Australia: TMSF v Merrill Lynch Bank – Breaking into Discretionary Trusts

Last Updated: 19 May 2012
Article by Bede Haines and Nick Riordan

Most Read Contributor in Australia, September 2016

It is a common source of frustration for creditors that the legally available assets of an apparently wealthy debtor are housed in a discretionary trust and placed beyond reach. Conversely, it is likely to be a source of anxiety for a debtor-beneficiary of a discretionary trust as to how well it is able to protect itself against claims of the beneficiaries creditors.

A Turkish fraud

A recent decision of the United Kingdom's Privy Council TMSF v Merrill Lynch Bank [2011] UKPC 17 found that the assets of a discretionary trust established in the Cayman Islands were available to creditors of an extremely wealthy individual. The decision has caused some consternation in the common law world (including in Australia).

The case concerned (of all things) a failed Turkish bank. The bank was ultimately owned by a Mr Demirel who now finds himself housed in a Turkish gaol.

In the 1990s, Mr Demirel was the beneficiary of $30 million in fraudulent loan transactions entered into by the bank. The Turkish equivalent of APRA – TMSF – commenced proceedings against Mr Demirel and obtained judgment for $30 million. On paper, Mr Demirel appeared to own very little. TMSF was unable to satisfy its judgment in Turkey, and Mr Demirel was declared bankrupt under Turkish law.

A Cayman Island's trust

Despite Mr Demirel's bankruptcy (and before his gaoling), he exhibited the ostensive trappings of wealth. Adopting William Thackeray's phrase, recently re-employed by Justice Young in the New South Wales Court of Appeal, Mr Demirel was a living example of How to Live Well on Nothing A-Year. The source of this wealth was a discretionary trust located in the Cayman Islands.

A discretionary (or family) trust is a trust in which its beneficiaries have no absolute entitlement to the trust property, but receive distributions from the trust at the discretion of the trustee. These trusts can shield assets from creditors as a beneficiary-debtor has no right or property in the trust assets and therefore no property against which a creditor can have recourse to satisfy the beneficiary-debtor's debt. A creditor's frustration will often be further exacerbated where the debtor-beneficiary receives favourable distributions from, or has their debts paid, by the trustee. In effect, the beneficiary may live sumptuously whilst on paper appear as poor as a church mouse.

Upon discovering the trust, TMSF looked into the possibility of wresting assets from the trustee. Some features of Mr Demirel which gave TMSF a sense of hope were:

  • Mr Demirel was the person who set up the trust by giving the trust property to the trustee (known as the "settlor")
  • Mr and Mrs Demirel and any children were the beneficiaries; and
  • Importantly, Mr Demirel, as settlor, had an express power to revoke the trust. Upon it being revoked, the trust assets reverted to Mr Demirel.

Court application

TMSF approached the court seeking the court's assistance with the enforcement of its $30 million judgment debt. The orders that TMSF sought concerned appointing a receiver to the trust. In particular, TMSF wanted a receiver appointed to the trust as trustee, and a separate order mandating Mr Demirel to assign the power of revocation to the (court appointed) trustee. The trustee would then revoke the trust, take possession of the assets and enable their distribution amongst Mr Demirel's creditors, including TMSF.

The Cayman court refused to make such an order on the basis (broadly) that Mr Demirel's power to revoke the trust was not akin to "property" and that the court's power to make such an order was circumscribed to it applying to property.

The Privy Council took a different view. It saw a clear connection between the power to revoke the trust and the concept of "property". It found that Mr Demirel's power of revocation was tantamount to property because Mr Demirel, as settlor, only gave his property to the trustee on the condition that he could reclaim it at any time by exercising his power or revocation. It was a Clayton's giving. In a sense Mr Demirel still had rights over the trust property which could be enlivened at his discretion.

It should be noted that treating a right of revocation as property is not entirely novel. In Australia a similar approach is adopted in respect of tax laws – the income of a trust revocable by the settlor will be taxable as the settlor's income. Also, in the area of bankruptcy, section 116 of the Bankruptcy Act 1966 (Cth) gives a trustee in bankruptcy rights to exercise powers over property which the debtor could exercise. In a sense, the decision in TMSF is no broader than an exercise of this power by a trustee. Indeed, the Privy Council noted that had the bankruptcy been under UK law, the trustee in bankruptcy could have exercised Mr Demirel's power (there was no corresponding Turkish bankruptcy law).

What to take away

Any case that pries open a discretionary trust attracts attention, and TMSF is no exception. It has been remarked upon extra-judicially and in leading law journals. However, and as with other cases concerning access to trust assets, such as the Kennon v Spry litigation, the headlines following such cases, often heralding a breakthrough into formerly off-limits trusts, are often prone to overstatement.

The reality is that most discretionary trusts will continue to enable beneficiary-debtors to protect their assets from creditors. Most discretionary trusts will not be revocable by the settler, which was the crucial fact in TMSF.

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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