Relationship property and trusts
Section 44C of the Property (Relationships) Act 1976
R50 Section 44C(2)(c) of the Property (Relationships) Act 1976 should be amended to provide that the court may make an order requiring the trustees of the trust to pay to one spouse or partner a specified sum of money from the trust property or to transfer to one spouse or partner any property of the trust. A consequential amendment would need to be made to the wording in section 44C(3)(b)(i) to replace the reference in that subsection to “distribute the income of the trust” with something like “distribute a sum of money or property of the trust”. Section 44C should otherwise remain unchanged.
Current law and issues
19.3Section 44C of the PRA makes provision for compensation where relationship property is disposed of to a trust. It provides:
44C Compensation for property disposed of to trust
(1) This section applies if the court is satisfied—
(a) that, since the marriage, the civil union, or the de facto relationship began, either or both spouses or partners have disposed of relationship property to a trust; and
(b) that the disposition has the effect of defeating the claim or rights of one of the spouses or partners; and
(c) that the disposition is not one to which section 44 applies.
(2) If this section applies, the court may make 1 or more of the following orders for the purpose of compensating the spouse or partner whose claim or rights under this Act have been defeated by the disposition:
(a) an order requiring one spouse or partner to pay to the other spouse or partner a sum of money, whether out of relationship property or separate property:
(b) an order requiring one spouse or partner to transfer to the other spouse or partner any property, whether the property is relationship property or separate property:
(c) an order requiring the trustees of the trust to pay to one spouse or partner the whole or part of the income of the trust, either for a specified period or until a specified amount has been paid.
(3) The court must not make an order under subsection (2)(c) if—
(a) an order under subsection (2)(a) or (b) would compensate the spouse or partner; or
(b) a third person has in good faith altered that person's position—
(i) in reliance on the ability of the trustees to distribute the income of the trust in terms of the instrument creating the trust; and
(ii) in such a way that it would be unjust to make the order.
(4) The court may make 1 or more orders under subsection (2) if it considers it just to do so, having regard to—
(a) the value of the relationship property disposed of to the trust:
(b) the value of the relationship property available for division:
(c) the date or dates on which relationship property was disposed of to the trust:
(d) whether the trust gave consideration for the property, and if so, the amount of the consideration:
(e) whether the spouses or partners, or either of them, or any child of the marriage, civil union, or de facto relationship, is or has been a beneficiary of the trust:
(f) any other relevant matter.
19.4Section 44C was introduced into the PRA in 2002 to redress the detrimental effect trusts were having on property rights under that Act. Earlier, the Ministerial Working Group on Matrimonial Property and Family Protection had concluded that the difficulty of proving intention to defeat under section 44 of the Act, and the increasing use of trusts, had placed large amounts of relationship property beyond the reach of the courts, often to the detriment of one of the spouses or partners.
19.5Section 44C provides that the court may order compensation where relationship property is transferred to a trust and the effect of that transfer is to defeat one of the party’s rights, even though at the time of the transfer there was no intention to defeat those rights. Section 44C can be contrasted with section 44, under which the court must determine the disposition was made “in order to defeat the claim or rights of any person” under the Act before it can set aside any disposition of property to a trust.
Under section 44C(2), as currently drafted, the court may make an order:
(a) requiring one partner to pay the other a sum of money out of relationship property or separate property;
(b) requiring one partner to transfer to the other any relationship property or separate property; or
(c) requiring the trustees of the trust to pay one partner the whole or part of the income of the trust for a specified period or until a specified amount has been paid.
19.7The court’s power to order the trustees to pay compensation is limited. Under section 44C(2)(c) it may order the trustees to pay the income (but not capital) of the trust to the defeated partner. It may only make such an order where there is insufficient relationship or separate property from which to otherwise compensate the defeated partner. Also, the court must not make any order against the trustees if this would prejudice beneficiaries of the trust who have altered their position in the bona fide belief that they could rely on the ability of the trustees to distribute the income from the trust.
19.8The most problematic constraint imposed on the court is that the court has no power to require trustees to distribute capital or to withdraw assets from the trust. In its 1988 report the Working Group on Matrimonial Property and Family Protection recommended that the court’s power to award compensation from trust assets should be broader. The Working Group proposed that where the other partner’s share of relationship or separate property was insufficient to adequately compensate for the disposition, the court should have the power not only to divert income from the trust, but also to distribute capital from the trust and, as a last resort, to withdraw assets from the trust.
19.9Notwithstanding the Working Group proposal, the legislature determined that section 44C should only allow distributions of income and that the courts should not have the power to distribute capital or claw back assets. The reason given in the Select Committee report for limiting compensation to income was that trusts are created for legitimate reasons and so should be permitted to fulfil that purpose where there is no intention to defeat a relationship property claim at the time the trust was established.
19.10One of the stated principles of our review is that individuals can utilise trusts to hold property as they wish. We recognise that there are legitimate reasons for establishing trusts and that consequently the courts should not interfere with trusts lightly. However, as provisions like sections 44 and 44C in the PRA and provisions for the protection of creditors in other legislative regimes demonstrate, there are competing policy reasons that mean property held in trust is not absolutely protected.
