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This article is part of a mini series that explores the relationship between sham trusts and illusory trusts.
Whilst both will give rise to a finding that a trust is invalid, sham trusts and illusory trusts are two very different beasts, as noted by the New Zealand Supreme Court:
‘a sham is a pretence: the terms of the document do not represent what the party or parties really intended. A finding of sham … would involve the Court assessing the subjective intention of [the settlor] and concluding that the [trust] deed did not conform with his real intention.
… we do not find the term “illusory” trust helpful. What the [lower courts] meant by that term was that no trust was created. In such a case, the document as executed does represent the terms to which the party or parties intended to agree but, despite their subjective intention to create a trust, they failed in their attempt to do so.’[1]
Put another way:
‘A sham trust is one where as a matter of construction the terms of the document would establish a valid trust, but the intention of the relevant parties is that they will not be bound by those terms, but hold the property for or at the direction of the settlor.
An illusory trust is one where the intention of the parties is that they will be bound by the terms of the document, but as a matter of construction those terms do not establish a valid trust.’[2]
Sham trusts
Per Diplock LJ in Snook v London and West Riding Investments Ltd,[3] the term “sham” connotes ‘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.’ As will be clear from this definition, subjective intention is important. The parties to the sham must intend to create a false impression of their legal rights and obligations, described as “the shamming intent”.[4]
Many of the cases involving sham trusts have been family law cases where one party to a divorce (often the husband) uses a fictitious trust structure in an attempt to put assets out of the reach of the other party to the divorce. For example, in Minwalla v Minwalla[5] the husband purported to create an offshore trust to keep assets out of the reach of his wife in their divorce proceedings. The trust had a Jersey company as its trustee. That company was controlled by the husband. The court found that neither the husband nor the company controlled by him intended to act on the trust deed, such that it was a sham. The alleged trust property was therefore a marital asset for the purposes of the divorce proceedings.[6]
It is possible for the sham to be limited to some of the trust assets only, for example, where the original trustees, dealing with the trust assets validly and in accordance with the trust deed, receive additional assets which they agree to hold for the settlor’s benefit or otherwise than provided for in the trust deed.[7] It has also been suggested that it may be possible for the sham to be limited to some of the provisions of the trust deed, whilst other provisions are valid.[8] This suggestion is based on caselaw in relation to lease agreements, where it has been held that a particular provision can be a sham even if the lease as a whole is valid.[9] It is worth noting that the provision that was held to be a sham without invalidating the whole lease (a provision entitling the landlord to introduce new occupiers, which was intended to give the impression that the tenants did not have any statutory protection) could easily be excised from the lease without affecting the remainder of the agreement. In relation to a trust, whilst there might be some provisions that could conceivably be shams without invalidating the entire trust, the provisions that are most likely to be subject to shamming intent (for example, in relation to the treatment of trust assets) are also the least easily excised, such that a finding of sham in relation to those provisions may have the effect of rendering the whole trust a sham.
The shamming intent
Where professional trustees are involved, it is likely to be incredibly difficult to establish that the trust is in fact a sham.[10] This is because it will be necessary to show that all of the parties to the trust (i.e. including the professional trustee) were aware of and intended to perpetuate the fiction.[11] ‘Thus, if the trustees are parties to the declaration of trust, then they normally must, for it to be held a sham, be implicated in the intention that the trusts are not to be given effect. … If the original trustees do not share the settlor’s shamming intent then the settlor will have placed assets under the control of trustees who will administer them in accordance with the trust instrument, and the settlor’s private intention that the instrument should be a sham will have no effect.’[12]
Reckless indifference will be enough, on the part of the trustee, to establish the requisite intent that the assets are to be held on terms other than those set out in the trust deed, but there is some uncertainty as to whether more than this may be required for the second part of the shamming intent: the intention to mislead. The Royal Court of Jersey in Administrators of the Estate of Hanson v O’Leary found no sham trust in circumstances where two of the three trustees lacked a positive intention to mislead, despite being found to be recklessly indifferent as to the terms of the trust deed or their compliance with it.[13]
This analysis somewhat denudes the finding (made in earlier cases, including the Pugachev case[14] and others[15]) that reckless indifference is sufficient for the first limb of the shamming intent of its force and effect, as it is difficult to conceive of circumstances where a trustee will be merely recklessly indifferent as to the terms of the trust deed yet positively intend to mislead third parties so as to satisfy the test for a sham.[16]
Of course, a finding of intent to mislead necessarily imports a finding of dishonesty, which might explain the Jersey Court’s reluctance to be satisfied with anything less than a positive intention, but it is hard to see how reckless indifference in this context is qualitatively different from recklessness as to the truth of a statement, for example, in the context of a finding of fraudulent misrepresentation.
