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10
Apr 2017

Discretionary Trusts: Can they be trusted?

It has long been understood that a bankrupt’s potential interest in assets of a discretionary trust (arising by virtue of being one of a number, or class, of beneficiaries of the trust) is not property of the bankrupt within the meaning of section 5 of the Bankruptcy Act 1966 (Cth.).

A bankrupt in these circumstances does not have any right to a distribution from the income or capital of the trust, he or she is merely one of a number of people to whom the trustee may make a distribution in the trustee’s discretion. By comparison, in a unit trust the beneficiary usually has a legal entitlement to a proportion of the trust income or capital commensurate with the number of units held.

Discretionary and unit trust entitlements are treated differently at law and what is discussed below applies only to discretionary trusts.

In Fordyce v Ryan & Anor; Fordyce v Quinn & Anor [2016] QSC 307, the Supreme Court of Queensland considered the extent to which a potential right to a distribution from a discretionary trust  may amount to property which vests in a trustee in bankruptcy.

In Fordyce, the bankrupt was the sole director and shareholder of the company acting as trustee of the FD Trust. The FD Trust was a discretionary trust and prior to his bankruptcy, the bankrupt had caused the trustee to distribute all of the income of the trust to himself.

The trustee in bankruptcy applied to have a receiver appointed to the trust in order to realise its property for the benefit of creditors. In support of his application, the trustee relied upon Australian Securities and Investments Commission v  Carey (No 6) [2006] 153 FCR 509 (commonly known as Richstar) in which  French J distinguished the interest of a beneficiary where the trustee is at arm’s length from a beneficiary where the trustee is effectively the alter ego of the trustee. In the latter circumstance, French J held that the beneficiary has a contingent interest in the trust given the certainty of a distribution.

In Fordyce, Justice Jackson declined to follow Richstar. His Honour noted that Richstar has not been followed or applied since the decision was handed down and indeed has been the subject of academic criticism.

His Honour Jackson J did not accept that the Bankrupt’s control of the trustee changed the nature of his interest in the trust and accordingly held that the Bankrupt’s position remained as a potential beneficiary of a distribution, an entitlement which did not constitute property within the meaning of the Bankruptcy Act.

In summary, the Bankrupt’s rights as a beneficiary of the discretionary trust were not property which vested in his Trustee in Bankruptcy.

We do note in passing however that if the shares in a corporate trustee are owned personally by a bankrupt those shares will ordinarily vest in a trustee in bankruptcy.  The vesting of the ownership of the shares in a corporate trustee would usually entitle a trustee to change the director(s) of the relevant corporate trustee, thereby gaining control of any distributions to be made from the trust.

For more information, please contact ERA Legal.