Clayton v Clayton: nipping the Illusory Trust in the bud

Introduction

The Court of Appeal's recent decision in Clayton v Clayton1 as been described as redrawing the landscape on trusts and divorce.2 The decision has already generated discussion within the legal community because the Court decided that a settlor's power of appointment could be relationship property. The Court went on to determine that the value of the appointment was the net value of the trust's assets.

The decision is also important because it is the first New Zealand case where the concept of an "illusory trust", as distinct from a "sham trust", has been considered. It is this aspect of the decision which I intend to discuss in this article.3

Background

Mr and Mrs Clayton separated in 2006 after 17 years of marriage. The proceedings concerned the division of relationship property under the Property (Relationships) Act 1976. The case concerned various trusts settled during the parties' marriage. Three of the trusts gave rise to nine questions in the Court of Appeal but only one trust is relevant to the issue I wish to discuss.

The Vaughan Road Property Trust ("VRPT") was settled in 1999 by way of a declaration of trust by Mr Clayton as trustee. He is the settlor and sole trustee. The discretionary beneficiaries include Mr Clayton as the principal family member, Mrs Clayton as his wife, and the children are the final beneficiaries.

The VRPT was described as operating as a banker. It has largely borrowed from BNZ to advance loans to other entities.

I intend to set out the provision of the trust deed only as they relate to the reasoning of the courts.

The Family Court decision

In the Family Court Judge Munro held that the VRPT did not meet the basic elements of a trust and was therefore illusory.4 The effect of this finding was that the VRPT's property was owned both legally and equitably by Mr Clayton, and was therefore relationship property.

In particular, Judge Munro was concerned with three issues. Firstly, he reasoned that the provision conferring the trustee unfettered discretion, read with a provision allowing the trustee's interests to conflict with his duties to the VRPT trust fund "negated the beneficiaries' ability to call the trustee to account in the exercise of his discretion"5. It was therefore held that the beneficiaries had no rights under the deed enforceable against the trustee.

Secondly, the Judge Munro held that, unlike an administrative power to appoint and remove trustees, the power of revocation in the trust...