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This article is part of a mini series that explores the relationship between sham trusts and illusory trusts.
As set out in Parts 1 and 2, a settlor who retains too much power and control in relation to a trust and its assets is at risk of creating an illusory trust, either because there is a failure of the irreducible core obligations necessary for a valid trust or because there is a failure to make an effective disposition of trust property. A finding that a trust is illusory does not require the settlor to have acted with any improper intent, and it is possible that a settlor will inadvertently create an illusory trust (or, more accurately, fail to create a trust) notwithstanding that he had every intention of creating a valid trust. For this reason, any settlor creating a trust will want to know, with as much certainty as possible, that the trust he is creating is valid. He will want to strike the right balance between retaining the control he wishes to retain, and divesting himself of sufficient control that the law recognises the validity of the trust he establishes.
Some jurisdictions have legislation setting out the interests and powers that can be retained by a settlor without invalidating the trust (so-called “reserved powers legislation”). Bermuda, for example, has the Trusts (Special Provisions) Act 1989, which provides at section 2(3): ‘The reservation by the settlor of certain rights and powers, and the fact that the trustee may himself have rights as a beneficiary, are not necessarily inconsistent with the existence of a trust.’ As noted by the Supreme Court of Bermuda in Re AQ Revocable Trusts, the use of the words “not necessarily” ‘implicitly contemplates that in certain circumstances the reservation of rights to the settlor and the trustee having rights as a beneficiary may indeed be inconsistent with the existence of a trust.’[1]
In 2014 (after the decision in Re AQ Revocable Trusts), s.2A was introduced, specifically setting out powers that may be reserved without invalidating the trust, including: the power to revoke the trust; the power to vary or amend the trust instrument; powers in relation to the distribution of trust assets; the power to give “binding directions” in relation to trust property; the power to add, remove, appoint or replace the trustee, protector and any other office holder; the power to add, remove or exclude beneficiaries; the power to change the governing law of the trust; and the power to restrict the exercise of any trustee powers by requiring that they be exercised with the settlor’s consent.[2] The reservation of these powers will not invalidate the trust or prevent it from taking effect in accordance to its terms.[3] For trusts created after the commencement of the Trusts (Special Provisions) Amendment Act 2014 (which introduced these provisions), any such powers reserved by the settlor will be personal in nature provided the settlor is not the sole trustee (in which case they will be fiduciary in nature) unless the trust instrument provides otherwise.[4]
Many other offshore jurisdictions have similar provisions, for example: s.14 of the Trusts Act (2021 Revision) in the Cayman Islands; s.15 of the Trusts (Guernsey) Law 2007; art. 9A of the Trusts (Jersey) Law 1984; s.86 of the Trustee Act 1961 in the British Virgin Islands; and s. 3 of the Trustee Act 1998 in the Bahamas.
The question has been asked whether statutory provisions such as these would have made a difference in the Pugachev case, had the trusts there been subject to the law of one of these offshore jurisdictions rather than the law of New Zealand. One commentator has suggested that, whilst they would undoubtedly have been factors to weigh in the balance, it is unlikely they would have changed Birss J’s conclusion.[5] We disagree. Bermuda, as with other offshore jurisdictions that have enacted reserved powers legislation, takes a much more lenient approach to the reservation of powers (and control) by settlors before it will consider a trust invalid.[6] Of course, Mr Pugachev did not just reserve some powers to himself; he reserved a whole host of them. Section 2A of Bermuda’s Trusts (Special Provisions) Act 1989 expressly provides for the reservation of ‘any or all of the powers listed’, however. The case in Pugachev may therefore have been decided differently had it come before a Bermuda court applying Bermuda law.[7]
It is worth noting that, even if these statutory powers are capable of saving an otherwise illusory trust in its home jurisdiction, disputes may arise in other jurisdictions were trust assets can be found, and those jurisdictions may take a different view of things. ‘There the question will be framed against a matrix of local legislation and the question will usually be whether the legal implications of what has been effected by the trust documentation are that the assets in question either have remained part of the settlor’s estate or are the subject of powers held by the settlor which are themselves amenable to the jurisdiction of the Court. As a matter of private international law, unaided by reference to the Hague Convention on Trust Recognition, a legal arrangement defined in one jurisdiction to be a trust will not necessarily have that character in another.’[8]
Article 2 of the Hague Convention on Trust Recognition provides as follows:
‘For the purposes of this Convention, the term “trust” refers to the legal relationships created – inter vivos or on death – by a person, the settlor, when assets have been placed under the control of a trustee for the benefit of a beneficiary or for a specified purpose.
