Protecting your children’s inheritance

The Family Court of Australia’s recent decision in Bernard v Bernard [2019] FamCA 421 demonstrates the benefit of obtaining tailored estate planning advice in order to protect your children’s inheritance. 

The case involved proceedings for a property settlement between a husband and wife following their separation. 

The wife claimed that the husband’s interest in a discretionary testamentary trust established under his late father’s Will was property of the marriage within the meaning of the Family Law Act 1975 (Cth) (‘the Act’).      

The husband rejected this. He claimed that at most his interest in the discretionary testamentary trust was a financial resource the value of which was not to be added to the matrimonial pool of assets for division between the separating parties, but to be taken into account when adjusting the property settlement orders. 

The case was heard before Justice Henderson who rejected the wife’s claim and found in favour of the husband. 

The case needs to be considered in the context of the Family Court’s ability to extend the concept of property, for the purposes of family law proceedings, to interests which a party to the marriage or de facto relationship has in a discretionary trust.  

Discretionary trusts are attractive business and estate planning tools for families because of the tax advantages and asset protection they may offer.   However, the extent to which they offer asset protection depends on a number of factors, including the terms of the trust deed and the reality or factual circumstances in which the trust operates. The case of Bernard v Bernard is testament to this.         

The asset protection stems from the notion developed by courts of equity that neither trustees nor beneficiaries of discretionary trusts have any significant proprietary interest in the assets of a trust.  Whilst trustees hold legal title to the trust’s assets they do so for the benefit of the beneficiaries.  However, because the beneficiaries are objects of a discretionary, as opposed to a fixed interest trust, their entitlement to receive income and/or capital from the trust is entirely at the discretion of the trustee.  The beneficiaries have a right to due administration of the trust and to be considered amongst the class of eligible beneficiaries when the trustee turns their mind to making a distribution.  However, ordinarily they cannot compel a distribution in their favour. Their interest is proprietary in nature but in the limited sense of being a chose in action.

However, the 2008 High Court case of Kennon v Spry (‘Spry’) (2008) 238 CLR 366 and a number of its precursors, including In the Marriage of Goodwin (1990) 101 FLR 386, undermined the asset protection traditionally afforded by discretionary trusts. 

In Spry the husband was the settlor and trustee of a discretionary family trust. The assets initially contributed to the trust were those he acquired before his marriage to the wife.  However, the fund was augmented during the marriage.  

The beneficiaries of the trust included the wife, the children of the marriage and the husband’s nieces and nephews.  The husband varied the terms of the trust so that he was permanently removed as a beneficiary. 

The majority of the High Court held that in these circumstances the assets of the trust were property of the parties to the marriage.   The reason being because, under the terms of the trust deed (and the valid deeds of variation) the husband was in full control of the trust.  He had the power to vary the trust, appoint and remove trustees, and most importantly, to appoint the assets of the trust to his wife, if he so decided.  His legal ownership of, and power to appoint, the trust’s assets, coupled with the wife’s right to due administration and consideration, constituted property of the parties to the marriage.

Turning now to the facts in Bernard v Bernard, the husband and wife married in 1988, separated in 2015 and divorced in 2017.  In 2012, the husband’s father died leaving his estate equally to the husband and the husband’s sister under two discretionary testamentary trusts. The husband was the trustee of his sister’s trust and his sister was the trustee of his trust.  Each was the primary beneficiary of their own trust.  Each trust had a number of potential beneficiaries including the spouse, children and grandchildren of the primary beneficiary. 

The substance of the wife’s claim was that as the trusts mirrored each other, with the husband and his sister having the same rights and obligations as trustee of each other’s trust, and using the trusts to conduct a partnership, the husband had control of his own trust as did the sister hers. The wife claimed that in effect the husband controlled his own trust and that this control equated to property of a party to the marriage.    

Justice Henderson had no difficulty rejecting this argument. He held that the facts in this case were distinguishable from those in Spry and the like of cases where the Family Court has ‘busted’ discretionary trusts set up for the purpose of defeating family law property settlements, or, which in reality were controlled by a party to the marriage for their individual benefit or the benefit of both parties to the marriage.     

In particular, he noted that in this case: 

• The trusts were established from the assets of the late father’s estate and not from property acquired by the husband either before or during his marriage to the wife;
• The settlor of the trusts was the husband’s father;
• The husband was a mere beneficiary of his trust and had no more than a right to due administration and consideration. On examination of the facts, he had no control over his sister to procure a distribution or appointment of the trust’s assets in his favour.  And as trustee, his sister legitimately owed fiduciary obligations to all of the beneficiaries not just her brother.
• Each trustee was ‘scrupulous’ in filing separate tax returns, making resolutions pursuant to the terms of the trust deed and avoiding the mingling of trust assets.

What is apparent from this case is that the husband’s late father obtained sound estate planning advice customised to the particular circumstances of his estate. 

This enabled his children to enjoy their inheritance via testamentary discretionary trusts and reducing the risk that their inheritance would constitute property subject to family law proceedings. 

However, there is no ‘one size fits all’ when it comes to planning and drafting discretionary testamentary trusts.  There are many issues to consider.  It is important to seek professional estate planning advice to ensure that the right structures are put in place to meet your individual needs. 

If you have any questions about this article or estate planning generally, please feel free to contact Paul Watkins or Andrea Olsson on (03) 8540 0200 or by emailing Paul at paul.watkins@mst.com.au or Andrea at andrea.olsson@mst.com.au.