The best-laid SMSF estate plans can unravel if the courts invoke the notional estate mechanism. Caroline Harley examines a recent legal case highlighting this set of circumstances.
We all know wills can be challenged in the courts. Despite having the right to decide how our property is distributed on death, if we don’t provide for certain people, then the courts can step in. The result is often a reshuffle and reallocation of our assets, resulting in a hand the deceased member and super beneficiaries were not expecting. This is a means for the courts to ensure everyone who is deserving gets paid their fair share. The mechanism that allows the courts to do this is ‘notional estate’.
While notional estate only exists in New South Wales, people who live and have their estate in other jurisdictions can still be at risk. For example, a NSW company as trustee of a family trust, owning shares held on a NSW register or contributing to a super fund located in NSW may all give rise to a claim in that state.
This article will look at how SMSF benefits can be pulled into court by making a notional estate order during a family provision claim. This shows that once an estate plan is created it cannot be ‘set and forget’. Transactions where full consideration is not received may place super death benefit strategies at risk. Let’s look at a recent case involving super death benefits to show how it can happen.
Douglass was decided in the NSW Supreme Court last year. The facts are that Alan Carr spent the latter years of his life battling cancer. He had been married twice. He had two children with his first wife, Margaret Carr, and two children and a stepson with his second wife, Heather. Heather unfortunately died two years after giving birth to their youngest child, Adam (who was born with a disability). Heather’s daughter, Tina Carr, was the applicant in these proceedings.After Heather died, Alan reunited with Margaret. They remained divorced but lived together. Margaret was not the executor of Alan’s will and there was evidence ‘things were not good’ between them when Alan died. Margaret and Tina did not get along.
Tina was only allocated some personal possessions from her father’s estate. The estate contained about $50,000, so Tina applied for orders of notional estate, which would bring in her father’s SMSF death benefits of $673,878.80 and half of the proceeds of the sale of a property in Austral, NSW, amounting to $582,386.15. Notional estate was also claimed over the earnings from these funds at almost $3500 a month.
Tina sought $400,000, which included her court costs. This would satisfy all her debt, including her mortgage, Higher Education Contribution Scheme debt and credit cards, and provide a contingency fund.
The case of Carr v Douglass was decided in the NSW Supreme Court last year. The facts are that Alan Carr spent the latter years of his life battling cancer. He had been married twice. He had two children with his first wife, Margaret Carr, and two children and a stepson with his second wife, Heather. Heather unfortunately died two years after giving birth to their youngest child, Adam (who was born with a disability). Heather’s daughter, Tina Carr, was the applicant in these proceedings.After Heather died, Alan reunited with Margaret. They remained divorced but lived together. Margaret was not the executor of Alan’s will and there was evidence ‘things were not good’ between them when Alan died. Margaret and Tina did not get along.
Tina was only allocated some personal possessions from her father’s estate. The estate contained about $50,000, so Tina applied for orders of notional estate, which would bring in her father’s SMSF death benefits of $673,878.80 and half of the proceeds of the sale of a property in Austral, NSW, amounting to $582,386.15. Notional estate was also claimed over the earnings from these funds at almost $3500 a month. Tina sought $400,000, which included her court costs. This would satisfy all her debt, including her mortgage, Higher Education Contribution Scheme debt and credit cards, and provide a contingency fund.
The SMSF death benefits The SMSF death benefits had previously been subject to a binding death benefit nomination (BDBN) directing all benefits to Alan’s estate. Alan’s will stated his super should be used to establish a trust to financially support Adam. The will did not anticipate that the super may not be paid to Alan’s estate.
The issue was that the BDBN had lapsed. It was signed on 1 July 2008 and expired on 1 July 2011. There is no discussion in the judgment as to the provisions of the trust deed which relates to the BDBN lapsing; it simply refers to three years being the maximum period for a BDBN permitted under superannuation law. Alan signed his will on 5 December 2012 and died five weeks later. The judge commented that it was “puzzling” why Alan’s estate planning lawyer did not remind him to renew his BDBN when preparing his will the month before he died. Perhaps like Ioppolo v Conti, different professionals were involved in preparing the BDBN and the estate planning.
The half share of the Austral property In addition to the super benefits, Tina sought an order over half of the proceeds of the sale of the Austral property. We need to understand the background as to why.
Margaret and Alan owned the property as joint tenants. Alan’s will stipulated his half share be equally divided between his children: Tina, Matthew and Glen (Adam already had provision from the super death benefits).
Alan was only able to deal with the half share of the property if he ‘severed’ the joint tenancy to convert the ownership to tenants in common. Where a joint tenant dies, the other owner automatically receives that person’s interest through the right of survivorship; it does not become part of the deceased person’s estate.
