New Zealand: Trusts – a good port in a storm but design is key

Brief Counsel
Last Updated: 1 March 2012
Article by Arthur Young, Neil Gray, Phillippa Wilkie and Lyndsey Partridge

Most Read Contributor in New Zealand, September 2016

The take-out from the latest round of litigation between the Financial Markets Authority, Mark Hotchin and two family trusts associated with him is that the trust is an effective asset protection tool – but that good design is essential.

The background

The Financial Markets Authority (FMA) is investigating suspected breaches of the Securities Act 1978 by Mr Hotchin in his role as a director of companies within the Hanover Group. Interim asset freezing orders were granted over the two trusts, which have Mr Hotchin's children as beneficiaries, and over the assets of Mr Hotchin in December 2010.

The orders have been amended a number of times and have been subject to successive claims and counter-claims since they were imposed. This latest case - Financial Markets Authority v Hotchin - involved a strike out application from the two trusts in respect of the FMA's claims.

In essence, the FMA wants to be able to access the trust assets and has attempted this from several angles. It claimed that the powers reserved to Mr Hotchin under the trust deeds meant that he could reclaim the trust property for himself beneficially and therefore that the requisite intention to create a binding trust was missing. It also claimed that both of the trusts were shams.

The findings

Lack of intention to create a valid trust

The claim that there was no intention to create a valid trust was successfully struck out for both trusts. The FMA was relying on a number of powers that had been reserved to Mr Hotchin on settlement of the trusts to indicate that he intended to keep control of them and of their assets.

The powers in question are fairly standard to settlors and included the power to nominate and remove discretionary beneficiaries and the power to appoint and remove trustees.

Justice Winkelmann considered whether it was open to Mr Hotchin to appoint himself as sole trustee, appoint himself as a discretionary beneficiary and distribute the property to himself. She noted that the self-dealing prohibition would have prevented him from doing that.

She also considered whether Mr Hotchin could appoint himself as trustee and use the power of variation to remove the self dealing prohibition. She concluded, correctly in our view, that it would be impossible to justify this as a proper exercise of a power by a trustee and that the trust beneficiaries would have good grounds to complain of a breach of fiduciary duty and if necessary seek recovery of any distributions to the settlor achieved by these actions.

This is not the first time that powers reserved to a settlor have been bundled together and analysed from the perspective of a creditor of the settlor. The "bundle of rights" concept emerged from a family law case in 2007 where it was said that a party's interest in a trust whether as settlor, trustee, appointor or beneficiary, may be Relationship Property and, as such, could be divided between warring spouses.

The assets in that dispute included the directorship of the trustee company, shares of the trustee company, power to appoint and remove directors of the trustee company, power to appoint and remove trustees of the trust and the party's discretionary interest under the trusts.

One of the weaknesses of the bundle of rights concept is that it overlooks the fact that trustee powers are fiduciary powers and therefore to be exercised not in self interest but in the interests of beneficiaries.

Sham claims

The FMA made a separate argument that the trusts were shams because they were under the effective control of Mr Hotchin, the settlor. He was the sole trustee initially of one of the trusts. He was one of two trustees initially of the other, with the other trustee being an independent third party. Legal requirements for a sham are:

  • that the trust deed is effectively a mask, cloak or facade for the true position between the parties
  • that there be a common intention to mislead on the part of the settlor and the trustee or, if there is only one party to the deed, by that party, and
  • that this sham intention can be evidenced.

The Judge struck out the sham claim in relation to the trust which was established with a third party as co-trustee with Mr Hotchin. However, she found that there were sufficient particulars to support an arguable case of sham for the other trust which was set up with Mr Hotchin as both settlor and sole trustee. The operations of that trust in relation to the property that it held were also relevant.

Chapman Tripp comment

It is perplexing that there was evidence of an intention to create a trust sufficient to strike out the invalidity claim for both trusts yet not the sham claim for both of the trusts. The FMA has been given another opportunity to re-formulate its sham pleading for one of the trusts.

Regardless of the outcome, the fact that the FMA has honed in on conventional settlor reserved powers in this manner should alert settlors and trust draftspersons.

To minimise risk of attack, the following should be considered:

  • ensuring that the settlor does not have sole powers to appoint the trustees, either by splitting the power with another or by appointing a special independent 'appointor'
  • conferring on the settlor the right to consent to certain actions of the trustees rather than the powers themselves
  • having one or more independent trustees from establishment in preference to a sole settlor/trustee, and
  • incorporating a prohibition on self dealing.

These factors go to the design of the trust at creation. The trust may still be vulnerable to attack if the operation of the trust does not reflect its design.

The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.

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