When is a Trust not a Trust?

Recently, a decision in the Supreme Court has been handed down in the case of Clayton V Clayton that has cast light, or shadow, depending on your perspective on the use of trusts for asset protection in matrimonial circumstances.

Some valuable learnings have come from the judicial comments in the case which involved a couple who married in 1989, separated in 2006 and divorced in 2009. The case involved a trust that was settled by the husband who held the power to appoint and remove trustees. The trust was formed after the marriage. The trustees were the husband and another. Final beneficiaries were the children of the relationship with the wife and husband included as discretionary beneficiaries.

On divorce the wife sought an award under S 182 of the Family Proceedings Act to a share of the trust assets. Ultimately she was successful as the court found that the bundle of rights that the husband held that gave him effective power under the deed to control the trust himself and to distribute assets of the trust back to himself amounted to a property right. The court then valued this right at the net assets of the trust and divided this with the wife.

So what are the learnings from the outcome?

Firstly, the court did not find that the trust was a sham. To be a sham, the settlor would not have intended to actually create a valid trust. It was accepted that the husband had intended to create a trust and as such it was not, of and in itself, a sham.

The court did though find that the trust was somewhat illusionary as it did not truly separate the husband from control of the assets he had settled onto the trust. By holding the power of appointment and the ability to run the trust alone he was effectively able to remove all beneficiaries other than himself and in so doing had really only created the illusion of separation from his assets.

The essence of a trust is the creation of a fiduciary obligation for one person to hold assets on behalf of and for the benefit of another. The absence of a fiduciary duty to another person undermined the trust. A classic trust though, where a settlor has transferred property to one or more trustees other than themselves for the benefit of another person other than themselves, is an arrangement that can’t be challenged.

When a settlor retains the ability to reverse a transaction by reverting back to himself it is possible that no trust has been created or that there is not yet a trust. The judiciary will attempt to answer these questions with reference to common law and the law of equity, i.e. they will consider substance over form.

Whilst the decision in Clayton V Clayton is only specific to matrimonial law, it is likely that the success Mrs Clayton had will mean that in future the courts may look to apply similar reasoning to other areas like insolvency law.

From a matrimonial perspective, it is apparent that individuals will need to turn more and more to section 21 contracting out agreements which may need to include reference to assets held in trusts pre-relationship for protection in the event of separation. Real thought when drafting deeds of trust will need to go into the substance of the trust and the key creation of the fiduciary duty to hold the assets for another person’s benefit rather than the form of trust that may simply create the illusion of a trust if no genuine fiduciary duty is created.

If on review of a trust if it is decided that it does not meet this test it may though be possible to alter the form of the trust to strengthen its substance and in so doing create a valid trust.

In light of the decision if you have formed a trust for matrimonial asset protection especially if it was formed during your marriage it would be timely to now review your deed with your advisors.