An innocent third party who relies on the validity of a sham trust to his detriment will be protected from any attempts by the settlor to set aside the trust based on his own shamming intent because the settlor will be estopped from seeking to recover the apparent trust assets for himself.[17]
Illusory trusts
An illusory trust is not really a trust at all. Whilst the parties may all intend to create a trust (thus distinguishing the illusion from the sham), and may be acting honestly and even in accordance with legal advice, the terms of the trust documents they execute, properly analysed, fail to achieve their goal. In contrast to sham trusts, whose existence will depend on analysis of the subjective intentions of the parties, a finding that a trust is illusory turns on an analysis of the trust documents, irrespective of the parties’ intentions.
Broadly speaking, there are two different routes to finding an illusory trust: the “irreducible core” route; and the “failure to divest” route. These two approaches are effectively two sides of the same coin. For this reason, in Webb v Webb (explored further in Part 2) the parties agreed that it would make no difference to the outcome which of these two analytical routes was taken: ‘the powers reserved to [the settlor] under the trust deeds may be analysed in two different ways. One is to consider whether those powers were so extensive that [the settlor] can be said never to have disposed of any of the property purportedly settled on or acquired by the trusts. In this connection one might also ask whether the trusts lacked the irreducible core of obligations[18] owed by the trustees to the beneficiaries and enforceable by them which is fundamental to the concept of a trust.’ [19]
The amount of control retained by a settlor will generally provide a good measure of whether a trust is illusory.
In Mordo v Nitting,[20] the Supreme Court of British Columbia considered a trust containing the following clause:
‘Until Eida Mordo’s death, Eida Mordo shall be entitled to receive all of the Net Income and the Trust Property and the Trustees shall pay, transfer or apply such amount or amounts thereof to or for the benefit of Eida Mordo at such time or times and in such manner as Eida Mordo shall request or, if Eida Mordo should become incompetent, as the Trustees in their discretion shall determine to be required for Eida Mordo’s maintenance, care and comfort. Any Net Income not paid to or for the benefit of Eida Mordo in any fiscal period shall be accumulated. No person except Eida Mordo may, before Eida Mordo’s death, receive or otherwise obtain the use any of the Net Income or the Trust Property.’
The Court found that ‘the beneficiary must exercise his or her power by actually calling for the property before any right to the property is created. [The settlor’s] power to appoint Trust Property to herself did not give her any rights in the Trust Property nor the unrestricted power to dispose of it. The power to appoint merely gave her the ability to create for herself an equitable right in some or all of the Trust Property by calling for its return from the Trustees. For that reason, in my view, [the settlor] did not have absolute control of, or full equitable title to, the Trust Property.’[21] The trust was therefore a valid inter vivos trust.
