Can Trustees Treat Beneficiaries Unequally?
Many family assets in New Zealand are owned by a family trust. The trustees os such trusts must comply with a wide range of duties and obligations. This post will consider one of the duties a trustee owes - the duty of impartiality, and what this duty means in practice, particularly when trustees want to distribute trust assets unequally amongst the trust's beneficiaries.
Trustees have wide ranging powers to distribute trust assets amongst the trust's beneficiaries. Trust deeds often will contain no restrictions, nor will they give guidelines for the trustees to distinguish between different beneficiaries when considering distributions of trust assets. This ensure that trusts can be flexible and meet the changing needs of beneficiaries over time, but can also create real challenged for trustees in balancing competing beneficiary demands.
Even though a trust deed may not include any restrictions or guidelines for the distribution of trust assets, that does not mean that the trustees can distribute the trust's assets without being subject to any duties. Both the statutory and common law impose a range of duties on trustees that they must comply with when exercising their discretionary powers. Some of these are that, the trustees must:
- Act in good faith and with proper motives.
- Correctly apply the terms of the trust deed.
- Actively manage the trust's assets and investments.
- Take into account all relevant considerations.
- Ignore irrelevant considerations.
- Not reach a decision that is perverse or capricious.
- Maintain impartiality amongst beneficiaries.
The duty to maintain impartiality amongst beneficiaries can be particularly challenging. An important question for the trustees is whether the duty of impartiality requires, or creates a presumption, that distributions of trust assets should be made equally to all beneficiaries. Does the duty of impartiality mean that all beneficiaries of a family trust need to receive exactly the same benefits from the trust? Can trustees be impartial bust still distribute trust assets unequally? What is the difference between impartiality and equality?
To answer these questions, the first thing that needs to be considered is the relevant trust deed. The general duty of impartiality can be limited and modified by the terms of the trust deed. Mosts trust deeds in New Zealand will include:
- Who the beneficiaries of the trust are.
- Whether any beneficiaries should take priority over other beneficiaries (such beneficiaries are often referred to as 'primary' or 'principal' beneficiaries)
- Powers for the trustees to distribute the trust assets to the beneficiaries in such proportions as the trustees in their sole, absolute and uncontrolled discretion think fit
Consequently, most trust deeds in New Zealand empower trustees to give preference to some beneficiaries and also confirm that trustees have absolute discretion when making distributions. However, these reasonably common provisions do not exclude the trustees' duty of impartiality. The duty of impartiality imposed by the statutory law of trusts still needs to be considered.
The proposed Trusts Bill includes specific reference to the duty of impartiality and provides a useful summary of the existing law. It provides in section 33 of the Trusts Bill, that:
(1) A trustee must act impartially in relation to the beneficiaries, and must not be unfairly partial to one beneficiary or group of beneficiaries to the detriment of the others.
(2) This section does not require a trustee to treat all beneficiaries equally (but all beneficiaries must be treated in accordance with the terms of the trust).
The proposed Trusts Bill therefore confirms that the duty of impartiality does not mean that trustees must distribute trust assets equally to the trust's beneficiaries. However, it can still be unclear what the duty of impartiality means in practice and trustees can still be concerned, when considering making unequal distributions to trust beneficiaries, that the unequal distribution will be a breach of their duty of impartiality.
When considering the duty of impartiality, it can be useful to distinguish between:
- Managing trust assets within the trust, and
- Distributing assets out of the trust to beneficiaries.
The duty to act impartially is clearly relevant when managing trust assets. Trustees must actively manage the trust assets on behalf of all the trust's beneficiaries. Individual beneficiaries have no rights to assets until the trustees exercise a discretion in their favour. Consequently, an obligation for trustees to act impartially while managing trust assets for the benefit of all beneficiaries is reasonable and appropriate.
In this context, the duty of impartiality provides useful guidance for trustees about balancing the potential interests of various beneficiaries, particularly when there are different classes of beneficiaries that benefit from trust capital. For example, some trusts have beneficiaries that benefit from trust income and other beneficiaries that benefit from trust capital. In this situation, the duty of impartiality means that the trustees need to fairly and even-handedly balance the interests of the beneficiaries who receive income distributions with the beneficiaries who receive capital distributions.
In the case of Re Mulligan (deceased), the trustees were found to have breached their duty of impartiality because they invested the trust assets in an income earning asset that benefited the beneficiary that was to receive income distributions, but resulted in no capital gain for the beneficiaries who were to receive capital distributions. In other words, in their management of the trust fund, the trustees failed to treat the income and capital beneficiaries impartially and had clearly favoured the interests of the income beneficiary.
The duty of impartiality is therefore useful for trustees and protects beneficiaries while trustees are managing trust assets on behalf of the beneficiaries as a whole. The duty creates an obligation for trustees to follow processes that respect the rights and interests of all beneficiaries. However, although the duty of impartiality affects how trustees manage assets within the trust, it does not dictate how trustees must exercise their discretionary powers to distribute those assets out of the trust.
This issue was discussed in the English case of Edge v Pension Ombudsman, which involved distribution decisions by the trustees of a pension fund. The Court stated that:
The so-called duty to act impartially... is no more than the ordinary duty which the law imposes on a person who is entrusted with the exercise of a discretionary power: that he exercises the power for the purpose for which it is given, giving proper consideration to the matters which are relevant and excluding from consideration matters which are irrelevant.
If pension fund trustees do that, they cannot be criticised if they reach a decision which appears to prefer the claimed of one interest... over others. The preference will be the result of a proper exercise of their discretionary power.
This decision confirms that when trustees make a decision to make distributions from the trust, that they must follow a fair and impartial process (i.e. obtain relevant information and exclude irrelevant information) before making any distribution decision. Provided this process is followed, any subsequent distributions are unlikely to be criticised, even if it results in the beneficiaries being treated unequally.
In summary, when managing a trust, trustees must treat the beneficiaries of the trust impartially and even handedly. However, when it comes time to exercise powers to allocate trust funds amongst the beneficiaries, trustees can exercise those powers to distribute the trust's assets amongst beneficiaries unequally, even to the extent of excluding beneficiaries, provided that they have followed a fair and impartial process of management, investment and information gathering before making their distributions.
With any trust holding valuable trust assets, any major distribution decisions by trustees are vulnerable to challenge by disgruntled beneficiaries. Although such challenges can only succeed if a Court accepts that the trustees breached their duties, a significant amount of time, cost and stress can be incurred by trustees defending any claim. To minimise the risks where major distributions or transactions are involved, we recommend that the arrangements be approved in writing by the beneficiaries of the trust. However, this will not always be possible - for example, where the beneficiaries may be children and therefore unable to consent. In such cases, the trustees may want to consider obtaining consent of the Court prior to making the distributions or they could seek guidance from the Court on the best way to proceed. These processes however can be expensive, but minimise the risk of future challenges arising.
This post has provided some general guidance on when and how beneficiaries can be treated unequally. If you are a trustee considering your obligations for management, or your powers of distributions, you need to carefully consider the specific terms of your trust deed (which could override this general guidance) and obtain specialist legal advice if required.
Please contact us if you would like to discuss any of these issues in more detail or if you would like more specific advice about your trust.