable where the disposition to trust, which has the effect of frustrating non-trust property liability regimes, is in form only and functionally the settlor remains in complete control of their property.17 This dissertation focuses in on whether fiduciary obligations in trusts substantively change the way that property is held so that no one individual completely controls the trust property for themselves. To the extent that certain trust structures alter the ownership of property in form only, this author argues that those trusts are illusory.
The current litigation on the illusory trust question has arisen in situations where parties who have been prejudiced by the asset protection provided by trusts dispute the existence of a valid trust. Recognising trust structures that appeared to grant one party powers indistinguishable from ownership, plaintiffs have argued that the trusts in these cases were illusory because, among other things, they did not evidence an intention to relinquish control over the assets,18 or the beneficial interest in the assets lay with just one person.19 Courts have therefore had to question what, if anything, may separate such trusts from property beneficially owned. Understanding this inquiry first requires a deeper understanding of the reasons why people may choose to place their assets in trusts and some common features of those trusts.
15 Mark Bennett and Adam Hofri-Winogradow “The Use of Trusts to Subvert the Law: An Analysis and Critique” (2021) 41 OJLS 692 at 696-703.
16 Bennett and Hofri-Winogradow, above n 15, at 697.
17 Bennett and Hofri-Winogradow, above n 15, at 699.
18 Webb v Webb [2020] UKPC 22 at [69]
19 JSC Mezhdunarodniy Promyshlenniy Bank v Pugachev [2017] EWHC 2426 (Ch) [Pugachev] at [70].
This chapter begins with a description of some of the key incentives that settlors have to create trusts that they retain control over. It continues by characterising some key features of potentially problematic trusts with reference to some of the arrangements that have been the focus of recent case law. Finally, it briefly surveys the current uncertainty around what may make a trust illusory and identifies the fiduciary option to be analysed further.
It is worth noting from the outset that efforts are underway to close a number of loopholes that trusts have made use of in a way that may be viewed as contrary to public policy.20 However, it is difficult to understand the plethora of settlor-controlled trusts throughout New Zealand without an understanding of the incentives that drove their development. In 2010, the Law Commission published an issues paper setting out some of the common reasons for setting up a trust.21 Among the reasons identified were protecting property from relationship property claims, effective structuring for tax purposes, avoiding creditor claims and maintaining eligibility for certain state benefits.22 At the same time, there was an emerging social norm that every successful person should have a trust.23
Essentially, trust use may enable an individual to give the appearance of being poor to the world for certain legal purposes, and, if the settlor retains control over the assets, they may not actually suffer any of the difficulties associated with being poor.24 At this stage, a deeper delve into the uses of trusts will help to reveal why there is a problem in this space. This section focuses on incentives that may be relevant to situations where individuals are still seeking to retain control over assets they place into trusts to the exclusion of other reasons.
20 See for example the recommendations made in Law Commission Review of the Property (Relationships) Act 1976 (NZLC R143, 2019) at 277-293.
21 Law Commission Some Issues with the Use of Trusts in New Zealand (NZLC IP20, 2010).
22 At 10-13.
23 At 9.
Firstly, settling assets on trust can protect those assets from relationship property claims upon separation. The default position in New Zealand upon separation is equal sharing of relationship property.25 Typically, because of the distinction between property beneficially owned and property held in trust, trust property falls outside of the definition of relationship property.26 This means that trusts can be an effective way of limiting a partner’s rights to property upon separation without a contracting out agreement.27 An example of how trusts can shelter assets from relationship property claims can be found in Cooper v Pinney.28 In that case Marcus Pinney had separated from his de facto partner Raewyn Cooper and the pool of relationship property needed to be defined prior to division.29 The Court of Appeal upheld the High Court’s finding that property held by the MRW Trust, of which Marcus was both a trustee and a beneficiary, was not relationship property because Marcus’s powers to deal with that property were subject to fiduciary obligations.30 This prevented Ms Cooper from accessing any of the assets held in the trust.
The Act does provide mechanisms to ‘look-through’ trusts and account for trust assets in the division of relationship property in certain circumstances. Under s 44, the Act provides that dispositions, which includes dispositions to trust, may be set aside if the disposition was made with the intention to defeat the claim of any person. Alternatively, under s 44C, if a disposition to trust during the relationship has the effect of defeating one partner’s rights, the court can order that this is remedied through additional payments made to the prejudiced partner out of the remaining pool of relationship property, separate property or the income of the trust. However, this section does not enable property to be removed from the trust. Ultimately, these exceptions are relatively narrow and trusts remain a popular mechanism to ensure that only one party in a relationship can benefit from that property upon separation.31
25 Property (Relationships) Act (PRA) 1976, s 11.
26 PRA, s 2.
27 See PRA, s 21 for the contracting out procedure.
28 Cooper v Pinney [2023] NZCA 62, [2023] 2 NZLR 455.
29 At [9].
30 At [3] and [119].
31 Cooper v Pinney, above n 28, at [12].
Secondly, trusts can be an effective means of structuring assets to minimise tax liability. Trust income is assessed differently for tax than personal income which may provide benefits in certain circumstances.32 Notably, between 2001 and 2010 the tax rate for trusts was 33% while the top personal income tax rate was 39%.33 Historically, this was likely a strong incentive to utilise a trust to shelter income from higher tax rates.
Thirdly, trusts can be an effective way of shielding assets from creditors. As with relationship property claims, because trusts have the effect of alienating property from your personal asset base, creditors are prima facie unable to access property you have placed into trust.34 This position is what sparked the litigation in the Pugachev case. Mr Pugachev owned a bank called the Mehzprom Bank in Russia.35 In 2008, this bank collapsed and judgment was given against Mr Pugachev personally for around US $1bn as a result of the bank’s collapse.36 However, because Mr Pugachev had transferred many of his assets to trusts, the liquidators needed to argue that the trusts were invalid or illusory in order to be able to access the assets.37
Once again, there are exceptions to this position in New Zealand. For example, the Insolvency Act provides that insolvent transactions made by someone who later becomes bankrupt, which includes dispositions made to a trust, can be cancelled if the bankrupt was unable to pay their due debts at the time of the disposition and it was within six months of them being adjudicated bankrupt.38 The time limit is increased to two years if the transaction is with a related party which includes many forms of trust where the bankrupt is entitled to benefit.39 Ultimately though, these exceptions are narrow and do nothing to prevent trusts set up years in advance of any imagined financial difficulty from successfully shielding assets from creditors. When it comes to strong settlor control, this can create situations where individuals become bankrupt
32 Inland Revenue Trusts and Estates Income Tax Rules (IR288, 2020) at 15-20.
33 Law Commission, above n 21, at 10.
34 Law Commission, above n 21, at 13.
35 Pugachev, above n 19, at [7].
36 At [47].
37 At [71].
38 Insolvency Act 2006, ss 194-195.
39 Section 193A.
and leave their creditors without full repayment while still being able to provide financially for themselves using trust assets.40
Finally, trusts have been able to be used to retain eligibility for government assistance in certain cases. One notable example was the use of trusts to create eligibility for the residential care subsidy. This is a means-tested subsidy for those needing long term care.41 If your personal income and assets are below a certain threshold, you are eligible for the subsidy. Trusts have previously been an effective way to reduce assets below that threshold and to achieve eligibility for the subsidy.42
The notable thing about these incentives is that as primary motivators they rely on the settlor retaining a significant amount of control over the assets they settle on trust. For example, while individuals may want the tax benefits associated with a trust, many will also want to keep control of the assets and income being taxed. Similarly, in at least some cases, a settlor motivated by a desire to protect assets from any potential future relationship property claim would be seeking to retain the benefit of any property protected from a claim. Overall, this means there is often a heavy incentive on individuals to settle a trust but, in doing so, to structure it in such a way as to allow themselves to retain the benefit of the property even once it is in trust. The following section will canvass some examples from recent cases of ways that trusts can be structured in order to achieve this.
B Powers in Some Leading Cases
In Clayton v Clayton, a New Zealand case, Mr Clayton, as settlor, sole trustee, Principal Family Member and one of a number of discretionary beneficiaries had a wide range of powers under
40 Law Commission, above n 21, at 13.
41 Ministry of Social Development “Residential Care Subsidy” Work and Income
<www.workandincome.govt.nz/products/a-z-benefits/residential-care-subsidy.html>.
42 Law Commission, above n 21, at 12.
the Vaughan Road Property Trust (VRPT).43 Under the deed, as trustee, Mr Clayton could pay or apply all of the trust property to any one of the discretionary beneficiaries including himself.44 He could also resettle the trust assets to any trust where one or more of the discretionary beneficiaries was a beneficiary.45 In addition to these powers, there were multiple clauses restricting the duties that Mr Clayton as trustee was under when exercising these powers.46 He could exercise any one of these powers without considering the interests of all the beneficiaries or where it would be contrary to the interests of one of more of the beneficiaries.47 Mr Clayton was also able to exercise the powers in his own favour notwithstanding any conflict of interest.48 Furthermore, as Principal Family Member, he was able to appoint and remove discretionary beneficiaries and trustees.49
In the English case of Pugachev, Mr Pugachev retained a number of powers as ‘Protector’ despite not being a trustee. In fact, the trust deed prohibited any discretionary beneficiary from becoming a trustee and distributing to themselves.50 His powers as Protector included a veto power of trustee decisions such as distributions of income and/or capital from the trust fund, appointment and removal of discretionary beneficiaries and variations of the trust deed.51 As Protector he also had the powers to appoint and remove trustees and appoint further discretionary beneficiaries.52
In Webb v Webb, a case arising from the Cook Islands, Mr Webb was the sole-trustee of the Aorangi Trust.53 As trustee he could pay the whole of the capital and income to himself to the exclusion of any other beneficiary notwithstanding any conflict of interest.54 As trustee he
43 Clayton v Clayton [2016] NZSC 29, [2016] 1 NZLR 551 at [55].
44 At [53].
45 At [55].
46 At [56].
47 At [56].
48 At [56].
49 At [51].
50 Pugachev, above n 19, at [125].
51 At [115].
52 At [117].
53 Webb v Webb, above n 18, at [80].
54 At [82] and [84].
could and did appoint himself as Consultant which came with a number of powers including a power to replace the trustee, request the early vesting of the trust property and provide consent for the trustees to vary the trust deed.55 As settlor, Mr Webb also held the power to appoint himself as sole beneficiary to the exclusion of all the existing beneficiaries.56
Finally, in Cooper v Pinney, another New Zealand case, Mr Pinney, as trustee of the MRW Pinney Trust had the power to add and remove trustees without giving reasons.57 Notably though, the trustees of this trust could never be less than two. The trustees were empowered to appoint the trust income and/or capital to any discretionary beneficiary, including Mr Pinney himself, to the exclusion of others.58 Finally, trustees could exercise their powers to acquire trust property in their private capacity notwithstanding any conflict of interest.59 Interestingly, Mr Pinney was not the settlor but had been given his significant powers by others.
In each of these cases, the relevant court was asked to consider whether the trust was illusory. As the Supreme Court explained in Clayton, illusory trusts are not trusts at all and therefore cannot provide any of the legal privileges of a trust.60 The question is being asked of the courts precisely because of the benefits canvassed above. In each of the four cases mentioned above the plaintiff was disadvantaged because of the existence of a trust. Clayton, Webb and Cooper, all concerned relationship property claims, and Pugachev concerned creditors’ claims.