19.11For a number of reasons, section 44C does not strike the right balance between the interests of a partner whose rights have been defeated by the transfer to the trust and those beneficially interested in the trust. The constraints on the compensation powers mean it is too easy for one partner to circumvent the PRA and place relationship property beyond the reach of the courts.
19.12Our review of cases under the PRA revealed that there have been cases in recent years where section 44C applied but there was insufficient relationship or separate property outside the trust from which the court could adequately compensate the partner whose interests were defeated by the disposition of property to the trust. In most cases the property in the trust did not produce income, which resulted in the current power the courts have to require the trustees to pay the income of the trust to the defeated partner almost never being used.
19.13In a few of the cases we reviewed, the defeated partner was able to successfully make an alternative application for relief under section 182 of the FPA. However, in others the defeated partner was left with no redress under either section. In some of these cases the courts considered alternative arguments seeking to challenge the validity of the trust. As ways of dealing with the perceived injustice in some cases where the property has been placed beyond the reach of sections 44 and 44C, applicants have employed arguments questioning the validity of the trust, such as sham trusts, alter ego trusts, illusory trusts and the bundle of rights doctrine. These theories often cannot get to the basic issue of restoring the effectiveness of the equal sharing of relationship property policy of the PRA, and risk distorting trust law.
19.14The number of cases where section 44C provides no remedy due to insufficient relationship or separate property outside the trust from which to source compensation is likely to increase. In a portion of the cases we reviewed, the main relationship asset from which compensation was sourced was the debt back from the trust to the transferor following the disposition to the trust. The repeal of gift duty in 2011 has now largely removed the need for dispositions to trusts to be coupled with a debt back and a staggered programme of debt forgiveness. If there is no debt back, from which compensation might be sourced by the court, the result is likely to be more cases where the provision applies but no compensation is available.
19.15Also, as noted, our review of cases revealed that it is rare for an order against trustees requiring the payment of income to be made. The circumstances in which this would be appropriate occur only occasionally in relationship property cases. Most of the trusts under consideration contain little more than residential properties, so do not generate income. The Commission has recommended in chapter 7 of this Report that the distinction between capital and income for the purposes of investment and distribution of trust funds be removed (see paragraphs [7.19] to [7.25]). Consequently, in future under the default provisions, trustees will determine what returns are to be treated as capital and income for the purposes of distribution. Again, this is likely to make section 44C even less effective than it is now if it continues to restrict the courts’ compensation powers to income.
Orders against trustees under section 44C(2)(c)
19.16After much consideration, we recommend that section 44C(2)(c) be amended. Courts should have the power to make an order requiring the trustees to pay a specified sum or transfer property of the trust to compensate the partner whose rights were defeated by the disposition of relationship property to the trust. That power to order compensation should be restricted to the value of the relationship property that was transferred to the trust. A consequential amendment would need to be made to the wording in section 44C(3)(b)(i) replacing the reference to “income of the trust” with something like “money or property of the trust”.
19.17The recommended change would essentially give effect to the original proposal that was put forward by the 1988 Working Group to address dispositions to trusts. While it was important for Parliament to move cautiously in respect of the PRA’s reach into trusts in 2002 when section 44C was enacted, subsequent cases have convinced us that the provision has been proved to be too easily circumvented.
19.18Our recommended amendment does not change the requirements in section 44C(1) that define the scope of the section. The property disposed of to a trust must be relationship property at the time of disposition; it must have been transferred by one of the partners rather than by someone else; and the disposition must have the effect of defeating the claim or rights of one partner rather than affecting both partners equally.
19.19Further, section 44C(3) contains important safeguards:
- the court must not make an order against the trustees under section 44C unless there is insufficient relationship or separate property from which to otherwise compensate the defeated partner for the disposition to the trust; and
- the court must not make any order against the trustees if it would be unjust to do so because beneficiaries of the trust have, in good faith, altered their position in the belief that they could rely on the ability of the trustees to distribute funds.
19.20Section 44C(4) also lists a number of relevant matters the court must have regard to when considering whether it would be just to make an order for compensation under section 44C(2). These factors, which the court must consider, include whether the trust gave consideration for the property, and if so, the amount of the consideration; whether one or both of the partners or any child of their relationship is or has been a beneficiary of the trust; and any other relevant matter. Therefore, before making any order, the court must weigh the overall fairness of ordering compensation from the trust. In some cases such relevant matters have resulted in the court making no award of compensation or reducing the level of the award.
19.21There are, in our view, adequate protections in the section to ensure that recourse to the trustees for compensation will be the last option. Further, proper consideration will be given by the court to the interests of the beneficiaries. Before exercising its discretion the court must consider whether, in all the circumstances before the court, it is just to make orders against the trustees.
Views of submitters
19.22As noted, submissions on the Second Issues Paper generally considered that the current provisions in the PRA should be strengthened because the court’s ability to make orders in respect of property transferred to trusts in property relationship cases was too limited. However, only a few submitters responding to the Preferred Approach Paper supported amending section 44C in the way we are recommending. Most submitters did not support the proposal. Some considered that changes to the PRA should not be addressed within a review of core trust law. Some also considered that any recommendation would likely be controversial and that there are wider social questions over how far look-through provisions in the PRA should go.
