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Death benefit allocation boundaries

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A recent court case challenged the improper use of trustee powers upon the death of a fund member. Michael Hallinan discloses the result and the implications it has for SMSFs.

The Victorian Supreme Court recently overturned a case dealing with a trustee’s death benefit allocation decision. The court found the decision of the SMSF trustees was defective and removed the trustees from their office as well.

Undoubtedly, this decision will be closely read by SMSF advisers and is likely to be a leading case on death benefit allocation decisions. The case is Re Marsella: Marsella v Wareham (No 2) (also known as the Swanson Superannuation Fund case) [2019] VSC 65.

Significance of the case

The significance of the Swanson Superannuation Fund case lies in the means by which the court was able to infer the existence of both bad faith and inadequate deliberation of the trustees when making the allocation decision.

Additionally, the case illustrates how an allocation decision should be made in order to minimise the possibility of the decision being successfully challenged in litigation proceedings.

Unlike other SMSF allocation decision cases, this case turned upon substantive issues, that is, bad faith and inadequate deliberation, rather than technical deficiencies as occurred in Donovan v Donovan (nomination not binding), Munro v Munro (incorrect description of beneficiary), McIntosh v McIntosh (capacity of claimant), Brine v Carter (capacity of claimant) and Re Narumon Pty Ltd (requirements for a valid refresh of a nomination).

Background

Helen Marsella was the sole member of the Swanson Superannuation Fund, an SMSF. The fund was established in 2003 with Helen Marsella and her daughter, Caroline, as the two trustees. They remained as the trustees until the death of Helen.

Helen died on 27 April 2016 leaving a superannuation death benefit then estimated to be about $450,000. While she left a binding death benefit nomination (BDBN), it was agreed by all the parties that the nomination was invalid.

As there was no valid BDBN, the trust deed provided that the trustees had to allocate the death benefit to or among the eligible beneficiaries of Helen. In the circumstances of the case it was accepted by the parties that the only eligible beneficiaries were Riccardo, the deceased’s husband of more than 30 years, the legal personal representative of Helen’s estate (that is, the executor of her estate, who was Riccardo) and her issue from her previous marriage being her daughter, Caroline, and son, Martin.

Shortly after the death of Helen, disputes emerged between Riccardo and Caroline.  Riccardo commenced legal proceedings to have the court vary Helen’s will to provide greater provision for him, given that limited provision had been made for him in the will. Caroline asserted that a particular property (the Frankston property) was held on pre-existing trusts for herself and her brother and therefore did not form part of the estate. The claim for further provision was resolved in favour of Riccardo and the dispute as to the Frankston property was resolved in favour of the property being part of the estate.

Almost a year after Helen died, and before the resolution of the two disputes, the daughter as sole surviving trustee made a decision (the death benefit allocation decision) to appoint the entire death benefit to herself and also made a decision to appoint her husband as co-trustee. Due to uncertainty as to whether the trust deed required or did not require two trustees, after the appointment of her husband as co-trustee, they made the same allocation decision. Both decisions were recorded in writing and both occurred on the same day.

Riccardo commenced legal proceedings to challenge the death benefit allocation decision and also to remove the two trustees. The court held that the death benefit allocation decision was defective and that two trustees should be removed.

Why was the death benefit nomination invalid?

The nomination was deemed invalid for two reasons and each reason was sufficient for the nomination to be invalid alone.

The first was the deceased nominated individuals, being her grandchildren, who were not dependants as defined by the Superannuation Industry (Supervision) (SIS) Act 1993. Grandchildren are not SIS Act dependants simply by virtue of their status as grandchildren. Additionally, the grandchildren were not dependants by reason of being financially dependent on Helen.

The second reason was the trust deed of the SMSF imposed a three-year time limit on BDBNs and the three-year time limit had already expired.

Under superannuation law the ‘will-like’ execution requirements and the three-year time limit do not automatically apply to SMSFs. They can apply if the fund’s trust deed incorporates them, whether explicitly or implicitly. In this particular case the three-year time limit was expressly incorporated by the terms of the trust deed.

How can a death benefit allocation decision be invalid?

A death benefit allocation decision can be legally challenged on a number of possible grounds. The grounds that were alleged in this case were, firstly, bad faith, secondly, improper purposes and, thirdly, inadequate deliberation.

In the current case, the other possible grounds for challenging the allocation decision, such as excessive execution, failing to exercise the allocation power or exercising the allocation power under the dictation of others, were not relevant. Caroline was clearly a dependant and was eligible to be paid the death benefit, so the exercise was not excessive. Additionally, the trustees did make a decision and their decision was not made under dictation of others.

Bad faith

As the power to allocate the death benefit was a limited power, that is, it could only be exercised for the benefit of one or more of a limited range of individuals, the power had to be exercised in good faith. If the allocation decision is not exercised in good faith, then the decision has been made in bad faith.

In the context of death benefit allocation decisions, bad faith extends to making a decision capriciously, wantonly, irresponsibly, mischievously or irrelevantly to any sensible expectation of the purpose for which death benefits are provided by super funds. Additionally, and significantly for this case, it extends to a refusal to consider a potential beneficiary of the power or dismissing an individual as being ineligible for consideration without good reason. Finally, it can be inferred from the trustees making a decision that no reasonable trustees could reach.

