A slippery concept
Fraud on a power can be one of the most difficult equitable concepts for trustees to understand.
The principle of fraud on a power aims to ensure that powers relating to property are used for the purpose for which they are conferred. It does that by requiring that such powers not be exercised for an improper purpose. It may apply where deceit exists, but that is not a requirement. The most basic difficulties in applying the concept are:
- identifying, in an appropriate way, the consequences of the exercise of a power (from immediate to ultimate); and
- determining which of these consequences were intended by the power holder when the power was exercised.
The concept will be otiose where an excessive appointment has occurred. The test is whether the power has been used to benefit a non-object, and the user intended that outcome. The issue most commonly arises in trust distributions.
An appointment coupled with a contemporaneous settlement by the object on a non-object will not of itself involve fraud on a power. This is because the donee must intend this to occur when the appointment is made. That will normally require the existence of some formal or informal arrangement between the donee of the power and the object receiving the property to enable its use to benefit a non-object. It can be difficult to determine where the evidential burden rests in such situations.
Not all consequences are necessarily intentional, for instance where:
- a power holder decides to exercise a power in favour of an object; then
- the object tells the power holder that it will use the relevant assets to benefit a non-object; then
- the power holder exercises its power by making a distribution to the object.
The position is different where the power holder makes that decision because it has been told by the object that the relevant assets will be used to benefit a non-object. Proof is therefore required that the proposal to benefit the non-object caused the power holder’s decision in favour of the object. If separate transactions are related simply because the appointment had to be made before the benefit could flow to a non-object, that does not, of itself, justify an inference that the appointment was made because the settlement would occur.
In Kain v Hutton  3 NZLR 589 (SC), C was an object and joint donee of a power of appointment. The power was exercised in favour of C on an understanding between the joint power holders that C would settle the distributed property on a new trust, of which C, her spouse and her children would be potential beneficiaries. The New Zealand Supreme Court felt that no fraud on a power had occurred because the trustees’ ‘dominant purpose’ was to benefit C, not her spouse or children.
That outcome can be contrasted with the result of Wong v Burt  1 NZLR 91 (CA), where the life tenant under a will considered that two of her grandchildren had not been properly provided for under it. The trustees of the estate exercised discretion to distribute NZD250,000 to the life tenant, who lent that money to the trustees of a trust for her grandchildren. The court decided that the trustees’ intention was to indirectly achieve something that the will gave them no power to do. They had therefore committed a fraud on a power and the distribution was invalid.
The Court of Appeal held that the trustees would be personally liable to restore the NZD250,000 to the trust fund, plus interest at 7 per cent, if they could not recover it from the trust settled by C. Costs were also awarded against the trustees.
Committing a fraud on a power leads to considerable difficulties for trustees:
- They will be personally liable to reimburse the trust fund for its loss (including interest).
- They may not be indemnified by the trust fund (depending on the terms of any express indemnity).
- They will have to take all steps required to recover the proceeds of the fraud on a power from the donee or payee.
- whatever the terms of any indemnity conferred by the trust deed, the Court may order them to pay costs on the successful claim made against them.
This reinforces the truism that before exercising any power a trustee should be satisfied that it clearly encompasses the actions they are contemplating.
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