Discretionary Trusts and Succession Planning

There is an old adage that goes something like this:  The first generation make the fortune, the second generation consolidate and build the fortune, and the third generation spend it.

It is mightily important then, if we are to provide for the needs of the spendthrifts of the third generation, that the succession plan between the first and second generations is sound.

When discretionary trusts are used in estate planning, a number of issues arise that need to be adequately addressed as part of this process; not the least of which is identifying and appointing the right person to control the trust into the future to ensure fairness and equity prevail amongst the potential beneficiaries going forward.

Often closely-held, family-orientated, trading trusts are established around a central figure.  That individual may have started the business in question, and it is usually by reference to that individual that the class of beneficiaries able to potentially benefit under the trust will be determined.  For example, in a family trust, the primary beneficiary may be John Smith but the potential class of beneficiaries may extend more broadly to the lineal descendants of John Smith and their spouses.  

That central individual is usually given the power under the trust deed to appoint and remove trustees (a function known as the “controller”, “appointor” or “guardian” of the trust), and hence they control the trust by controlling the trustee who determines what distributions go to which beneficiaries.  So John Smith, may also be the controller of the trust and/or the trustee itself.

So what happens when that individual dies or wishes to exit the business? The decision as to a replacement is not only crucial to the smooth running of the business, but to the transfer of power to the next generation and to the continuance (or disruption) of any existing pattern of distributions to beneficiaries.  Appointing a controller who is not sympathetic to these considerations can do untold damage to the business itself.

A number of broad considerations need to be entertained beyond the simple question of who is the right person to manage the control the trust and hence the business in the future; considerations such as:

  • Which individuals deserve to be recompensed into the future for their work in the past in establishing the business?
  • Are there competing entitlements that need to be respected and allowed for?
  • Who can be trusted to preserve the trust for future generations?
  • What mechanisms are in place (in the trust deed or by will or operation of law generally) that will effect this process and the transfer to third and subsequent generations?
  • Are there any other considerations that need to be taken into account – ie can a single individual have too much control over the trust and hence erode the asset protection features of the trust itself (see the Richstar case)?
  • Is there a need for a professional and independent voice to contribute to this process?
  • Does the process need to be codified into the trust deed itself?

These are difficult considerations that need to be addressed on a case by case basis. Every family, every company and every situation is different. 

Detailed legal advice from an expert in this area of law is crucial if the transition is to be as painless as possible.  The third and subsequent generations are relying on us!

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