The High Court recently affirmed in K v R [2020] NZHC 923 that a trust cannot be established to defeat a party’s claim to relationship property.

Background

The parties were in a de facto relationship for seven and a half years. They met when they were in their 40s and each had adult children from prior relationships.

Ms Lee was originally from Hong Kong and spoke little English. She met Mr Smith while she was a tourist in New Zealand.

Shortly after the parties met, but before their de facto relationship commenced, Mr Smith purchased a bare block of land where he intended to build a house. He purchased the land using his separate property funds.

Around 2 and a half years after the parties started living together, Mr Smith sought legal advice on how he could protect himself from a relationship property claim. He had been through relationship property proceedings twice before following the breakdown of his previous relationships and wanted to protect his assets.

Pursuant to advice he received, Mr Smith settled a trust and transferred the section to the trust. Mr Smith was the settlor, the sole trustee and appointer and a beneficiary of the Trust along with his sons.

The parties then built and moved into a substantial house on the land.

Following the parties’ separation there was a dispute about whether Ms Lee had a claim to the family home. The respondent brought proceedings in the Family Court, but these were moved to the High Court when the appellant made a claim against the lawyer seeking indemnity for the negligent advice regarding the trust.

The issues

The primary issues considered by the High Court was whether Ms Lee was entitled to a half share of the house or whether the trust provided an effective defence to that claim, and if the trust did not provide an effective defence, whether Mr Smith have a claim against the law firm.

Ms Lee’s claims against the Trust

Ms Lee’s claims were that:

  1. The Trust was not a valid Trust meaning that Mr Smith retained a proprietary interest in the family home.
  2. Mr Smith’s powers under the Trust amounted to property which was relationship property.
  3. Mr Smith disposed of the property to the Trust and used funds to build the family home in order to defeat Ms Lee’s claims.
  4. Ms Lee made contributions to the property in reasonable expectation that she would gain an interest in it and Mr Smith as trustee should reasonably expect to yield such an interest to her.

Mr Smith sought to defend the claim on the grounds that his powers in the Trust were not unfettered, that prior to transferring the bare section to the Trust it was his separate property and therefore he did not know he could be potentially defeating Ms Lee’s future rights, the parties were not in a qualifying de facto relationship until after the Trust was establish.

Mr Smith’s claim against the law firm

Mr Smith and the Trust brought a claim against the law firm in negligence and breach of contract on the alleged failure of the firm to properly advise them on the relationship property risks. They claimed compensation to meet any award made in favor of Ms Lee and general damages of $35,000 for stress, and damages in the amount of any costs award and for the costs they had incurred to defeat Ms Lee’s claim.

During the hearing the law firm accepted that its advice was negligent. Therefore, the issues were causation and damages.

The High Court decision

Duration of de facto relationship

The commencement date of the de facto relationship was relevant in determining the ownership status of the section prior to it being transferred to the Trust and the status of the relationship at the date the Trust was established.

There was a large amount of evidence including information that had been provided to Immigration New Zealand in the process of applying for visas for Ms Lee. Mr Smith claimed his representations to Immigration New Zealand were overstated and he argued the relationship was not a de facto relationship until after the Trust was established on 27 April 2011.

Having considered the evidence the Court decided the de facto relationship commenced in early March 2009 when Ms Lee arrived in New Zealand having been granted a six-month visitor visa. By that time they had known each other for 6 months, had spent time living together in Hong Kong. Shortly after Ms Lee came to New Zealand they attended Mr Smith’s sister’s wedding together and from then they lived together and Ms Lee was financially dependent on Mr Smith having left her job in China.

Section 44

The Judge considered Ms Lee’s claim under section 44 was her strongest.

In the decision the Court noted the key element of section 44 was the intention to defeat which will exist where a person disposes of property to a trust knowing that as a consequence his or her partner risks losing rights to that property.

Mr Smith’s clear evidence was that his intention in creating the Trust was to protect the section and any future house from any claim from Ms Lee.

