Guarding SMSF wealth – part one

Recent legal events in New South Wales have challenged the ability to ring fence SMSF assets in the event of a member’s death. Grant Abbott assesses these significant developments.

GRANT ABBOTT is director of I Love SMSF.

It takes a long time, good management, great ideas, insights, careful budgeting, great advisers and skills to build family wealth. For many with good advisers, wealth is housed in trusts for asset protection, as well as the taxation advantages of streaming taxable income across a family or into a bucket company. SMSFs have also done very well with more than $700 billion in assets growing from only $11 billion 25 years ago. The advantages of an SMSF are, like a trust, asset protection and a slew of taxation benefits.

Yet family wealth is so vulnerable and open to attack by viruses, lawyers, agencies, regulators and government. Look no further than the Supreme Court of Western Australia case Miller v Taylor [2018] WASC 75. Here the second spouse of the deceased, Andre Taylor, contested his will under the Family Provision Act (WA) 1972, which had provided a split of $600,000 for the two children from his first marriage. The case was commenced in 2013 and heard before Justice Jeremy Curthoys in the WA Supreme Court in 2018.

Surprised to see six lawyers present at the lawyer tables, Justice Curthoys tore into them, courtesy of the $500,000 in legal fees that had been racked up decimating the estate proceeds for the benefit of the second spouse, Angela Taylor, and the two children. In the end it should come as no surprise the only winners were the lawyers. A lawyer made a will for the deceased 10 years prior to his death and then other lawyers attacked it under the Family Provision Act, “ravaging the estate”, according to Curthoys.

The estate in this case was a simple family home, but it could easily have been a binding death benefit nomination (BDBN) paid by the trustee of an SMSF to the legal estate of a deceased member, or the commutation of a reversionary pension where a BDBN overrides the reversionary pension and inserts the lump sum into the estate. Anything close to a deceased’s legal estate can be challenged under family provisions claims in all states by ‘eligible persons’. Lawyers who operate on a no-win, no-fee basis love these clients, particularly with super and SMSFs playing a big part now, and a huge part into the future.

SMSFs are not immune

In the next 20 years, more than $300 billion will be distributed by deceased SMSF members, mostly to the surviving spouse and then to their estate. Now Miller’s case is not a one-off – we have all seen, been involved with or heard of estate cases breaking apart families and costing the legal earth. And it is no surprise, as any family provisions challenge starts in the relevant state Supreme Court, that it is a very expensive proposition.

And SMSFs are right in the thick of things. Look at Katz v Grossman [2005] NSWSC 934, a fight for SMSF death benefits between a brother and sister, or Donovan v Donovan [2009] QSC 26, where the de facto spouses’ SMSF death benefit payment was challenged by the daughter from the deceased’s first marriage. And more recently you may have seen the Victorian Court of Appeal case Wareham v Marsella [2020] VSCA 92, where the trial judge booted out a surviving SMSF trustee, and her daughter, who sought to pay all the deceased member’s death benefits to herself and not the estate, seemingly in conflict with the NSW case of Katz v Grossman. Different states and different decisions. SMSFs are not immune, in fact they are the perfect hosts for estate planning litigation and I can guarantee litigation will increase and at some point there will be a constitutional challenge of state versus federal laws. And I say bring it on, but, until then, we need to navigate the waters and protect our clients and their family wealth. One thing we can learn from Marsella is the court castigated the trustee and their lawyers for not seeking specialist advice, which is a bonus.

Note the Court of Appeal upheld the decision to remove the trustees of the SMSF in order to determine which dependants, including the deceased’s husband of 32 years (her executor), who should share in the deceased’s death benefits. But I ask the question: If the trustees were removed, who should take their place and ensure the fund remained an SMSF pursuant to section 17A of the Superannuation Industry (Supervision) (SIS) Act 1993? The only person entitled, as there was no member of the fund because the deceased was the sole member, is the executor husband. In an acrimonious case such as this, isn’t that pouring fuel onto the fire and extending legal proceedings?

A direct attack on SMSFs

The Marsella case was a game-changing decision and will give the lawyers a huge leg up, because it can be interpreted any discretionary decision by an SMSF trustee can now be challenged if they act arbitrarily. This includes the payment of death benefits, but would extend to making an investment strategy without considering each member’s retirement objectives as required under the tax commissioner’s February 2020 guidelines. And a challenge is not cheap. If you look at the Marsella case, it went through the Supreme Court then to the Victorian Court of Appeal, which means in excess of $100,000 in legal fees. All for a $490,000 superannuation death benefit.

