Trust disputes typically fall into two major categories:

• Claims by third parties;
• Claims by beneficiaries.

Key risks and strategies in these disputes depend on a party’s relationship with the trust - i.e. whether they are a third party, a trustee, or a beneficiary. This article outlines common trust disputes and key considerations when navigating them.

Claims against trusts by third parties

Trusts have long been a favoured asset protection mechanism in New Zealand. The trust structure allows ownership of property to be vested in trustees, making it more difficult for third parties to access those assets through the original owner (the settlor). However, the increased use of trusts for asset protection has led to the development of legal mechanisms - both statutory and non-statutory - that can undermine trust structures. This area of law is sometimes referred to as ‘trust busting.’

Commonly encountered statutory challenges to trusts include: Claims by creditors against trust property under the:

• Claims by creditors against trust property under the:
  • Property Law Act 2007:
    • Sections 344 to 350 allow the Court to set aside (or 'claw back') certain dispositions of property, even where such disposition has been made to a trust.
  • Insolvency Act 2006:
    • Sections 204 – 213 enable the Official Assignee to cancel gifts made within two to five years of adjudication of bankruptcy.
• Claims by ex-partners (i.e. ex-husbands/wives, or de facto partners), under the:
  • Property (Relationships) Act 1976:
    • Section 44 enables a Court to set aside a disposition of property if made with the intention of defeating a spouse's rights.
  • Family Proceedings Act 1980;
    • Section 182 enables a Court to look into any 'nuptial settlement', and make any orders the Court sees fit.

Common non-statutory challenges include:

• Claims that a trust is a 'sham' – where a trust is set up but never intended to be genuinely operated as such;
• Claims that a trust is an 'alter ego' of the settlor – where a settlor continues to treat trust property as their own, without meaningful trustee independence;
• Claims that a trust is 'illusory' – where the settlor retains effective control;
• Claims that a party is entitled to access trust property via a constructive trust – where a party has made contributions to trust property (typically in a relationship property context).

The risks of these claims can be mitigated through proactive trust management, including:

• Careful drafting of the trust deed: Ensure clear and precise trust terms that explicitly outline trustee powers, beneficiary entitlements, and the trust’s purpose.
• Independent trust administration: Trustees should exercise genuine discretion and avoid undue influence.
• Proper documentation and record-keeping: Maintain accurate records of trustee decisions, asset distributions, and trust-related transactions.
• Regular trust reviews: Conduct periodic assessments to ensure compliance with legal requirements.
• Trustee independence: Appoint professional or independent trustees where possible to avoid perceptions of settlor control.

If faced with/considering such a claim (as a trustee, beneficiary, or third party), it is essential to assess the legal position early and seek professional advice.

Claims by beneficiaries

Beneficiary claims generally fall into two categories:

• Breach of trust claims against trustees ('hostile litigation');
• Disputes regarding trust administration ('non-hostile litigation').

Breach of trust (Hostile litigation)

As outlined in a previous article, trustees have a number of responsibilities and duties, arising out of the trust deed itself, and the Trusts Act 2019.

An important concept of trusteeship is that beneficiaries are entitled to have the trust properly administered, and are able to hold trustees to account for their administration of the trust. Breach of a trustee's duties can, and often does, give rise to claims by beneficiaries against that trustee for breach of trust.

Common allegations include:

• That a trustee has failed to act impartially (or, has preferred one beneficiary over another);
• That a trustee has failed to adhere to the terms of the trust deed;
• That a trustee has failed to act with reasonable care and skill.

Administration of the trust (Non-hostile litigation)

Disputes also arise as to the proper administration of the trust, notwithstanding there may be no allegation of any breach of trust. These disputes typically involve disagreements over:

• The interpretation of the trust deed;
• The exercise of trustee discretion;
• The distribution of trust assets;
• The appointment and removal of trustees;
• Requests for information by beneficiaries.

Managing trust disputes - Key considerations

When considering any dispute involving a trust, either making or responding to a claim, there are some key matters to consider. Specialist legal advice will assist with these considerations, which are summarised below.

Causation

Trustees are not insurers of trust losses, and will only be liable to the extent that their breach of trust has caused loss. In other words, in order for a trustee to be liable, a claimant would need to show a causative link between the alleged breach of trust, and the loss suffered.

Remedies

Where a breach of trust which has caused loss has been established, there are a number of remedies available, including:

• Restoration of the trust property;
• Payment of compensation where restoration might be unavailable;
• Disgorgement of any wrongfully gained profits or benefits.

The appropriate remedy will depend on the nature of any breach, and the loss suffered.

Costs of litigation

Litigation is costly, and trustees should carefully consider the financial implications before pursuing or defending legal action.

Trust deeds often provide an indemnity in respect of trustee's legal costs, however trustees are generally not entitled to an indemnity for legal costs if:

• The litigation is hostile;
• The costs are unreasonable or improperly incurred;
• The trustee engaged in misconduct;
• The trustee acted in self-interest.

Where no protection is provided by a trust deed, trustees may preemptively apply to the Court for approval – such applications are known as Beddoe applications (Re Beddoe [1893] 1 Ch 547).

A Beddoe application involves a trustee making an application for directions from the Court in respect of any apprehended litigation, and seeking the Court's direction as to whether or not it is appropriate to proceed. If approved by the Court, a trustee would be entitled to be indemnified by the trust fund in respect of their legal costs.

Likewise, beneficiaries may also apply to have their costs of litigation covered – these applications are known as prospective costs orders (PCO). Beneficiaries may seek PCOs that:

• Their own legal costs be paid out of the trust fund on an indemnity basis; and/or
• They be immune from any adverse costs awards in respect of the apprehended litigation.

Pre-emptive orders for cost protection (such as Beddoe applications, or applications for PCOs) are typically unavailable in respect of hostile litigation.

Absent any pre-emptive order regarding the costs of litigation, liability for litigation costs follows standard cost principles and depends on the outcome of the dispute.

Limitation

Beneficiaries must bring claims within statutory limitation periods. Failure to act within these timeframes can bar claims, regardless of merit.

Key limitation periods to be aware of:

• Limitation Act 2010:
  • Claims must generally be filed within six years of the act or omission giving rise to the claim.
  • If the claimant gains late knowledge of the claim, they have three years from the date of discovery to file a claim.

The precise limitation period depends on the nature of the claim and the beneficiary’s interest.

Conclusion

Trust litigation is complex, and effective management of trust disputes requires specialist knowledge and expertise. Whether you are a trustee, beneficiary, or third party, it is important to proactively engage specialist legal counsel to ensure any dispute is handled effectively. If you're facing trust-related disputes, reach out to our team of specialists.

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