Lee and Public Trust v Torrey and Folwell  NZHC 2135
This was an action brought against trustees of a discretionary trust settled by the later Mrs Lee. She apparently had a fractious relationship with her children and while living set up a trust to which she appointed a friend, Mrs Folwell as a co trustee. Mrs Folwell and Mrs Lee’s sons were discretionary beneficiaries along with others.
Mrs Lee died and the trust assets were then distributed, in very large measure to the trustee and her husband. One of Mrs Lee’s sons took umbrage at this and in the face of his complaints he received a modest payment. Some of the trust assets were lost in an internet scam.
The decision of Faire J considers a number of issues relating to discretionary trusts. It is a reminder that even wide language in a trust deed will not absolve trustees from basic obligations of trusteeship and to benefit themselves. It is apparent from the tenor of the judgment that the actions of the trustees did not find the slightest favour with the Judge, and nor should they have. It is not often that such a stark case of trustees’ duties being breached finds its way to the Court.
The Court considered, first, the interest of a discretionary beneficiary. This was relevant because one of the claims was for an accounting for income that would have been earned had the offending distributions from the trust not been made. The Court confirmed the now well established position that a discretionary beneficiary has a mere expectation of being considered for benefit and no interest in trust property as such. It held that this extended to income as well.
Next it examined the obligations of trustees of a discretionary trust and its commentary on the behaviour in this case was scathing. The trustees’ conduct “fell far short of good faith and displays no moral concern to provide for other beneficiaries of the trust.” Direct losses to the trust funds were attributable to breaches of the trustees’ duty to act reasonably. The Judge found it unnecessary to determine how that duty applies in relation to an absolute discretion because there had never been any effort by the trustees to try to deal reasonably with the trust assets. In other words the protection of an absolute discretion only engaged when the trustees could be shown to have purportedly exercised the discretion, ie to have positively considered how to apply it. In most cases they had simply decided to pay themselves regardless of others.
Although the Court acknowledged that under a discretionary trust there is no duty to act impartially, that duty also did not engage because of the fundamental failure to consider the position of other beneficiaries. A failure to keep accounts, pay taxes and seek advice meant that the duty to act prudently and responsibly had not been met, another hallmark of the trust fund having been treated as the trustees’ own.
The Court then examined how the trustees ought to have exercised their powers. It was careful to state that it could only examine three components that would determine if a decision in exercise of discretion was correct. They are whether the decision was reached in good faith, whether it was based on real and genuine considerations and whether it had been made in accordance with the purposes for which the discretion was conferred. The trust deed conferred an absolute discretion without giving any guidance as to how that should be exercised. The trustees’ actions were examine against the three yardsticks referred to and clearly came up short except in respect of a distribution made to one of the named discretionary beneficiaries who had approached them asking for help to save her house. Their decision to asst was judged to the outcome of a correct process.
The Court considered then the principles of trustee’s liability, making the point that equitable remedies must preserve flexibility to meet differing situations. One established kind of breach was that of self dealing and the Court repeated the principles of that breach, confirming that a robust and realistic view had to be taken and that without the informed consent of all beneficiaries, action under conflict of interest would be voidable.
The Court held that the rule against self dealing applied to the two major distributions complained of, those to the trustee and her husband and that which was lost in the internet scam, where the trustee had used trust funds seek a windfall for herself. It then examined the liability of the trustees beginning with the effect of the liability exclusion clause in the trust deed.
The Judge confirmed that a liability exclusion clause cannot override an irreducible core of trust obligations. Where trustees have breached a duty which is fundamental to the concept of trust they cannot rely on the exclusion. The fundamental duties to act honestly and in good faith had not been met and so the liability arising from such a breach was not excluded. As a result the trustees were ordered to reinstate the trust with a sum of $106,533. The trustees had asked to be removed and after examining the case law the Judge decided that they must be and the Public Trust was appointed instead.
The decision in Kea is a timely reminder that trustees act for others and not themselves. Even if they are also discretionary beneficiaries of their trust, before they take anything from it, they must act in a manner which demonstrates that they are considering the interests of other beneficiaries alongside their own in a fair and measured way. They will bear the practical burden of proving this if their decision is challenged. Even a broad exclusion of liability will not save a trustee from liability for a decision which involves self dealing and which fails the test of having been reached in a good faith exercise of trust powers and discretions.
© G D Clews, 2015