At first glance, the prospect of a distribution from a trust would benefit a beneficiary. The distribution might not be for as much as they would like, but receiving something is surely better than receiving nothing. However, courts in England and Wales and overseas have considered scenarios where a beneficiary opposes a proposed distribution by a trustee on the basis that it does not confer any benefit on them.
This typically happens in cases where the distribution is intended to pay off or reduce a beneficiary’s debt. Lavinia Randall examines some recent decisions involving this issue.
“No benefit” to the beneficiary
In Smith v Michelmores Trust Corporation [2021] EWHC 1425 (Ch), the deceased had established a trust for her son and his issue in her will. Her son (“the beneficiary”) had been in a business partnership with the deceased during her lifetime, and after her death, her executors issued a claim against him in relation to action he had taken while in the partnership. The executors were successful and obtained an order for damages plus costs totalling nearly £500,000. The beneficiary did not pay, and the executors successfully petitioned for his bankruptcy.
The estate’s only asset (apart from the judgment debt) was a cash sum of around £230,000. Under the will, this was to be divided into four equal shares, one of which was settled on the trust. The trustees of the trust (who were also the executors of the estate) decided to distribute the trust fund in full to the beneficiary while he was an undischarged bankrupt. They did so in the knowledge that the funds would vest in his trustee in bankruptcy and then be paid mostly to the estate as the beneficiary’s biggest creditor. The trustees made a Public Trustee v Cooper application to the High Court for a blessing of the decision to make the distribution.
The beneficiary objected to the distribution being made to him while he was an undischarged bankrupt on the basis that it would be of no benefit to him. The trustees’ Public Trustee v Cooper application was refused primarily because the claim had not been properly constituted. His Honour Judge Matthews also concluded that the proposed distribution would be a fraud on a power as it was not being used for the purpose intended, which was to benefit the beneficiary or his issue. The real beneficiary of the appointment would be the deceased’s estate, of which the trustees were also the executors. There was, said the judge, a “stark and obvious conflict of interest”.
The judge also concluded that the distribution would confer no direct benefit on the beneficiary, as it would vest in his trustee in bankruptcy, and he would not receive any of the cash. There would be an indirect benefit to the beneficiary as his debts would be reduced but only by 11%, which was described as a “small fraction” of the overall sum owed.
The judge referred to some indirect benefits that could perhaps accrue to a beneficiary of a distribution, other than financial benefits, such as “the ability to carry on a new trade, to become a member of a club he wished to join, or to live a new life of some kind”. In this case, the benefit accruing from the distribution was considered to be so minimal, particularly when compared to the alternatives open to the trustee, such as making the distribution after the beneficiary was discharged from bankruptcy, that it was “impossible to say that the proposed appointment was for [his] benefit”.
Objective and subjective test
The court in Smith v Michelmores considered a decision of the Royal Court of Jersey in Re Esteem Settlement [2001] JLR 7 and the English cases referred to in that judgment. In that case, the settlor, Mr Fahad, had created a discretionary trust with assets worth around $18m, of which he, his wife and his son were the beneficiaries.
Mr Fahad was later found to have embezzled nearly $700m from his employer, who obtained a judgment against him. The employer attempted to enforce the judgment against the assets in the trust, although it was not alleged that the assets in the trust came from the embezzled funds (either directly or indirectly), which could have opened up the possibility of proprietary claims. The trustee of the discretionary trust surrendered its discretion to the court and applied for an order that the trust assets be applied to the part payment of the judgment debt against Mr Fahad. Mr Fahad, his wife, and his son opposed the application. Mr Fahad wrote to the trustees’ lawyers, stating that he did not consider he owed any moral obligation to his former employer (the judgment creditor) and did not wish the trustees to make any payment towards the judgment debt.
