Facts and Decision

Mr Reynolds (the "Settlor") was the settlor of the GM Reynolds Family Trust (the "Trust") under which he appointed Messrs Wilson and Harvey as trustees (the "Trustees"). A property was acquired (the "First Property"), the title to which was registered in the name of the Trustees and subject to a mortgage guaranteed by the Settlor personally. The Trustees subsequently sold the First Property to the Settlor. The Settlor then entered into a contract on behalf of the Trust to acquire a further property (the "Second Property"), which required substantial further borrowing. The Settlor offered the First Property for sale, but the sale did not occur until after the acquisition of the Second Property and after the Settlor (having defaulted on the mortgage) had been declared bankrupt. The proceeds of the sale of the First Property were applied towards reducing the loans outstanding against the Second Property. The Trust was never administered well and there was intermingling and confusion between the affairs of the Trust and of the Settlor.

The Official Assignee in bankruptcy of the Settlor (standing in the shoes of the Settlor) claimed against the Trustees, as legal owners of the Second Property, that the property should vest for the benefit of the Settlor's creditors in bankruptcy. The claim was based on the grounds that the Trust was a sham, or alternatively, an "alter ego" of the Settlor. The High Court of New Zealand dismissed the claim and the Official Assignee appealed to the Court of Appeal of New Zealand (the "Court of Appeal").

The Court of Appeal considered two principal arguments as to the invalidity of the Trust. First, that the Trust was a sham and, secondly, that the Trust was the "alter ego" of the Settlor. In upholding the Trust and unanimously dismissing the appeal, the Court of Appeal considered that the requirement for common intention was of central significance in assessing whether the trust was a sham. Further, the Court of Appeal concluded that alter ego trusts are not an independent cause of action. In the trust context, alter ego arguments are confined to helping establish a sham, or may give rise to a breach of trust.

The main points arising from the Court of Appeal's judgment are summarised below.

Sham Trusts

A sham trust exists where there is an intention to conceal the true nature of a transaction under the guise of a trust. In order for a valid trust to be created the three certainties must be satisfied: certainty of object, certainty of subject matter and certainty of intention to create a trust. If this latter certainty is missing, the "trust" could be invalid on the grounds that it is a sham.

In his judgment, Robertson J stated that a sham requires an intention to mislead. The Court of Appeal considered whether this intention needs to be a common intention between a settlor and the trustees before a sham can be found. The Court of Appeal considered a number of cases from other jurisdictions, including Jersey (Re Abacus (CI) Ltd (trustee of the Esteem Settlement), Grupo Torras SA v Al Sabah (2003) 6 ITELR 368, Rahman v Chase Bank (CI) Trust Co Ltd [1991] JLR 103), and noted that the majority of such cases are firmly in favour of the requirement that there must be a common intention before a transaction is found to be a sham.

Further, the Court of Appeal considered that in order for a trust to be a sham it must be sham from its inception, so a trust which is valid at its creation would remain valid, even if the appearance of a sham occurs later. The Court of Appeal also noted the importance of distinguishing between a sham and a situation where a settlor fully intends to set up a trust but also intends to later breach that trust, the latter not constituting a sham. The Court of Appeal (citing Tito v Waddell, Tito v A-G (No. 2) [1977] Ch 106, 220-225) considered that the use of the word "trust" does not conclusively indicate an intention to create a trust. In determining whether the requisite intention exists, the court may look at the nature of the transaction, the whole of the circumstances surrounding the relationship of the parties (including evidence of the actions and words of the parties) and the documentation which exists. The Court of Appeal averred that evidence of poor administration of a trust is insufficient, of itself, to establish a sham.

The Court of Appeal noted two further points. First, the result of declaring a trust to be a sham is that the rights of the discretionary beneficiaries of the "trust" are extinguished. Due to this extreme consequence (and in the interests of commercial certainty) a court will only question a trust's validity if there is a good reason to do so, based on some compelling evidence. Secondly, the party asserting the existence of a sham bears the onus of proving this on the balance of probabilities.

Alter Ego Trusts

The term "alter ego trust", is used to describe a situation where the settlor controls the trust to such an extent that the trustees relinquish control and are said to be mere puppets of the settlor. A valid trust could be created, but the trustees' discretion is then subsumed by the settlor to the extent that the "trust" is merely an alter ego of the settlor.

The Court of Appeal noted that, unlike a finding of a sham trust, a finding of an alter ego trust does not involve the court treating the trust as void. The assumption of control of a trust by someone other than the trustees cannot be sufficient to extinguish the rights of the beneficiaries under a trust. Unlike a sham, an alter ego trust is intended to be a genuine trust. There is no requirement of an intention to deceive.


This decision is of interest for two reasons.

First, the Court of Appeal cited a number of well known international precedents (including Re Abacus (CI) Ltd (trustee of the Esteem Settlement), Grupo Torras SA v Al Sabah (2003) 6 ITELR 368, in which Ogier acted) with approval and upheld the existing view of a requirement for a common intention between a settlor and trustees in order for a sham to exist. Secondly, the Court of Appeal discussed the relationship between alter ego trust claims and other types of claims and concluded that alter ego trusts, although potentially providing evidence for a finding of a sham or breach of trust, are not a separate cause of action.

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.