SMSF advisers and trustees should potentially expect this sort of challenge as a matter of course if there is no BDBN, SMSF will or auto-reversionary pension with no BDBN override. Be very careful with BDBNs because if they fail due to no or improper witnessing of the member’s directive, then the Marsella case decision is let out of the cage.

SMSFs and family provisions claims Each state has its own family provisions laws, enabling eligible people to make a claim against a deceased’s estate, which includes any superannuation benefits paid into the estate. Looking at NSW, for instance, Part 3.2 of the Succession (NSW) Act 2006 (SA 2006) provides for a family provisions claim.

In short, a family provisions claim under the SA 2006 can be made within 12 months of the death of the deceased if the person making the claim:

• is an ‘eligible person’, and

• has been left out of a will, or

• did not receive what they believed they were entitled to receive.

Section 57 of the SA 2006 provides an ‘eligible person’ includes the following claimants:

• the wife or husband of the deceased,

• a person who was living in a de facto relationship with the deceased (including same-sex couples),

• a child of the deceased (including an adopted child),

• a former wife or husband of the deceased,

• a person who was, at any particular time, wholly (entirely) or partly dependent on the deceased, and who is a grandchild of the deceased or was at that particular time a member of the same household as the deceased, and

• a person with whom the deceased was living in a close personal relationship at the time of the deceased person’s death.

Make no mistake, this is a very wide net and one the lawyers love. In Kelly v Deluchi [2012] NSWSC 841, the lawyers scoured far and wide for claimants. To show you how far, the deceased, Roy Edward Kelly, married Filipino Loretto Pasion in January 1982. There were no children from their union, although Pasion had two daughters who lived in the same household with the deceased. About a year aft er they moved in, Pasion and her children left , and were not seen again. The marriage was annulled in February 1984, as Loretto had remained married to her husband in the Philippines. But the lawyers did look and search for her and came up empty handed, resulting in the trial judge dismissing her ability to claim.

But the Kelly case isn’t famous for eligible persons, but for being the first ever case where a direct attack was mounted on SMSFs with a family provisions claim. This arose from the Supreme Court taking the view an SMSF was a ‘notional estate’ of the deceased, so Part 3.3 of the SA 2006 applies.

So what is a notional estate and how could NSW laws intervene in commonwealth laws?

Notional estates and SMSFs

Under the SA 2006, a notional estate is for the sole purpose of bringing money and property outside of the estate into the estate for a family provision claim. The first step pursuant to section 75 of the act is for the Supreme Court to find a ‘relevant property transaction’. A relevant property transaction is where property is divested prior to the deceased’s death for the purpose of beating a family provision claim. But, and this is a big but, it can include money held on trust which is dealt with at the time of death and for which no adequate compensation has been paid.

I can guarantee litigation will increase and at some point there will be a constitutional challenge of state versus federal laws.

In the Kelly case, Justice Hallen looked at whether the payment of a death benefit from an SMSF to the deceased’s spouse was a relevant property transaction. To that regard, Hallen stated: “I am satisfied that the basis of a relevant property transaction for the purposes of section 75 has been established and that it is taken to have been entered into immediately before, and to take effect on, the occurrence of the resolution of the trustee, in February 2010, that is to say, aft er the deceased’s death .... In all the circumstances of this case, I propose to make an order designating part of the property held by the trustee as notional estate.”

So making the decision to pay a death benefit created a notional estate. The end result was that the children of the deceased, who were not members of the fund, had the bequests their father left them in the will doubled and more than $150,000 in costs awarded against the trustee of the SMSF. All of this went to reduce the death benefit to be paid to Mary Kelly, the wife of the deceased member of the SMSF.

At this time it is only NSW that has the concept of a notional estate, but this, combined with the Marsella case decision operating potentially across other states, means a brave new world for SMSFs. They were once protected, but are now open to litigation and destruction.

Some words of wisdom

So here are some conclusions I have made. The first is if there is a family estate, the greater the estate, the more likely the challenge. The second is SMSFs are no longer protected and won’t be until the High Court decides where trustee law and notional estates invade the SIS Act 1993. The third is if there is a challenge to an estate under family provisions or trust law, the legal fees are expected to be at least 20 per cent of the estate and more if you come across some bad actors as in Miller v Taylor. So we are left with a predicament. If an estate, SMSF and discretionary trust are all open for challenge by the Family Court, Family Provisions Act, regulators, creditors and people seeking to rile up a legal challenge to get fees, what can the client do? Also, would you want to be the adviser that can deliver a real solution to protect the client’s family wealth?