Trusts are no longer simple vehicles whereby the Trustee holds trust property for a beneficiary in order that the family wealth may be preserved for future generations. A 'trustee industry' has been developed and with it a variety of sophisticated tools which can allow the settlor to shelter his assets from taxes and many other necessary evils.

We have moved on from the days when a settlor would simply elect his friend to be trustee, with the trustee in most cases providing his services gratuitously. As there is usually no personal link between the settlor and the trustee, the settlor can no longer be confident that the trustee will simply act in complete accordance with his wishes and so will try to retain as much control as possible over the trustees. At the same time, trustees are under huge commercial pressures to live up to the settlor's expectations and wishes, otherwise they face losing his business elsewhere. For this reason alone it is easy to see how the settlor/trustee relationship can commonly reflect that of Gepetto and Pinocchio.

In this changing climate, with an increasingly litigious society and a rising divorce rate, trustee conduct is increasing being brought into question from all angles. Beneficiaries with competing interests are only too ready to make a claim against the trustees or trust assets, divorce courts shrink only from putting "undue pressure" on trustees and beneficiaries, creditors and spouses of the settlor are increasingly seeking to attack the trust by claiming it is a "sham".

Only a few years ago it was estimated that between 50-80% of all trusts were sham trusts. Such estimation was no doubt made following consideration of what were at the time considered to be the successful sham cases of Rahman v Chase Bank, Midland Bank v Wyatt and R v Allen. However, the requirements that are now considered necessary to be satisfied before a trust can be deemed a sham have changed significantly and so it is likely that this estimation would now be considered to be an exaggerated one. Nevertheless, sham claims are progressively becoming the central issue of trust cases and a peripheral issue in matrimonial cases. Whilst the Isle of Man Courts have not yet had to specifically adjudicate on a sham trust claim this is seen as being just round the corner.

So, what is a sham trust now considered to be? The classic definition of sham is found in the oft cited dicta of Diplock LJ: "if it has any meaning in law, it means acts done or documents executed by the parties to the "sham" which are intended by them to give to third parties or to the Court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create."

This principle was considered in the 'Esteem' case of the Jersey Royal Court, which has subsequently been followed in the UK High Court decision of Shalson v Russo and the Jersey case of MacKinnon v The Regent Trust. It is now felt that the Rahman case (above) is of limited assistance in relation to allegations of sham, given that the requirements for a sham were not considered in any detail.

The judgment in the Esteem case helpfully sets out what any party alleging sham must prove and undoubtedly the threshold for those making allegations of sham has been raised. An intention only on behalf of the settlor to deceive third parties, a trustee who is found to have exercised its discretion but virtually always done as the settlor/beneficiary asks, or a settlor who has reserved a number of powers in the trust deed for himself in the hope of controlling the trustee, will not be enough to satisfy the current sham threshold. For a sham trust claim to succeed there must be a common intention of both the settlor and the trustees that the trust assets should be held otherwise than as set out in the trust deed which they both executed and that both the settlor and the trustee had a common intention to mislead third parties by giving a false impression of the position. A trustee will have the necessary intention if he goes along with the settlor "neither knowing or caring what he is signing (i.e. who is reckless)". The time for ascertaining such intention is at the time of the creation of the trust, or, if assets are subsequently added, at the time the assets are added. Conduct of the trustees subsequent to the creation of the trust is however admissible in evidence, from which inferences can be drawn as to intention.

Whilst it would appear from the recent cases involving sham allegations that offshore courts are reluctant to allow the fact that the settlor acts as though he still owns the trust assets to lead to a finding of sham (because there is essentially still a valid trust) there may still be a claim against the trustee for breach of trust. Furthermore, in each of these recent cases, there have been flaws in the way that sham has been pleaded and the facts and evidence have fallen short of showing any intention on the part of the trustees to mislead. As such, it is likely that these cases will not deter those who believe a sham exists from seeking the Court's recourse. It is certainly the case that sham allegations increasingly continue to be pleaded in a number of trust cases dealt with by the author.

As stated above, even if the sham allegation does not succeed, it may still be open to a beneficiary to sue the trustee for breach of trust if it is shown that it has breached its fiduciary duty and failed to exercise a discretion (allowing instead the settlor/ beneficiary to dictate to them). Indeed "puppet trustees" should still beware. Increasingly, matrimonial courts faced with offshore trusts are adopting a robust attitude to trusts. Whilst they often do not go so far as to say that the trust is a sham, they avoid having to determine this issue by looking at "the reality of the situation, and what is, or is likely to be in all probability, the totality of the resources."

If it is the case that it can be seen from the history of the trust that the trustee effectively deals with the trust assets in accordance with the settlor/beneficiaries requests, the matrimonial courts are prepared to look through the trust and make an order against a beneficiary which presumes that the trustee will make sufficient assets available to enable them to satisfy the order. Such orders fall short of declaring that a trust is a sham because they do not dispute that there is a valid trust in existence. However, they not only place the trustees in a very difficult position, leaving them with little or no option other than to pay out, but completely negate one of the main benefits and reasons for putting assets into a trust.

In the Isle of Man it remains the case that there has been no decided case ruling whether or not an order of an English Court, which is attempting to vary the terms of a Manx trust or declaring a Manx trust to be a sham, would be recognised and enforceable. However a cautious approach should be taken and when facing any kind of involvement in matrimonial proceedings or sham claims in another jurisdiction, offshore trustees should always, prior to making any submissions, seek the guidance of the court on how they should proceed by making a Beddoe application.

To reduce the chances of attack on the validity of a trust on any grounds and to avoid potential pressure being put upon trustees by the matrimonial courts, trustees should understand the importance of acting independently. If asked to exercise a power, trustees should ensure that they regularly hold meetings and give full consideration to their discretion and properly minute this to ensure that proper records are kept which can show their independence. It may also be advisable to be prepared to refuse a beneficiary's request. Separate trust bank accounts should be kept and the beneficiary/settlor should not be allowed access to such accounts and any money being appointed from the trust assets should only be done so following the exercise of a trustee's discretion. Most importantly, both the settlor and the trustees should have a clear intention to create a valid trust and the settlor should always have the benefit of separate legal advice. If the settlor wishes to maintain a degree of control over the trust then this should be provided for by inclusion within the trust deed.

High standards are expected of trustees and, win or lose, any attempted attack on a trust is likely to be bad news for the trustee. If there is any potential that a claim for sham trust may be brought, trustees are well advised to ensure the trust assets are within their control in order that the trust assets will be available to satisfy any claim rather than the trustees being made to compensate (other than in cases where breach of trust is alleged). Provided trustees act in accordance with the terms of the trust and keep adequate records which show that they have properly exercised their discretion, any argument that the trust is a sham will be very difficult to prove.

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.