Introduction

On April 6th 2016 the High Court handed down a 3-2 majority decision holding, inter alia, that a trustee had validly exercised a power to “advance” and “apply” trust capital, or income, by creating a debt, enforceable at law, that reflected the increase in value of the main asset of the trust, at the time the advance was made.

The significance of this is that a trustee can ‘advance and apply’ an amount of trust capital, or income, without having to transfer, or set aside’ any actual assets of the Trust (by following the process in the deed). This was particularly so, where the amount distributed is acknowledged in the trust’s accounts, in an account for that beneficiary. The other matter of moment* was that the beneficiary can sue for their entitlement in either law or equity (HCA paras [4] – [6]). (*However, it is not immediately apparent, to the author, as to what the significance of this distinction might be. Perhaps equitable rights could be lost, more easily, or endure longer, under legislation limiting the period in which actions can be taken – which is to say: ‘statutes of limitations’).

There were were more issues than these, when the action commenced in the the Supreme Court of New South Wales [2014] NSWSC 203, and was appealed to the Court of Appeal of the Supreme Court of New South Wales [2015] NSWCA 6. The High Court only gave leave to appeal on the (1) validity of the resolution issue and the (2) recoverable in law, or equity, or both, issue [2016] HCA 11.

I propose to go back to the beginning of the case, and track the various issues through, as they are interesting, establish precedent, and give context to the High Court decision.

The Background

In 1974, a deed was executed (the ‘Trust Deed’) establishing a discretionary trust. The name of the trust was the Nemes Family Trust (the ‘Family Trust’) and its trustee was Nemeski Pty Ltd (a defendant and respondent in the above actions). The Family Trust had one substantive asset, which was a parcel of shares in a private company called Aladdin Pty Ltd. In 1994, Nemeski retained an independent valuer to revalue the Aladdin shares. The resulting increase in value (over the book value of the shares) was $3,904,300 and this amount was recorded in an ‘asset revaluation reserve’ in the books of the Trust. This is the amount that was ‘advanced and applied’, as will be clear shortly.

The Trust Deed named a number of ‘Specified Beneficiaries’, including the Fischer siblings, who were, by the time of Mr Neme’s death, the last surviving members of this class. Being the ‘Specified Beneficiaries’, at this time, also made the Fischers the ‘appointors’ of the Family Trust (which meant that they could remove and appoint the trustee(s) of that Trust – a powerful position when the trustee has such wide discretions).

The Fischers were the Plaintiffs in the original proceedings brought in the Supreme Court of New South Wales and ultimately became the Appellants in the Court of Appeal and High Court proceedings.

How the contest arose

The contest arose, in September 2011, when Mr Nemes passed away. Mr Nemes had been the sole holder of the shares in Nemeski Pty Ltd (the trustee of the Family Trust). He left all his shares in this company to the Fischer siblings, by a bequest in his last will. The Fischers were, therefore, in a position to control the Trustee and distribute its income and capital to themselves. At first blush, it appeared that the Fischers had effectively inherited the full value of the Aladdin shares but this overlooked an important question about the validity of a 1994 resolution to distribute $3,904,300 of the Trust’s capital to Mr and Mrs Nemes. If this resolution was valid, there was $3.9m less, in the Family Trust, for the Fischers to distribute to themselves.

This distribution was made to both Mr & Mrs Nemes, but Mr Neme’s inherited his wife’s half share, in the alleged $3.9m, when she pre-deceased him. If the Family Trust did owe this amount to Mr Nemes, it fell into his residuary estate, to be distributed, under his will, to persons other than the Fischers.

The way in which the case began is also of interest. A long time friend of Mr Nemes: Mr Loblay and his daughter: Ms Loblay, were not only the executor and executrix of Mr Nemes’ deceased estate (LPR’s), but were also directors of the Trustee (Nemeski). As a result of this, the Fischers contended that Mr Loblay and his daughter were in a position of potential conflict. For this reason the court was satisfied ‘special circumstances’ existed to bring this proceeding.

The issue was, whether the Family Trust owed the $3.9m amount to Mr Nemes (and thus fell into his residuary estate). The executors contended that it did and the Fischers contended that it did not.

Background to the disputed $3.9m distribution

Back in 1994, Mr Nemes made arrangements to secure control of his assets or estate, or at least, that is how his then accountant: Mr Elliot described it in a contemporaneously written letter.

Mr Nemes first attempted this, on May 3rd 1994,when he tried to orchestrate a purported retrospective vesting of the Family Trust, to a date two years earlier: June 24th 1992 (advancing it from the stated date: June 24th 2034). No-one acted on this resolution (made by the two Nemeski directors: Mr Loblay and Mr Elliot).

