New Zealand: Clayton v Clayton: Trust busting

The Court of Appeal's recent decision in Clayton v Clayton1 has been described as redrawing the landscape on trusts and divorce.2 In this article I discuss the more controversial aspect of the judgment - the Court's finding that the settlor's power of appointment is relationship property.

Although the context of the decision is a relationship property dispute, the Court's reasoning could be applied in other contexts, such as bankruptcy.

Background

Mr and Mrs Clayton separated in 2006 after 17 years of marriage. The proceedings concerned the division of relationship property under the Property (Relationships) Act 1976.

Mr Clayton is a sawmilling magnate. He established a timber milling business and inherited an existing business established by his father.

The case concerned various trusts settled during the parties' marriage. If the trusts' property is added to the parties' relationship property pool, Mrs Clayton said it would swell from $850,000.00 to approximately $29,681,000.00.3

The trust which is the focus of this article is the Vaughan Road Property Trust ("VRPT"). It was settled in 1999 by way of a declaration of trust by Mr Clayton. He is the settlor, trustee and a discretionary beneficiary, along with Mrs Clayton and the parties' children. The children were also the default final beneficiaries.

For the purposes of this article I note that the provisions of the VRPT trust deed provided:

  1. that the trustees were permitted to apply the VRPT's income and capital before vesting day;
  2. that notwithstanding their duty to act impartially towards the beneficiaries, the trustees' discretion when exercising their powers was unfettered, and they need not consider the interests of all the beneficiaries;
  3. that the trustees were permitted to self-deal notwithstanding a conflict of interest;
  4. that with the consent of Mr Clayton, the trustees were able to vary, revoke and enlarge the provisions of the trust deed; and
  5. that Mr Clayton, as the "Principle Family Member", was empowered to appoint and remove discretionary beneficiaries, and trustees.

These last powers are what the Court of Appeal decision turned on.

The lower courts

A focus in the lower courts with respect to the VRPT was whether it was an illusory trust. While the concept of a sham is well established, the argument of an illusory trust in New Zealand is relatively novel. Prior to Clayton v Clayton, it had never been accepted by the courts.

In the Family Court it was held that the provisions of the trust deed gave Mr Clayton total control over the trust without the need to account to beneficiaries, meaning that the basic elements of a trust were not met.

The High Court Judge disagreed with the Family Court's reasoning. However, it also found that the VRPT was illusory, because under the trust deed Mr Clayton had retained powers tantamount to ownership of the trust property.

The courts' approach to this issue is not the focus of this article.4

The power of appointment as property

Under Mr Clayton's power of appointment he could appoint himself the sole beneficiary to receive the VRPT's income and capital. Importantly, the power allowed him to remove final beneficiaries because they were included in the definition of discretionary beneficiaries.

The issue in the Court of Appeal was whether the Mr Clayton's right to exercise his power of appointment constituted relationship property.

Generally, a power is not regarded as property. However, the Court of Appeal relied on the Privy Council judgment in TMSF v Merrill Lynch Bank5, where the Court held that in some contexts the distinction between a power and property will not be preserved. It drew upon case law which held that the holder of a power will be treated as the effective owner of the property subject to the power, where the holder can use the power to appoint the property to himself.6

The Court of Appeal applied the reasoning in TMSF v Merrill Lynch Bank. As Mr Clayton held the power of appointment as the "Principal Family Member" and not as a trustee, he owed no fiduciary duties to the discretionary beneficiaries of the trust. Therefore, the Court held that Mr Clayton held a personal dispositive power, as was the case in TMSF v Merrill Lynch Bank.

Accordingly, Mr Clayton was held to be the holder of a general power of appointment in his personal capacity. As the definition of "property" in the Property (Relationship) Act 1979 includes "any other right or interest", the value of the power would be added to the parties' pool of relationship property.

The next question was the the value of Mr Clayton's right to exercise his power of appointment. The Court held that the value of Mr Clayton's right was the value of the property received in the event that the power was exercised. This was said to be the value of the assets of the VRPT as at 31 March 2011, which was the date the parties agreed to be the date of Mr and Mrs Clayton's separation.

Comment

The power in TMSF v Merrill Lynch Bank was not the same as Mr Clayton's power of appointment. In that case, the power was to revoke the trust. The Court of Appeal held that there was no practical distinction between that power and Mr Clayton's power to appoint himself as the sole beneficiary of the VRPT.

The Court's reasoning was that, if Mr Clayton was to exercise his power in this way, he would become both the legal and beneficial owner of the trust assets. If this occurred then there would be no trust at all – the trust would effectively have been revoked. In principle, this approach appears sound.

Given this reasoning, it seems that if the definition of discretionary beneficiaries in the trust deed had not included final beneficiaries, then Clayton v Clayton would have been distinguishable from TMSF v Merrill Lynch Bank. This is because, although Mr Clayton would be the sole discretionary beneficiary, he would still owe fiduciary duties to the final beneficiaries in his capacity as trustee. Any dealings between himself as trustee and discretionary beneficiary would be subject to those fiduciary obligations.

It must be remembered that Mr Clayton held the power of appointment solely, and was also the sole trustee of the trust. Whether the Court's reasoning would apply if the power was held jointly is unclear. No doubt this point will be tested in the courts at some point.

Exposure to creditors

While Clayton v Clayton concerned a relationship property dispute, the reasoning of the Court of Appeal and in particular, the Privy Council case relied on, suggest that it may be applicable to the bankruptcy context.

TMSF v Merrill Lynch Bank involved two discretionary trusts established by a Mr Demirel in the Cayman Islands with assets of USD 24,000.000. The trustee was Merrill Lynch Bank and Trust Compnay (Cayman) Ltd. Mr Demirel and his wife and children were beneficiaries of the trusts and, as settlor, Mr Demirel retained a general power of revocation of the trusts. Mr Demirel was adjudicated bankrupt in Turkey and his creditors sought to "bust open" the trusts.

This suggests that powers of appointment similar to those in Clayton v Clayton may give rise to sufficient grounds for creditors to claim against trust assets in such cases. However, until there is judicial comment it remains uncertain as to how far Clayton would apply in a commercial context.

Footnotes

1Clayton v Clayton [2015] NZCA 30 (the "Court of Appeal decision").
2Hamish Fletcher Rotorua sawmill magnate's $28 million divorce wrangle: Ruling 'redraws the landscape' (The NZ Herald website, 6 March 2015).
3Mr Clayton's valuers arrived at a considerably lower value for the trusts' property.
4That issue is discussed in the writer's article: Clayton v Clayton: Nipping the "Illusory Trust" in the Bud.
5[2011] UKPC 17 (PC).
6In re Triffitt's Settlement [1958] Ch 852 citing Thomas, Power (1998) at 1-08.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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