“There is no such thing as a sham Trust”

The title of my article today is the title that a student at Victoria University, Steven Li, has given to a Paper that he has submitted for an Honours degree.

There is a mass of writing about sham Trusts. It extends far beyond the capacity of most practising lawyers to read and consider, and it is helpful to have many of these sources drawn together in one place and for an attempt to be made to bring greater coherency into this area of the law.

Steven’s thesis is essentially this:

“… the sham doctrine, as a means of analysing the validity of a trust, may not be the best approach. A better starting point would be a return to the certainty of intention requirement for a valid express trust.” [Page 5]

It has traditionally been accepted that the Courts will not accept that an express Trust exists unless there is sufficient evidence to establish that there was an intention to create a valid Trust. The thesis contends that Courts and litigants should focus on that question, rather than on the secondary topic of whether a “Trust” may be a sham.

The Law Commission has recently given some support to this analysis.

Claims that a Trust is a sham are commonplace. In my experience, some lawyers and non-lawyers invoke the term in a simplistic and naïve way, in the apparent belief that such claims can easily be proven. Their confidence is misplaced. The Court of Appeal’s decision in OA v Wilson [2008] 3 NZLR 45 is a significant impediment to proving that a Trust is a sham.

I have often wondered, when reading cases which concern claims that a Trust is a sham, why litigants have not focussed on the primary proposition that there can be no Trust unless at the time of its creation the settlor had the necessary degree of intention to create a Trust. A focus on the secondary question of whether a Trust is a sham – with the contentious and, to a degree, often uncertain principles that have arisen to accompany that doctrine – deflects the enquiry away from the primary question.

An enquiry that focusses on whether the settlor had a genuine intention to create a Trust does away with some of the baggage that has grown up to accompany the sham doctrine. I have in mind the “unilateral and bilateral” analysis of Trusts (ie whether it is necessary to prove that all the trustees had an intention to treat a “Trust” as a sham), and the restrictions on the type of evidence that the Court will consider when determining whether a Trust is a sham. In Steven’s words:

“Before the word sham infiltrated trust law, when ascertaining [a] settlor’s intention, the settlor’s subjective intention and the post-settlement conduct of the settlor and trustee were always part of the enquiry. Moreover, the ‘excluded evidence’ of the sham intention is the same evidence that courts have traditionally relied upon for drawing the inference that the settlor did not intend to create a trust.” [Page 19]

His conclusion is this:

“The only question that should concern the court when determining whether or not a trust exists is whether the settlor had a genuine intention to dispose of his or her beneficial interest in the trust property.” [Page 30]

I commend readers who have an interest in this topic to read Steven’s Paper. He has allowed me to put it on my website so that readers can have ready access to it. It is on the “Trusts” page alongside the reference to this article.

An article about sham Trusts would be incomplete without making reference to the Court of Appeal’s recent decision in KA No 4 Trustee Ltd & Anor v FMA [2012] NZCA 370. At a preliminary stage in the FMA’s litigation against Mr Hotchin, the Court of Appeal has held that the particulars that the FMA has pleaded of sham “are sufficient given the current stage of the proceeding and the fact that discovery has not yet occurred” [43].

The Court’s decision was delivered by O’Reagan P. He said:

“The essence of the FMA’s sham argument is that … ‘Mr Hotchin maintained full and effective control over’ the assets of a Trust.” [45].

The Court of Appeal appears to have accepted that if Mr Hotchin did maintain “full and effective control” over the Trust’s assets, the Trust would be a sham. This position can be contrasted with the Supreme Court’s decision in Kain v Hutton [2008] 3 NZLR 589 at [23] where it was suggested – if not stated – that “effective control” was a badge of validity, rather than invalidity. To this extent, the Court of Appeal’s decision contains a helpful clarification of the law.