This is a topic that worries many New Zealanders under financial stress, and the more they have treated their family trust as an extension of their personal bank account, or have simply not been able to keep up with the record keeping, the more they worry.
The word they should keep in mind is “independence”. Do the trustees look independently at the needs of the trust and consider the interests of the beneficiaries? Or, do they simply do what the settlor tells them to (or serve their own interests first and only if they and the settlor are the same person(s))?
One very important method of demonstrating independence is having a trustee who is not one of the settlors/primary beneficiaries. This is often a professional trustee company set up by their lawyer or accountant, but it can also be a family friend. A sign of independence is the inclusion of the independent in all decision making BEFORE decisions are made….not getting them to rubber-stamp the decisions of you and your partner afterward…and the independent actually putting their foot down when it needs to be put down.
The second contributing method to easing your concerns is record keeping. Does the trust prepare and sign trustee resolutions on a regular basis? Does your trust prepare a simple set of accounts…even if it is no more than a yearly balance sheet? Is the independent trustee always consulted before decisions are made together?
However, for many trusts all of the above is just caution – prudent caution, we suggest (and we expand on this a little later), but mere caution nonetheless. For now, anyway.
In 2008 the NZ Court of Appeal in Official Assignee v Wilson  NZCA 122 set the bar so high (to prove a sham) that very few need worry about it unless they establish the trust as an intentional sham right from the outset. “Alter-ego” trusts…so-called where one or more persons, usually the settlors, control the trust as an extension of themself – their alter-ego…..are not in and of themselves, said the Court of Appeal, a reason for declaring a trust void and depriving the beneficiaries of their rights to trust property.
A sham exists where there is an intention to conceal the true nature of a transaction: Snook v London and West Riding Investments Ltd  2 QB 786 (CA), per Lord Diplock; Paintin and Nottingham Limited v Miller Gale and Winter  NZLR 164 (CA). A trust will be held to be a sham where there is an intention to have an express trust in appearance only. An example is where the settlor seeks the protection offered by the pretence of there being a valid trust. A sham requires an intention to mislead. Equity looks to intent rather than form. The absence of an intention to create a genuine trust prevents the trust from being valid, because one of the essential ingredients for its creation is missing. The trust is void for the lack of intention to create a trust.
In the case, it was alleged that the trust was a sham because the settlor intended right from the outset that the trust property be held for himself and at his direction, rather than for his beneficiaries. In addition:
there was an absence of resolutions or minutes, no annual accounts, intermingling of financial arrangements between the trustees and Mr Reynolds and no record of decisions or other documentation relating to the use of trust properties by the beneficiaries’ parents. The trust records were sent to Mr Reynolds rather than the trustees.
However, none of this was, in itself, capable of having the trust seen to be a sham. The Court found it more likely than not that Reynolds (the settlor) had set up the trust with a genuine intention of creating one, to favour his family in the event of business failure.
Evidence of poor administration of the trust is insufficient, of itself, to establish a sham. This may be evidence of a breach of trust, but the fact that the trustees have acted poorly in managing the trust does not establish an intention that the trust operate as a sham.
The trustees argued that they would not necessarily have gone along with anything the settlor wanted (although they seemed to have done so on every occasion up to then!). However:
Actual control alone does not provide justification for looking through/invalidating a trust. The uptake of control by someone other than an authorised person cannot be sufficient to extinguish the rights of the beneficiaries under a trust. It is difficult to see the alter ego trust operating in New Zealand as an independent cause of action.
So there you have it….a fairly generous threshold for all sorts of ineptitude, as long as you intended to create a genuine trust or, more accurately, your accusers can’t prove otherwise. Don’t get us wrong…we are in no sense advocating or condoning the way the trustees and settlor behaved in the case. You would be well advised to avoid being dragged through the courts by operating your trust in a manner that does not invite challenge. Setting a legal precedent is expensive business – let someone else do it.
A higher level of danger will come where the settlor and the trustees are the same and there are no other trustees…so that the conduct of the trustees can be taken to imply the lack of good faith of the settlor (being the same people) in setting up the trust. That type of arrangement is more vulnerable.
In addition to this, the law can and does change…and perhaps a recent case from the Canadian Federal Court points the way. A timely article in the NZ Lawyer Magazine by barrister Anthony Grant of Radcliffe Chambers provides an update on the legal definition of a sham trust in light of that decision. Justice Wilson of the Canadian Federal Court opined that:
“The required intent or state of mind is not equivalent to mens rea and need not go so far as to give rise to what is known at common law as the tort of deceit” (at ).
This might be a little impenetrable for non-legal readers…basically it means that someone challenging the trust as a sham does not need to go so far as to prove intentional deception by the settlor and trustees. Justice Wilson went on:
“While the claim to ‘some legitimacy’ may show that there was no criminal intent to deceive … and perhaps no tortious deceit, it does not detract from the Tax Court judge’s finding that both the [settlor] and the trustee gave a false impression of the rights and obligations created between them. Nothing more was required in order to hold that the Trust was a sham.
Barrister Anthony Grant has noted that:
Justice Noël relied in part on a passage from Professor Donovan Waters’ Law of Trusts in Canada (Third Edition, Carswell, at 145), where he and one of his two co authors said that a trustee who “is indifferent to whether, in fact, he merely implements the settlor’s decisions will equally enable the assertion to be made that the [Trust] is but a deception and consequently void”.
The moral of the story is that the present threshold for sham trusts in NZ is judge-made law. It isn’t written down in statute. Judges can and do change their minds in later cases, or they can be overturned or overruled by a higher court, in this case the NZ Supreme Court.
Readers operating their trusts would be well advised to take the precautions set out in the early part of this post. At worst, you’ll have better record keeping and a functioning governance system for your trust. What’s not to like?
NB: A couple of queries have indicated that I should make it clear what this post is not about. It is not about people transferring relationship or some other contentious property into what is otherwise a valid trust, and whether or not you can attack that transfer. People write text-books about that sort of thing, not blog posts. Neither is it about getting property taken off the trust because the person gifting was insolvent or something like that. It is simply about people attacking a trust that, because of the behaviour of the trustees and/or settlor, is alleged to be a sham. People write text books about that, too, but my intention is to grossly over-simplify to give the average reader a basis from which they can make further enquiry if they need to. Finally, should it be necessary I advise that nothing in this post constitutes legal advice. This is free. Legal advice you have to pay for.