The cases also demonstrate a number of trends when it comes to trust drafting. Firstly, in Clayton, Cooper and Webb the trustees were entitled to make payments to themselves as beneficiaries to the exclusion of other beneficiaries. They were permitted to do so despite the inherent conflict of interest in exercising such a power. This is the power of primary interest to this dissertation. While commonly accepted, this dissertation questions whether such an arrangement is compatible with the fiduciary nature of a trust. Secondly, all of the cases included a power to appoint and remove trustees. In all the cases bar Cooper, this power was
55 At [81].
56 At [83].
57 Cooper v Pinney, above n 28, at [29].
58 At [31].
59 At [33].
60 Clayton v Clayton, above n 43, at [129].
held in a position other than trustee, arguably giving some degree of control over the trustees to people who may not owe fiduciary obligations. Finally, each case other than Cooper included powers to remove discretionary beneficiaries. This power could potentially be used to reduce the scope of who the trustees owe obligations to.
Broadly, the illusory trust question asks if the terms of the deed succeed in establishing a trust or whether they fail to do so because they are inconsistent with the essence of what we understand a trust to be. While each of the preceding cases examined if a trust was illusory, Mark Bennett pointed out that in each case the courts have applied slightly different lines of reasoning.61 Therefore, there is not yet a consensus understanding of what makes a trust illusory.
Armitage v Nurse is often cited as laying down the irreducible core of a trust. In that case Millet LJ stated:62
There is an irreducible core of obligations owed by the trustees to the beneficiaries and enforceable by them which is fundamental to the concept of a trust. If the beneficiaries have no rights enforceable against the trustees there are no trusts ... The duty of the trustees to perform the trusts honestly and in good faith for the benefit of the beneficiaries is the minimum necessary to give substance to the trusts.
While this is well accepted, it does not on its own provide sufficient detail for when a trust may be considered illusory. This is especially so given it was stated in the context of a dispute around an exemption clause so was not targeted specifically to a situation where a settlor has significant control over a trust.
Webb v Webb made a slightly different inquiry. The Privy Council in that case asked whether the powers reserved to Mr Webb were so extensive that his rights were indistinguishable from ownership.63 As part of that inquiry, they emphasized that there must be some constraint on the
61 Bennett, above n 2, at 219-221.
62 Armitage v Nurse [1998] Ch 241 at 253.
63 Webb v Webb, above n 18, at [89].
ability of the settlor to recover all the property for oneself in order for the settlor to have evidenced an intention to divest themselves of beneficial ownership.64 The two possible constraints mentioned were an enforceable fiduciary duty or a truly independent person. Mark Bennett has identified this as an unlimited self-benefit test and suggests that it could invalidate a significant number of trusts.65 In his view, this would make “any trust where the settlor is the sole trustee and may at any time make a capital distribution to himself” illusory.66 But is that really the case? In Webb v Webb, Mr Webb conceded that if he retained beneficial ownership there would be no trust, but nevertheless argued as a trustee he was still subject to fiduciary obligations including a duty to act in the best interests of all the beneficiaries.67 This would constrain his power to appoint and mean he did not have an unlimited power to self-benefit. Ultimately, the Court did not need to decide the issue because they found he held the power to appoint himself as sole beneficiary to be a personal power and therefore not subject to fiduciary obligations.68 They concluded the trust was illusory on this ground, but the question remains. Is there some fiduciary duty which remains even where trustees are entitled to distribute to themselves? If so, is it enforceable in such a way as to limit the ability to self-benefit so that even on an unlimited self-benefit test there must be more than the factors identified by Bennett to make a trust illusory.
That is the question this dissertation seeks to address. It considers, particularly, the unlimited self-benefit test and addresses the “enforceable fiduciary duty” element of that. Essential to answering that question is the nature of the fiduciary obligation and the following chapter examines that.
64 At [73].
65 Bennett, above n 2, at 220.
66 At 220
67 Webb v Webb above n 18, at [76].
68 Webb v Webb, above n 18, at [83].
Chapter II: The Fiduciary Duty
For centuries trusts have been regarded as the paradigm example of a fiduciary relationship.69 So prevalent is this understanding, that the relationship between trustee and beneficiary is cited in countless texts as exemplifying a fiduciary relationship.70 Given that, one would think you should be able to safely assume that a trust must be a fiduciary relationship. Yet, the terrain is more murky than one might expect. Traditionally the heart of the fiduciary relationship, obligation and duties have been defined by disinterested loyalty.71 This obligation of loyalty has been epitomized by the duties not to profit and not to act under a conflict of interest.72 However, it is now well-established in New Zealand that those duties are not essential to a valid trust.73 One response to this might be to claim that trusts no longer have to be fiduciary relationships.74 Alternatively, something more limited could be carved out of the fiduciary principle that remains essential to the nature of a trust and can be used as a criteria for trust validity. This chapter seeks to identify and isolate a duty of that nature and show how it may operate in a discretionary trust setting to constrain the ability to benefit oneself completely.
To reiterate, in Webb v Webb, Mr Webb argued that even though the trust deed allowed him to self-benefit and act notwithstanding any conflict of interest, he was still bound by other fiduciary duties.75 Evaluating this claim requires an inquiry into the scope of fiduciary duties. The chapter begins by outlining the different approaches to what duties are properly considered to be fiduciary. In doing so, it also examines the question of when fiduciary relationships arise to conclude that all fiduciaries must owe a duty to act in what they perceive to be the best interests of the beneficiaries.76 The chapter then goes on to apply this duty to discretionary trusts to see whether it is capable of restricting a trustee’s ability to benefit oneself.
69 Robert H Sitkoff “Fiduciary Principles in Trust Law” in Evan J Criddle, Paul B Miller and Robert H Sitkoff (eds) Oxford Handbook of Fiduciary Law 41 at 41.
70 See for example Andrew S Butler “Basic Concepts” in Andrew Butler (ed) Equity and Trusts in New Zealand (2nd ed, Thomson Reuters, Wellington, 2009) at 28; Lindsay Breach Nevill’s Law of Trusts, Wills and Administration (14th ed, LexisNexis, Wellington, 2023) at 4; Peter Devonshire Account of Profits (Thomson Reuters, Wellington, 2013) at 20 and Gerard Curry “Who is a Fiduciary and to Whom is The Duty Owed” in Fiduciary Relationships (New Zealand Law Society seminar, November 1986) 2 at 2.
71 Bristol & West Building Society v Mothew [1998] Ch. 1 CA at 18.
72 Bray v Ford [1895] UKLawRpAC 54; [1896] AC 44 HL at 51; Keech v Sandford [1726] EngR 954; (1726) Sel Cas T King 61, 25 ER 223.
73 Trusts Act 2019, ss 28, 34 and 36.
74 Barkley, above n 9, at 1.
75 At [76].
76 Lionel Smith “Can we be Obliged to be Selfless” in Andrew Gold and Paul Miller (eds) Philosophical Foundations of Fiduciary Law 141 at 148.
In Bristol and West Building Society v Mothew, Millet LJ stated “The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary.”77 This is fairly well accepted in the literature, but what that means in terms of fiduciary duties is still in contention. One question central to this debate is whether a fiduciary owes a duty to act in the best interests of the beneficiaries. That question is of utmost importance to an illusory trust criteria based on fiduciary duties because without it any trustee entitled to self-benefit could not properly be called a fiduciary. The positions of three authors, Matthew Conaglen, Paul Finn and Lionel Smith on this question will be addressed and evaluated in order to come to a conclusion on this question.
Matthew Conaglen in his text Fiduciary Loyalty, advocates that the only the proscriptive duties not to profit and not to act while under a conflict of interest are fiduciary duties.78 His identification of these duties alone as fiduciary duties stems from an approach that seeks which duties are peculiar to fiduciaries.79 This emanates from Millet LJ in Bristol who identified that not every breach of duty by a fiduciary is a breach of a fiduciary duty.80 Conaglen goes on to identify only the conflict and profit principles as unique to fiduciaries. He argues that these duties are universally applicable to fiduciaries and are not applied to actors in other situations.81 In contrast, he argues that other potentially fiduciary duties, including the duty to act in good faith in the principal’s best interests, are not peculiar to fiduciaries. His argument against this as a fiduciary duty characterizes the duty as an extension of the duty to perform the task undertaken. He also says that although this duty may apply to certain fiduciary duties such as company directors it does not apply to all fiduciaries. For other fiduciaries, such as trustees, he says that their actual duty is to perform the trust according to the deed. Therefore, they must only act in the best interests of the beneficiaries “insofar as the trust deed so provides.”.82
77 Bristol & West Building Society v Mothew, above n 71, at 18.
78 Matthew Conaglen Fiduciary Loyalty: Protecting the Due Performance of Non-Fiduciary Duties (Hart Publishing, Oxford and Portland, Oregon, 2010) at 39.
79 At 32.
80 At 16.
81 At 39.
82 At 57.
Conaglen’s position is consistent with judicial authority in Australia which supports the proscriptive duties only approach. The judgment of Gaudron and McHugh JJ in Breen v Williams stated:83
equity imposes on the fiduciary proscriptive obligations – not to obtain any unauthorized benefit from the relationship and not to be in a position of conflict. ... But the law of this country does not otherwise impose positive legal duties on a fiduciary to act in the interests of the person to whom the duty is owed.
Under this approach, the characterization of a relationship as fiduciary does not prescribe anything that the fiduciary must do; that is governed by the specific undertakings of the parties which impose, on Conaglen’s view, non-fiduciary duties.84 Therefore, the essential duties of a fiduciary relate to the circumstances at the time the task was undertaken (conflict principle) and the prohibition of self-benefit (profit principle) but do not create a duty to act in a certain way or with a certain motive.
The implication of this analysis is that those who do not owe the duties to avoid a conflict of interest and not to profit do not owe fiduciary duties. Now, according to Finn “It is not because a person is a fiduciary that a rule applies to him. It is because a particular rule applies to him that he is a fiduciary.”85 Therefore, trustees not owing these duties would not be fiduciaries. If someone is authorised to act notwithstanding conflict and to self-benefit from their position, Conaglen’s view leaves no room for an underlying fiduciary duty. Trust law in New Zealand no longer recognises these rules as necessary for the formation of trust.86 Therefore, acceptance of this view would be inconsistent with the idea that a trust is a fiduciary relationship. There are however legitimate critiques that can be made to this approach which would appear to undermine it.