Bad faith can exist without any dishonesty being involved. However, bad faith cannot simply be inferred from the existence of a strained relationship between the potential individual and the trustee.

Was the allocation decision made in bad faith?

The court held the allocation decision was made in bad faith. The existence of bad faith was inferred from the conduct of the trustees and, more significantly in this case, by the conduct of the trustees’ solicitors being agents of the trustees. Normally bad faith is very difficult to establish on the basis of the trustees’ testimony. Rather, bad faith must be inferred from conduct and correspondence made by or on behalf of the trustees.

In the Marsella case the correspondence of the solicitors for the trustees indicated the trustees did not consider Riccardo to be an eligible beneficiary despite being the former spouse and also being the executor of Helen’s estate, misconstrued the legal nature of the allocation power, stating it was a general power of appointment rather than a special power of appointment, failed to undertake any reasonable inquiries as to means and circumstances of the eligible beneficiaries and made an allocation decision that no reasonable trustee could make. All of these factors permitted the court to infer the allocation decision was affected by bad faith.

Was the allocation decision made for improper purposes?

In the context of death benefit allocation decisions, improper purpose means making an allocation decision without regard to the purposes for which the power was created. In this case, the purpose for which the power is conferred was determined by the text of the trust deed and also by the fact the fund was intended to be a complying superannuation fund. The court concluded the proper purpose of the allocation power was to support one or more of Helen’s dependants. It was not the purpose to support all of Helen’s dependants. Further, it was not the purpose to support the most impecunious dependant as superannuation funds are not charitable trusts for the relief of poverty.

The court found, possibly generously to Caroline, the allocation decision was made for a proper purpose as the allocation was made to an eligible dependant (namely Caroline).

Was the decision made with inadequate deliberation?

Inadequate deliberation essentially means taking into account irrelevant matters or not taking into account relevant matters. The inadequacy of the deliberation in making the decision can be inferred from the nature of the inquiries made by the trustees, the information before the trustees when making the allocation decision, the trustees’ understanding of the legal and trust deed requirements relating to the decision (such as the nature of the allocation power and the conflicted position of the trustees) and, finally, if the decision is so “grotesquely unreasonable”, the decision itself.

The court identified the following factors as relevant: the relationship between the deceased and each dependant and the financial circumstances and needs of each dependant. In the current case, the trustees, due to the family provision litigation by Riccardo against the estate for further provision, had knowledge of the financial circumstances and needs.

The court held the allocation decision was made with inadequate deliberation for essentially the same reasons that supported the finding that the decision was made in bad faith.

Swanson super case – five key lessons

There are five key lessons from the Swanson Superannuation Fund case.

Ensure the trust deed has a conflicts clause – that is, a provision that permits the trustee, or a director of the corporate trustee, to exercise a discretion even if the trustee or director has an interest in the exercise of that power.

Ensure the trustee correctly understands the trust deed rules relating to the allocation of a death benefit. This entails understanding the trustee must exercise the allocation power (that is, the power to select which dependant or dependants is or are to receive the death benefit and, if more than one dependant is selected, the proportion of the death benefit each selected dependant is to receive).

The trustee must ascertain all relevant information as to the allocation before the allocation decision is made. This includes identifying each dependant, obtaining information as to each dependant’s current means and finances, obtaining information as to each dependant’s requirements and, finally, obtaining information about each dependant’s relationship with the deceased. This information could be contained in a report prepared for the trustees and tabled at a trustee’s meeting.
As the court will not investigate or consider what weight the trustees should have given to each beneficiary’s current means and circumstances, their requirements or the nature of the relationship with the deceased, the trustees should simply note they have considered the relevant information and then made an allocation decision having considered that information.

The trustee and its agents, for example, the trustee’s lawyers, must never be dismissive of a dependant or their merits. In particular, an agent for the trustee, for example, the lawyers acting for the trustees, must not use language that indicates the trustees have summarily dismissed or discounted a dependant’s status or entitlement to be considered in the allocation decision.
In this particular case, the lawyer’s language in their correspondence with Riccardo, or more correctly Riccardo’s lawyers, clearly showed they misunderstood the legal nature of the allocation power in that it was a special power and not a general power, did not recognise Riccardo as a dependant of the death benefit, considered Riccardo had no rights in relation to the death benefit and failed to consider the strength and merits of Riccardo’s claim to be considered for selection (that is, duration of the marriage – over 30 years and the marriage only terminating by reason of the death of Helen, and also the relatively modest provision for Riccardo from Helen’s estate).

The trustees should, before making an allocation decision, obtain expert advice and consider the merits of the advice. While trustees are not bound to follow expert advice, if they decide not to follow the advice, they must have a reasoned and recorded view as to why they are not following the advice.

How could this matter have been avoided?

Had Helen had a properly drafted BDBN, this case would never have arisen. A properly drafted nomination would have avoided nominating individuals who were not eligible to receive the death benefit. Had the nomination simply allocated the death benefit to Caroline and Martin, then Riccardo’s only course of action would have been against the estate for further and better provision from it. Unlike New South Wales, Victoria has no notional estate legislation enabling the court to treat all or part of a death benefit as if it were part of the estate.

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