A trust has the following characteristics –
- the assets constitute a separate fund and are not a part of the trustee’s own estate;
- title to the assets stands in the name of the trustee or in the name of another person on behalf of the trustee;
- the trustee had 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.
The reservation by the settlor of certain rights and powers, and the fact that the trustee may himself have rights as a beneficiary, are not necessarily inconsistent with the existence of a trust.’
Whilst the reservation of certain rights and powers by the settlor will not ‘necessarily’ be inconsistent with the existence of a trust, the scope of the powers that may be reserved without invalidating the trust under the Hague Convention is not clear. Moreover, the existence of a trust depends on the settlor placing assets ‘under the control of a trustee’; if the settlor still retains too much control, there can be no trust. It is unlikely that reserved powers legislation would trump the Hague Convention, such that, at least in relation to the many trusts that have an international component in terms of the location of the trust assets, reliance on reserved powers legislation may be dangerous.[9] Settlors would therefore be well-advised to keep their powers to a minimum: ‘The greater the degree of control and interest, the greater the risk that the trust may be found to be illusory. Precisely where the line is drawn depends on each case.’[10]
It may also be possible for a settlor to draft his way out of trouble, thereby avoiding a finding that his trust is illusory. If, for example, the trust deed makes clear that beneficiaries have enforceable interests in respect of the trust property (i.e. the irreducible core obligations), that may be sufficient to prevent a finding that the trust is illusory, notwithstanding a certain amount of control being retained by the settlor: ‘instead of negating or confining trustees’ duties, it should be made explicit that the trustee must act honestly and in good faith and is bound to give due consideration to the interests of beneficiaries before exercising a discretion, but may, if a beneficiary, also consider the trustee’s own interests. … it would then be clear that [the] person named as the trustee exercises the powers as a fiduciary and is a true trustee.’[11] Certainly, a finding that the settlor’s powers qua protector were fiduciary rather than personal would likely have made a difference to the outcome in Pugachev. Whether careful drafting would have been sufficient, or whether the Court would have found such drafting to be a sham, we cannot be sure, although it seems unlikely that drafting such as this would have been enough to save the trusts created by Mr Pugachev.
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 1: An introduction to sham and illusory trusts;
- Part 2: The unholy trinity of recent cases: Clayton, Pugachev and Webb;
- Part 4: The idea of emerging validity; and
- Part 5: The nomenclature for the future.
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[1] Re AQ Revocable Trusts [2010] Bda LR 26 at [17]
[2] Section 2A(2)
[3] Section 2A(1)
[4] Section 2A(7)
[5] Russell, D. & Graham, T., (2018) Illusory Trusts, Trusts & Trustees. 24 (4), 307-318, at 317.
[6] This much is clear from the long list of powers set out in its reserved powers legislation.
[7] It is worth recalling that s.2A of the Trusts (Special Provisions) Act 1989 was introduced after the decision in Re AQ Revocable Trusts so readers should not assume that that case provides guidance on the approach that would now be taken by the Bermuda courts.
[8] Russell, D. & Graham, T., Loc. Cit.. (n. 5).
[9] See: Ibid., at 318: ‘caution must be the watchword and overreliance on reserve powers legislation is fraught with danger in those cases where the drafting of the trust instrument is such as to not effectively alienate the trust property from the settlor or the actual conduct of the parties provides evidence that the original intention of the parties was to guarantee effective control of the trust property to the settlor irrespective of the terms of the documentation.’
[10] Ibid., at 317.
[11] Young, G., (2018) Sham and illusory trusts – lessons from Clayton v Clayton, Trusts & Trustees. 24 (2), 194-204 at 203
Bermuda