The first critique is the identification of the duties that are or are not peculiarly fiduciary. As Lionel Smith points out, it is not in fact only fiduciaries who owe a duty to act under a conflict
83 Breen v Williams (1995) 186 CLR 71, at 113.
84 Conaglen, above n 78, at 61-62.
85 Paul Finn Fiduciary Obligations (The Law Book Company, Sydney, 1977) at 2.
86 Trusts Act, ss 28, 31, 34 and 36.
of interest.87 In fact, no conflict clauses may be quite common in employment contracts or other agreements, but that does not make the employee a fiduciary. Smith's position suggests that Conaglen has merely conveniently picked examples that back up his position. Similarly, Conaglen’s rejection of the best interests duty partially rested on the fact that it was a composite duty made up of the duty of good faith, the duty to act for a proper purpose and the duty to perform the task undertaken.88 However, as Smith argues, if the composite duty is unique to fiduciaries then it should be recognised as a uniquely fiduciary duty.89
The second critique is that Conaglen’s method of identifying fiduciary duties by reference to their peculiarity is a flawed way of identifying fiduciary duties. The method treats fiduciary relationships as being defined by the unique duties owed as opposed to resting on something deeper inherent to the nature of a fiduciary relationship. A contrasting view would see fiduciary duties as those that flow out of the fiduciary relationship.90 The fiduciary relationship then sets the scope of the duties that are owed with reference to the inherent features of that relationship.
Under this view, duties that are necessary to give effect to a fiduciary relationship could be properly characterized as fiduciary duties. Most notably, if the best interests duty is a necessary duty to have formed a fiduciary relationship, then it is a fiduciary duty. So, when Conaglen argues that trustees, as fiduciaries, only owe a duty to act in the best interests of the beneficiaries insofar as the deed requires, this fails to recognise that if the deed does not require them to act in the best interests of the beneficiaries, they are not fiduciaries. Therefore, to classify the duty to act in the beneficiaries best interests as a non-fiduciary duty because it is dependent on the agreement of the parties misunderstands that the agreement of the parties is part of what makes the agreement fiduciary.
Paul Finn’s text, Fiduciary Obligations, takes a different approach to the best interests duty. In Chapter Three Finn identifies the fiduciary obligation as such; “A fiduciary must act honestly in what he alone considers to be the interests of the beneficiaries.”91 Despite this, Finn does not
87 Lionel Smith “Prescriptive Fiduciary Duties” (2018) 37 UQLR 261 at 269.
88 Conaglen, above n 78, at 54-58.
89 Smith, above n 86, at 268, n 37.
90 Smith, above n 86, at 273.
91 Finn, above n 85, at 15.
characterize this as a duty. Instead, Finn highlights eight specific duties that fall under and give effect to the general obligation. These duties are separated into two groups. The first group ensures that a fiduciary exercises their discretion. Among these duties are a duty not to delegate discretions92 and a duty not to act under another’s dictation.93 The second group directs the fiduciary in exercising that discretion for the benefit of the beneficiaries by prohibiting certain actions. This group includes a duty not to act for his own benefit, or for the benefit of any third person94 and a duty to treat beneficiaries equally where they have similar rights.95
In Finn’s view these duties recognise that a court cannot determine what is in the best interests of the beneficiaries, and therefore focus on prohibiting situations which are said to not be in the beneficiaries’ interest.96 Courts are therefore always asked to undertake a negative inquiry which focuses on the results of fiduciary action as opposed to the motive behind it. Notably, Finn does not suggest that each of the duties identified are fiduciary duties, that would take much too wide of an approach, instead he focuses on how the duties interact to give effect to the broader obligation. This creates an issue in that it is unclear at what point the exclusion of some of these duties means that someone exercising a power is no longer doing so in a fiduciary manner. In fact, on Finn’s approach the exclusion of any one duty may appear to undermine the obligation. There are once again, however, legitimate critiques that can be made to this view.
Finn views acting in the best interests of the beneficiaries as an obligation, but not a duty on fiduciaries. The first issue with this view is that the obligation ends up being defined by the extent to which the specific duties apply and wilts proportionately when any one of them is excluded. Without an underlying duty to act in the best interests of the beneficiaries what is to guide a fiduciary in delegating their discretions if they are permitted to do so? Similarly, what is to guide a fiduciary in their decisions when they are permitted to self-benefit? Finn appears to recognise this issue when discussing self-benefit. Here, Finn recognises that many fiduciaries are allowed to benefit themselves but suggests that fiduciaries in those situations
92 Chapter 5 at 20.
93 Chapter 6 at 21.
94 Chapter 11 at 47.
95 Chapter 12 at 56.
are subject to a further limitation in which they cannot act with the sole purpose of benefitting themselves.97 While this is presented as simply being part of the self-benefit rule, it is perhaps more properly understood as resting on an underlying duty to act in the best interests of the beneficiaries as a whole.
Secondly, Finn’s approach does not address motive but merely results. Lionel Smith argues that the duty of loyalty at the heart of fiduciary obligations cannot be understood in terms of results because its proper focus is the manner in which one acts.98 By not recognising the best interests obligation as a duty, it could be argued that Finn has lost sight of the core duty that all the other duties grow out of.99 Therefore, while Finn’s work may be helpful in understanding how the fiduciary obligation is given effect to, it fails to pinpoint the heart of the fiduciary duty.
Lionel Smith has written a great deal about fiduciary duties and the obligation to act in the best interests of the beneficiaries. At times he has described this as a duty,100 at others a requirement101, and at others a legal norm.102 This section uses his writings to argue that there is an underlying duty of loyalty in all fiduciary relationships. The proper articulation of that duty is a duty to act in what the fiduciary perceives to be the best interests of the beneficiaries.103 Properly understood, loyalty is not results based, so one who is negligent is not necessarily disloyal.104 Instead, loyalty is about exercising powers with the right motive.105 In this way, it does not prescribe any particular course of action, but whether the fiduciary decides to act or not to act, they must do so loyally.106
97 At 91.
98 Lionel Smith “The Motive, Not the Deed” in J Getzler (ed) Rationalizing Property Equity and Trusts: Essays in Honour of Edward Burn (2003) 53 at 65.
99 Smith, above n 98, at 67.
100 Smith, above n 98, at 65-66.
101 Lionel Smith “Fiduciary Relationships: Ensuring the Loyal Exercise of Judgement on Behalf of Another” (2014) 130 LQR 608 at 609.
102 Smith, above n 75, at 157.
103 Smith, above n 98, at 63 and Smith, above n 101, at 611.
104 Bristol & West Building Society v Mothew, above n 71, at 18.
105 Smith, above n 98, at 13.
106 Smith, above n 75, at 148.
That is not to say that the duty of loyalty never requires action. As Geraint Thomas points out, although the law does not require that the best interests of the beneficiaries actually be served, the best interests of the beneficiary still serves an important role as the target of the fiduciaries consideration.107 It is the outcome that the efforts of the fiduciary must be directed towards.108 This means loyalty requires more than merely avoiding certain situations or results.109 A fiduciary who sits at home with the blinds drawn could not be said to be loyal albeit they may also have breached their separate duty of skill and care.110
The existence of this duty is also reinforced when considering the scope of the proscriptive rules identified by Conaglen. It is now well-accepted that these duties can be excluded by trust deeds, however it would be absurd to say that if a fiduciary is permitted to act while under a conflict of interest, they are entitled to completely prefer their own interest to the exclusion of others. Instead, even where permitted to transact with oneself, a fiduciary must only do so in a way that advances the interests of the beneficiaries as a whole.111 This is because the duty to act in the best interests of the beneficiaries continues to lie behind the specific conflict rule. It is a foundational duty from which many other duties flow, but it remains a duty in of itself.112 This underlying duty also explains why we permit fiduciaries to get approval from the court for situations involving a conflict because the court can exercise its judgement to ensure the decision was in the best interests of the beneficiaries as separate from whether it occurs in circumstances with a temptation to prefer self-interest over duty.113 The existence of this duty as the core duty in fiduciary relationships is also backed up by considering when fiduciary relationships arise and that is the question to which this chapter turns next.
B The Nature of Fiduciary Relationships
Another way to justify the best interests duty is to suggest that such a duty is essential for the categorization of a relationship as fiduciary. Broadly speaking, fiduciary relationships arise
107 Geraint Thomas “The duty of trustees to act in the ‘best interests’ of their beneficiaries” J EQ 177 at 183.
108 Thomas, above n 107, at 184.
109 Smith, above n 98, at 59.
110 Smith, above n 87, at 268.
111 Thomas, above n 107, at 194.
112 Thomas, above n 107, at 186.
113 John Langbein “Questioning the Trust Law Duty of Loyalty: Sole Interest or Best Interest?” (2005) Yale LJ 929 at 933.
where one person undertakes to act in the interests of another.114 More specifically, they are relationships where one has undertaken to act on behalf of another.115 In entering a fiduciary relationship the fiduciary must have bound themselves in some way to protect and/or advance the interests of another.116 What this demonstrates is that it is fundamental to the existence of a fiduciary relationship, that the fiduciary owes a duty to act in the best interests of another.
To unpack that idea a little more, some have argued that the undertaking is an essential stage and fiduciary duties are therefore quasi-contractual in nature.117 However, this overlooks that equity does impose certain default rules on fiduciaries who are part of a class of recognised fiduciaries,118 and that fiduciary relationships can be found as a matter of fact according to the circumstances.119 So an undertaking is not necessary. Alternatively, Paul Miller has argued that fiduciary relationships arise when one holds discretionary power over the significant practical interests of another.120 However, this does not emphasize that the fiduciary must have bound themselves somehow to act in the interests of another. They are so bound either because of an undertaking, which could be implied from the nature of their position, or because equity says they are bound in the circumstances.121 Therefore, a hybrid definition where you hold discretionary power over the significant practical interests of another, and you have bound yourself to exercise that power for the benefit of that other is the best descriptor of when a fiduciary relationship arises. In those circumstances, equity will impose certain default rules such as the conflict and profit principles. However, the fundamental and essential duty that necessarily exists by nature of its definition, is the duty to act in what they perceive to be the best interests of the beneficiaries.122
To conclude on this point, fiduciary duties are those that control the exercise of discretion on behalf of another. The duty of loyalty is essential to a fiduciary relationship and requires that discretions be exercised in what the fiduciary perceives to be the best interests of the
114 Breen v Williams, above n 83, at 137 per Gummow J.
115 Smith, above n 87, at 267.
116 Finn, above n 85, at 9.
117 See John Langbein “The Contractarian Basis of the Law of Trusts” (1995) 105 Yale LJ 625 and James Edelman ‘When do Fiduciary Duties Arise?” (2010) 126 LQR 302.
118 Paul Miller “The Fiduciary Relationship” in Andrew Gold and Paul Miller (eds) Philosophical Foundations of Fiduciary Law 63 at 64.
119 Chirnside v Faye [2006] NZSC 68, [2007] 1 NZLR 433 at [82] per Tipping J.
120 Miller, above n 118, at 69.
121 See Stephen Laing “Two forms of the fiduciary relationship” (LLB (Hons) Dissertation, University of Otago, 2013) at 14-22 for discussion of the circumstances where equity will say an individual is bound.
122 Smith, above n 101, at 611.
beneficiaries. The proscriptive duties are simply a means of giving effect to the underlying duty. So even where those duties are excluded, the underlying duty remains.
C Fiduciary Duties in a Discretionary Trust
Having recognised that the core fiduciary duty essential to all fiduciary relationships is the best interests duty, the application of that duty to discretionary trusts where the deed permits the trustee to benefit oneself and act with a conflict of interest needs consideration. It is first important to differentiate between management powers and dispositive powers in a discretionary trust. Management powers relate to the holding of property on behalf of the beneficiaries.123 For these purposes, trustees have all the powers of an absolute owner of property.124 Trustees must exercise these powers in the best interests of the beneficiaries as a whole regardless of whether the proscriptive duties are present.