On September 23rd 1994 (several months after the attempt to retrospectively vest the trust), these same directors passed another resolution, distributing the whole of the ‘Aladdin’ asset revaluation reserve, to two of the Trust’s beneficiaries: Mr and Mrs Nemes.

Their resolution was made under clause 4(b) of the Trust Deed, which broadly reads; “the trustee may advance an amount for the maintenance, education, advancement in life, or benefit of any of the Specified Beneficiaries provided that, where the amount is for more than $10,000, the Trustee provides, in writing, notice to the Specified Beneficiaries, who have power to remove the Trustee”.

Mr and Mrs Nemes then loaned the entire $3.9m amount back to the Trust. The Trustee, accordingly recorded the amount it owed a non current liability ([39] SC).

Nearly a year later (on August 30th 1995), Mr and Mrs Nemes entered into a Deed, with the Trustee, under which the Trustee gave Mr & Mrs Nemes a charge over the Aladdin shares (the ‘Charge’) to secure repayment of their loan.

Mr Nemes survived his wife and became the sole person entitled to the $3.9m debt. Later Mr Nemes died leaving a Will (made July 3rd 2005). Under this Will he bequeathed all the shares in the Trustee (Nemeski) to the Fischers and the residue of his estate to a number of other persons.

Therefore, the Fischers came to control the Trust, but it was stripped of $3.9m of its value, if the 1994 capital distribution was enforceable, because that money accrued to the residuary beneficiaries of Mr Neme’s deceased estate. The Fischers, therefore, sought to impugn the distribution of capital or argue it was no longer payable.

The proceedings began in the Supreme Court of New South Wales and went all the way through to the High Court of Australia.

In the Supreme Court of New South Wales

The judge at first instance was Stevenson J.

The Fischers’ Statement of Claim outlined the questions for the Court under a ‘First Claim’ and a ‘Second Claim’.

In the First Claim ([54]-[60] SC) the Fischers argued:

  • that the transactions were a legal nullity or voidable and that accordingly the Charge had no effect.They contended that no Trust property was distributed to Mr and Mrs Nemes.
  • Also in contention was that the resolution, made on September 23rd 1994, to make the distribution to Mr and Mrs Nemes, on the basis that it was not validly exercised within the Trustee’s power because it was not for the ‘maintenance, education, advancement in life, or benefit,’ as provided by clause 4(b) of the Trust Deed, but rather for bringing the assets of the Trust within the Nemes’ ‘testamentary control’.
  • In the alternative, the Fischers argued that the Trustee acted beyond power, as there was no notice of the distribution given to all those beneficiaries who may exercise the power under clause 15.2 of the Trust Deed to remove the Trustee.

The Second Claim ([61]-[64] SC) was brought as an alternative to the First Claim.

  • In it, the Fishers contended that the May 3rd 1994 resolution retrospectively altered the vesting date, from June 2034 to June 1992, and, as a result, the distribution could not be validly made as, from that time, the Family Trust became a bare trust (where the Trustee had no power to distribute capital, much less, to chose the beneficiaries who would benefit).
  • Finally, the Fischers argued the Estate was statute barred from recovering the $3.9 million from the Trust.

How the Court dealt with the First Claim

The resolution purported to distribute “out of the asset revaluation reserve” the “entire reserve”.

The Fischers first submitted that the Trustee only had power to “advance” funds from the assets representing “Trust Funds”, and that, as the only assets in the Trust were shares, the distribution was an advance of capital, which would have to result in a transfer of at least some shares, which did not happen. Counsel for the Fischers argued that to make a distribution from the asset revaluation reserve was merely an accounting notation with no legal or practical effect.

Stevenson J considered the language used by the directors of the Trustee in the resolution of September 23rd 1994, and presumed the intention of the Trustee was to effect the distribution with legal validity [69]. He went on to discuss that the law presumes the relevant parties are unlikely to intend to do something legally ineffective, and that the wording in the resolution was a mistake or unfortunate choice of language. He went on to substitute various words in order to be reflective of what he considered to be the true intention of the Trustee [71]-[85].

Stevenson J then went on to review the effect of the accounting entries and whether simply noting an asset with a corresponding liability was sufficient to give effect to the resolution. The Fischers’ second argument was that that this was not sufficient because the Trustee sought to create a debt owing to Mr and Mrs Nemes when it had no power to do so under the trust deed. However, Stevenson J did not accept this proposition and accepted the evidence from Mr Elliot, the accountant for Mr Nemes and the assumed author of the accounts, who said that the distribution “was made by way of crediting the loan account of Mr and Mrs Nemes” [87]. He outlined, with reference to case law, that a trustee has power to borrow funds for the purposes of the Trust, even if there is no express power in the Trust instrument, and may make a distribution by crediting a beneficiary’s loan account [93]. Accordingly, Stevenson J concluded that the Trustee intended to make an advance or distribution of an amount equal to the revaluation reserve, and then credited Mr and Mrs Nemes loan account with the same amount, giving effect to the resolution [101].