Considered in the context of other reported decisions on this issue, the case of Mordo is a clear outlier. It may represent the position in British Columbia,[22] but it does not accord with the jurisprudence in England and Bermuda. In Re AQ Revocable Trusts,[23] for example, the Bermuda Supreme Court found that the settlor’s conduct, and the amount of control he retained over the trust assets, made it clear that he had no real intention of abiding by the terms of the trust. A significant factor pointing towards the finding of an illusory trust in this case was a provision in the trust deed enabling the settlor to approve any transaction and for the trustee to be relieved of their liability if that happened. As the judge found, this effectively gave the settlor sole dominion over the trust assets during his lifetime.[24] The illusory trust provisions were therefore found to be ineffective and void.[25]
The authors of Lewin on Trusts propose a very narrow view of what is required in order to establish that a trust is illusory and therefore invalid: ‘We do not consider that the reservation to the settlor even of very considerable rights and powers would mean that on a true construction of the purported trust instrument the settlor remained the absolute equitable owner of the trust property or, at any rate in some circumstances, retained powers that were tantamount to beneficial ownership of the trust property. An example of a trust where the settlor remained the absolute beneficial owner would be if the terms of the trust declared that the trust property was held in trust as to capital and income for the settlor absolutely and indefeasibly and then purported to set out trusts in favour of other beneficiaries, because those trusts would be repugnant to the absolute interest retained by the settlor.’[26]
Establishing that a trust is a sham or illusory
As set out above, the burden rests with the party asserting that the trust is not as it seems to prove it.[27] The standard of proof is the usual civil standard (i.e. the balance of probabilities). In relation to an alleged sham, ‘the court is not restricted to the four corners of the document and may examine external evidence, such as oral testimony and evidence of the subsequent conduct of the parties.’[28] This is because the question is one of the parties’ subjective intentions. In this regard, the court must be wary of self-serving evidence adduced by the people whose intention is in question without corroborating evidence.[29] On the other hand, the court ought not to be too quick to find the existence of a sham. Indeed, there is a strong presumption that parties intend to be bound by the provisions of the documents they enter into.[30] It can therefore be difficult to establish the requisite “shamming intent”: ‘one should not lose sight of the fact that there is obviously a strong presumption, even in the case of an artificial transaction, that the parties to what appear to be perfectly proper agreements on their face, intend them to be effective, and that they intend to honour and enjoy their respective obligations and rights. That that is so is supported by the fact that an allegation of sham carries with it a degree of dishonesty, and the court should be slow (but not naively or unrealistically slow) to find dishonesty.’[31]
In contrast with a sham trust, where there must necessarily be an examination of the parties’ intentions, which may pose evidential difficulties, an illusory trust depends simply on the construction of the terms of the trust itself. The settlor’s subjective intention is immaterial. Evidentially, therefore, cases of illusory trusts are easier, although, of course, establishing that a trust is illusory is akin to establishing that there is, in fact, no trust at all.
Further articles in this series
This article is part of a mini series that explores the relationship between sham trusts and illusory trusts. Other articles in the series include:
- Part 2: The unholy trinity of recent cases: Clayton, Pugachev and Webb;
- Part 3: The effect of reserved powers legislation;
- Part 4: The idea of emerging validity; and
- Part 5: The nomenclature for the future.
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[1] Clayton v Clayton [2016] NZSC 29 at [128]-[129]
[2] Young, G., (2018) Sham and illusory trusts – lessons from Clayton v Clayton, Trusts & Trustees. 24 (2), 194-204 at 199
[3] Snook v London and West Riding Investments Ltd [1967] 2 Q.B. 786, at 802D
[4] See: Lynton, T., Le Poidevin, N., and Brightwell, J., (2020) Lewin on Trusts, (20th ed.), London Sweet & Maxwell at § 5-021
[5] Minwalla v Minwalla [2004] EWHC 2823 (Fam)
[6] One commentator has suggested that this family law context has contributed to the unprincipled development of the law in this area as the courts seem more inclined to try to do justice between the parties in matrimonial proceedings, where one party may otherwise be left with substantial assets and the other with virtually nothing. He blames this context for many of the cases in which it has been found that a settlor has retained too much control for the existence of a valid trust, suggesting: ‘the court’s natural inclination to ensure that justice is done sometimes seems to overcome their regard for legal principles’. It is worth noting, however, that this commentator practises in British Columbia, where the Supreme Court in Mordo v Nitting, 2006 BCSC 1761 found a valid trust notwithstanding extensive settlor control over the trust assets – see: Nitikman, J., (2021) More about illusory trusts: is “tantamount” to ownership the same as “ownership”? The Privy Council take a step too far, Trusts & Trustees. 27 (1-2), 69-81, at 77.