Dispositive powers allow the trustees to pay or apply trust income and capital out of the trust to an object of that trust.125 It is these powers that must be constrained in some way to provide a meaningful distinction between trust powers and absolute ownership. If they are not, then a trustee could at any time apply the whole of the trust property to themselves and become the absolute owner.126 This was the issue identified in Webb v Webb and was why the Court attempted to identify if there was any enforceable fiduciary duty preventing Mr Webb from appointing all of the property to himself.127 Therefore, it must be asked whether the best interests duty of loyalty can attach to dispositions of property under a discretionary trust.
At the point of distribution for a discretionary trust, it is inherent that a trustee cannot act in the best interests of all the potential beneficiaries. This is because disposition requires choosing between beneficiaries.128 It also often requires choosing between beneficiaries in the strict sense of that term, who have a vested or contingent right,129 and objects of a discretionary
123 Chris Kelly and others Garrow and Kelly: Law of Trusts and Trustees (8th ed, LexisNexis, Wellington, 2002) at 607.
124 Trusts Act, s 56.
125 Kelly, above n 123, at 31.
126 Webb v Webb, above n 18, at [73].
127 Webb v Webb [2017] CKCA 4 at [56].
128 Smith, above n 98, at 17.
129 Lionel Smith “Massively Discretionary Trusts” (2017) 70 CLP 17 at 21.
dispositive power.130 Therefore, the law says that in exercising dispositive discretions, trustees must exercise them according to the purpose for which the power was granted.131 This may appear to give the settlor ultimate control over distribution of trust assets because the only guiding feature is their purpose. So, if they always intended to be able to retrieve the property, then as trustee the automatic distribution to themselves when convenient would surely be in accordance with the purpose of the settlor. This is reinforced by the fact that non-trustee settlors can continue to influence the workings of the trust after settlement through letters of wishes.132 However, letters of wishes are only relevant in so far as they are not inconsistent with the purposes of the trust as expressed through its terms.133
The above concerns assume that the settlor’s purpose is unrestrained. It is not. A fiduciary relationship requires being bound to act for another. Therefore, to make the trust fiduciary, there must be an intention to create an instrument capable of benefitting others. The certainty of intention requirement requires an intention to create a trust.134 Section 13 of the Trusts Act defines a trust as a fiduciary relationship. So, to create a valid trust the settlor must have intended for the trustee to hold property for the benefit of others. Although it is now accepted those ‘others’ can include themselves, it must go further than that. The duty of loyalty requires loyalty to someone other than yourself.135 This is also reflected in s 14 of the Trusts Act which states that the sole trustee cannot be the sole beneficiary.
The purpose of the trust, which informs how trust assets are distributed, must then have a fiduciary nature and require the consideration of the interests of another. Therefore, when s 26 makes it a mandatory duty for a trustee to act for the benefit of the beneficiaries according to the terms of the trust, the terms of the trust must in some form require at least genuinely considering benefitting a beneficiary who is not the settlor/trustee. Lucas Clover Alcolea has suggested the Act is not quite so clear because s 24 also makes it a mandatory duty to act in accordance with the terms of the trust, which may create difficulties if the terms of the trust are not for the benefit of the beneficiaries.136 However, because s 13 requires a trust to be a
130 Lionel Smith “Mistaking the Trust” (2011) 40 HKLJ 787 at 793.
131 Vatcher v Paull [1915] AC 372 (PC) at 379; McPhail v Doulton [1970] UKHL 1; [1971] AC 424 (HL(E)) at 449; Re Beatty
[1990] 1 WLR 1503 (Ch D) at 1506.
132 Chambers v S R Hamilton Corporate Trustee Ltd [2017] NZCA 131; [2017] NZAR 882 at [36].
133 Kain v Public Trust [2021] NZCA 685 at [136].
134 Kelly, above n 123, at 58
135 Smith, above n 101, at 609.
136 Lucas Clover Alcolea “‘Reform, Reform: Aren’t things bad enough already?’ The case of the Trusts Act 2019” (2023) 17 J EQ 93 at 107-110.
fiduciary relationship, the terms of the trust must at least purport to be for the benefit of the beneficiaries, if they do not, it is possible the trust will be illusory as Alcolea himself recognises.137
D Fiduciary Constraints When Making Distributions in Practice
Finally, this chapter turns to consider how fiduciary constraints may operate in practice when a trustee comes to make distributions from a trust. Three scenarios are considered. Firstly, a trust with trustee prohibited from benefiting themselves or acting under a conflict of interest. Secondly, a family trust, allowing self-benefit, designed to benefit the members of that family. Thirdly, a family trust, again allowing self-benefit, designed to protect assets.
Trustees prohibited from benefitting themselves are best placed to exercise their dispositive discretions fairly, according to the purpose of the trust. This is because the proscriptive duties imposed on them prevent them from being swayed by self-interest and so they have no incentive to make distributions in any way other than according to the purpose of the trust.
In the second scenario, the proscriptive duties are not in play. The trustee is entitled to act for their own benefit. This will often arise in family trusts where the settlor names themselves as trustee and one of the beneficiaries.138 However, in these scenarios the overarching duty of loyalty remains because it is present in the purpose of the trust. So, where the purpose of the trust is to provide for family members, the trustee must consider the interests of all the family members permitted to benefit under the trust and make a decision about what the best use of the trust property is. They must have genuinely considered and given weight to the prospect of benefitting someone other than themselves and therefore have acted with the motive of benefitting the beneficiaries as a whole. This demonstrates loyalty as opposed to automatically distributing to oneself when they want the property. In other words, despite being entitled to benefit themselves, they are being asked to exercise their discretion in the same way an independent trustee would.
137 At 110.
138 McLaughlin v McLaughlin [2021] NZHC 3015 at [339].
In the third scenario, a settlor trustee’s real intention in settling the trust was to protect their assets with no desire to benefit anyone other than themselves. The ability of the trustee to distribute to themselves would therefore be unfettered by the purpose of the trust. Unfortunately for the settlor, their intended purpose for their trust is inconsistent with an intention to create a trust because it excludes any fiduciary element. Protecting assets cannot then be the purpose of a trust. Dagan and Samet have suggested that trusts designed to avoid the liabilities of property ownership cannot be justified under a liberal property regime.139 This is because they operate in a way that “other property types appropriately render impossible.”140 Bennett and Hofri-Winogradow have further explained how conventional justifications for trusts fail to account for their uses to subvert the law.141 The courts have also taken note of this, with the Privy Council in Pugachev paying particular attention to the unscrupulous individual and the opportunity to manipulate trusts for their own benefit while never really intending to lose control of the property.142 These purposes are therefore rightly excluded by the fiduciary requirement in establishing a trust.
Ultimately then, the fiduciary duty of loyalty expressed as a duty to exercise powers in what the trustee perceives to be the best interests of the beneficiaries is an essential element of a trust. It endures even when the proscriptive duties are excluded by the trust deed and is present at the distribution stage of a trust through its necessary incorporation into the purpose of a trust. In theory, this restrains a trustee from appointing the entire trust property to themselves, however the courts must maintain a sense of worldly realism and so it is also necessary to consider the enforceability of this duty before we can safely say it differentiates discretionary trusts from beneficial ownership.143
139 Hanoch Dagan and Irit Samet “What’s Wrong with Massively Discretionary Trusts” (2022) 138 LQR 629 at 654.
140 At 647.
141 Bennett and Hofri-Winogradow, above n 15, at 708-713.
142 Pugachev, above n 19, at [179].
143 Clayton v Clayton, above n 43, at [79]. The need for “worldly realism” was emphasized in relation to relationship property disputes in this case but is worthy of wider applicability as explained in Chapter III.
Chapter III: Enforcement Mechanisms
Having concluded that behind the proscriptive fiduciary duties is the best interests duty of loyalty that must be owed by all fiduciaries, the ability to enforce that duty will now be considered. This chapter begins by looking at the importance of enforcement before turning to the possible means of enforcement and how they might apply to modern discretionary trusts.
The enforcement of duties is necessary to give them any weight. When trustees breach their duties, their actions can be challenged in court and if found to be in breach appropriate remedies can be awarded. This not only rectifies the breach but it demonstrates to the trustee that their conduct will not be tolerated and incentivises them not to breach their duties again. This is what makes the duty meaningful. However, an unenforceable duty provides no such protection. The trustee can breach the duty with no consequences because the court is unable to enforce it. The following two examples demonstrate the importance of enforcement in the law of trusts generally.
The beneficiary principle demonstrates the need for a trust to be enforceable. This principle, which requires certainty of the objects of a trust, was laid down in Morice v Bishop of Durham on the basis that the court must be able to assume control over a trust.144 In order to do so, they must know who the beneficiaries of the trust are. The rationale for the principle has more recently been rearticulated on the ground that there must be beneficiaries to enforce the trustees responsibilities.145 Although the strict nature of the beneficiary principle has been relaxed from needing a complete list of the beneficiaries to a requirement of certainty as to whether a particular individual is or is not a member of the class, the rationale behind the rule remains.146
144 Morice v Bishop of Durham [1804] EngR 177; (1804) 9 Ves 399 at 404.
145 Re Astor’s Settlement Trusts [1952] 1 All ER 1067 at 1071.
146 McPhail v Doulton, above n 130, at 456.
The importance of enforceability is also supported by decisions relating to exclusion clauses and the limits the courts have placed on those. In Armitage v Nurse, the Court was asked to consider the validity of an exclusion clause providing that trustees were not liable for any loss to the trust fund unless it was caused by actual fraud.147 Actual fraud required proof of dishonesty and did not include constructive nor equitable fraud.148 The Court found the exemption clause was valid. However, they noted that if an exemption clause purported to exclude liability for dishonesty it would be invalid.149 Honesty was part of the minimum core of obligations owed by trustees.150 To exclude liability for dishonesty would be equivalent to not requiring it at all and that could not be tolerated. This also demonstrates the importance of enforcement within the law of trusts.
Writing in 1977, Paul Finn highlighted the difficulties of enforcing a duty to act in the beneficiaries’ best interests. While acknowledging the obligation to do so, he suggested that to use that criteria as the basis for judicial review would be extremely challenging.151 The difficulty was primarily because it was not the court’s role to determine what was in the interests of the beneficiaries.152 However, as explained in Chapter II, the inquiry is one as to motive not to results to determine a breach of the duty. The following part of this chapter canvasses the potential means for enforcing the duty of loyalty at the point of distribution to inform the appropriate boundaries of modern trust practice and how illusory trusts could be identified.
The first, and perhaps most effective means of enforcing the duty to act loyally towards the beneficiaries at the point of distribution are the default, proscriptive duties not to act while
147 Armitage v Nurse, above n 62, at 241.
148 At 250.
149 At 253.
150 At 253.
151 Finn, above n 85, at 15.
152 At 16.
under a conflict of interest and not to self-benefit.153 While there is debate about the exact justification for these duties, with some arguing they do not serve a protective function, this section will demonstrate how these duties can be used to enforce loyalty to the beneficiaries at the point of distribution of a trust.154 It is acknowledged that these duties are only default duties under s 28 of the Trusts Act and can be excluded by the trust deed. If, however, it becomes apparent by the end of this chapter that they are the only effective means of enforcing the duty of loyalty, the defensibility of allowing these duties to be excluded at the point of distribution will be called into serious question.