Further to this, the recording of the liability (to Mr & Mrs Nemes), in the Trust’s accounts, resulted in the Trustee’s liability being enforceable in debt, or in other words, under law, for reasons discussed below [101].

The Fischers’ third argument was that the distribution was not in line with the power conferred by clause 4(b) of the Trust Deed which stipulated that an advance or distribution can only be made for the “maintenance, education, advancement in life, or benefit” of a beneficiary. Also the Fischer’s submitted the “actuating purpose” of the distribution was not to benefit Mr and Mrs Nemes, but rather the beneficiaries of their estates.

The primary judge drew from various cases, secondary sources and a number of guiding principles, as to how ‘benefit’ may be interpreted, and concluded that it can be given a broad meaning [105]-[107]. He held that as the distribution and the subsequent creation of the Charge resulted in Mr and Mrs Nemes becoming creditors of the Trust, who could call upon the debt, at any time they please, rather than merely discretionary objects of the Trust, they conferred a ‘benefit‘ [109].

Stevenson J considered that to be the end of the matter, but, in case he was wrong, went on to discuss the Fischers’ related contention, regarding the “actuating purpose”. He relied upon a letter dated April 26th 1995, written by Mr Elliot, which stated that the purpose of the ‘advance and apply’ transaction, of September 1994, was for the Nemes to secure control of their assets or estate. The letter also incorrectly referred to the assets of the Trust as “assets of Mr and Mrs Nemes”, which the Fischers suggested indicated the purpose of the distribution was to liberate what were incorrectly believed to be the assets of Mr and Mrs Nemes from the Trust and therefore bring them within their testamentary control. Stevenson J did not agree with this inference and stated that given Mr Nemes was effectively in control of the Trustee, and thus the Trust, it can be inferred that for some reason Mr Nemes felt it in his interests that the transactions take place [120]. He then indicated that, even if the distribution was to secure control of their assets or estate, that would confer a ‘benefit’ to Mr and Mrs Nemes [121].

Stevenson J then turned to the Fischer’s last argument in their first claim – namely, that the distribution failed for want of notice to the relevant Specified Beneficiaries. Clause 4(b) of the Trust Deed provided that, where an advancement is made, involving more than $10,000, notice must be provided, in writing, to the beneficiaries who had the power to remove the Trustee. Clause 15.2 gave a number of beneficiaries, of which the Fischer siblings were included, the power to remove the Trustee. However, it did not take all Specified Beneficiaries to remove the Trustee. At the time of the disputed distribution resolution, it was Mr Nemes, who could remove the Trustee, until the time of his death or mental incapacity, at which point, the next listed beneficiary would be able to exercise the power. Nonetheless, the Fischers argued that the Trustee was required to notify them of the advancement of the $3.9 million pursuant to clause 4(b) and that, as notice was not provided, the Trustee had acted outside of its power.

Stevenson J considered this requirement of notice in the trust deed and reasoned that it would be overly burdensome and inefficient to require the Trustee to give notice to all those beneficiaries listed at clause 15.2. He suggested that it could not have been intended for the Trustee to provide notice to all those listed at clause 15.2 regardless of their age or whether they were in fact even still living and so held that the notice requirement was intended to require notice be provided only to those beneficiaries who at the time could exercise powers to remove the Trustee [139]. Given that, at the time, the Fischer siblings did not have the power to remove the Trustee, Stevenson J held that the Trustee had acted within its power.

The Second Claim

As noted, the second claim was brought as an alternative to the first claim.

The Fischers first argued that the resolution made on May 3rd 1994 had the affect of retrospectively altering the vesting date, resulting in the Trust assets having vested, and being held by the Trustee, under a bare trust, from the new vesting date. If this were the case the result would have been that the distribution was beyond power of, or in breach of the bare trust, and so, therefore, void. (It is not entirely clear how this argument would have helped the Fischers as it was unlikely that they were the beneficiaries of the bare trust at that time.) In any event, the argument was short lived as Stevenson J ruled the purported alteration to the vesting date ineffective. He reasoned that it would be an extraordinary thing if Mr Nemes or the Trustee could alter the vesting date retrospectively, effectively rendering all actions, made by the Trustee, since the new vesting date, ineffective and void [158]. He went on to suggest it was very unlikely that this was the intention of the Trust Deed. Indeed, Mr Nemes actions reinforced this. Nothing was done, to implement the unlikely retrospective vesting resolution, and it was only four months later that the quite inconsistent capital distribution resolution was made [165].

Lastly, the Fischers argued that the claim for recovery of debt was outside the limitation period and was therefore statute barred.

