The Supreme Court has ruled that some family trust structures will be ineffective in protecting assets from claims by former partners and, potentially, other creditors.
The decision in Clayton v Clayton has implications for everyone who establishes trusts to manage relationship property, estate planning and insolvency risk.
Mr and Mrs Clayton are divorced. The case was about whether substantial assets built up during their relationship and held in a series of family trusts were “relationship property” under the Property (Relationships) Act 1976 (the PRA).
The litigation discussed here focused on the Vaughan Road Property Trust (VRPT), holding around $28 million in assets. Under the trust deed, Mr Clayton was the VRPT’s settlor, sole trustee, and “Principal Family Member”. He was also a discretionary beneficiary.
Mrs Clayton contended that her former husband’s extensive powers over VRPT assets were relationship property in which she was entitled to share. The Supreme Court agreed with her.
The parties eventually settled out of court but agreed that the Supreme Court should publish its judgment given the importance of the issues raised.
The Supreme Court’s analysis
The Court agreed that the rights held by Mr Clayton in the trust came within the definition of property under the PRA. In particular:
- he was able to remove any other discretionary beneficiaries unrestricted by any fiduciary obligations, and
- as sole trustee, he could distribute all of the income and capital to himself as a discretionary beneficiary – a power the trust deed allowed him to exercise in his own self-interest, to the exclusion of all other beneficiaries and regardless of whether he had a conflict of interest.
The unconstrained nature of these powers over the assets of the trust were as good as ownership and, as they had been acquired during the Clayton’s relationship, they were relationship property.
When is a trust a sham – or illusory?
Mrs Clayton also argued that the VRPT was a sham. But the Court rejected this on the basis that – to prove the claim – it is necessary to show a common intention on the part of the trustee and settlor to engage in a pretence. Here both roles were played by Mr Clayton and it was clear that he genuinely intended to create a trust.
However, the Court left the door open on Mrs Clayton’s argument that the VRPT was illusory in that the trust deed reserved so much control to the settlor (Mr Clayton) that there really was no trust at all.
It noted that, because the parties had settled and the facts were so specific, there was no need for it to determine this issue.
Our analysis: big implications for divorce and insolvency
The Supreme Court took a substance-over-form analysis of Mr Clayton’s rights and powers and their value in this case.
But what about claims on trust assets from someone other than a former partner – say a creditor suing to enforce a judgment debt or a personal guarantee? Although Clayton v Clayton is a PRA claim, the judgment paves the way for others to attack trusts where one individual has substantial practical control uninhibited by fiduciary restraints.
Anyone using a trust structure for asset protection should vet it for the features deemed problematic in the Clayton case.
Our thanks to Matt Sumpter and Laura Fraser for writing this Brief Counsel. For further information, please contact the lawyers featured.