It is also necessary to point out that any trust deed that permits a trustee to appoint trust property to themselves whether as sole trustee or one of many trustees excludes these duties. This is because there is an inherent conflict between the trustee’s self-interest and duty in being able to choose to appoint to themselves and appointing property to themselves is obviously a form of self-benefit.
Conaglen provides a helpful analysis of how these duties work as an enforcement mechanism for other duties.155 While Conaglen did not recognise the duty to act in what the fiduciary perceives to be the best interests of the beneficiaries as a fiduciary duty, his analysis can nevertheless be applied to demonstrate how these default duties work to enforce the underlying best interests duty. But first, each duty needs to be considered.
(i) Duty to Avoid a Conflict of Interest
The duty to avoid a conflict of interest requires a trustee not to act in a situation where there is a conflict between their personal interest of their duty to a third party and the interests of the beneficiaries as a whole.156 The rule is based on the need to avoid the danger of a person being “swayed by interest rather than duty” to ensure the beneficiaries are protected.157
153 The duty not to self-benefit is a more appropriate description of the duty not to profit when it comes to distributions from a trust which is the focus of this dissertation. The duty is also recorded as a distinct default duty in s 31 of the Trusts Act alongside the duty to avoid a conflict of interest and not to profit at ss 34 and 36. 154 See for example, Deborah A DeMott “Disloyal Agents” (2007) 58 Ala.L.Rev 1049 discussed in Conaglen, above n 78, at 100.
155 Conaglen, above n 78, at 61.
156 Finn, above n 85, at 199 and 252.
157 Bray v Ford, above n 72, at 51.
The duty is strictly applied. It rests on the mere possibility of conflict and does not require evidence that the conflict in any way swayed the decision.158 Devonshire suggests that this may have been tempered or eroded somewhat since the decision in Boardman v Phipps where liability lay on the mere possibility of conflict.159 However, at most the duty has been reduced to one where there is a real sensible possibility of a conflict which is still a relatively strict standard.160 The rule is also not dependent on evidence of further wrongdoing. The focus is on the temptation and not the actual breach of an additional duty the fiduciary is bound to respect. An action becomes invalid for the very reason that it occurred in circumstances where the temptation inherent in a conflict existed.161
(ii) Duty not to Self-Benefit
There is also a default rule not to self-benefit.162 By preventing a fiduciary from acting for their own benefit, the duty ensures that the trustee is bringing an open mind to the discretions they have to make and fairly considering who they should act in favour of. The moment a trustee is allowed to benefit from their own actions they face a temptation to skew the decision-making process and ensure their interest is prioritized to the utmost and this cuts across their duty of loyalty.
In practice, if these two duties were not excluded from a trust deed, a trustee permitted to benefit under the trust would have to remove themselves from decisions to distribute which would involve the potential to benefit themselves and in which conflicts are inherent.163
What this demonstrates is that the duties serve a protective function in the performance of other duties such as the best interests duty of loyalty. They work to protect against breach by ensuring that fiduciaries do not even act when they have the temptation to breach their other duties because of their self-interest.164 This purpose also explains why the rules are ‘over-inclusive’
158 Boardman v Phipps [1966] UKHL 2; [1967] 2 AC 46 (HL) at 103.
159 Devonshire, above n 70, at 22.
160 Queensland Mines Ltd v Hudson [1911] ArgusLawRp 95; (1978) 18 ALR 1 (PC) at 5.
161 De Bussche v Alt [1878] UKLawRpCh 107; (1878) 8 ChD 286 (CA) at 316.
162 Finn, above n 85, at 47.
163 Conaglen, above n 78, at 63.
164 Conaglen, above n 78, at 62.
or prophylactic and apply even in situations where a breach of an additional duty has not occurred. As Conaglen explains:165
They capture situations in which no true wrong has been committed – or at least in which it is not clear that any such wrong has been committed – in order to be sure that they also capture situations in which wrongs have occurred.
The rationale for these wide proscriptive duties lies in the difficulty of proving impropriety in relation to the other duties such as the best interests duty.166 So when one is acting under a conflict of interest, it is difficult to know if they exercised their power in a way that genuinely considered the benefit of all the beneficiaries or instead with the sole ends of benefitting themselves. Therefore, traditional fiduciary doctrine has imposed these proscriptive duties to ensure the fiduciary is acting in the best interests of the beneficiaries.167 However, the existence of these duties is now fundamentally inconsistent with the form of many family trusts because they often depend on trustees who are also beneficiaries.168 Naturally, when it comes to dispositive powers, a trustee who cannot benefit themselves is best placed to exercise their discretion soundly, honestly and loyally.169 That does not mean that conflicted trustees cannot fulfil their duty of loyalty. However, if conflict is permitted, there must be some other mechanism to ensure enforceability of that duty. This chapter now turns to the possible ways of doing so in the absence of the proscriptive duties.
The next place to turn is the mandatory duties in the Act. If these provide a means of enforcing the duty of loyalty then that duty can be properly relied upon to provide a limit on self-benefit under a settlor controlled trust differentiating it from ownership because they can never be excluded. The mandatory duties expressed in ss 25, 26 and 27 of the Trusts Act will be considered in turn.
165 At 68.
166 Conaglen, above n 78, at 69.
167 Smith, above n 98, at 56.
168 McLaughlin v McLaughlin, above n 138, at [339]. See also Adam Hofri-Winogradow “The Irreducible Cores of Trustee Obligations” (2023) LQR 311 at 334 where Hofri categorizes such trusts as non-fiduciary.
169 I J Hardingham and R Baxt Discretionary Trusts (2nd Ed, Butterworths, Melbourne, 1984) at 93.
(i) The Duty to Act in the Best Interests of the Beneficiaries
The duty to act in the best interests of the beneficiaries may appear on face value to be the perfect duty to enforce the best interests duty of loyalty.170 However the way it has been applied by the courts does not incorporate the need to act for someone other than yourself which is key to the fiduciary element of a trust. Instead, the courts primarily uphold this duty through the doctrine of fraud on a power.171 This doctrine ensures that trustees do not exercise their power in favour of someone who is not in the class of beneficiaries.172 However, it does not regulate the motive of the trustee when choosing between beneficiaries. Therefore, this duty, as currently interpreted, cannot provide a means to enforce the best interests duty of loyalty.
(ii) The Duty to Act Honesty and in Good Faith
The duty to act honestly and in good faith is a lot more promising. In fact, it is this duty that Lionel Smith considered the duty of loyalty was most analogous to when he was articulating his version of the duty.173 In the same way as the duty of loyalty, the duty of good faith is primarily concerned with a state of mind. The test is aimed at whether the trustees have genuinely exercised their discretion according to the purpose for which it was conferred, but does not look to the ultimate outcome of that decision.174 So in Armitage v Nurse Millet LJ emphasized that if trustees deliberately breached the terms of the trust but did so in the honest belief that it was in the best interests of the beneficiaries they would not be acting fraudulently.175 However, if trustees were automatically making distributions to themselves without considering the needs of all the beneficiaries capable of benefitting, then it could be said they were acting in bad faith.
Barkley has argued that this restriction does not substantially restrict the ability of a trustee to self-benefit.176 While this paper concedes that is true to the extent that a trustee could in some circumstances appoint all the trust property to themselves in good faith, they can only do so
170 Trusts Act, s 26.
171 Kelly, above n 123 at 505.
172 Kain v Hutton [2008] NZSC 61; [2008] 3 NZLR 589 at [46]- [47].
173 Smith, above n 98, at 55, n 12.
174 Karger v Paul [1984] VicRp 13; [1984] VR 161 per McGarvie J.
175 At 251.
176 Barkley, above n 9, at 19.
after a real and genuine consideration of the interests of all of the beneficiaries. That is a restriction, albeit one based on motive and not outcome. An appointment made in bad faith would be voidable and, subject to a few exceptions unlikely to apply to a trustee beneficiary,177 could be pulled back into the trust until a proper discretion was exercised.178 The recent Australian case of Owies v JJE Nominees demonstrated this principle when the Court found that distributions of income were voidable because the trustee had not genuinely considered the interests of two estranged children who were beneficiaries under the trust.179 Therefore, good faith appears to be a viable enforcement mechanism, but it runs into evidential difficulties to be considered later in this chapter.
(iii) The Duty to act for a Proper Purpose
The final mandatory duty that might play a role in the enforcement of the best interests duty is the duty to act for a proper purpose.180 Crucially, this duty is tied to the purpose of the trust as indicated by the terms of the trust.181 So when the terms of the trust provide a number of discretionary beneficiaries who could benefit under the trust, the purpose must be taken to have intended for those person’s interests to be considered when distributions are being made. Although the proper purposes rule is broader than the best interests duty, because the purpose of a New Zealand trust must be to benefit the beneficiaries, the rule overlaps significantly with the best interests duty when it comes to trusts.182 Thus, Lord Nicholls has said the best interests duty is simply a different formulation of “a trustee’s obligation to promote the purpose for which the trust was created.”183 It may therefore be argued that if a trustee acts for the sole purpose of benefitting themselves as opposed to furthering the purpose of the trust (which may include benefitting themselves) they are acting with an improper purpose.
The issue with this argument is it does not align with the way the courts apply the duty. The proper purpose doctrine primarily focuses on authorised ends as opposed to motive in
177 See for example Peter Birks Unjust Enrichment (Oxford University Press, the United States, 2003) at 188 for discussion of the change of position defence.
178 Pitt v Holt [2013] UKSC 26, [2013] 2 AC 108 at [99].
179 Owies v JJE Nominees Pty Ltd [2022] VSCA 142 at [130].
180 Trusts Act, s 27.
181 Bank of New Zealand v Bank of New Zealand Officers Provident Association Management Board [2003] UKPC 58, [2004] 1 NZLR 577, at [21].
182 Thomas, above n 107, at 191-192.
183 Lord Nicholls “Trustees and their Broader Community: Where Duty, Morality and Ethics Converge” (1996) 70 ALJ 205 at 211.
achieving that ends.184 Kain v Hutton provides an example of this. There, the Court inquired as to whether the purpose of an appointment to an object of the trust, Mrs Couper, was actually to benefit non-objects, her children.185 If so, the appointment would have been a fraud on a power.186 However, the Court was not prepared to consider an argument that the appointment was fraudulent because it was intended to shut out the other beneficiaries.187 What this demonstrates is when considering the scope of a power according to its purpose, the courts focus is on whether the intended result was one of the results permitted by the purpose of the trust and not on whether the motive in exercising the power was to give effect to the purpose of the trust.
