British Virgin Islands: Guiding You Through Sham Trusts

When is a sham not a sham?

At a time when trusts are coming increasingly under attack, it is quite common for the validity of a trust to be questioned on the basis that the instrument creating it is a sham document or fails to fulfil the requirements for the creation of a valid trust.

The validity of a trust may be challenged in many circumstances, for example, during a divorce, if you suspect a creditor is hiding assets or if you are a judgment debtor.

It is important to understand when a trust can be considered to be a sham and consequently be void. This guide sets out the defining characteristics of sham trusts and provides an overview of some of the issues. It does not provide definitive advice on the law. You are recommended to seek legal advice on your specific circumstances.

Sham?

The term 'sham trust' is really a misnomer. In the sham cases it is not the trust that is a sham, but rather the document which purports to evidence the terms of the trust which may be found to have been a sham.

The 'Sham' test

The test for establishing if a transaction is actually a sham was set out in Snook v. London and West Riding Investment Ltd (1967) 2 QB 786, where Lord Diplock identified the elements in a sham transaction as:

"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 rights and obligations (if any) which the parties intend to create...for acts or documents to be a sham, with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. No unexpressed intentions of a 'shammer' affect the rights of a party whom he deceived".

This definition was subsequently held to apply to ascertaining whether a trust was a sham, by the Court in Midland Bank plc v Wyatt [1995] 1 FLR 696.

Intention

It is clear that the key prerequisite for finding that a transaction is a sham is the parties' common intention (ie the settlor and the trustee/s), that the transaction does not create the rights and obligations that it appears to create.

Although Diplock LJ's statement of a sham in Snook requires a common intention of pretence by all parties to the allegedly sham transaction, there was some doubt as to its application in the trust context in Abacus (CI) Ltd and Grupo Torras SA v Sheikh Fahad Mohammed Al- Sabah 2003 6 ITELR 368 (the 'Esteem' case), in which Withers advised the beneficiaries. The Court dealt with various issues relating to intention in turn:

• Acceptance of a trust by the trustees
  The Court observed that the fact that in some circumstances a trust will be validly constituted even where it is not accepted by the trustees, is not a sufficient basis for the conclusion that only the settlor's intention is relevant to the concept of a sham trust.
• An essential element of a trust is the settlor's intention to divest himself of the trust property. If that is not present there is no trust
  The question of the intention of the donor / settlor should be ascertained objectively¹. If a settlor enters into a trust document, then objectively he intends to create a trust. It does not matter if subjectively he did not intend to create a trust, as there is no good reason to concentrate on the settlor's subjective intention when he has deliberately misled other parties to the document.
• An analogy with cases of unilateral mistake
  The Royal Court held that cases on mistake (such as Gibbon v Mitchell [1990] 3 All ER 338) are of no assistance in considering a sham trust because the rationale of allowing relief on the grounds of unilateral mistake is that equity acts on the conscience of the donees of property. It is wrong for volunteers to insist on keeping property once they know that the donor has made a mistake in giving it to them, but the situation is different where the donor has deliberately led the beneficiaries into thinking that he has conferred a benefit on them and has effectively lied to them and the trustees. The Court asked the question 'Why should equity come to the donor's assistance in those circumstances?'

Control

The issue of control of the trust assets is important in considering whether or not there is evidence of a sham transaction. However, if the Court considers that at the outset the trust was not intended to be a sham, then the control that the trustee allows the settlor to exercise over trust assets subsequently could be said to be evidence for a claim of breach of trust rather than direct evidence of a sham trust. In the Esteem Case, the fact that the trust was established in 1981 pursuant to advice from respectable City solicitors, almost a decade before the fraudulent conduct of the settlor, was strong evidence in itself that the settlor did not establish the trust to put assets beyond the reach of those whom he later defrauded. Nonetheless, the Court gave some helpful comments on the general approach to trusts and how one might expect them to be administered.

The Court noted that:

• Great trouble had been taken over the drafting of the trust deed (it had gone through various drafts and was settled by Leading Counsel and Jersey advocates) and so it was unlikely that the Jersey trustee – Abacus – intended to ignore the deed.
• It was unlikely – although not impossible – that Abacus, as a professional trustee, intended to act otherwise than in accordance with the trust deed.
• Abacus had not met with the settlor – Sheikh Fahad – during or after the establishment of the trust – all communications had been through his London solicitors, Stephenson Harwood.
• No one sought assurances from Abacus that they would always comply with Sheikh Fahad's requests nor did Abacus offer any such assurances.
• Abacus' trust files demonstrated that they had independently considered each request made by Sheikh Fahad and his son through his solicitors, Stephenson Harwood,
• There was nothing in the subsequent conduct of Abacus that led the Court to doubt that at the time of execution of the trust deed Abacus intended to act as a proper trustee.

The judgment of the Royal Court in the Esteem case is the most comprehensive review of the law relating to sham trusts and the considerations that the court must apply when considering whether the administration of a trust is such that it should be set aside for the benefit of a creditor of the settlor. This decision has been followed by the English Courts, notably in Shalson v Russo (2003) 8 ITELR 435, Whaley v Whaley [2011] EWCA Civ 617 and Charman v Charman [2007] EWCA Civ 503, in which Withers acted for the husband.

What is not a sham

The following, whilst they may appear on first glance to be shams will not be considered to be so:

• Entering into a transaction with an improper or illegal motive, as long as the trust documents indicate an intention to carry out the trust which has been created for an immoral/ illegal purpose; and
• A failed attempt to create a trust.

Furthermore, there must be an intention to mislead or give a false impression. The question of whether or not that amounts to dishonesty is not relevant to the issue of sham.

Conclusion

The judgment in the Esteem case shows that even in cases where a trust has been administered "not always very cleverly", there will be no sham if the Court can find no evidence of an intention that the particular trust assets should remain in the beneficial ownership of the settlor. Furthermore the approach of the courts in these cases show that the prerequisite of a common "shamming" intention of all parties, as laid down in Snook, is necessary in order for the court to make a finding that a trust is a sham.

Whilst this makes finding that a trust is a sham difficult, as Withers has acted on some of the leading cases involving allegations of sham trusts (Esteem, Charman), we can offer you specialist advice if you know or suspect that a trust which holds assets which you are pursuing is a sham. If the evidence suggests that the trust is legitimate and not a sham, we will be able to offer you advice on alternative methods to achieve your goal.

Footnote

1 Twinsectra v Yardley [2002] 2 All ER 377

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.