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Succession Planning for the Family Trust - Helpful hints when dealing with the detail

This article was originally published by the Retirement and Estate Planning Bulletin.

In previous articles on this topic we have suggested a framework methodology to follow when planning for the succession of your family trust as well as identifying some common approaches that, in our experience, are adopted when implementing a succession planning strategy.

As with many aspects of estate planning and succession planning the 'devil is often in the detail' and many succession planning arrangements can easily fail if the details are not understood and planned for.  

This article highlights some of the 'details' that need to be considered in order to properly plan for the succession of the family trust.  

The Core Legal Documents

It might be a case of stating the obvious but, in order to plan properly, you need to obtain, read and understand the core legal documents that underpin the existence of your family trust.  This fundamental step is unfortunately often not followed to the detriment of achieving the intended objectives.

What are the core legal documents for a family trust?  That will depend on the nature of the trust, the activities of the trust and the history of the trust. However, as a general comment you will need to consider the following documents:

  • the original trust deed and all other deeds of amendment that have amended the trust deed over the years - it is amazing how many times deeds of amendment are overlooked even though the effect of a deed of amendment may have been to amend the trust deed in some very significant manner;

  • the most recent financial statements for the trust;

  • if the trustee (or any other officeholder) of the trust is a company - the constitution and any shareholder agreement for that company and the most recent annual company statement for that company which is lodged at ASIC; and

  • any other documents that set out critical legal rights and obligations that the trust may have, for example, financing arrangements, lease agreements over business premises, licensing agreements with third parties and the like.

Going through this disciplined approach often has other benefits in that it could identify gaps in the family's record keeping and document storage arrangements. For example: Do you know where the constitution for the trustee company is?  Do you know where the title deed for the investment property or the holiday home is?

Why will all this background research be important in the succession planning? For many reasons and because you need to know the detail so that you can plan accordingly....planning does not exist in a vacuum!

The trust deed, for example, will disclose a range of absolutely critical information including:

  • who controls the trust and what rules exist in the trust deed that impact on how that control is exercised;

  • what is the class of people and entities who can benefit from the trust and are there any restrictions that have been placed on how or when those beneficiaries can benefit; and

  • what powers does the trustee have in terms of the general administration of the trust and are there any restrictions on these powers.   

The constitution of the trustee company will then provide a lot more detail as to how the directors of the company make their decisions and how they cast their votes on relevant issues, the rights that the shareholders have generally and specifically in terms of each class of shares that is on issue, how shareholder rights relate to (or don't relate to as the case may be) the appointment of directors and the rights and obligations that shareholders have vis-a-vis each other.

The annual company statement identifies who is currently recorded on ASIC records as being the directors , the shareholders and importantly, how many shares each shareholder owns and what class of shares they own.

An Example - the A Family

To put this into context consider the A Family. The A Family is not a complex family in terms of relationships or family dynamics. Mr and Mrs A have been married for 35 years, the first marriage for both of them. They have two children, B and C.  B is 30 years of age and recently married, expecting their first child.  C is 26 years of age, single and currently working overseas.  Family relationships are very good between everyone in the family although B and C are very different people in terms of their investment risk profile. B and C are also at very different stages of life with B likely to experience some financial pressures in the near future starting a family.

The A Family are also not complex in terms of their financial asset holdings. Mr and Mrs A own their family home as joint tenant, they have joint bank accounts and they each have share portfolios in their own personal names.

In addition, the A Family have a self-managed superannuation fund (A SMSF) that holds a significant amount of their family wealth and a family trust (A Family Trust) that also owns a significant amount of their family wealth. Mr and Mrs A are both drawing reversionary pensions with each other nominated as the reversionary pensioner. Mr and Mrs A are both members of the A SMSF and B is also a member. A Co Pty Ltd is the trustee of the A SMSF.

A Co Pty Ltd is also the trustee of the A Family Trust. It is not unusual in a family context for the same company to be the trustee of both the family SMSF and the family trust. Mr and Mrs A both jointly hold the office of appointor of the A Family Trust, which gives them the power to remove the trustee and appoint a new or additional trustee and to also appoint a successor to the office of appointor. The rules of the trust deed for the family trust state that the office of appointor defaults to the surviving joint holder of the office. The last surviving person to hold the office of appointor can nominate a successor, or successors, to take over the office of appointor but, if they make no nomination, the default is that the executor of the estate of the last surviving appointor will then take over the office.

Closer investigation of A Co Pty Ltd reveals that it is a very simply structured company.  The directors of A Co Pty Ltd are Mr and Mrs A and B (which means that the superannuation laws are complied with because all members of the SMSF are also directors of the trustee company. The shareholders in A Co Pty Ltd are Mr and Mrs A and B, all of whom own one ordinary share with equal voting rights.

The estate planning objectives and succession planning objectives for Mr and Mrs A are also quite simple and straightforward. Mr and Mrs A would like to benefit each other with the entirety of their estate and, when the second of them die, they would like to benefit B and C equally.

The Wills of Mr and Mrs A are structured very simply. Mr and Mrs A are nominated to be the sole executor of each other's estate with B and C nominated jointly to be the substitute executors. The distribution clauses in the Will leave "the entirety of my estate to my surviving spouse provided that they survive me by 30 days and, if they don't, then I leave the entirety of my estate to B and C in equal shares".

