What are the key points I need to know about trusts under the Property (Relationships) Act 1976?

The key points are discussed under the following headings:

• Use of a trust to keep property separate
• Valuation of a beneficial interest under a discretionary trust
• Trust-busting
• Deciding if a transfer to a trust “has the effect” of defeating a claim
• Company-busting
• Legal advice
• Effect of separation on family trusts
• Trusts vs wills

Use of a trust to keep property separate
A person sometimes transfers his or her property to trustees, to try to keep the property unavailable to his or her spouse or partner (or potential spouse or partner).

However, the situation is not quite so simple. The settlor may still have property in the form of:
1. a debt owed to him or her by the trust; or
2. an interest as a beneficiary of the trust.

Property as debt owed by trust
The debt arises because property is not transferred to a family trust for free - otherwise, there would be gift duty implications. Commonly, the trust owes the settlor the market price of the asset transferred. That debt owed by the trust to the settlor is then forgiven by the settlor at a rate that does not attract gift duty ($27,000 pa currently). The part of the debt that is not yet forgiven is itself property, and could be the subject of a claim under the Property (Relationships) Act 1976. So, when a transfer of property to a trust has occurred not long before the couple separate, the transfer will have relatively little impact.

Property as beneficial interest
When assets are transferred to family trusts, often new forms of property are created. Normally, the settlor will include himself or herself as a beneficiary. The beneficial interest of a beneficiary who is a spouse or partner is property.

The law makes a distinction between trust assets which have been transferred to a trust by third parties (ie, other than the couple) and property that is transferred by one of the spouses or partners. If the property has been transferred to a trust by a spouse or partner, the new law seems to classify the equitable interest that either spouse or partner gains as a result of being a beneficiary of the trust as relationship property, and it is available for division. The court can therefore make orders in respect of this relationship property, and has a power to vary the trust.

A spouse or partner could ask the court to have his or her interest in the trust changed from a discretionary one - that depends on the exercise of the trustees’ discretion - to a defined interest in income or capital; or to have the trust deed amended to a point where both spouses or partners are equal trustees; or to grant a totally new trustee who is neutral (such as a professional trustee company) the power to run the trust.

Alternatively, the court could be asked to make vesting orders in respect of part of the trust property. The other beneficiaries would need to be given notice of this if their interests in the trust would be affected.

In some circumstances, the beneficial interest will be separate property - for example, where the assets of a third party have been transferred into the trust, or separate property of one spouse or partner has been settled into a trust. However, even then, the other spouse or partner may have a claim to any increase in the value of the trust capital.

If the beneficial interest is the use of a home, it will become relationship property automatically, along with the family chattels.

A limitation on a beneficial interest becoming relationship property is whether it can be valued (see below).

Valuation of a beneficial interest under a discretionary trust
In a discretionary family trust, the trustees have the discretion to distribute income and capital to any of the beneficiaries, whenever they choose. It is not always possible to put a value on the beneficial interest, unless some direct benefit has been conferred. For example, the right to occupy a home owned by a trust is at least a property right (or “licence”) - and that is capable of valuation.

If there is a very limited number of beneficiaries and a long-term policy ofhow income, for example, is distributed between the discretionary beneficiaries, it may be possible to value a discretionary interest.

If valuation of a beneficial interest is impossible, it will be impossible to order sharing of that beneficial interest. As an alternative, the court may order the trustees to pay income to the spouse or partner who is not a beneficiary. (This remedy is of little help if the trust does not have an income.)

Trust-busting

Even if a discretionary trust does not confer a valuable benefit on the settlor spouse or partner, there are several other possible ways a trust can be attacked, or the other spouse or partner can seek compensation to make up for the loss of property transferred into trust.

• Under the Property (Relationships) Act, compensation can be paid if a person transfers property to a trust after the relationship or marriage ends and this has the “effect” of defeating the other spouse or partner’s claim to that property.
• The Act also allows compensation to be paid out of other relationship property where there is no family home - for example, if the family home has been transferred to trustees.
• Where relationship property has been transferred by one of the partners or spouses into a trust, and either or both partners or spouses have a beneficial interest in respect of the trust, if the beneficial interest is relationship property, the court has powers to make orders varying the trust deed.
• There may be an argument for “extraordinary circumstances” if relationship property has been diverted into a trust (see chapter 3 for a discussion of the exceptions to equal sharing).
• The terms of the trust can be varied as an ancillary order of court (this is really just a mechanical order following a final order determining the couple’s actual shares in the property).
• The Family Proceedings Act 1980 allows the court to vary a trust when a marriage is dissolved or shortly afterwards, for the benefit of either the children or the parties themselves.
• The transfer of property to a trust to avoid maintenance or child support obligations can be reversed.
• The ordinary law of trusts can curtail and restrict a trustee who is not acting impartially.
• If the other spouse is a beneficiary, he or she could apply to the court to remove an existing trustee and appoint a different trustee, in the best interests of the beneficiaries (see Re Polkinghorn Trust; Kidd v Kidd (1988) 3 FRNZ 636; (1988) 4 NZFLC 756).
• Existing trust law may be used to get the court to declare the trust a sham if it has been operated as the alter ego of one spouse or partner and is not truly a trust.