Therefore, the mandatory duty to act in good faith appears to be the only mandatory duty that could be used to enforce the best interests duty of loyalty. However, the only way to consider if trustees have properly exercised their discretion by giving real and genuine consideration to the best interests of the beneficiaries permitted to benefit under the trust is through an examination of the decision-making process. This is substantially hindered by the general principle in trust law that trustees are not required to give reasons for their decisions.188 However, there are theoretical exceptions to this principal if trustees have exercised their powers in bad faith or with improper motives.189 These exceptions support the idea that the duty of good faith could be used to enforce the best interests duty. The exceptions have recently been called into question by the Trusts Act which excluded “reasons for decisions” from the definition of trust information.190 Despite this, McCrae has convincingly argued that this does not prevent the court from ordering disclosure of reasons in certain circumstances. The crux of her argument centres around the purpose of exclusion being to remove reasons for decisions from the presumption of disclosure under s 52 of the Act as opposed to preventing the court exercising its inherent jurisdiction to order disclosure of reasons in certain circumstances.191
184 Thomas, above n 107, at 192.
185 At [13].
186 At [17].
187 At [16].
188 Erceg v Erceg [2017] NZSC 28, [2017] 1 NZLR 320 at [55]; Foreman v Kingstone [2004] 1 NZLR 841
(HC) at [99]; Re Londonderry’s Settlement [1965] Ch 918 at 928.
189 Rebekah McCrae “Has the Trusts Act 2019 Abrogated the Court’s Inherent Jurisdiction to Order Disclosure of Reasons for Trustees’ Decision to a Beneficiary?” (2022) 53 VUWLR 45 at 50.
190 Trusts Act, s 49.
191 At 58.
Despite the existence of the exceptions, they appear unlikely to operate in a way that allows enforceability of the best interests duty. This is because as McCrae puts it:192
“there would have to be evidence of some breach of conduct duty by the trustee that would justify release of such information. This may be, for example, where the trustee has acted in bad faith or in pursuit of a self-serving interest.”
The issue here is that the only initial evidence to support an inference that the trustee acted in bad faith would be in the reasons themselves which are not initially available. The only other evidence available may be the decision to appoint to oneself which, so long as it is permitted by the trust deed, could not alone provide evidence of misconduct. The difficulty of finding evidence to meet this threshold is likely to be the reason there are no documented instances of the jurisdiction being exercised.193
Courts are also entitled to draw inferences from a failure of trustees to provide reasons, however they have generally shown an unwillingness to do so.194 Therefore, “in the face of a wall of silence erected by [a] fiduciary” aggrieved beneficiaries face a near insurmountable challenge to prove impropriety.195 Ultimately, this means that the best interests duty of loyalty cannot be enforced effectively by the mandatory duties. Although the duty of good faith may be capable of capturing situations where a trustee has not loyally exercised their powers, it is generally powerless against the sort of unscrupulous trustee mentioned in Pugachev who is very deliberately running a scheme entirely for the benefit of themselves.196
This conclusion holds despite the existence of the occasional case where trustees were found to be in breach of duty for failing to genuinely consider all of the beneficiaries. The Owies case is a recent example of this. However, the occasional crystallization of successful enforcement of the duty does not undermine the finding that it is generally incapable of enforcement. The uniqueness of the decision in Owies serves to emphasize this point. A key reason relied on by the Court was the lack of any inquiry by the trustees about the circumstances of two of their
192 At 60.
193 McCrae, above n 189, at 50.
194 Finn, above n 85, at 42; Owies v JJE Nominees Pty Ltd, above n 179, at [119].
195 Finn, above n 85, at 42.
196 Pugachev, above n 19, at [174].
children who were beneficiaries of the class.197 This meant the trustees were unable to effectively hide behind the protection of not needing to give reasons, which was expressly affirmed by the Court, because their lack of knowledge meant they simply could not have exercised their powers in what they believed to be the best interests of the beneficiaries as a whole.198 This sort of reasoning would not be available to a court asked to consider a distribution made to oneself in an ordinary family trust where the trustee is at least aware of the circumstances of the other beneficiaries. Therefore, the Owies case does not negate the conclusion that the best interests duty of loyalty is for the most part unenforceable and therefore essentially meaningless.
The final potential means of enforcing fiduciary loyalty is through the use of an independent trustee. The analysis here focuses in on the use of independent trustees alongside trustees who are entitled to benefit themselves. In one sense, the presence of an independent trustee recognises that a trustee beneficiary is likely to be swayed by self-interest but the independent trustee can act to ensure the trust operates for the benefit of all the beneficiaries and that proper discretions are exercised in regard to distributions.
Webb v Webb noted independent trustees as a separate form of constraint on a trustee that could inhibit unlimited self-benefit and validate a trust.199 Ultimately, what this dissertation sees as essential to the validity of the trust is its fiduciary component. Therefore, only if independent trustees can effectively ensure that trusts operate as fiduciary relationships will they be viewed as an effective enforcement mechanism.
The theory behind independent trustees as an effective enforcement mechanism relies on the default duty of trustees to act unanimously.200 For so long as that duty is in place, trustees who are also beneficiaries cannot simply appoint to themselves without the consent of the independent trustee. That nature of an independent trustee means that they will not be under any inherent conflicts and therefore are well placed to exercise their discretions in a manner
197 Owies v JJE Nominees Pty Ltd, above n 179, at [115].
198 At [119].
199 Webb v Webb, above n 18, at [73].
200 Trusts Act, s 38.
that is loyal to the beneficiaries. Therefore, even if certain trustees are permitted to self-benefit, the independent trustee should be able to hold them accountable to their core fiduciary duty and ensure all the beneficiaries are considered. While effective in theory, this position needs a reality check to see if it holds up in practice. Two distinct reasons suggest that independent trustees cannot be relied upon.
Firstly, when exercising their discretions in a discretionary trust, the long-accepted principle has been that trustees must do so according to the purpose of the trust.201 Settlors are also permitted to continue to wield some influence over the trustee’s discretions through non- binding letters of wishes.202 Although this control is not technically absolute, because the purpose of the trust must have a ‘fiduciary’ element and letters of wishes cannot be inconsistent with that, in practice settlors who are also trustees and beneficiaries are likely to exercise effective control over the trust. An independent trustee sitting alongside the settlor of a trust as a trustee, knowing their powers should be exercised according to the settlor’s purpose in creating the trust are likely to feel obliged to simply acquiesce to the desires of the settlor trustee.
Even in situations where the trustee beneficiary is not the settlor, an express provision in that deed allowing that trustee to exercise powers to benefit themselves reads as effectively unconstrained to the independent trustee. There does not appear to be a mandate requiring them to prevent this until a proper decision making process has occurred given that one of their other mandatory duties is to act in accordance with the terms of the trust.203 It is relevant that independent trustees are unlikely to be acting dishonestly in doing so, they are simply consenting to the use of a power the trust deed expressly includes. This demonstrates the real difficulty in the claim that there is something further restraining a trustee from appointing to themselves in situations where the deed excludes the proscriptive duties.
Now, this is not to say that these actions would not put the independent trustee in breach of the best interests duty articulated in Chapter II. However, it demonstrates that independent trustees cannot be relied on in and of themselves as an enforcement mechanism. The breach would still
201 McPhail v Doulton, above n 131, at 449.
202 Smith, above n 129, at 25.
203 Trusts Act, s 24.
need to be proved under the duty of good faith which is difficult for the reasons previously expressed.
Secondly, even if an independent trustee was determined to exercise their independent judgement and not just agree with the trustees who were entitled to benefit themselves, many trusts now also include a power for the settlor to add or remove trustees. Each case discussed in Chapter I included such a power. The recent case of Legler v Formannoij demonstrates how a power of that nature could further undermine any utility an independent trustee might have.204
Legler concerned the decision of a Ms Formannoij to appoint a corporation controlled by her as the sole trustee of the Kaahu Trust.205 Ms Formannoij subsequently used that corporate trustee to remove other beneficiaries and appoint property to herself which was not prohibited by the trust deed when there was a corporate trustee.206 The Court primarily concerned itself with the question of whether Ms Formannoij’s decision to appoint the corporate trustee was for the improper purpose of evading the legal limits on benefitting herself.207 Ultimately, the Court found it was not for an improper purpose.208 This was because she had been advised that even though she would have the power to benefit herself she would still be subject to the overarching duty to act in the best interests of the beneficiaries and she accepted that advice.209 Ms Formannoij’s later use of the power to exclude other beneficiaries and appoint to herself was a separate issue and not evidence of her intention in appointing the corporate trustee.210
This case demonstrates the ease of avoiding the effects of an independent trustee in cases with a power to add and remove trustees. So long as a trustee accepts that the core trustee duties will apply to the new trustees while exercising the power, the court will not impinge an individual using this power to gain control of a trust. Once they have that control it then becomes almost impossible to enforce those duties as demonstrated earlier in this chapter.
204 Legler v Formannoij [2022] NZCA 607.
205 At [10].
206 At [11].
207 At [24].
208 At [37].
209 At [38].
210 At [39].
Ultimately, having considered the potential means of enforceability it becomes clear that only in trusts where trustees are prohibited from self-benefitting can any meaningful effect be given to the underlying fiduciary duty of loyalty expressed in Chapter II. Therefore, it is a hollow claim that fiduciary duties remain in trusts permitting self-benefit. The reality is that trusts of that nature are not meaningfully fiduciary. There is nothing to prevent a trustee treating the trust property like their own and appointing it all to themselves at their own whim. If the law wants to insist that trusts must be fiduciary relationships, trusts permitting self-benefit should rightly be deemed illusory.211
211 The express inclusion of the fiduciary term in the characteristics of an express trust in the Trusts Act 2019, s 13 would suggest the law in New Zealand does insist.
Chapter IV: A Reconsideration of the Illusory Trust
Having concluded that there is no way to enforce the fiduciary element of a trust unless trustees are prohibited from self-benefitting, we are left understanding that, in practice, trusts that permit self-benefit are structures of “unlimited self-benefit”. This means trusts permitting self-benefit are not meaningfully fiduciary and should be deemed illusory. While Chapter II demonstrated that a theoretical constraint can remain, the reality is that it lacks any force against those who may intend to use discretionary trusts as their own property to subvert the law. This final chapter examines the relationship between the approach of this dissertation and the approach currently adopted by the courts and the legislature through a reconsideration of the reasoning adopted in the decisions in Clayton, Pugachev, Webb and Pinney. Finally, it highlights some further mechanisms which could be used to maintain control over a discretionary trust even if self-benefitting was prohibited.
This section analyses the reasoning of the courts in four major decisions on the illusory trust question searching for support for the fiduciary approach and critiquing the judgments in light of the above analysis.
The Supreme Court in Clayton refused to conclude on whether the VRP Trust was illusory.212 Instead, they resolved the dispute by classifying Mr Clayton’s powers under the deed as within the definition of property provided by the Property (Relationships) Act.213 The Court concluded that Mr Clayton’s powers as a whole were effectively a general power of appointment.214 These powers could therefore be valued at the value of the trust assets.215
While the conclusion of the Court was not that the trust was illusory, its finding that Mr Clayton had a general power of appointment proceeded on very similar grounds to the analysis
212 At [127].
213 At [98].
214 At [68].
215 At [107].
presented in this dissertation. The Court did not rely on Mr Clayton’s power to remove discretionary beneficiaries as Principal Family Member.216 Instead, the Court relied on certain freedoms given to Mr Clayton as rendering the so-called normal fiduciary constraints on his power to appoint as being of “no practical significance”.217 Therefore, the fact his power to appoint trust property was held as a trustee, usually importing fiduciary obligations, was not significant.218 The freedoms relied on by the Court were the power to exercise powers, which could result in appointing all of the trust property to one beneficiary, in his own favour despite any conflict of interest as well as a freedom to not consider the interests of all the beneficiaries.219 These freedoms, which the Court rightly concluded made any underlying fiduciary obligation practically worthless, are generally entirely standard in any trust deed permitting self-benefit. The only freedom that is not inherently included in a trust permitting self-benefit is the freedom not to consider all of the beneficiaries. In fact, considering all of the beneficiaries is the crux of the fiduciary duty identified in Chapter II. The Court did not suggest what it may have done if that particular freedom was not included, but given the analysis in Chapter III, it is difficult to see how even without it Mr Clayton would have encountered any real difficulty in appointing all the trust property to himself.
