What is a sham trust?
The essence of a sham trust is pretence. The relevant parties do not intend to create a valid trust. Rather, they intend to create the impression of a valid trust, by purportedly transferring legal title of an asset to trustees to manage for beneficiaries. Yet, in reality, the relevant parties retain ownership and control of the asset. In other words, the parties say one thing, but intend another.
The issue may be faced by creditors or ex-spouses in matrimonial proceedings. For example, a trust may be set up to create the impression that one party has transferred ownership of an asset to hide assets from creditors or a divorcing spouse, but that party may, in reality, retain ownership and control.
It is presumed that the trust deed is intended to have the legal effect based on its terms. The burden of proof is on those seeking to allege a sham trust. Their investigation would ultimately aim to decipher the parties’ actual intentions.
In practical terms, an investigation would address the trust deed itself. For example, whether it grants extremely wide powers to the person setting up the trust (the “settlor”). The settlor must give up all control over the trust assets once they have been transferred to the trust.
What will happen if a trust is held to be a sham?
If a trust is held to be a sham, it will typically be void (i.e. treated as if the trust never existed) with the asset reverting to the person who set up the trust. It is possible to minimise the risk of a sham trust and some practical examples follow below:
- A settlor or trustee understanding the nature of the relationship and the importance of trustees acting independently – there can be no conflict of interests;
- A trustee ensuring that they have evidence of the settlor's intention to fully and totally divest themselves of the asset to be placed on trust, and that decisions are properly considered and recorded;
- A trustee not promising to give effect automatically to every request from the settlor.
As the above examples demonstrate, prevention is better than the cure. It is important to establish good trust governance terms and practices at the outset to avoid sham trust concerns down the line.
Andrew Morgan is a senior associate in the trust and estate disputes team. His work spans claims pursuant to the Inheritance (Provision for Family and Dependants) Act 1975, domicile disputes, will challenges, will construction and rectification claims, property trust disputes and trust, estate and administration issues.