When does a distribution to a beneficiary under a trust confer no benefit?


At first glance, the prospect of a distribution from a trust would benefit a beneficiary. The distribution may not be as large as they would like, but receiving something is certainly better than receiving nothing. However, courts in England and Wales and overseas have considered scenarios where a beneficiary objects to a distribution proposed by a fiduciary on the grounds that it confers no benefit to him or her.

This typically occurs in cases where the distribution is intended to repay or reduce a beneficiary’s debt. Lavinia Randall examines some recent decisions bearing on this issue.

“No benefit” for 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 while she was alive and after her death her executors brought an action against him in relation to the actions he took while he was in the partnership. The executors were successful and won an order for damages plus costs totaling nearly £500,000. The beneficiary failed to pay and the executors successfully filed for bankruptcy.

The only asset in the estate (apart from the court debt) was a cash sum of approximately £230,000. Under the terms of the will, this was to be divided into four equal parts, one of which was settled on the trust. The trustees of the trust (who were also the executors) decided to distribute the trust fund in full to the beneficiary while he was an undischarged bankrupt. They did so knowing that the funds would vest in his trustee in bankruptcy and would then be paid primarily to the estate as the beneficiary’s largest creditor. The trustees made a Public Trustee v. Cooper petitions the High Court for blessing of the decision to proceed with the distribution.

The beneficiary objected to the distribution being made to him while he was an undischarged bankrupt on the grounds that it would not benefit him. Trustees Public Trustee v. Cooper application was refused primarily because the application had not been properly constituted. His Honor Judge Matthews also found that the proposed distribution would be a fraud on a power because it was not being used for its intended purpose, which was to benefit the beneficiary or his descendants. The true beneficiary of the appointment would be the estate of the deceased, whose trustees were also the executors. There was, the judge said, a “pure and obvious conflict of interest”.

The judge also concluded that the distribution would confer no direct benefit to the recipient, as it would vest in his trustee in bankruptcy and he would not receive any part of the money. There would be an indirect benefit for the beneficiary since his debts would be reduced but only by 11%, which was described as a “small fraction” of the overall sum due.

The judge referred to certain perquisites that could possibly accrue to a recipient of a distribution, other than financial benefits, such as “the opportunity to pursue a new profession, to become a member of a club which he wished join, or live some new life.” In this case, the benefit from the distribution was considered so minimal, particularly when compared to the alternatives available to the trustee, such as making the distribution after the beneficiary’s release, that it was “impossible to say that the proposed appointment was for [his] benefit to”.

Objective and subjective test

The court in Smith vs. Michelmores examined a decision of the Royal Court of Jersey in Esteem settlement [2001] JLR 7 and the English cases cited therein. In this case, the settlor, Mr. Fahad, had created a discretionary trust with assets worth approximately $18 million, of which he, his wife and son were the beneficiaries.

It was later discovered that Mr Fahad had embezzled almost $700 million from his employer, who won a judgment against him. The employer attempted to enforce the judgment against the assets of the trust, although it was not alleged that the assets of the trust came from the embezzled funds (directly or indirectly), which could have opened up the possibility property claims. The trustee of the discretionary trust surrendered its discretion to the court and sought an order that the assets of the trust be applied to partially pay the judgment debt owed by Mr. Fahad. Mr. Fahad, his wife and son opposed the request. Mr. Fahad wrote to the trustees’ lawyers, stating that he did not consider that he had a moral obligation to his former employer (the judgment creditor) and did not want the trustees to make payment for the judgment debt.

The Royal Court first considered whether the beneficiary’s objection to the distribution prevented the trustee from exercising its power of appointment. Although in most cases a beneficiary consents to receive a distribution, the court found that this was not a condition precedent to the fiduciary’s exercise of its power to distribute. Making it a precondition would exclude, for example, distributions to minors or protected persons, unless legal action was taken and the minor or protected person formally represented. The court also noted that in some cases where a beneficiary objected to receiving a distribution to repay his debts, this could be irrational and to the detriment of other beneficiaries (for example, if the debt was for school fees and prevented the further education of the beneficiary).

The court then distinguished between “direct” and “indirect” distributions and accepted that a beneficiary could not be compelled to accept a direct distribution, such as a cash transfer to their account. A beneficiary’s objection to a direct distribution could therefore prevent the fiduciary from exercising its power of appointment. However, this was not the case for indirect distributions such as direct payments to a beneficiary’s creditor, with which the beneficiary need not be involved. The court concluded that the trustees have the power to make indirect distributions and that the objection of a beneficiary to this effect will not be an obstacle to the exercise of this power by the trustee.

Definition of “profit”

The second issue for the Royal Court to consider was whether the proposed distribution would benefit Mr Fahad. The court considered that the word “benefit” must be interpreted in a broad sense and goes well beyond the simple financial benefit, encompassing all kinds of ways to improve the situation of a beneficiary. However, the court pointed out that this is not unlimited and that there is an objective test, namely that the fiduciary’s proposed exercise of its powers can be properly considered to be for the benefit of the beneficiary. In addition, there is a subjective element: the fiduciary must sincerely believe that the constitution of the capital will be for the benefit of the beneficiary. The court said the question of benefit must be considered in a “realistic and sensible way rather than in a theoretical or academic way”.

Applying these considerations to this case, the court concluded that the proposed distribution, which would repay a small portion of the judgment debt, would not benefit Mr. Fahad or any of the other beneficiaries. On appeal, the Jersey Court of Appeal noted that the proposed distribution would have led to a proportionally small reduction in Mr Fahad’s debt to the judgment creditor. The creditor’s argument that the distribution would ‘reduce Mr. Fahad’s burden’ was dismissed as ‘simply unreal’, given the magnitude of the remaining debt to which Mr. Fahad would remain exposed. There was no indication that the partial payment could cause the creditor to settle the case and leave Mr Fahad and his family alone.

Both the Royal Court and the Jersey Court of Appeal rejected the creditor’s argument that the proposed distribution would improve the moral or ethical position of Mr Fahad 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 the benefit being dependent on the trustee’s view of the moral justification for compelling a debtor to repay part of his debt, which was deemed unsatisfactory .

When will payment to a beneficiary’s creditors be made for his benefit?

At a time Smith v. Michelmores Trust Corporation and Re esteem, the court took into account that the proposed distribution constituted only a small proportion of the beneficiary’s debt, which in both cases greatly exceeded its ability to repay in full. Even if other factors were relevant, in particular the timing of the proposed distribution in Black-smith, the payout-to-debt ratio was significant. The court did not consider that the payment of a small contribution to a large debt would materially change the situation of the beneficiary.

On the other hand, in Lowther vs. Bentinck [1874] 12 WLUK 52, the High Court approved the distribution of half of the trust fund for the payment of the debts incurred by the life annuity, the interest of which absorbed most of his income and left insufficient funds to raise his children “d ‘in a manner commensurate with their social position.’ The distribution greatly reduced the sums owed in principal and the interest payments owed, leaving the beneficiary with sufficient income for himself and his family (who were also objects of the trust) to live.

In all the cases mentioned above, the beneficiary class of the trust was broader than the debtor alone, so the court had to take into account the needs of other beneficiaries for whom the funds offered for distribution would no longer be available. The court might have had a different view if the debtor was the sole specified beneficiary, particularly if he was 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 paying part of their debts.


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