Shortly after the will was signed, Alan’s lawyer lodged a signed notice with the land titles office to sever the joint tenancy. Unfortunately, Alan died before it was processed by the land titles office. This left the joint tenancy intact, with Margaret receiving Alan’s half interest of the property by survivorship and Tina substantially missing out under Alan’s will. Margaret sold the property and kept the entire proceeds of sale for herself.
Control of the SMSF
What happened to the SMSF death benefits and lapsed BDBN? Clearly it was Alan’s intention that his death benefit be paid to his estate, however, that didn’t happen. Unsurprisingly, the person who obtained control of the trustee paid themselves.
Margaret appeared to have already been a director of the SMSF trustee and appointed her son, Glen, as a co-director after Alan died. The judge commented that the speed in which Margaret dealt with the super entitlements and the Austral property following Alan’s death displayed a “well-developed sense of her own financial best interests”.
As co-directors of the trustee, Margaret and Glen passed a resolution to pay Alan’s entire death benefit of $673,878.80 to Margaret. The fact the death benefits had already been paid to Margaret at the date of the judgment would be of no consequence if a notional estate order was made by the court.
The court did not question the process or provisions of the trust deed in the event of a lapsed BDBN or the actions of the trustee. The judge did say Glen “gave unsatisfactory evidence about why he caused the whole of the … entitlements to be paid to his mother” and he “showed not the slightest indication of having understood the nature of the duties of the fund’s corporate trustee … or trust deed”.
The process of deciding whether super is notional estate
So how did Tina’s claim eventuate? First, it’s important to understand how and why orders of notional estate may be made over super and other property. This judgment was quite clear about the steps when making an order of notional estate.
There must be a relevant property transaction (RPT). An RPT can be an action or failure to act. It occurs where full valuable consideration is not paid in a transaction or circumstance affecting property. In this case, failure to split the joint tenancy before Alan died was an RPT as neither he nor his estate received consideration for the half share in the property. Similarly, Alan failing to renew his BDBN in favour of his estate constituted an RPT.
Is there enough in the estate without a notional estate order? The court can only make a notional estate order if there isn’t enough to pay everyone. Alan’s estate comprised $50,000 and his notional estate was $1.2 million. Court costs were around $100,000, which clearly exceeded the value of the estate and left an insufficiency.
Did the RPT occur within the time frames required by law? The law provides that RPTs must have occurred within one to three years of Alan’s death to qualify for a notional estate order. The tricky part is that the one to three-year rules don’t apply where transactions ‘take effect’ on death.
Failing to sever the joint tenancy took effect on death, so it did not need to satisfy a one to three-year time frame. Failure to renew the BDBN on 1 July 2011 fell within three years of Alan’s death. Additionally, the three-year provisions require that the RPT was entered with the intention of limiting Alan’s estate. This was not the case as Alan merely overlooked the renewal. Alan assumed the BDBN was still in place when he made his will and clearly intended to benefit his estate. Therefore this RPT did not meet the requirements for a notional estate order to be made.
Has the estate been disadvantaged by these transactions? It was held that both transactions directly disadvantaged Alan’s estate by denying the estate around $1.2 million.
What restrictions may apply to the court in making notional estate orders? There are general matters that must be considered by the court, including the importance of not interfering with reasonable expectations in relation to property, and the justice and merits in refusing or making an order. This is where a BDBN (that had not lapsed) would be considered.
Based on the need to consider these matters, Margaret in her defence argued she had made substantial financial and non-financial contributions to the Austral property. The court held that despite those contributions it did not entitle her to the whole property and prevent a notional estate order from being made over the proceeds of sale.
The court made an order of notional estate over part of the Austral property. It was ordered that Tina receive $275,000 plus costs (enough to pay off her mortgage), being more than Alan had given her in his will. The super death benefits were not eligible for a notional estate order as the RPT was not intended to deprive Alan’s estate.
If, unlike this case, a BDBN had been made in favour of a dependant (that is, Adam) instead of the estate, the making of the BDBN would likely have constituted an RPT eligible for notional estate orders. However, the super would only be at risk if there was insufficient in the estate to meet all claims. So, if the other children lodged claims, this would create higher demand on the estate, making it more likely for a notional estate order to be made over the SMSF benefits.
What are the lessons from Carr v Douglass
- A family provision claim may be one way to seek a reallocation of super death benefits where the SMSF controller has paid themselves and left dependants wanting. • Despite the risk of being an RPT, a member making a valid BDBN may influence the court when deciding if it will make a notional estate order over superannuation.
- Non-lapsing BDBN provisions in your trust deed remove trustee discretion in death benefit allocation.
- Prepare all estate planning documents together.
- Transactions impacting on property without full consideration (such as transferring property into a family trust) could unravel estate planning strategies.