When to cry sham

  • Author : Nigel Mifsud
  • Date : May 2010
ABOUT THE AUTHOR: Nigel Mifsud TEP is Head of Structuring at Kestrel S.A.

Much has been written on the subject of ‘sham trusts’, particularly as the case law developed from Snook1 through cases like Rahman2, Esteem3 and Minwalla4, and practitioners have had the benefit of extensive commentary on the sham doctrine and how it applies to trusts.

This article does not therefore presume to try to cover this topic in any depth, but only to consider some practical matters of relevance to trustees.

The established position

It is clear from the case law that in order for the document which purports to evidence the terms of the trust, to be held to be a sham, both the settlor and the trustee must have subjectively intended, at the time that the trust was created, that it would be a sham. After In Re Esteem, reckless indifference on the part of the trustee will be taken to constitute the necessary intention.

Courts are aware that a finding of sham can have serious adverse implications for the trustee as this (at least) implies dishonesty and would (as was noted in Minwalla) in all likelihood lead to action by the relevant regulator.

A court will apply ‘a strong and natural presumption against holding …a document a sham’5 and will look at whether a trustee made its own decisions, whether in respect of distributions or investments. The question is always whether the trustee applied its own mind to the (settlor’s) recommendation, and it is irrelevant that time has proved that the decision was correct.

What approach would a Swiss Court take?

Switzerland’s importance as a trust jurisdiction continues to grow, and it is interesting to speculate on the approach that a Swiss Court could take when faced with such a claim.

The Swiss case of In Re WKR Trust6, which predates ratification of the Hague Convention7 by Switzerland, provides a helpful insight into what may well be the attitude of a Swiss court when faced with a sham allegation.

To be held to be a sham, both the settlor and the trustee must have subjectively intended, at the time that the trust was created, that it would be a sham

In that matter, having first established that Guernsey law was the applicable law under which to determine the validity of the trust, the court, applying the reasoning in Rahman to the facts (e.g. that the settlor had repeatedly interfered in the administration of the trust property and had, without the trustees’ prior approval, exercised voting rights over shares owned by the trust) held that the trust was a sham.

Post ratification of the Hague Convention and the incidental amendments to the Swiss Private International Law Act, it would be expected that the court’s first hurdle; ascertaining the nature of the trust, would be straightforward. What is harder to know with any certainty is how comfortable a Swiss judge may be when called upon to apply foreign law to the facts in cases where the position is not as clear-cut as it was in In Re WKR Trust, Rahman or Minwalla.

Can a trust become a sham after its creation?

Notwithstanding its best intentions at the beginning of the relationship, it may be that, due to factors such as, for example, commercial pressure, the trustee’s attitude changes over time and it begins to bend to the will of the settlor.

In such a case the trustee could automatically approve requests for distributions, or could apply trust assets towards risky or speculative investments at the settlor’s request, all to the detriment of the [other] beneficiaries.

In such cases, the trustee would, in effect, be attempting to change the character of the trust assets in a way that would be contrary to its powers under the trust, or which would otherwise be contrary to its fiduciary duties. It would therefore be acting in breach of trust, but this would not, in and of itself, render the trust as a sham.

In the recent English High Court case of A v A,8 Mumby J expressed the view that the only way in which a properly constituted trust, which is not a sham at inception, could conceivably subsequently become a sham would be if all the beneficiaries were, with the requisite intention, to join together for that purpose with the trustees in a Saunders v Vautier 9 type manner. In cases where the class of beneficiaries includes children or remoter issue not all the beneficiaries will be sui juris. Some will not even be ascertained. Such a possibility could, consequently, not arise.

What if an overly ‘pliant’, or even dishonest trustee were to be appointed?

It may be, that having found his trustee to be ‘difficult’, the settlor finds a replacement trustee who will be much more ‘commercial.’

For a sham to arise, it would not be enough for the new trustee to agree to take over and then administer the trust according to the settlor’s directions. The new trustee would need to dispute that the assets transferred to it are trust property or deny the existence of any fiduciary duties on his part. This would be unlikely if the new trustee had been a party to a deed of appointment/removal of trustee.

In the absence of such declarations by the new trustee, the new trustee’s actions would, again, merely, be guilty of breaches of trust.

Can poor administration and management amount to a sham?

This question was considered by the Court of Appeal of New Zealand in Re Reynolds; Official Assignee v Wilson and another.10 The case revolved around an onshore New Zealand trust and the court considered the facts in light of the main ‘sham trust’ cases.

In In Re Reynolds, the trustees appeared to have been directed by the settlor and the administration of the trust has been described as ‘a shambles.’11 The trustees kept no resolutions or minutes, no annual accounts, no records relating to the use of trust property by non-beneficiaries and there was intermingling of the financial arrangements of the trust and the settlor.