Stevenson J held that without Mr and Mrs Nemes having actually demanded payment of the debt, the statute barring period did not start running [178], and, as a demand was never made, the Estate was not statute barred [81]-[182] (which is not actually the law, about ‘at call’ debts, as the Court of Appeal held).

In the event that he was wrong about that, His Honour he went on to consider the limitation period in a different light. It was common ground that the statute barring period will start again, when the person who owes the money confirms their liability [185]. It was therefore significant that the Family Trust recognised its liability to pay the $3.9m amount in its 2003 financial statements. His Honour held that this was sufficient acknowledgement.

As Mr and Mrs Nemes were directors of the Trustee, at the time it confirmed its $3.9m liability, the Fischers made a last ditch argument that the confirmation was invalid, due to their conflict of interest. However, there were two other directors, who confirmed the debt, so there was a valid confirmation, even if this conflict issue were correct.

The trial judge held that the estate was not statute barred from collecting the debt [190]-[192].

In the Court of Appeal of the Supreme Court of New South Wales

Each issue raised in the original decision was raised again in the Court of Appeal, with an additional appeal on the question of whether the distribution amount (if valid) could be recovered in law.

The Court of Appeal agreed with the primary judge’s finding on all issues, except his reliance on no actual demand having been made, to defeat the statute barring claim ([100] CA). Barrett JA noted the case law, which establishes that, for statute of limitations purposes, the cause of action to recover an ‘at call’ debt is the date the debt is created (and does not wait for an actual demand). Clause 7 of the Charge expressly stated that collection of the debt was not dependant on an actual demand from Mr and Mrs Nemes, but could arise from a number of default events occurring. As a result, the Court of Appeal held that the cause of action accrued from August 30th 1995 (the date of creation of the Charge) and therefore would have been statute barred in August 2007 [100] but for the following. However, Barrett JA went on to qualify this finding. In light of s 54 of the Limitations Act, he confirmed that the primary judge’s conclusion about the subsequent acknowledgement resetting the limitation period, so that it began to run again from 25th May 2004, resulting in the Estate being entitled to collect the debt as it was not statute barred [113].

When considering the matter as to whether the Charge was enforceable under law, Barrett JA made note of established case law [see 79] which made clear there is no cause of action at common law against a trustee for its equitable obligations, unless it recognises the debt, in which case it ends the trust, and creates a creditor – debtor relationship, enforceable at law. He further acknowledged case law to the effect that a distribution resolution, for income or capital, coupled with account entries, resulted in recognition of the debt by the Trustee [81]. Accordingly, it was held that the Estate could pursue an action in law.

In the High Court of Australia

There were 5 issues raised on appeal, 3 of which the High Court were not prepared to give leave to appeal.

However, they did give leave to appeal on two issues. The first was, whether the distribution resolution (on September 23rd 1994) ‘to advance and to apply’ trust capital or income was an effective and valid exercise of the Trustee’s power. The second was, whether, if the resolution was effective, the subsequent recording of debt in the balance sheet gave rise to a right to bring an action for the amount of the loan at law.

A majority of 3 judges, to 2, upheld the previous decisions of the lower courts, ruling that the resolution was valid and that the Trustee had effectively ‘advanced and applied’ the asset revaluation fund. French CJ and Bell J, held that there are many ways of making an advancement for beneficiaries, one of which is to ‘advance and apply’ in the trust accounts, as was the case here ([30] HC). The text of the resolution showed a clear intention to create a debt in favour of Mr and Mrs Nemes [32]. Gageler J agreed with the interpretation of the resolution by the primary judge that even though it did not lead to any actual payment or change in ownership of property, it was nonetheless effective, and that, in them recording this obligation in the Trust’s accounts, a cause of action arose in law [90]-[92].

Kiefel J dissented on the basis that the circumstances surrounding the resolution, or the conduct of the Trustee thereafter, did not support an inference that the powers, given by cl 4(b) of the Trust Deed, were intended to be exercised by the Trustee [88]. This was particularly the case because no property had been set aside that would amount to an actual application of capital, or income, within the meaning of cl 4(b) (reasoning at [56]–[71]). Kiefel J placed emphasis on the contention that this was confirmed through the Trust accounts, which demonstrated that the property remained that of the Trust at all times [88].

Gordon J, also dissented, holding that the Trustee was not indebted to Mr Neme’s estate, giving particular regard to there being a ‘real and radical’ difference between an asset and its value [155]. Gordon J went on to reason that the resolution did not deal with any capital of the trust funds themselves, but involved only a bookkeeping entry that merely reflected a change in the value of an asset, and did not actually advance or raise, or pay and apply and money, as was specifically required by the specific terms of cl 4(b) [156]-[161].

 

Mr Patrick Rowe*

1 June 2016

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*Researched, and written, whilst I was a student, in the Law School of Deakin University (during work experience with Mr F John Morgan (of the Victorian Bar).

 

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