Trust-busting revisited

The effect of bankruptcy on a beneficiary in a trust was considered recently by the Queensland Supreme Court in Fordyce v Ryan [2016] QSC 307. This decision considered the effect of the trust-busting decision by Justice French in Re Richstar (No 6) [2006] FCA 814.

The effect of bankruptcy on a person who holds an interest as a beneficiary in a trust should be straightforward. SubSection 58(1) of the Bankruptcy Act 1966 (Cth) provides that all property of the bankrupt and all after-acquired property of the bankrupt vest in their bankruptcy trustee. Of course, not all property that vests in the trustee is necessarily distributable to the bankrupt’s creditors (see s116(2)). Property that a bankrupt holds on trust for another person is not distributable to creditors (s116(2)(a)). However, property that a bankrupt has as a beneficiary is not covered by the same exemption and may be distributable to creditors in their bankruptcy.

This raises the question of whether the interests of the bankrupt in the trust can be classified as property. Not all interests recognised by law can be classified as a proprietary interest. Whether the interests of a beneficiary in a particular trust can be characterised as property will depend on the form that the particular trust takes. As the courts often remind us, it is a mistake to start the analysis by asking what type of trust is involved. Every trust is different and the rights and liabilities of the parties involved need to be determined by reference to that specific trust, according to the terms of the constituent document.

Property for the purposes of the Bankruptcy Act is defined in s5(1):

‘Property’ means real or personal property of every description, whether situate in Australia or elsewhere, and includes any estate, interest or profit, whether present or future, vested or contingent, arising out of or incident to any such real or personal property.

These issues was considered in detail by Justice Jackson in the recent decision in Fordyce v Ryan. One of the major points of interest in this case was the consideration of the decision of Justice French (as his Honour the Chief Justice then was) in ASIC v Carey (No 6) [2006] FCA 814 (sub-nom Re Richstar No 6). In that case, French J held that a receiver could be appointed under s 1323 of the Corporations Act 2001 (Cth) over a number of trusts associated with the principal of the Westpoint group that was being investigated by ASIC. French J held that the extent of Mr Carey’s potential control over the trustees of the trusts was sufficient to recognise a proprietary interest in the assets of the trust and allow a receiver to be appointed.

In Fordyce, Jackson J was asked to consider whether a beneficiary’s control over trustees was sufficient to classify the beneficiary’s interest in a discretionary trust as property that vested in their trustee in bankruptcy.

Facts

The Fordyce case concerned 3 trust arrangements:

  • George St Unit Trust
  • Shore St Unit Trust
  • Fairdinks Discretionary Trust

The corporate trustees of both the George St and Shore St trusts were deregistered and the trust assets were vested in the Commonwealth. The real estate investments held in both trusts were either sold by receivers or proposed to be sold by mortgagees, but there was residual equity in both properties for the mortgagors. The majority of units issued in the George St Unit Trust, and all of the units in the Shore St Unit Trust, were held in the Fairdinks Discretionary Trust. The trustee of the Fairdinks Discretionary Trust had the absolute discretion as to distributions among the beneficiaries.

The Fairdinks Discretionary Trust had multiple classes of beneficiaries, including a ‘principal beneficiary’ (Sean Quinn) and 5 classes of ‘general beneficiaries’. Michael Quinn was a general beneficiary and also the father of Sean Quinn. Michael Quinn controlled each of the trustee companies (as director and sole shareholder) and received trust distributions in each prior income year when distributions were made. He was also the undischarged bankrupt.

The trustee in bankruptcy sought orders declaring that the bankrupt’s property in the discretionary trust vested in them as trustee under s58. This was argued on the grounds that the level of control that the bankrupt had over the trusts meant that his interest in the trust property was more than a typical discretionary object but was proprietary in nature. The trustee relied on the Re Richstar case to support this argument, in particular the following statement (at [29] per French J):

‘In my opinion, in the ordinary case the beneficiary of a discretionary trust, other than perhaps the sole beneficiary of an exhaustive trust, does not have an equitable interest in the trust income or property which would fall within even the most generous definition of ‘property’ in s 9 of the Act and be amenable to control by receivers under s 1323. I distinguish the ‘ordinary case’ from the case in which the beneficiary effectively controls the trustee’s power of selection. Then there is something which is akin to a proprietary interest in the beneficiary.’

and the following (at [36]-[37] per French J):

‘The difficulty with applying the notion of contingent interests to beneficiaries of a discretionary trust lies partly in the uncertain scope of the distribution be it income or capital, which may be made in favour of any given beneficiary. I am inclined to think that a beneficiary in such a case, at arms length from the trustee, does not have a ‘contingent interest’ but rather an expectancy or mere possibility of a distribution. … On the other hand, where a discretionary trust is controlled by a trustee who is in truth the alter ego of a beneficiary, then at the very least a contingent interest may be identified because, to use the words of Nourse J, ‘it is as good as certain’ that the beneficiary will receive the benefits of distributions either of income or capital or both.

As discussed earlier, the beneficiary who effectively controls the trustee’s power of selection because he or she is the trustee or one of them and/or has the power to appoint a new trustee has something approaching a general power and the ownership of the trust property.’

Decision

Justice Jackson in Fordyce rejected the trustee in bankruptcy’s argument that the interests of the bankrupt in the discretionary trust was property that vested in the trustee.

His Honour noted that Richstar relied heavily on decisions relating to trusts under s79 of the Family Law Act 1975 (Cth) and then stated:

[37] It is difficult to accept as a principle of reasoning that a beneficiary’s legal or de facto control of the trustee of a discretionary trust alters the character of the interest of the beneficiary so that it will constitute property of the bankrupt if the beneficiary becomes a bankrupt. To the extent that Richstar might be thought to support such a principle, it has not been followed or applied subsequently and it has been criticised academically… In my view, there is no general principle of law of that kind. [emphasis added]

The court rejected arguments that the fact that the trusts had traditionally paid out distributions to the bankrupt was sufficient to disregard the trusts as shams, applying Lewis v Condon [2013] NSWCA 204 (which rejected the notion of a doctrine of an emerging sham trust that converted a legitimate trust into a sham through its use).

The interests of the bankrupt in the discretionary trust did not vest in their bankruptcy trustee because the nature of that interest was not proprietary in nature. The interests of the trustee in bankruptcy was no more than ‘a statutory equivalent of an assignee of an expectancy’ (at [41]).

Key takeaways

The Fordyce case provides a further buttressing against the trust-busting implications of the Richstar case and prove a useful case for estate planners and business lawyers.

The decision provides an important reminder for insolvency practitioners that every trust is unique and not all interests of a beneficiary who becomes a bankrupt will vest in the trustee in bankruptcy because not all interests satisfy the definition of property in s5(1).

(feature image: ‘Trust’ by Terry Johnson; www.flickr.com/photos/lynellshooks; used under CC License 2.0)

 

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