The court’s view was that although the acts and omissions of the trustees were of evidential value, at their highest, they amounted to breaches of trust and were insufficient, on their own, to amount to a sham.

Is it effectively impossible to prove a sham?

In light of the above, the question arises that, bearing in mind the following:

  • the high threshold required to prove that a trust is a sham,
  • the courts’ approach when considering the facts and applying the doctrine,
  • the ever increasing regulation across the traditional offshore trust jurisdictions,
  • recent cases which have helped to ‘concentrate the mind’,
  • the drive by jurisdictions and service providers to improve their reputations, and
  • improved education and trust administration processes and procedures by professional trustees.
Is it no longer possible to prove a sham?

One would expect that a scenario such as that seen in In Re Reynolds would to be unlikely to arise in today’s highly regulated offshore centres, where professional trustees are subject to regular visits by their regulators, and where in addition to cases such as Re Esteem and Minwalla, well publicised cases such as Caversham12 and Dimsey & Allen13 have provided professional trustees and corporate services providers with clear examples of the dangers of operating businesses to less than the highest standards.

Even if such unacceptable practices were to take place, we have seen that these wholesale failures by trustees would not, of themselves, give rise to a sham, but merely to potential breaches of trust. They would however, almost certainly lead to sanctions by the relevant regulator.

Care should be taken to ensure that all necessary formalities as to the execution of documents are followed and that the documentation faithfully records the true intention of the parties
Some practical points to consider

As part of their procedures to ensure that the arms-length nature of the trust relationship is properly evidenced, trustees may wish to consider the potential benefits of applying the following practical guidelines:

  • Care should be taken to ensure that all necessary formalities as to the execution of documents are followed and that the documentation faithfully records the true intention of the parties.
  • Ideally the settlor should take independent legal advice on the terms of the intended trust, but in cases where the settlor does not have an independent legal advisor, all communications between the trustee’s agent (relationship manager or wealth planner) who first takes up contact with the proposed settlor should be properly noted. In addition, all advice given as to the nature of the trust relationship: its irrevocability, what an independent exercise of discretion by the trustee means, should be acknowledged by the settlor and recorded.
  • The documentation should be in a language that is understandable by the settlor and any terms that contain ‘legalese’ should be explained to the settlor, who should acknowledge that he or she has understood them. Trustees should also consider the benefits of providing the settlor with informal translations of the documentation in his or her native language, where applicable.
  • Once the trust has been created, it is imperative for the trustee to ensure that it fully and accurately records its independent decision-making process and reasons for the exercise by it of its discretions.
  • If the settlor recommends an investment to the trustee, it should ensure it has all the necessary information to be able to take its own independent and informed decision on whether or not to invest.
  • Where a letter of wishes is provided, this should be carefully drafted (in the settlor’s native language whenever possible). It should not contradict the trust deed and should clearly state the nature of the trust and that the settlor is conscious that the trustee has absolute discretion. Consideration should also be given to including such language in any deeds of gift executed by the settlor, to avoid any dispute as to the nature of the gift. Such deeds should not, whenever possible, be unilateral.
  • Finally, in the event that the settlor has reserved certain powers, as permitted by, for example, Article 9A of the Trusts (Jersey) Law 1984; extreme care, and proper advice, should be taken to ensure that the nature or extent of the powers reserved do not render the trust a sham.
The need to apply best practice

It is true that given the development of fiduciary services over time, it becomes more unlikely for the criteria to be present to enable a claimant to successfully prove a sham, particularly in well-regulated, well-established jurisdictions. Practitioners need to be aware however that not all jurisdictions that are active in the trust business have the benefit of an embedded trust heritage.

It is imperative that those civil law jurisdictions which are actively promoting a trust industry, particularly those where professional trustee services are presently unregulated, take steps to ensure that such trustees, are encouraged, at least by industry bodies, to apply best practice if they are to protect their own reputations and the reputations of other service providers.

Snook v London and West Riding Investments Limited [1967] 2 QB 786.
Rahman v Chase Bank (CI) Trust Co Ltd [1991] JLR 103.
Re the Esteem Settlement [2004] 3 WTLR 423.
Minwalla v Minwalla [2004] EWHC 2823 (Fam).
per Neuberger J in National Westminster Bank plc v Jones [2000] BPIR 1092 at para [59].
OD-Bank (in liquidation) v Estate of Rey (a bankrupt), 4 ITELR 487.
The Hague Convention on the Recognition of Trusts and the Law Applicable Thereto.
A v A [2007] 2 FLR 467.
(1841) 4 Beav 115.
[2007] NZCA122, 10 ITELR 1064.
Paul Stibbard, Baker & McKenzie Private Banking Newsletter, October 2008 at page 16.
Bell, Caversham Fiduciary Services Limited and Caversham Trustees Limited v. Attorney General [2006] JLR 61.
Regina v Dimsey [2001] UKHL 46, Regina v Allen [2001] UKHL 45.

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