The essence of the legal relationship known as a trust is the separation of legal ownership of assets from beneficial ownership of those assets. The trustee is the legal owner and beneficiaries are beneficial owners. Because of this separation, the law imposes strict obligations on trustees: for instance, the trustee must act in good faith and for the benefit of beneficiaries.

However, for many families, the discretionary trust largely owes its existence to suspicion of — and mistrust of — those associated with the trust creator’s family and/or parties dealing with the trust. Structuring the discretionary trust to deal with these suspicions and mistrust is a major pre-occupation of financial planners, accountants and lawyers that advise on and arrange for the creation of discretionary trusts.

A discretionary trust is a trust, much like a fixed trust. However, unlike a fixed trust, no beneficiary (or potential beneficiary) obtains an income or capital distribution/allocation unless the trustee exercises the discretion they have in favour of a beneficiary. And generally, the size of the distribution is also at the complete discretion of the trustee. This means that even if a beneficiary has been assured of income and capital distributions by the promoter or controller of a trust, or has a legitimate expectation of getting a distribution, that assurance or expectation is worth little should the trustee not make a distribution to them. In legal terms, a potential beneficiary of a discretionary trust only has a right to be considered for distributions.

And while it sounds strange, assets and property held in a discretionary trust are not beneficially owned by anyone. While discretionary trust assets are legally owned by the trustee, the trustee does not beneficially own the assets. The trustee must, however, manage and safeguard the assets for the general body of potential beneficiaries, but no beneficiary can demand an asset or income from the trustee.

Suspicion and mistrust can be manifested in a number of ways and at various levels.

Resentment or suspicion can flourish when the trustee makes “unequal allocations” of income between beneficiaries and/or the allocations made do not meet expectations of all beneficiaries. The same point can be made in regard to capital distributions from the trust fund, although capital distributions are usually deferred towards the end of the life of the trust.

The seeds of mistrust (or the need for protection) are also manifest in the area of the office of “appointer”. Most modern discretionary trusts will have an appointer or even joint appointers. An appointer will have the power to remove a trustee and appoint a new trustee. Appointers are usually the promoter or the controller of the trust. While it is prudent to have an appointer who can deal quickly with a trustee who is breaching their obligations, the appointer can also use their power to remove a trustee should the trustee make “unsatisfactory” allocations of income (or capital) where there is no breach of trust.

Mistrust can also fester in a more recent addition to the actors associated with the modern discretionary trust: the so-called “guardian” or “protector”. The role of this person is to provide an extra check on the otherwise wide powers of the trustee. This person can be given the power to veto certain trustee distribution decisions. This is important because the removal of a trustee by an appointer after the trustee has made an unsatisfactory allocation of income (or capital) will not prevent the allocation from being valid. In other words, the guardian or protector can provide protection against a circumstance that an appointer may not be able to protect against.

Mistrust also stems from the nature of potential beneficiaries’ interests. As noted earlier, beneficiaries of a discretionary trust do not beneficially (or legally) own the trust’s assets before the trustee makes an allocation to them. This means that a creditor of the potential beneficiary cannot get access to the assets in the discretionary trust to help satisfy a debt owed to them by the beneficiary. This also means the trustee in bankruptcy of a beneficiary usually cannot access assets in a discretionary trust.

Another concern is relationship breakdown. The assets held in a discretionary trust will not automatically be included in the property of the potential beneficiary. However, family law legislation also does not automatically rule out the property held in a discretionary trust from being counted as “property of the marriage” for the purpose of the property division on relationship breakdown. Whether or not the trust’s assets form part of property of the marriage will largely depend on whether the trust is the alter ego of the beneficiary. In spite of these contentious, case-by-case rules, there appears to be a perception that housing assets in a discretionary trust provides a safeguard against “gold-diggers”.

Furthermore, the legal principle that permits creditors of a trust (lenders, suppliers of goods on credit) to access the assets of beneficiaries of the trust in certain circumstances does not apply in a discretionary trust situation. This means that those providing credit to a discretionary trust are very likely to want guarantees for repayment of their debt.

Another area of mistrust is the “spendthrift children”. In short, if instead of “housing” or “parking” assets in a discretionary trust, the assets were distributed immediately to children, there is always the risk that some of the children may spend the funds on “wasteful things”.

Furthermore, by housing assets in a discretionary trust, there is a much greater safeguard (virtually guaranteed) that the children will not realise the assets to switch to another investment or another asset class. Apparently, this is one of the attractions of the discretionary trust to farming families as it provides greater assurance that the farm will not be transferred outside the family.

Even from this brief outline, it is clear that distrust is not a stranger to a discretionary trust.