19.23Some submitters, and some commentators, have expressed much more significant and substantive concerns over the approach we recommend. It has been argued by opponents that the proposed amendment undermines core principles of trust law. To allow the courts to make orders against the capital of the trust suggests that for relationship property purposes the trust can be disregarded. This means that dispositions of relationship property to a trust will be unreliable and vulnerable to recovery from the trust to satisfy a PRA claim. Submitters commented that not only does this defeat the interests of the beneficiaries, but it introduces a considerable amount of uncertainty into the operation of trusts because all of the assets of a trust can potentially be clawed back to compensate one of the partners under section 44C. Any disposition of property to a trust and all assets held in any trust to which qualifying dispositions are made would potentially be available as compensation. This arguably prioritises the relationship partner’s interests over those of the trust’s beneficiaries and others such as creditors. It has also been argued that the amendment gives partners greater protection and better remedies in respect of trusts than creditors and taxpayers.
19.24We carefully weighed these points when developing the recommendation. We believe that such concerns should not be overstated. Although it is confined to income, conceptually section 44C(2)(c) already allows the court to claw back property (in the form of income) from the trust. The section already gives partners a degree of priority, at least in respect of income. Conceptually the recommended amendment is a change in the degree, although obviously a significant one, to which property of the trust would be vulnerable to a claim for compensation. It does not introduce the concept of claw-back into the section, because it is already there. Rather, it gives the court a more effective tool to use.
19.25It should also be remembered that compensation from the trust must not exceed the value of the dispositions of relationship property (valued at the date of hearing) that have been made to the trust. Although all the assets of the trust are potentially available to compensate the defeated partner, other assets of the trust (over and above the value of the qualifying dispositions) are only at risk where the assets that made up the qualifying dispositions have been disposed of by the trustees, or the value of those assets has decreased for some reason. Where relationship assets are transferred to trusts, trustees are on notice that a portion of the assets remains vulnerable to a claim for compensation. They would be wise to plan accordingly.
19.26Finally, as already noted, there are protections for beneficiaries. The court must not make an order where any third party has acted in good faith and altered their position in reliance and it would be unjust to make an order. Further, the court, when considering whether it would be just to make an order against the trustees for compensation, must consider all relevant factors. Consequently, the claim of a defeated spouse or partner to assets in the trust as compensation is not necessarily prioritised by the court over the interests of the trust’s beneficiaries.
19.27We believe that the courts are perfectly competent to exercise discretion in this area and to determine in any case, after taking account of relevant matters, whether or not it is just to make orders against trustees for compensation.
19.28The transitional arrangements in respect of the amendment may in practice be significant so careful attention will need to be given to these when drafting a Bill.
19.29The amendment to section 44C should apply to existing relationships covered by the PRA from the date of enactment. We propose that, consistent with previous legislative amendment and case law, the amended section 44C should apply in all cases except where the hearing of proceedings has already commenced. When the Property (Relationships) Amendment Act 2001 came into force on 1 February 2002, its provisions (including section 44C) applied to all proceedings between married partners commenced after 1 February 2002, even if the marriage had ended before that date. Where proceedings had been commenced under the Matrimonial Property Act 1976 before 1 February 2002, but had not begun to be heard, then the new PRA provisions also applied. However, where proceedings had been commenced before 1 February 2002 and had begun to be heard before that date, the PRA did not apply. In that case the proceedings were to be completed under the Matrimonial Property Act.
19.30In the case of de facto partners, the PRA was applied from 1 February 2002 to de facto relationships whether they had begun before or after that date. However, the PRA does not apply to de facto relationships that ended before the 1 February 2002. Unlike marriages, de facto relationships came under the Act for the first time on 1 February 2001.
19.31Consistent with the approach taken with the 2001 Amendment Act, we consider that the amended section 44C should apply in all cases except where the hearing of proceedings has already commenced. The amended provision would apply to all proceedings commenced after it comes into force, regardless of whether the qualifying relationship ended before the provision came into force. It would also apply to proceedings commenced before the amendment came into force, provided they had not already begun to be heard. Where proceedings have begun to be heard, then they would be determined under the pre-amended version of section 44C. The transitional provisions should include a clear definition of when proceedings have begun to be determined so that there is no confusion.
19.32The one exception to this general approach would, of course, be that the PRA would continue not to apply to any de facto relationship that ended before 1 February 2002 because such relationships are not currently covered by the PRA.
19.33Consistent with the current provisions of the PRA, the application of the amended section 44C should apply to dispositions that occurred before it came into force. Section 44C, although introduced on 1 February 2002, was applied retrospectively by the 2001 Amendment Act to qualifying dispositions of relationship property made before that date. The amended section 44C would also apply retrospectively to dispositions that predate its coming into force, including those made before 1 February 2002. The alternative approach, which would be to apply the amended section only to future dispositions, would simply be too complex and confusing because the courts would apply one version of section 44C to dispositions before a certain date and another to subsequent transactions.