Because Mr and Mrs A consider their circumstances and their objectives to be quite simple and straightforward they don't bother getting any professional estate planning or succession planning advice.

So, how does this all play out for the A Family?  

Let's assume that Mr A dies first. The family home will pass to Mrs A as the surviving joint tenant owner and the joint bank accounts will also pass to Mrs A. Mrs A will receive the benefit of Mr A's superannuation being the nominated reversionary pensioner. Depending on the position of Mrs A in terms of her transfer balance cap, she may need to roll some or all of her own superannuation pension back into accumulation so that she can remain within the post 1 July 2017 pension cap rules.

In relation to the A Family Trust, Mrs A will now be the sole appointor, will continue to be a director of A Co Pty Ltd (with B) and will own 2 of the three shares on issue in A Co Pty Ltd (the Will of Mr A left his one share in A Co Pty Ltd to Mrs A and B owns the other share). Although Mrs A is one of two directors in A Co Pty Ltd she is effectively in control of the A Family Trust because she is the sole appointor and hold the majority of shares in A Co Pty Ltd.

What happens when Mrs A subsequently dies?

Under the Will of Mrs A, B and C are both executors of the estate and the assets of Mrs A are left equally to B and C. The family home will likely be sold, and the net cash proceeds distributed equally between B and C. Alternatively, the family home could be distributed to B and C so that they hold it as tenant-in-common in equal shares. The cash in Mrs A's bank account will be distributed equally to B and C.

Because Mrs A has not nominated anyone to succeed her to the office of appointor of the A Family Trust, that office will default to B and C jointly as they are the executors of her estate.

Mrs A's two shares in A Co Pty Ltd will be distributed under her Will to B and C so that they each receive one share.

What is the position of the A Family Trust?

B and C jointly hold the office of appointor.

B holds two shares in A Co Pty Ltd and C holds one share in A Co Pty Ltd. B is the sole director of A Co Pty Ltd.

B is actually in control of the A Family Trust, not B and C jointly. This is because B is the sole director of and majority shareholder in A Co Pty Ltd and, as a minority shareholder in A Co Pty Ltd, holding the same class of ordinary shares that B holds, C does not have any rights to appoint herself as a director.  C is reliant on B to appoint her as a director and as an equal shareholder. Further, as a joint appointor with B, C cannot unilaterally appoint a new or additional trustee to the A Family Trust without the consent of B.

Worst case scenario? B administers the A Family Trust for the significant financial benefit only of B and his family and to the significant financial detriment of C.  

It is easy to see how the simple, sensible and traditional intentions of Mr and Mrs A could easily not be achieved in relation to the A Family Trust, to the significant detriment of C. Depending on the nature of the relationship between B and C, it is possible that they can work together to rectify the problem so that all levels of control of the A Family Trust is shared equally by B and C. But why rely on the good character of B to achieve the desired outcome....it is not fair to put C in this position. Further, for many clients there is a regularly expressed concern about the influence that spouses can bring on previously very harmonious family relationships. Will the good relationship between B and C be adversely affected by the influence of B's new spouse....it is not fair to put B or C in this position?

It could get worse....what about the A SMSF?

Remember that A Co Pty Ltd is the trustee of both the A Family Trust and the A SMSF....and B now controls A Co Pty Ltd after the death of Mrs and Mrs A....and, save for making on the estate of Mrs A, C can't do anything about that without the consent of B. If Mrs A has not made a binding death benefit nomination for the payment of her superannuation death benefit, her death benefit will be distributed in accordance with the superannuation laws and at the discretion of the trustees....that is, B.  B could exercise the trustee discretion to distribute the entirety of Mrs A's superannuation to B, being a child of the deceased member. Is there anything that C can do to stop this? Yes, but unfortunately for C it involves bringing a legal action against B.

So, what could/should Mr and Mrs A have done differently to prevent these potential problems arising and ensure that their simple estate and succession planning objectives are achieved? The following is list of things that would have been important to consider and, if appropriate, implement.

  • Appoint a new company to be the trustee of the A Family Trust and structure that new company with Mr and Mrs A as the only directors and only shareholders.

  • Ensure that, when Mr and Mrs A have both died, B and C (or their nominee) both have rights to be appointed as directors of the new company that acts as trustee of the A Family Trust and will be equal shareholders in that company.

  • Ensure that the trust deed and company constitution deal appropriately with circumstances of deadlock in decision making between B and C.

  • Put in place binding death benefit nominations to ensure that the superannuation death benefit entitlements are paid in the way that they want them to be paid.

There are other very prudent and sensible strategies that Mr and Mrs A should think about when considering the multi-generational succession planning for the A Family Trust but, in reality, these four simple planning techniques could save this family an enormous amount of stress and legal fees in sorting out a messy set of unintended circumstances in the next generation.

As with many things in inter-generational succession planning for family entities, the devil is often in the detail....don't ignore it.  

Authors:  Belinda Cao and Andrew Frankland         

See related articles - 

Succession Planning for the Family Trust – Getting Started

Succession Planning for the Family Trust - Common Approaches