Usually but the answer is nuanced. It is often claimed that a trustee exercising a discretion [Discretion] to favour himself/herself/themselves/itself (HHTI) as a beneficiary of a family discretionary trust (FDT) is acceptable but legal authority for the claim isn’t given. Even the Australian Taxation Office distills the proposition to a sentence. They say:

The trustee may also be a beneficiary, but not the sole beneficiary unless there is more than one trustee.

Trusts, trustees and beneficiaries | Australian Taxation Office

To be fair this comment by the ATO mainly concerns the merger of trusts (considered in our blog post at Bringing trusts to a timely ending ) so maybe full accuracy shouldn’t be expected on the subsidiary point they raise about whether a trustee of a trust may be a beneficiary of the trust.

Conflict of interest

Is not the trustee exercising a Discretion to favour HHTI in a position of conflict of interest? Shouldn’t there be control over a trustee of a trust limiting when the trustee of a trust can exercise the Discretion to favour the trustee?

A primary concern for a trustee who exercises the Discretion is successful suit by a disgruntled beneficiary (DB) where the trustee distributes income or capital of the trust to HHTI instead of to the DB. Another concern is whether the trust is real or a sham: a trustee taking property held on trust for HHI is inconsistent with holding the property on trust.

Fiduciaries

Has a trustee who has done this breached a fiduciary duty?

A trustee is a fiduciary. The law imposes strict standards on a fiduciary:

It is an inflexible rule of the court of equity that a person in a fiduciary position, such as the plaintiff’s, is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict. It does not appear to me that this rule is, as has been said, founded upon principles of morality. I regard it rather as based on the consideration that, human nature being what it is, there is danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom he was bound to protect. It has, therefore, been deemed expedient to lay down this positive rule.

Lord Herschell in Bray v. Ford [1894] AC 44

and

It is perhaps stated most highly against trustee or director in the celebrated speech of Lord Cranworth L.C. in Aberdeen Railway v. Blaikie, where he said: “[a]nd it is a rule of universal application, that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect.

Lord Upjohn in Boardman & Anor v. Phipps [1966] UKHL 2; [1967] 2 AC 46 at page 124

A trustee who exercises the Discretion to favour HHTI can be exposed to suit for breach of fiduciary duty under this line of legal authority.

Impartiality

Another duty of a trustee of a trust is to act impartially between beneficiaries. This duty was described in Cowan v. Scargill:

The starting point is the duty of trustees to exercise their powers in the best interests of the present and future beneficiaries of the trust, holding the scales impartially between different classes of beneficiaries. This duty of the trustees towards their beneficiaries is paramount.

Cowan v. Scargill [1985] Ch 270 at 290-292 (Megarry VC)

Context of trustee power

One may infer from the nineteenth century case authorities cited, in particular, that these duties apply universally to all trustees. The inference is incorrect. In Bray v. Ford the exception ”unless otherwise expressly provided” is significant. Inquiry is needed into the the power given to the trustee to understand whether the rule said to be “inflexible” applies. That is, the extents of the trustee duties of fiduciaries and of impartiality to beneficiaries are at least flexibly ascertained in the context of the power given to the trustee.

In the case of a Discretion in a FDT the trustee will ordinarily be given an explicit power and duty to choose between beneficiaries. In the context of the exercise of a discretionary power in relation to a discretionary trust, there will then be no duty on the trustee to ensure impartiality; that is equal treatment of each beneficiary: Edge v. Pensions Ombudsman [1998] Ch 512, Elovalis V. Elovalis [2008] WASCA 141. In Edge v. Pensions Ombudsman, Scott V-C stated of the rule in Cowan v. Scargill:

Sir Robert Megarry was dealing with an issue regarding the exercise by pension fund trustees of an investment power. He was not dealing with the exercise of a discretionary power to choose which beneficiaries, or which classes of beneficiaries, should be the recipients of trust benefits. In relation to a discretionary power of that character it is, in my opinion, meaningless to speak of a duty on the trustees to act impartially. Trustees, when exercising a discretionary power to choose, must of course not take into account irrelevant, irrational or improper factors. But, provided they avoid doing so, they are entitled to choose and to prefer some beneficiaries over others.

