The power of appointment and removal of a trustee, and the high hurdle of invalidity

Baba v Sheehan [2021] NSWCA 58

In dismissing a claim that the exercise of a power to remove and appoint a trustee was for a foreign or extraneous purpose, the New South Wales Court of Appeal has provided guidance on the scope of trust powers and the importance of intention and good faith when ascertaining the validity of the exercise of a power.

The facts

The second appellant, Mr Baba, together with Mr Sheehan (the first respondent) and Mr Carney, ran an optometry practice. The practice was conducted under a trust deed. The deed issued units to the second appellant’s wife and to companies controlled by Messrs Carney and Sheehan. The trust deed gave power to Mr Sheehan to appoint and remove a trustee.

Having, among other things, grown concerned with what he considered to be distributions from the trust which were not in proportion to the unit holdings, as well as a reference in an email between Mr Baba and the trust’s accountant to an alleged ‘salary sacrifice’ arrangement (of which he had been unaware), Mr Sheehan sought to exercise his power as appointor. In October 2016, Mr Sheehan removed the existing trustee — of which each he, the appellant and Mr Carney were directors and shareholders — and appointed in its stead a company of which he and his wife were the only directors and shareholders.

In proceedings in the Supreme Court of New South Wales, the primary judge dismissed a claim that Mr Sheehan’s removal of the existing trustee and appointment of the new trustee was void and of no effect. The judge held that Mr Sheehan had exercised his power in good faith, even if Mr Sheehan had not done so for entirely well-founded reasons.

The appellants sought to appeal on the sole ground that the judge erred in failing to hold that the purported removal and appointment was void as a fraud on Mr Sheehan’s power under the trust deed. The appellants contended that the power had been exercised for an extraneous purpose.

On appeal

Emmett AJA, with whom Brereton JA and Simpson AJA agreed, dismissed the appeal. Their Honours could find no basis to disturb the primary judge’s finding of fact regarding the propriety of Mr Sheehan’s exercise of the power: [18] (Brereton JA), [52] and [57] (Emmett AJA), and [58] (Simpson AJA). This was so despite the primary judge not finding Mr Sheehan’s evidence as to his purpose to be “entirely satisfactory”; among other things, the primary judge did not consider that certain emails (upon which Mr Sheehan relied as justification for exercising his powers as appointor) fairly reflected the concerns that Mr Sheehan claimed he had. Nonetheless, the judge found Mr Sheehan to be a credible witness in providing his account of the concerns which had prompted him to act in order to protect his interest as a unitholder, even if those concerns were not accurately informed.

The refusal by the Court of Appeal to overturn the primary judge’s finding of fact, which was based in part on his assessment of Mr Sheehan’s credit, was determinative of the appeal. Nonetheless, their Honours went on to expound the requirements at law for the proper exercise of such a power.

Emmett AJA, having set out the background facts and the history of the dispute, began holistically with the point that “[t]he purpose of a trust deed in conferring a power is to benefit the objects of the relevant trust” and that “[a] power will be exercised for a foreign purpose if it is exercised with the intention of benefiting someone who is not an object of the power”: [49]. It followed that Mr Sheehan’s powers as appointor could only be exercised for the purpose of benefiting the unitholders of the trust in question.

His Honour noted that, in the present case, the trustee company which Mr Sheehan purported to appoint was one in his and his wife’s control and that if “the purpose and intention” of that appointment had been to deprive Messrs Baba and Carney of their involvement in the affairs of the trust, then Mr Sheehan’s actions would prima facie have been for a foreign purpose and therefore void: [50]. Emmett AJA noted that if, on the other hand, Mr Sheehan had “in good faith” formed a view that it was in the interests of all unitholders that the trustee be so replaced because the incoming trustee could better manage the affairs of the trust, this would not be liable to such characterisation: [50].

Brereton JA delved into the law in greater detail. His Honour distinguished the exercise of a power of appointment for substitution of a trustee — as was the case here — from an appointment of trust property to a particular discretionary beneficiary, noting that while the latter had a fiduciary quality it was “open to serious doubt, at least as a general rule”, that the former did: [4]. Whether or not it was proper to characterise the power of appointment and removal of a trustee as ‘fiduciary’, his Honour noted that “it has been accepted that such a power is controlled by the doctrine of ‘fraud on a power’, so that it must be exercised bona fide for the purpose for which it was conferred”: [5].

In expanding on the concept of ‘fraud on a power’, Brereton JA noted that the doctrine “operates to avoid the exercise of a power where it has been exercised for a purpose, or with an intention, beyond the scope of, or not justified by, the instrument creating the power”: [6]. Although the appellants contended that Mr Sheehan’s sole purpose in his actions was to obtain control of the trust for himself, Brereton JA noted at [9]:

I would not accept that a purpose of maintaining or exerting control of a trust is, absent any intention that the appointee act other than properly in accordance with its responsibilities as trustee, necessarily inconsistent with the purpose for which a power of appointment of this kind is created, particularly in the context of the modern discretionary trust. Usually, a significant if not dominant purpose of this type of power of appointment is to reserve to the appointor the ability to ‘control’ the trust by removing and replacing the trustee.

In referring to a number of earlier authorities, his Honour noted that, without more, there was no mischief in the appointment of a trustee who would comply with the appointor’s wishes — even if the new trustee were a company controlled by the appointor. Returning to the primary judge’s reasoning, his Honour quoted from the decision of the primary judge the following at [17]:

My conclusion [about the proper exercise of the power of appointment] does not depend upon Mr Sheehan’s concerns […] having been well founded in fact. In my view it is sufficient that Mr Sheehan acted, as I have found, genuinely and in good faith.

Comment

The Court of Appeal’s decision demonstrates the high hurdle in seeking to impugn the exercise of a power of removal and appointment of a trustee on the basis of it being for an extraneous purpose. The Court’s decision shows that an appointor will tend to have exercised such power properly if done genuinely and in good faith, even if not necessarily well-informed and even if it has the consequence of giving the appointor greater control over the trust care of an interest in the new trustee.

The Court’s approach was similar to that of the Court of Appeal of the Supreme Court of Victoria in another recent case concerning the exercise, and the reasons supporting the exercise, of power under a trust, albeit the exercise by a trustee. In Mandie v Memart Nominees Pty Ltd [2020] VSCA 281, the applicants — among which were grandchildren of the settlor of a discretionary trust — had alleged that the corporate trustee, in purporting to remove certain beneficiaries from the trust by virtue of two declarations, had acted without power and for an improper purpose (in respect of one of the declarations) and in bad faith and for an improper purpose (in respect of the other). The trial judge dismissed their claims.

On appeal, the Court of Appeal held that the text of one declaration went beyond the power conferred on the trustee under the terms of the trust deed. The Court held, however, that the applicants had failed to establish the other declaration had been made for an improper purpose; the evidence did not establish that the trustee’s directors knew that the particular declaration had been made beyond power, nor had it been designed to target or prejudice the applicants indirectly. In this respect, the Court held that the trial judge had not erred in failing to draw an adverse (Jones v Dunkel) inference against the trustee for failing to call evidence regarding its decision-making; the Court noted that a trustee of a discretionary trust was not obliged to disclose reasons for its decisions and that no adverse inference could be drawn from non-disclosure: Curwen v Vanbreck Pty Ltd (2009) 26 VR 335, 348–9 [25].