The little-known rule with huge implications for self-managed super funds

 

Imagine a self-managed super fund (SMSF) trustee that signs a pension agreement with a member stating that ...

... the trustee will start paying a pension to the member now and that later, when the member dies, the pension will automatically continue to be paid (that is, revert) to the member’s spouse. The trustee makes resolutions confirming this. Most would think that this agreement is binding.

 

 

Accordingly, most would think that when the member dies, the trustee is compelled to pay the pension to their spouse. However, there is more to the story.

The rule against “fettering”

There is a general law rule against trustees of trusts – which includes SMSF trustees – fettering their discretion. The specifics of this rule were conveniently summarised by Chesterman J in Dagenmont Pty Ltd v Lugton [2007] QSC 272:

“According to the Law of Trusts by Underhill and Hayton 16th edition (page 690): ‘… it is trite law that trustees cannot fetter the future exercise of powers vested in trustees ex officio…Any fetter is of no effect. Trustees need to be properly informed of all relevant matters at the time they come to exercise their relevant power’.”

Meagher and Gummow, in Jacobs’ Law of Trusts in Australia, 6th edition, paragraph 1616 say: “Trustees must exercise powers according to circumstances as they exist at the time. They must not anticipate the arrival of the proper period by…undertaking beforehand as to the mode in which the power will be exercised in futuro.”

Professor Finn (as his Honour then was) in his work Fiduciary Obligations wrote (at paragraph 51): “Equity’s rule is that a fiduciary cannot effectively bind himself as to the manner in which he will exercise a discretion in the future. He cannot by some antecedent resolution, or by contract with…or a beneficiary – impose a ‘fetter’ on his discretions.”

Finkelstein J summarised the position succinctly in Fitzwood Pty Ltd v Unique Goal Pty Ltd (in liq) [2001] FCA 1628 (para 121). His Honour said: “Speaking generally, a trustee is not entitled to fetter the exercise of discretionary power (for example, a power of sale) in advance. If the trustee makes a resolution to that effect, it will be unenforceable, and if the trustee enters into an agreement to that effect, the agreement will not be enforced.”

In short, if a trustee has a discretionary power and the trustee decides now how it will exercise that power in the future, such a decision will be unenforceable. This is extremely relevant for pensions.

How this applies to pensions

The vast majority of SMSF deeds provide that if upon death there is no binding death benefit nomination, then the trustee has a discretion regarding to whom (for example, to a spouse) and how (for example, as a pension) any death benefit is paid. Accordingly, if the trustee has previously a) resolved and/or b) agreed how this discretionary power will be exercised in the future (for example, that the pension will be reverted to a spouse), this constitutes a fetter and will not be enforceable

When is this a problem?

In a practical sense, if upon death the trustee wants to pay a pension to the person named in the fetter, it is unlikely to cause any practical problems. However, in that circumstance it was unlikely that a reversionary pension was needed in the first place. (That is, if there’s a trustworthy person running the SMSF, there’s no great need to restrict their actions – unless there is some particular social security law or tax reason resulting in an automatically reversionary pension being desirable.)

However, consider the situation if the trustee of the SMSF does not want to pay the death benefit to the spouse. It could be that the spouse is the member’s second spouse and the member has children from a previous relationship.

Subject to how the member’s Will is drafted, how the SMSF’s deed is drafted and how related documents are drafted, it is possible that the children from the previous relationship will end up as trustees of the SMSF after the member’s death. Assume that the children from the previous relationship no longer get on with their (now former) step-parent.

Accordingly, the children might point to the rule against fettering and say that any pension documents are invalid and that it would be wrong of them to blindly follow the reversion in the pension documents. Accordingly, they might choose to remake the decision as to whom to pay death benefits to. Somewhat unsurprisingly in these circumstances, children tend to pay the benefits to themselves. Although there are some grounds on which the children’s action could be challenged by the spouse, the spouse would be facing an uphill battle.

Can a fetter ever be valid?

It is possible for a fetter to be valid. After all, a binding death benefit nomination is really just a type of fetter. However, in order for a fetter to be valid, the deed must allow for it. As Harman LJ stated in Muir v Inland Revenue Commissioners [1966] 1 WLR 1269, 1283: “If a power is conferred on trustees virtute officii; that is to say, if it be a trust power which the trustees have the duty to exercise, they cannot release (eg, enter into a fetter) it in the absence of words in the trust deed authorising them so to do [emphasis in the original].”

Unfortunately, few deeds are written with clear enough provisions that would oust the prohibition on fettering.

Practical implications

There are several practical implications advisers must note.

First, pension documentation alone is unlikely to implement an enforceable reversionary pension.

Second, if someone does want to implement an enforceable reversionary pension, regard must be had to the wording of the SMSF deed, any binding death benefit nomination and other related documentation.

Finally – and most importantly – it is critical to determine who will be running the SMSF upon death. If someone trustworthy will be running it, a lot of these issues become somewhat moot (unless there are very specific tax or social security law reasons as to why an automatically reversionary pension is needed).

However, if someone who wishes to frustrate the wishes of the deceased is running the SMSF, regardless of whether there is binding documentation in place, the rightfully entitled recipients might face a very difficult legal battle in obtaining what is theirs.


October 22, 2014
Bryce Figot
Source:  Professional Planner    www.professionalplanner.com.au

 

 

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