On its face, a trustee of a discretionary trust appears to have the absolute discretion to determine when and if the trust will make a payment to a beneficiary and how much they will receive. Discretionary trusts are commonly used in estate planning, and for many trustees and beneficiaries, the question becomes, what does ‘absolute discretion’ mean?
Many people have discretionary family trusts. The reason they’re called ‘discretionary’ is because the trustees have very wide powers to decide who will receive benefits from the trust. This power also allows them to treat beneficiaries unequally. In most cases, the beneficiaries of a discretionary trust are family members, spouses, children, grandchildren, friends, and they can include the creator of the trust. The trustee has the power to decide who receives the investment income from the trust as well as when and how much property or money from the principal (in trust law called the “capital”) of the trust will be distributed to those beneficiaries in the future. A discretionary trust ultimately grants the trustee the absolute discretion to govern the administration of the trust and courts are reluctant to interfere with a trustee’s decisions unless the trustee has acted in bad faith.
Unfortunately, there is not a clear-cut definition of bad faith in this area of the law. The discussions of bad faith in the leading case of Fox v Fox Estate provide that bad faith is intended to be interpreted broadly. Trustees have the duty to act in good faith and be fair as between beneficiaries in the exercise of their powers to uphold the trust’s purpose, known in trust law as the “settlor’s (or creator’s) intention”. In this case, the Court clarified that conduct that does not necessarily amount to fraud can also still be considered bad faith, which would bring it within the scope of the Court’s supervision. Generally, a trustee will be acting in bad faith when their decisions do not uphold the purpose that the trust was created for initially or if their decision is contrary to public policy or what we might call “for the good of the public”. In the absence of bad faith, the trustee’s discretion will remain absolute, even if not all beneficiaries are treated equally, or what the beneficiaries might perceive as fair. Some examples of where a trustee’s discretionary decision could be challenged include: where a trustee refuses to pay a beneficiary because of their sexual orientation, or because he/she married someone outside of the family’s religious faith or racial background, or if the trustee refuses to pay a beneficiary because of a personal disagreement unrelated to the request for payment, or where the trustee appears to be ignoring reasonable requests for payments and refusing to give any explanation justifying their refusal.
Suppose it gets to the point where a trustee’s decision is challenged by a disgruntled beneficiary who has asked the court to a review the trustee’s discretion. In that case, the trustee’s decision-making process will be scrutinized to determine if they are exercising their powers correctly and for the purpose for which the trust was initially set up. The courts will look to see if the trustee has the power to make the impugned decision, whether they acted in good faith, whether their decision was one that another reasonable trustee in similar circumstances could also have arrived at, and whether there is an actual or potential conflict of interest.
If after conducting this analysis, the court believes that the trustee’s exercise of discretion was made in bad faith, the trustee’s decision can be set aside, and they can be removed as a trustee of the trust by a court order. If funds were improperly removed from the trust through the trustee’s improper use of their discretion, the court might further order the funds to be repaid to the trust. In most cases, any funds improperly removed from the trust can be traced. However, if they cannot be traced, the court may order the repayment of the funds from the trustee personally.
Adam Cappelli is a founding partner of Cambridge LLP, with offices in Toronto, Burlington, Ottawa, and Elliot Lake. Prior to co-establishing his own practice in 2010, Adam was a partner for nine years at the largest full-service law firm in Southwestern Ontario (“Golden Horseshoe”) area. Each year since 2006, Adam has been voted by his peers as one of "The Best Lawyers in Canada" in the area of Estates and Trusts Law.