It was submitted on behalf of Mr Smith that if the party disposing of the property did not understand that what they were disposing of was in fact relationship property there could be no relief under section 44. Mr Smith was aware of the three year de facto relationship threshold and thought that Ms Lee had no rights to the section.

That argument was rejected. Section 44 does not require the applicant to have any rights or interests at the time of the disposition so therefore the question of whether Ms Lee had any interest in the section was immaterial.

Mr Smith was aware that Ms Lee could in the future obtain an interest in the property and wanted to ensure that she would not and that was enough.

Mr Smith’s counsel also raised the argument that an order could not be made because the Trust had paid valuable consideration in the form of a deed of acknowledgment of debt. This argument was also rejected by the Judge who noted if the Court could not make an order where there has been valuable consideration then the words “whether for value or not” in section 44 would not be required and section 44 would only be able to be utilized by the Court when the disposition had not been for value.

The Court determined that while there had been valuable consideration, it was not a bona fide or good faith transaction.

Validity of the Trust

Mr Smith sought to distinguish his Trust from that in Clayton by saying self-dealing was not expressly permitted and that under the terms of the Trust it was possible for the other beneficiaries to allege breaches of fiduciary duty.

The Court considered that the Trust gave Mr Smith wide reaching powers and there was a very real question as to whether those powers carry with them fiduciary obligations. The terms of the Trust meant that Mr Smith could remove all the other beneficiaries other than himself and then be the sole beneficiary which is something that was going to be prohibited under the Trusts Act 2019.

The section was also never formally transferred from Mr Smith personally to him as the trustee of the Trust.

These factors meant that the Judge agreed with Ms Lee’s submission that there was a question as to whether the Trust was valid rather than a nullity which would have the consequence of the property remaining vested in Mr Smith personally.

Mr Smith’s Trust powers

Following on the Court agreed that the powers Mr Smith had in the Trust were his personal property so the question was whether the powers were relationship property.

Because the powers were derived from separate property, as Mr Smith owned the section prior to the de facto relationship, the Court said it was arguable that the powers were his separate property. The Judge refrained from determining the issue given Ms Lee’s claim under section 44 was successful.

Constructive trust claim

Ms Lee raised a claim by virtue of a constructive trust on the basis of the direct and indirect contributions she made to the property. The relief sought was a declaration that the Trust held the property on trust for Ms Lee and Mr Smith.

The Judge did not determine the issue but noted difficulties in the claim being that there was no evidence Mr Smith contributed to the property in the expectation of a beneficial interest and there were difficulties in assessing the value of the contributions.

Claim against law firm

Expert evidence was provided by a trust and estates partner who concluded that Mr Smith was led to believe that the Trust was a viable alternative to a contracting out agreement. In the expert’s opinion, any reasonable and prudent trust or generalist lawyer would have ensured Mr Smith was advised that, unless he was prepared to risk losing part of his assets if the relationship ended, he needed Ms Lee to sign a contracting out agreement.

The law firm attempted to argue their negligence was not causative because if their advice to Mr Smith had of been to leave the relationship unless a contracting out agreement was signed, he would not have left the relationship.

However, given Mr Smith’s experience with breakdowns of his previous relationship and his motivation to avoid similar results, the Court was in no doubt that if he had of been advised of the correct position, he would have terminated the relationship. The law firm’s negligence was therefore causative of Mr Smith’s loss.

The law firm also attempted to argue that the damages should be limited to half of $330,000 being the value of Mr Smith’s separate property at the time of the advice. This was rejected by the Court, it was “entirely foreseeable” that the loss would be incurred at the time of Mr Smith and Ms Lee’s relationship property claim was settled.

Ultimately the Court ordered the law firm to pay directly to Ms Lee the sum of $499,855 representing her share of the family home, as well as costs incurred by Mr Smith and the costs award against Mr Smith.

Takeaway

The Court has now repeatedly affirmed that it will not allow one party to dispose of relationship property to a trust if it is transferred for the purpose of defeating that parties claim.

If separate property is transferred to a trust prior to, or during, a de facto relationship it is essential to also enter a contracting out agreement (commonly known as a pre-nuptial agreement).

 

Note: Names have been changed to protect the parties privacy.