Deciding if a transfer to a trust “has the effect” of defeating a claim

Formerly, only the intentional use of trusts to keep property out of the reach of one spouse could be challenged. Under the new Act, the transfer of property to a trust also gives rise to a right of compensation if the transfer merely has the effect of defeating the claim of a spouse or partner.

The court will look at a range of factors to decide whether compensation should be paid to the person whose share in the relationship property has been lost to a trust. Those factors are:

• the value of all of the couple’s relationship property;
• the value of the relationship property transferred to the trust;
• the dates it was transferred;
• the price paid by the trust;
• whether the partner or the children of the relationship are beneficiaries; and
• any other relevant matter.

The court is interested in whether the person seeking compensation really has been disadvantaged, or is still benefiting from the property via the trust. The court will also look at who controls the trust and, consequently, who will ultimately benefit as discretionary beneficiaries. If the property has been sold to the trust for a fair value, the court will look at what stage the gifting programme is at - if all or most of the value has already been gifted away, the court will be more likely to intervene and grant compensation. Compensation is also more likely to be paid if the transfer was not for full value (see Re Polkinghorn Trust; Kidd v Kidd).

Company-busting

Sometimes businesses owned by one spouse or partner are run as companies, which can be used to place property beyond the reach of the other spouse or partner. In most cases, the owner of the business owns the controlling shares and lists the assets as assets of the company. The new Act specifically targets this use of companies.

The law will deal with this situation largely in the same way as for trusts. Compensation will go to the partner whose claim has been defeated because the property is no longer in the parties’ names. There is one important limitation though. The Act applies only to a “qualifying company” - defined as a company where the “controlling interest” is held by a spouse or partner. The controlling interest is defined as an interest in the company that carries 50% or more of the voting rights at a general meeting of the company.

The court will look at:

• the value of all of the couple’s relationship property;
• the value of the relationship property transferred to the company;
• the dates it was transferred; and
• the price paid by the company.

Legal advice
The new Act does not state that both spouses or partners have to have independent legal advice before the transfer of relationship property to a trust or company goes ahead.

Some people would still argue that independent legal advice should be a prerequisite before relationship property is transferred to a trust. “Trust-busting” may be expensive - and in some situations, impossible or impractical. If both parties have independent legal advice, this might avoid the situation where trust-busting is later necessary - the transfer of relationship property to the trust might not go ahead, or the parties may come to some agreement about alleviating the potential negative effects of the transfer to the trust.

Effect of separation on family trusts
The trust deed is the first port of call - it may spell out what happens in the event of a separation. Possibilities are:

• automatic termination and vesting of the assets in the final beneficiaries;
• retirement and/or reappointment of trustees; or
• sale of specific assets and distribution of the proceeds to certain beneficiaries.

The main concern is if one spouse or partner in effect has sole control of a trust - ie, he or she is a trustee or can “hire and fire” trustees. The spouse or partner who is the trustee (or who has the power to appoint trustees who are sympathetic to him or her) can exclude the other spouse or partner from benefits in the future. Even though a claim could be made under the Trustee Act 1956 to force the trustee to act fairly, litigation is often expensive and there are no guarantees of success.

The best way to change a trust that operates unfairly is to modify or unwind it completely, using the powers in the trust deed itself. However, other factors may dictate just how a trust is treated after a separation — eg, there may be tax or gift duty implications.

Trusts vs wills

A trust created during the settlor’s lifetime is less open to challenge than a will. There are several means of challenging the way that property is left in a will:

• a spouse or de facto partner can claim under the Property (Relationships) Act;
• a close family member can claim under the Family Protection Act 1955; or
• someone seeking the performance of a promise can claim under the Law Reform (Testamentary Promises) Act 1949.

A discretionary trust that is created while the settlor is still living can effectively reduce the effects of claims against the settlor’s will. A trust - as long as it respects the other partner’s property interests - cannot be
challenged because the assets have ceased to be part of the settlor’s estate.

For more information on the new Property Relationships Act buy your copy of for Richer For Poorer from the Good Returns bookstore - CLICK HERE