The Royal Court first considered whether the beneficiary’s objection to the distribution was a bar to the trustee exercising its power of appointment. Although in most cases a beneficiary will consent to receiving a distribution, the court found that this was not a pre-requisite to the trustee exercising its power of distribution. Making this a prerequisite would rule out, for example, distributions to minors or protected persons unless court proceedings were instituted and the minor or protected person formally represented. The court also noted that in some cases where a beneficiary opposed receiving a distribution to pay off his debts, this might be irrational and to the detriment of other beneficiaries (for example, if the debt related to school fees and prevented the continuation of a minor beneficiary’s education).
The court went on to distinguish between “direct” and “indirect” distributions and accepted that a beneficiary could not be forced to accept a direct distribution, such as a cash transfer to their account. A beneficiary’s objection to a direct distribution could therefore be a bar to the trustee’s exercise of its power of appointment. However, this was not the case for indirect distributions such as payments direct to a beneficiary’s creditor, with which the beneficiary need not have any involvement. The court concluded that trustees have the power to make indirect distributions and that a beneficiary’s objection to it will not be a bar to the trustee exercising that power.
Defining ‘benefit’
The second question for the Royal Court to consider was whether the proposed distribution would benefit Mr Fahad. The court considered that the word “benefit” is to be construed widely and goes far beyond mere financial benefit, encompassing all sorts of ways a beneficiary’s position can be improved. However, the court stressed that this is not open-ended, and there is an objective test, which is that the trustee’s proposed exercise of its powers can fairly be regarded as being for the benefit of the beneficiary. Furthermore, there is a subjective element: the trustee must genuinely believe that the appointment of capital will be for the benefit of the beneficiary. The court said the question of benefit is to be considered in a “realistic and common sense manner rather than in a theoretical or academic way”.
Applying those considerations to this case, the court concluded that the proposed distribution, which would pay off a small part of the judgment debt, would not benefit Mr Fahad or any of the other beneficiaries. On appeal, the Court of Appeal of Jersey noted that the proposed distribution would have led to a proportionately tiny reduction of Mr Fahad’s indebtedness to the judgment creditor. The creditor’s argument that the distribution would “reduce Mr Fahad’s burden” was rejected as “simply unreal”, given the size of the remaining debt to which Mr Fahad would remain exposed. There was no evidence to suggest that the part payment might lead to the creditor settling the matter and leaving Mr Fahad and his family alone.
Both the Royal Court and the Court of Appeal of Jersey rejected the creditor’s argument that the proposed distribution would improve Mr Fahad’s moral or ethical position by “confronting his dishonesty” and partly compensating the victim of his fraud. The Royal Court observed that this would lead to the trustee’s assessment of benefit being dependent upon the trustee’s view of the moral case for making a debtor repay part of his debt, which was considered unsatisfactory.
When will payment to a beneficiary’s creditors be for their benefit?
In both Smith v Michelmores Trust Corporation and Re Esteem, the court took account of the fact that the proposed distribution constituted only a small proportion of the beneficiary’s debt, which in both cases was far beyond their ability to repay in full. Although other factors were relevant, particularly the timing of the proposed distribution in Smith, the ratio of distribution to debt was significant. The court did not consider that payment of a small contribution towards a large debt would materially change the beneficiary’s position.
By contrast, in Lowther v Bentinck [1874] 12 WLUK 52, the High Court approved the distribution of half of the trust fund towards payment of debts incurred by the life tenant, the interest on which was absorbing most of his income and leaving insufficient funds to raise his children “in a manner corresponding to their social position”. The distribution significantly reduced the principal sums owed and the interest payments due, leaving the beneficiary with sufficient income for him and his family (who were also objects of the trust) to live on.
In all the cases referred to above, the beneficial class of the trust was wider than just the debtor, so the court had to consider the needs of the other beneficiaries for whom the funds proposed to be distributed would no longer be available. The court may have felt differently if the debtor was the sole ascertained beneficiary, particularly if they were also the settlor. This could lead to difficult policy considerations as to whether debtors should be able to use trust structures as a shield to avoid making a part payment towards their debts.
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