The decision in Clayton therefore demonstrates many of the hallmarks of the enforceability analysis in Chapter III in recognising there were no meaningful restraints on Mr Clayton’s ability to appoint all of the trust property to himself. This dissertation does not take issue with the reasoning, only the conclusion. In the view of this dissertation, when there is no meaningful restraint on the ability to self-benefit there is no trust and the courts do not need to resort to classifying the powers as property as the Supreme Court did in this case.
In Pugachev, Birss J concluded that the effect of Mr Pugachev’s powers as Protector was to leave him in complete control of the trust assets so that he was the beneficial owner.220 The purported discretionary trust was therefore illusory, although Birss J preferred not to use that
216 At [64].
217 At [64].
218 At [65].
219 At [64].
220 At [455].
terminology, and amounted to a bare trust for Mr Pugachev.221 The bulk of the analysis focused on whether Mr Pugachev’s powers as Protector were purely personal and able to be exercised in a selfish way or whether they were fiduciary. Ultimately, the Court concluded on a contextual approach that the powers of the Protector were personal and this meant Mr Pugachev could exercise complete control over the trust by exercising his powers to veto any distributions made to other discretionary beneficiaries and replace any trustees who refused to appoint to him with ones who would.222 This conclusion aligns with the argument in this dissertation as it effectively demonstrates that this trust did not operate as a fiduciary relationship. Mr Pugachev’s veto powers completely overrode any discretion that the trustees had and because his powers were personal, the ‘trust’ was not controlled by fiduciaries and was therefore only a bare trust.
Of more interest to this dissertation are the obiter comments made by Birss J about the position had the Protector’s powers been fiduciary. He suggests that if the powers were fiduciary they would need to be exercised in the best interests of the beneficiaries as a class.223 This aligns with the approach adopted in Chapter II. However, Birss J suggests that duty would actually be enforceable, in contrast to the conclusion of Chapter III, and the Protector could not exercise his power to remove a trustee who refused to prioritise the Protector’s interests.224 The response to that lies in the evidence of such a breach. As expressed in Chapter III, when a trustee is permitted to appoint to themselves it is almost impossible to prove they did not consider the interests of all of the beneficiaries in doing so, especially given they do not need to give reasons for their decisions. The position would be different for a Protector in the position of Mr Pugachev. If he were to veto a proposed distribution and then seek to replace the trustees, the trustees could bring evidence of how they were attempting to exercise their discretion while considering all the beneficiaries and this may show the Protector’s bad faith in attempting to remove them. In other words, because of the additional steps required there is likely to be more evidence available to enforce the underlying fiduciary duty than for a trustee permitted to self- benefit.
221 At [225].
222 At [236] and [267].
223 At [244] and [267].
224 At [244].
In Webb v Webb the Privy Council decided that the Aorangi Trust was not a valid trust.225 They did so on the basis of a power under clause 10 that Mr Webb held as settlor, to be used for his own benefit, to appoint himself as the sole discretionary beneficiary to the exclusion of any other beneficiaries.226 Exercising this power would have made him sole trustee and sole beneficiary, removing any fiduciary obligations to other beneficiaries. The Trusts Act now recognises this is not a trust.227 This makes the trust analogous to the trust in TMSF v Merrill Lynch Bank which included an express power of revocation.228 While the Court in that case was content to classify this power as a general power capable of vesting in the Official Assignee as property, it is suggested that a revocable trust should not be recognised as a trust at all.229
The Court in this case also suggested that Mr Webb’s power as sole trustee to appoint all the trust property to himself not withstanding any conflict of interest could have made the property indistinguishable from ownership.230 However, they then proceeded to say that Mr Webb remained under fiduciary duties in exercising that power. My argument would accept that point, but say that those residual duties cannot be given effect to and therefore Mr Webb’s power to appoint to himself is indistinguishable from ownership. This means the Court would not have needed to rely on the clause 10 power to find the trust invalid and could have done so simply on Mr Webb’s ability to self-benefit.
Finally, in Cooper v Pinney the Court of Appeal upheld the MRW Trust as a valid trust. It did so despite Marcus Pinney’s position as a trustee able to appoint trust property to himself, albeit as one of two trustees, and his additional power to add and remove trustees. The majority expressly noted that:231
225 At [89].
226 At [80] and [87].
227 Trusts Act, s 14.
228 Tasaruff Mevduati Sigorta Fonu v Merrill Lynch Bank & Trust Co (Cayman) Ltd [2011] UKPC 17; [2012] 1 WLR 1721 (PC).
229 Jessica Palmer and Nicola Peart “Clayton v Clayton: A Step Too Far?” (2015) 8 NZFLJ 114 at 117.
230 At [84].
231 At [110].
The fiduciary nature of the powers of the dispositive powers is not negated by the fact that, as is not uncommon, one of the trustees is both a donee of the power and an object of the power as a discretionary beneficiary.
So they relied on fiduciary constraints on the dispositive powers. They also relied on the requirement to have at least two trustees, so Marcus’ discretion would always be subject to that of another.232
This conclusion directly contradicts the argument of this dissertation. This dissertation would take the approach that because Marcus was a trustee authorised to appoint the trust property to himself there is no meaningful ability to restrict him from doing so. While he may have theoretically been under a fiduciary obligation to consider the interests of the beneficiaries in making any dispositions, there was no realistic way to enforce this. Miller J, dissenting, recognised this when he stated that he saw no realistic prospect of successfully challenging a decision to appoint the entire trust corpus to Marcus because the deed expressly envisioned that outcome.233 Even the independent trustee would not be able to enforce this obligation because they are likely to comply with the wishes of the trustee entitled to self-benefit. This is especially so when the deed appears to be framed for their benefit which is likely in the case of a trustee beneficiary. Again, Miller J recognised this when he said the settlors had clearly framed the deed to recognise their view that the trust property was Marcus’ inheritance.234 That, in itself demonstrates that there is no meaningful fiduciary restraint on the ability to self- benefit. However, in this case Marcus also had a power to add and remove trustees without giving reasons. While also subject to a broad fiduciary restraint in the abstract, because it was held as trustee, Marcus’ ability to use this power is practically unrestrained and he could use it to appoint a corporate trustee that he controlled as the other trustee while still complying with the requirement for there to be two trustees.235 The decision in Legler only seems to affirm this position.
Overall, the review of the cases demonstrates that the courts are wrongly proceeding on the basis that a trustee permitted to self-benefit is still bound by fiduciary obligations. This fails to recognise the reality that any fiduciary duty still in play in these situations is realistically
232 At [111].
233 At [91].
234 At [91].
235 Miller J recognised this point at [86].
unenforceable. This is forcing the courts to search for other reasons to find a trust invalid when a proper analysis of enforceability would demonstrate that permissible self-benefit alone is enough to remove the fiduciary element of a trust.
This analysis implies that the Trusts Act was wrong to include no self-benefit as only a default duty. In fact, in doing so it has contradicted itself because it also expresses that a key characteristic of a trust is that it is a fiduciary relationship but this analysis has demonstrated that trusts permitting self-benefit are not meaningfully fiduciary.
It is worthwhile recognising that even if trust law shifted back towards its fiduciary roots and began to prohibit self-benefit, there are further mechanisms available to settlors that could be utilized to give them effective control over trusts even if they were not permitted to be a trustee beneficiary. Two of these will be discussed briefly below.
The first potential issue is powers exercised over a trust by a protector. Protectors are non- trustees, although they may be trustees as well, who exercise some powers over a trust.236 Protector’s powers are not inherently fiduciary and therefore may be purely personal as a matter of construction.237 An example of a non-fiduciary protector was seen in Pugachev where the Court concluded he could use his powers entirely for his own benefit.238 Arrangements like this demonstrate the possibility of individuals skirting any rule against self-benefitting. While the courts would still be able to find arrangements illusory, if the non-fiduciary protector was found to have complete control, as they did in Pugachev, this would likely require complex litigation. While it was possible to do so in Pugachev, the value of the claim was significant in that case and thus incentivised the complex fact-finding process undertaken.239 Ordinary creditors are less likely to have the resources to undertake this inquiry.
236 Matthew Conaglen and Elizabeth Weaver “Protectors as fiduciaries: theory and practice” (2012) 18 T&T 17 at 19.
237 Conaglen and Weaver, above n 236, at 22.
238 At [267].
239 At [35].
A second issue is the influence of settlor’s letters of wishes. It is well recognised that settlor’s can direct trustees in the exercise of their discretions through non-binding letters of wishes.240 These can be issued subsequently over time after the creation of the trust.241 Letters of wishes are only relevant insofar as they are consistent with the terms and purposes of the trust, but that position is under threat.242 Toby Graham and David Russell have criticised the courts for being too lenient with the extent they are prepared to let letters of wishes influence trustee discretion.243 As an example, the Court in Kain v Public Trust was prepared to let wishes directing the trustees to prefer the interests of certain beneficiaries over others be taken into account despite any preference not being present in the trust deed.244 Relevant to that finding was their characterization of the trust as an “unqualified discretionary trust”.245 What this creates is a situation where the settlor’s wishes can end up controlling the trust, despite the settlor not being a trustee.246 This risks a situation where a settlor could direct through a letter of wishes that all of the trust property be appointed to them as one of many discretionary beneficiaries.
All of this is to say that problems may still persist even if trustees were prevented from acting for their own benefit. As Bennett and Hofri-Winogradow point out, the more that loopholes are sought to be closed, the more that further loophole seeking will take place.247 Strengthening of the fiduciary nature of a trust is therefore likely to aid, though not solve many of the issues identified at the beginning of this dissertation.
240 Breakspear v Ackland [2008] EWHC 2002 (Ch), at [5]; Kain v Public Trust, above n 133, at [114]-[115].
241 Kain v Public Trust, above n 133, at [145]-[146].
242 Kain v Public Trust, above n 133, at [136].
243 David Russell and Toby Graham “Letters of wishes and understanding the purposes of a trust” (2019) 25 T&T 277 at 281; Toby Graham and David Russell “Letters of wishes and trust purposes” (2022) 28 T&T 335 at 342.
244 At [147].
245 At [147].
246 Smith, above n 129, at 41
247 Bennett and Hofri-Winogradow, above n 15, at 717.
Conclusion
To conclude, this dissertation has sought to demonstrate a contradiction in the law of trusts. Trust law frequently claims to be a field governed by fiduciary obligations, however the acceptance of trusts for self-benefit undermines that claim. Fiduciary duties should require that real weight is given to the best interests of another, yet when we exclude the prohibition of self-benefit and conflicts of interest, we lose the ability to meaningfully require that. In this author’s view this is something the courts and the legislature have failed to recognise in expressly permitting trusts of this nature and has led to trust law taking a wrong turn.
