Sham Trusts in New Zealand


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 [2008] 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 [1967] 2 QB 786 (CA), per Lord Diplock; Paintin and Nottingham Limited v Miller Gale and Winter [1971] 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 [20]).

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.

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About Ivan McIntosh

I am a partner of Carter Atmore Law...residing in City Road just off the busy thoroughfare of Symonds Street, Auckland, New Zealand....where we are specialist business & property development lawyers, working for both local and international clients. Proud husband to Joanna, and dad to two sons. Passionate rugby supporter. Email: imcintosh@calaw.co.nz Ph: 64 9 921 5026
This entry was posted in Banking & Finance, Business Law, Family & Relationships Law, Property Law, Trusts & Estates Law and tagged , , . Bookmark the permalink.

10 Responses to Sham Trusts in New Zealand

  1. David says:

    hi, What does “A settlor continuing to treat the property as if it were his own” really mean?

    Thanks

    • For example, selling trust property such as shares or a house and putting the money into your own bank account (not ever having established one for the trust), then just spending it as you see fit without ever asking the other trustees or signing trust resolutions. That’s pretty common.

      • David says:

        Thank you for your quick reply. Im curious about my current situation. I currently have three rental properties and a forth property which I am living in held in a family trust. All the rents are paid into one trust account. The trust account the rent is being paid into also has a revolving credit facility. The revolving credit facility mortgage amount is for the actual house I am living in. Hence the more money in this trust (revolving account) the lower the mortgage payments are on the house i’m living in is. I will put personal money into this account (i keep a record of this in a spreadsheet) to offset my mortgage even more.

        Is this considered “A settlor continuing to treat the property as if it were his own” really mean”? My accountant advised me to do this. But im only guessing he has said this from a tax perspective.

        Im only really worried about ‘relationship property bill’, ie if we do break up, I would hate to lose half of what the trust owns. I set up this trust way before I met my current partner.
        Thanks again.

      • Doesn’t sound like “treating the property as if it were your own”, unless you’re also using the revolving credit facility for personal rather than trust expenses. It’s a fairly high bar to accuse a trust of being a sham.

  2. jr says:

    my partners lawyer heard that he was in a defacto relationship 3 years ago. we since married and he passed not long after. Since his death, I have found letters from his lawyer, one to formulate a strategy incase I made a claim if we were to end our relationship. That same year, the lawyer suggested setting up a second trust which was established the following year, where the first trust owed monies to the 2nd trust and not to my husband personally. Three the lawyer being the other trustee, has put his name on the propertys. Because the house that I am in belongs to the trust, the lawyer sent me an email to vacate the house, he also had the cars uplifted saying they belonged to the trust too, but one is registered to my late husband and the other to his company that has been struck off last year. It has been cleverly done by my husbands lawyer, but I beleive it to be an act of injustice to me and a sham.

    • Sorry not to have seen your post earlier. You need legal advice from a quality matrimonial and/or trusts lawyer. It is not at all certain that those trusts will hold up, or some of the other matters such as the cars, but you do need to do something about it.

  3. t c berthold says:

    My brother who had been bankrupt set up a trust without consulting me (sister) to put my mum’s one wee house into it. She signed it under duress and wasn’t given any advice as to have it go to her own acct. Or lawyer. My brother lives and works overseas. But he and his acct are trustees. My brother has had several indolvent coy’s ~ on registersections 141 442, 5&7.
    Mum has been very mistrustful and upset by the above. Her lawyer wrote to ask my bro to resign but he didnt.
    The acct. Has behaved badly and threw a huge tantrum in fro t of mum and her friend and he is owed money by my bro.
    Is this something i could get a court order re dissolution of ddt trust. It isnt categorised. Just called DTT Trust.
    Terrie berthold daughter/sister

    • The answer is, well….possibly. It is certainly potentially capable of being unwound and there are a number of potential avenues, but it would need a fair bit of reading (of the trust deed and associated documents), talking (with your mum) and thought to advise on whether the chances and benefits of sucess outweigh the costs of doing so. There is also the possibility that the trustees can be removed without court action, depending on the trust provisions….and a read of the trust deed would be the best place to start – wouldn’t take long. I worry that the trustees led by your brother may have guaranteed business operations….they could be doing anything. Do feel free to call me on 09 921 5026.

  4. Well said Perry, and I agree that any trust demonstrating that level of prudence is unlikely to run into any trouble.

    There were cases prior to 2008 which would have made people a bit more nervous….an example.

    Hard to have much sympathy for the people described in that case….

  5. Perry says:

    Nice, easy-to-grasp summary, Ivan. I suspect
    there’s a lot of scare-mongering in the media
    and by people with books to sell. A basic Trust,
    with an annual meeting of trustees, over lunch,
    producing a resolution that they’ve considered
    all matters prudent trustees should, with all
    papers and bank statements filed, should give
    99% of valid NZ Trusts all the protection they’re
    ever likely to need.

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