Edge v. Pensions Ombudsman [1998] Ch 512 at p. 533

The limits of FDT trustee power

Adequately cast discretionary powers of a trustee such as given to the trustee of a FDT are thus unlikely to transgress fiduciary and impartiality duties contextually inapplicable to these powers. What checks on the exercise of a Discretion remain? These are explained in Karger v. Paul [1984] VR 161 where it was found that a trustee with an absolute and unfettered discretion must nevertheless exercise the discretion:

• in good faith;
• upon a real and genuine consideration of the interests of the beneficiaries; and
• in accordance with the purpose for which the discretion was conferred.

In this way the obligation on the trustee not to take irrelevant, irrational or improper factors referred to in Edge v. Pensions Ombudsman is put in more positive terms in Australian courts. These benchmarks from Karger v. Paul were applied, and trustees fell short, in Owies v. JJE Nominees Pty Ltd [2022] VSCA 142 and in Wareham v. Marsella [2020] VSCA 92 (which is also considered in this blog at:

Controlling who gets death benefits from a SMSF )

Real and genuine consideration

The real and genuine consideration of the interests of the beneficiaries’ obligation of the trustee on exercising a Discretion will depend on the kind of trust, the interest of the beneficiary in the trust and the standards to be imposed on the type of trustee. For instance in Finch v. Telstra Super Pty. Ltd. [2010] HCA 36, a professional trustee of a large superannuation fund was found to have an amplified real and genuine consideration obligation extending to giving reasons in writing for the exercise or non-exercise of the discretion to pay total and permanent invalidity benefit benefits to a member of the fund.

In contrast an unpaid trustee, such as a family trustee of a FDT, is ordinarily under no obligation to provide the DB with written reasons for a decision to exercise or not exercise a Discretion. Without written reasons the DB can be left with scant evidence to challenge a trustee who instead favours another beneficiary, beneficiaries or HHTI by an exercise of a Discretion under Karger v. Paul benchmarks.

Freedom of a trustee of a FDT to favour beneficiaries including HHTI over others

Within the context and confines of those parameters a trustee of a FDT can favour one beneficiary over another. It follows that a trustee of a FDT can usually exercise a Discretion to favour HHTI to the complete exclusion of the DB so long as the Karger v. Paul parameters are observed.

But power to favour beneficiaries is exceptional

Whether or not there is an exceptional Discretion turns on the purpose for which the Discretion was conferred evident in the terms of the Discretion which is in the trust deed of the trust. An adequate expression of the Discretion in the trust deed of a FDT is expected and needed so its purpose, as an absolute and unfettered discretion to choose between beneficiaries and as to amount distributed to them, is clear.

Certainty of beneficiaries

Who the discretionary beneficiaries of a FDT also must be clear. Frequently a trust deed of a FDT will prescribe persons who are excluded from being a beneficiary of the FDT and occasionally the trustee can be so excluded because of the perceived conflict of interest or, in New South Wales, for a stamp duty reason.

A FDT for a family which includes trustee or trustees included as discretionary beneficiaries is likely to be accepted as genuine:

• where the trustee is a merely a discretionary beneficiary among a widely cast class of family beneficiaries; and
• and is understandable where family members of the family sought to benefit under trust terms are or could be trustees.

So a trust deed of a FDT should be checked to confirm that the trustee is a beneficiary of the trust before the trustee of a FDT exercises a Discretion to distribute to itself. It is only where the trustee qualifies as a discretionary beneficiary under the terms of the trust instrument that a distribution can be safely made to the trustee/beneficiary where the trustee is satisfied that the distribution complies with the Karger v. Paul parameters.

The drafting of the FDT deed

Ideally the trust instrument will expressly confirm that the trustee of the FDT is a beneficiary. It can be the case that the trustee is a member of a class which is included as beneficiaries under the trust instrument but the trust deed might not expressly say that a trustee can be a beneficiary. An exercise of the Discretion in the favour of the trustee is likely OK then too but the trustee runs a risk and could possibly face action asserting the trust instrument ought to be construed on a basis that the trustee is unacceptable as a beneficiary.