On this approach, when courts are faced with a claim that a trust is illusory, they should not be able to rely on vague statements about the trustee’s duty to consider the interests of all the beneficiaries as differentiating the trustee’s powers from ownership. The more realistic position to take is that nothing enforceable distinguishes the position of a trustee entitled to appoint trust property to oneself from a true owner of property. This should render all trusts permitting self- benefit illusory because they are not meaningfully fiduciary.
Alternatively, one may have to concede that the ship has sailed on self-benefitting trusts. They are firmly established in both our law and culture and to suggest all trusts of that nature are invalid would have significant consequences. Even if that position has to be taken, this dissertation would insist that self-benefitting trusts be recognised for what they really are. Contrary to popular belief they are not fiduciary relationships. Recognising this should at the very least enable Parliament to more adequately legislate for their control with the understanding that in substance they are structures of unlimited self-benefit.
A: Cases
1 New Zealand
B v X [2011] NZHC 2117; [2011] 2 NZLR 405 (HC).
Bank of New Zealand v Bank of New Zealand Officers Provident Association Management Board [2003] UKPC 58, [2004] 1 NZLR 577.
Chambers v S R Hamilton Corporate Trustee Ltd [2017] NZCA 131; [2017] NZAR 882.
Chirnside v Faye [2006] NZSC 68, [2007] 1 NZLR 433.
Clayton v Clayton [2013] NZHC 309, [2013] 3 NZLR 236.
Clayton v Clayton [2015] NZCA 30, [2015] 3 NZLR 293.
Clayton v Clayton [2016] NZSC 29, [2016] 1 NZLR 551.
Cooper v Pinney [2023] NZCA 62, [2023] 2 NZLR 455.
Erceg v Erceg [2017] NZSC 28, [2017] 1 NZLR 320.
Foreman v Kingstone [2004] 1 NZLR 841 (HC).
Harrison v Harrison (2008) 27 FRNZ 202.
Kain v Hutton [2008] NZSC 61; [2008] 3 NZLR 589. Kain v Public Trust [2021] NZCA 685. Legler v Formannoij [2022] NZCA 607.
McLaughlin v McLaughlin [2021] NZHC 3015.
2 England and Wales
Armitage v Nurse [1998] Ch 241.
Boardman v Phipps [1966] UKHL 2; [1967] 2 AC 46 (HL).
Bray v Ford [1895] UKLawRpAC 54; [1896] AC 44 HL at 51.
Breakspear v Ackland [2008] EWHC 2002 (Ch).
Bristol & West Building Society v Mothew [1998] Ch. 1 CA.
De Bussche v Alt [1878] UKLawRpCh 107; (1878) 8 ChD 286 (CA).
JSC Mezhdunarodniy Promyshlenniy Bank v Pugachev [2017] EWHC 2426 (Ch).
Keech v Sandford [1726] EngR 954; (1726) Sel Cas T King 61, 25 ER 223.
McPhail v Doulton [1970] UKHL 1; [1971] AC 424 (HL(E)).
Morice v Bishop of Durham [1804] EngR 177; (1804) 9 Ves 399.
Pitt v Holt [2013] UKSC 26, [2013] 2 AC 108.
Queensland Mines Ltd v Hudson [1911] ArgusLawRp 95; (1978) 18 ALR 1 (PC).
Re Astor’s Settlement Trusts [1952] 1 All ER 1067.
Re Beatty [1990] 1 WLR 1503 (Ch D).
Re Londonderry’s Settlement [1965] Ch 918.
Tasaruff Mevduati Sigorta Fonu v Merrill Lynch Bank & Trust Co (Cayman) Ltd [2011] UKPC 17; [2012] 1 WLR 1721 (PC).
Vatcher v Paull [1915] AC 372 (PC).
3 Australia
Breen v Williams (1995) 186 CLR 71.
Chief Commissioner of Stamp Duties v Buckle [1998] HCA 4; (1998) 192 CLR 226.
Karger v Paul [1984] VicRp 13; [1984] VR 161.
Owies v JJE Nominees Pty Ltd [2022] VSCA 142.
4 Cook Islands
Webb v Webb [2017] CKCA 4.
Webb v Webb [2020] UKPC 22.
B Legislation Insolvency Act 2006. Property Law Act 2007.
Property (Relationships) Act 1976.Trusts Act 2019.
C Books
Peter Birks Unjust Enrichment (Oxford University Press, the United States, 2003).
Lindsay Breach Nevill’s Law of Trusts, Wills and Administration (14th ed, LexisNexis, Wellington, 2023).
Matthew Conaglen Fiduciary Loyalty: Protecting the Due Performance of Non-Fiduciary Duties (Hart Publishing, Oxford and Portland, Oregon, 2010).
Peter Devonshire Account of Profits (Thomson Reuters, Wellington, 2013). Paul Finn Fiduciary Obligations (The Law Book Company, Sydney, 1977).
I J Hardingham and R Baxt Discretionary Trusts (2nd Ed, Butterworths, Melbourne, 1984).
Chris Kelly, Greg Kelly, Colette Mackenzie and Kimberly Lawrence Garrow and Kelly: Law of Trusts and Trustees (8th ed, LexisNexis, Wellington, 2002).
D Chapters in Edited Books
Andrew S Butler “Basic Concepts” in Andrew Butler (ed) Equity and Trusts in New Zealand (2nd ed, Thomson Reuters, Wellington, 2009).
Paul Miller “The Fiduciary Relationship” in Andrew Gold and Paul Miller (eds)
Philosophical Foundations of Fiduciary Law 63.
Robert H Sitkoff “Fiduciary Principles in Trust Law” in Evan J Criddle, Paul B Miller and Robert H Sitkoff (eds) Oxford Handbook of Fiduciary Law 41.
Lionel Smith “Can we be Obliged to be Selfless” in Andrew Gold and Paul Miller (eds)
Philosophical Foundations of Fiduciary Law 141.
Lionel Smith “The Motive, Not the Deed” in J Getzler (ed) Rationalizing Property Equity and Trusts: Essays in Honour of Edward Burn (2003) 53.
Graham Virgo “Abuse of Trust” in Richard Nolan, Tang Hang Wu and Man Yip (eds) Trusts and Private Wealth Management: Developments and Directions (Cambridge University Press, Cambridge, 2023) 285.
E Journal Articles
Paul Adams “Pugachev five years on: were the trusts really bare trusts?” (2022) 28 T&T 260.
Lucas Clover Alcolea “Nothing New Under the Sun: The Case of the Illusory Trust” (2022) 30 NZULR 225.
Lucas Clover Alcolea “‘Reform, Reform: Aren’t things bad enough already?’ The case of the Trusts Act 2019” (2023) 17 J EQ 93.
Mark Bennett “The Illusory Trust Doctrine: Formal or Substantive” (2020) 51 VUWLR 193.
Mark Bennett and Adam Hofri-Winogradow “The Use of Trusts to Subvert the Law: An Analysis and Critique” (2021) 41 OJLS 692.
Matthew Conaglen and Elizabeth Weaver “Protectors as fiduciaries: theory and practice” (2012) 18 T&T 17.
Hanoch Dagan and Irit Samet “What’s Wrong with Massively Discretionary Trusts” (2022) 138 LQR 629.
Jack Davies “Are the Floodgates Open? A Brief Analysis of the Supreme Court’s Decision in
Clayton v Clayton [Vaughan Road Property Trust]” (2016) 22 AULR 383. Deborah A DeMott “Disloyal Agents” (2007) 58 Ala.L.Rev 1049.
James Edelman ‘When do Fiduciary Duties Arise?” (2010) 126 LQR 302.
Toby Graham and David Russell “Letters of wishes and trust purposes” (2022) 28 T&T 335. Adam Hofri-Winogradow “The Irreducible Cores of Trustee Obligations” (2023) LQR 311.
John Langbein “Questioning the Trust Law Duty of Loyalty: Sole Interest or Best Interest?” (2005) Yale LJ 929.
John Langbein “The Contractarian Basis of the Law of Trusts” (1995) 105 Yale LJ 625.
Rebekah McCrae “Has the Trusts Act 2019 Abrogated the Court’s Inherent Jurisdiction to Order Disclosure of Reasons for Trustees’ Decision to a Beneficiary?” (2022) 53 VUWLR 45.
Lord Nicholls “Trustees and their Broader Community: Where Duty, Morality and Ethics Converge” (1996) 70 ALJ 205.
Jessica Palmer and Nicola Peart “Clayton v Clayton: A Step Too Far?” (2015) 8 NZFLJ 114. Jessica Palmer “Controlling the Trust” (2011) 12 OLR 473.
Jessica Palmer and Charles Rickett “The Revolution and Legacy of the Discretionary Trust” (2017) 11 J EQ 157.
David Russell and Toby Graham “Letters of wishes and understanding the purposes of a trust” (2019) 25 T&T 277.
Lionel Smith “Deterrence, Prophylaxis and Punishment in Fiduciary Obligations” (2013) 7 J EQ 87.
Lionel Smith “Fiduciary Relationships: Ensuring the Loyal Exercise of Judgement on Behalf of Another” (2014) 130 LQR 608.
Lionel Smith “Massively Discretionary Trusts” (2017) 70 CLP 17.
Lionel Smith “Mistaking the Trust” (2011) 40 HKLJ 787.
Lionel Smith “Prescriptive Fiduciary Duties” (2018) 37 UQLR 261.
Geraint Thomas “The duty of trustees to act in the ‘best interests’ of their beneficiaries” J EQ 177.
Donovan Waters “Settlor control – what kind of problem is it?” (2009) 15 T&T 12.
F Law Commission Publications
Law Commission Dividing relationship property – time for change? (NZLC IP41, 2017). Law Commission Review of the Property (Relationships) Act 1976 (NZLC R143, 2019). Law Commission Some Issues with the Use of Trusts in New Zealand (NZLC IP20, 2010).
G Reports
Andres Knobel Trusts, Weapons of Mass Injustice (Tax Justice Network, February 2017).
H Dissertations
Matthew Dynes-Morgan “Is there really an Alternative? The Conflict Between an Account of Profits and Compensation” (LLB (Hons) Dissertation, University of Otago, 2018).
Stephen Laing “Two forms of the fiduciary relationship” (LLB (Hons) Dissertation, University of Otago, 2013).
I Internet Resources
Ministry of Social Development “Residential Care Subsidy” Work and Income
<www.workandincome.govt.nz/products/a-z-benefits/residential-care-subsidy.html>.
J Other Sources
Tobias Barkley “Is the Trustee-Beneficiary Relationship Necessarily Fiduciary?” (Paper presented at Obligations VII, Hong Kong, 2014) at 2.
Gerard Curry “Who is a Fiduciary and to Whom is The Duty Owed” in Fiduciary Relationships (New Zealand Law Society seminar, November 1986) 2.
Inland Revenue Trusts and Estates Income Tax Rules (IR288, 2020).
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