Why Trusts May Not Be As Watertight As Previously Thought…Clayton v Clayton

Earlier this year, the Court of Appeal considered the case of Clayton v Clayton.  This is the case where the High Court had previously upheld a Family Court ruling that one of the trusts involved was an “illusory trust”, creating a cause of action which was used by the lower Court to set aside one of the trusts.

Mr. and Mrs. Clayton were married in 1989 and separated in 2006.  During the relationship Mr. Clayton set up numerous trusts that held various assets that were accumulated during the relationship.  The lower Courts examined all of the Trust Deeds and the operation of the various trusts. 

The Court of Appeal considered specific points of law on appeal and, while largely upholding the decision of the High Court, did weigh in on some important factors.  Specifically; the ‘sham’/’illusory’ trust distinction, trust deed provisions constituting property rights, and the expanding scope of the Court’s willingness to set aside dispositions to trusts under section 44 of the Property (Relationships) Act 1976.

We have summarised some of those specific issues below.

“Sham” v “Illusory” Trusts…

The Court of Appeal decided the concepts of sham trusts and illusory trusts are effectively the same and therefore any distinction is redundant.  This is welcome news to those concerned about “trust busting” as the lower High Court had previously ruled that even though a trust may be found to be valid (not a sham), in some instances, it could still be disregarded on the basis it was illusory.  The High Court decision had, even if for a short time only, provided another means to “bust” a trust. 

The Court of Appeal did however agree with the High Court in finding the trust in question was not a sham, as it was created for a valid purpose.  The Court of Appeal concluded that if a trust is created validly, it should not be treated as non-existent simply because the trustee has wide powers of control over the trust property.  

Property Rights created by Trust Provisions…

A provision in one of the trusts in question gave Mr. Clayton, as “the Principal Family Member”, the sole power to appoint and remove beneficiaries and trustees.   If Mr. Clayton exercised this power, he could be left as the only person who could receive income and property dispositions from the trust.

Importantly, what the Court of Appeal held was that, in this case, the power of the Settlor to appoint and remove beneficiaries was “Relationship Property” for the purposes of the Act.  It was held that the value of that property was the same as the value of the assets of the Trust. Mrs. Clayton was therefore able to make a claim in respect of the assets of that Trust.

Application of Section 44 of the Act…

Section 44 of the Act gives the Courts the power to claw back a disposition to a trust that is intended to defeat a possible claim by a spouse, civil union partner, or de facto partner. 

The Court found five of the Clayton’s trusts fell foul of this provision.   Three of the trusts that were settled after the Clayton’s separation were found to have been used by Mr. Clayton to dispose of assets before they could be subjected to a Relationship Property claim by Mrs. Clayton.

Two of the trusts settled during the relationship, supposedly for the purposes of the Clayton’s children’s education, were also found to fall foul of section 44.  Mr. Clayton settled those trusts after receiving legal advice about how to protect his assets and business interests in the event of separating from Mrs. Clayton.   

The beneficiaries of the two trusts included the Clayton’s children and Mr. Clayton. Somewhat farcically however, other beneficiaries included: any nominated business associate, employee or consultant of any business connected with Mr. Clayton, any child, grandchild or great-grandchild of the children, any relative of Mr. Clayton, any company in which any of the previous beneficiaries have at least a 10 per cent shareholding, any trust of which any of the previous beneficiaries are a beneficiary, and any charitable organisation. Crucially Mrs. Clayton was not a beneficiary, and the children were not final beneficiaries despite the apparent purpose of the trusts. 

Unsurprisingly, the Court of Appeal concluded that in respect of those trusts, the dispositions of assets were made with the intention of defeating Mrs. Clayton’s interests.  Mrs. Clayton was therefore entitled to a share of both trust’s property.

The final analysis

While this decision is to be appealed to the Supreme Court, the Clayton litigation serves as yet another reminder that trusts are no longer a watertight means of protecting ones assets, particularly against Relationship Property claims.  More than ever it is important that legal advice is sought in respect of both the establishment and ongoing operations of the trust.