UK: When Is A Trust Not A Trust?

Last Updated: 30 August 2017
Article by John Darnton

Trusts often crop up in divorce cases involving substantial wealth.

The family court has various ways of dealing with trusts. In some cases the trust will be what is known as a 'nuptial settlement' which is capable of variation by the court on divorce. The court has very wide powers of variation in appropriate cases. It can remove trustees or make provision for an applicant spouse from the trust fund. It is not, however, always possible to show the necessary 'nuptial' element to trigger the court's power to vary. In other instances the court may not be able to make an order directly against the trust but will see the spouse's interest in the trust as being a 'resource' to be taken into account. The court will need to assess the benefit that the beneficiary is likely to derive in the future from the trust. The court can use its powers to try and 'encourage' trustees to come to the aid of a beneficiary going through divorce proceedings.

Exceptionally, a claimant spouse may deploy the 'nuclear' option of seeking to obtain a declaration that the trust arrangement is a 'sham'. The intention behind this is usually to get the court to proceed on the footing that the trust assets remain belonging to the spouse who has claimed to have put them into the trust. Such an application will only succeed in an unusual case where all the necessary ingredients are made out.

The court was recently faced with a preliminary application for a declaration that an offshore trust was a sham in the case of ND v SD and Others. The dispute involved a trust set up by the husband in 2007 for the benefit of the two children of the marriage into which had been placed the vast bulk of the parties' fortune – some £50 million according to the reported judgment. In her judgment, Mrs Justice Roberts carefully reviewed the earlier authorities on what constitutes a sham before deciding that the arrangement in this case was not one.

The classic statement of law now dates back to 1967 and the key passage reads:

'For acts or documents to be a "sham", with whatever legal consequences follows from this, all the parties thereto must have a common intention that the acts or documents are not to create legal rights and obligations which they give the appearance of creating.'

Mrs Justice Roberts cited what she considered to be 'five fundamental principles' in relation to sham acts or documents. She then went on to set out what she considered to be two headline points.

The first headline point was that there must be a dishonest intent before the court will find an instrument to be a sham and, where instruments or agreements are properly and formally drawn, absent dishonest intent, there is a strong presumption that the parties intend to honour their rights and obligations thereunder.

The second headline point is that before transactions or documents will be construed by the court as sham transactions, all the parties to them must share a common intention that the documents themselves will not create the legal rights and obligations which they give the appearance of creating.

Clearly, these are high hurdles to surmount. A wife may argue that her husband told her in happier days that the money placed in the trust remained 'his' to do with as he pleased but, if all the formalities were in place when the trust was set up, and the wife cannot show that her husband had a 'common intention' with the trustees that the arrangement was a sham, the court will not declare it to be one.

Sometimes it is even argued (perhaps somewhat hopefully) that a trust that started out as being perfectly proper has somehow become a sham. The applicant spouse may argue that, in reality, the trustees simply did her husband's bidding. This is an even more difficult argument to substantiate. It was said in a case of A v A in 2007 that:

'Once a trust has been properly constituted, typically by the vesting of the trust property and the trustee(s) and by the execution of the trustee setting out the trust upon which the trust property is to be held by the trustee(s), the property cannot lose its character as trust property save in accordance with the terms of the trust itself, for example, by being paid to or applied for the benefit of a beneficiary in accordance with the terms of the trust deed. Any other application of the trust property is simply and necessarily a breach of trust: nothing less and nothing more.'

In this case the judge explained that counsel for the wife needed to establish that not only did the husband have a dishonest intention in that he regarded the 2007 trust deed as being no more than a 'paper' which created no legal rights or obligations as between himself, the trustees and the purported beneficiaries, he must also establish that the trustee either shared that dishonest intent or was recklessly indifferent to the fact that it was entering into a document which on its face purported to impose on it, qua trustee, onerous fiduciary obligations towards the beneficiaries and the trust property which it had no intention of honouring.

The judge decided that the wife had failed to discharge the burden placed upon her. In her conclusion Mrs Justice Roberts explained that there was a distinction between motive and intent. An artificial transaction which is put in place for the purposes of asset protection will not necessarily be cast aside as a sham and of no legal effect if all the parties to that transaction genuinely intended the agreements incorporated into the document in which they appear to take effect.

Of course this may well not be the end of this litigation. As mentioned earlier, even though the trust may be valid, the trust fund may not be entirely ignored for the purposes of the wife's claims.

13 July 2017

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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John Darnton
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