[7] Lynton, T., Le Poidevin, N., and Brightwell, J., Op. Cit. (n. 4) at § 5-025
[8] Ibid. at § 5-028
[9] A. G. Securities v Vaughan [1990] 1 AC 417
[10] Per Lady Arden, Family Trusts Today, Trusts and Wealth Management Conference, Singapore, Asian Wealth and the Global Context 2019 (1 August 2019) at [29]. (Accessed online at: https://www.supremecourt.uk/docs/speech-190801.pdf) Pugachev (explored further below) is, of course, an exception to this rule, given the Court’s finding of the shamming intent on the part of Mr Patterson, the solicitor who prepared the trust deeds.
[11] Lynton, T., Le Poidevin, N., and Brightwell, J., Op. Cit. (n. 4) at § 5-023. See also: Haley, M., and McMurty, L., (2023) Equity & Trusts: Textbook Series, (7th ed.), London Sweet & Maxwell at § 2-011
[12] Lynton, T., Le Poidevin, N., and Brightwell, J., Op. Cit. (n. 4) at § 5-023
[13] Administrators of the Estate of Hanson v O’Leary and others [2021] JRC 319. It is worth noting, however, that the court found that the trust in this case was invalid on other grounds (it was a purportedly charitable trust and not all of its purposes were recognized as charitable according to the law of Jersey, such that it contravened s.11(2)(a)(iv) of the Trusts (Jersey) Law 1984). It is unclear whether the court’s analysis of the shamming intent may have differed had the outcome of that analysis made more of a difference to the ultimate outcome in the case. As it was, the shamming intent of the settlor and the principal trustee came home to roost anyway as the court declined to exercise its power to rescue the trust under s.11(3) of the Trusts (Jersey) Law 1984, notwithstanding that the other two trustees’ lack of positive intention to mislead prevented the court from finding that the trust was a sham.
[14] JSC Mezhdunarodniy Promyshlenniy Bank v Pugachev [2017] EWHC 2426 (Ch) at [150]
[15] A v A [2007] EWHC 99 (Fam) at [52]
[16] Arnull, T., Sham trusts and the requirement that a shamming intent be shared: Administrators of the Estate of Hanson v O’Leary and Ors (2022), Trusts & Trustees. 28 (5), 405-412, at 408
[17] Carman v Yates [2004] EWHC 3448 (Ch) at [219(f)(ii)]
[18] See: Armitage v Nurse [1998] Ch 241 at 253H: ‘there is an irreducible core of obligations owed by the trustees to the beneficiaries and enforceable by them which is fundamental to the concept of a trust. If the beneficiaries have no rights enforceable against the trustees there are no trusts.’ See also the defining characteristics of a trust as enshrined in Bermuda’s Trusts (Special Provisions) Act 1989 at s.2(2)(c): ‘the trustee has the power and the duty in respect of which he is accountable, to manage, employ or dispose of the assets in accordance with the terms of the trust and the special duties imposed upon him by law.’
[19] Webb v Webb [2020] UKPC 22 at [89]
[20] Mordo v Nitting, 2006 BCSC 1761
[21] Ibid. at [371]
[22] Although the authors express no view in this regard, not being British Columbia practitioners.
[23] Re AQ Revocable Trusts [2010] Bda LR 26
[24] The judge found that the evidence of the settlor’s wife ‘paint[ed] a picture of a man who would not willingly relinquish control of his property’. Ibid. at [22].
[25] It is worth noting that Bermuda’s reserved powers legislation was introduced after this decision. It is therefore not clear whether the Bermuda courts would reach the same decision on the facts of Re AQ today.
[26] Lynton, T., Le Poidevin, N., and Brightwell, J., Op. Cit. (n. 4) at § 5-035
[27] See: Haley, M., and McMurty, L Op. Cit. (n. 11) at § 16-012 and Erlam v Rahman, [2016] EWHC 111 (Ch) at [77] (obiter).
[28] Haley, M., and McMurty, L., Ibid. at § 2-011
[29] Thandi v Sands [2014] EWHC 2378 (Ch) at [75].
[30] Carman v Yates, Op. Cit. (n. 17) at [219(d)]
[31] National Westminster Bank Plc v Jones [2001] 1 BCLC 98 at [46]. See also: Lynton, T., Le Poidevin, N., and Brightwell, J., Op. Cit. (n. 4) at § 5-021.
Bermuda