16 Sep 2006

When is a trust a sham?


It is common for wealthy individuals to set up trust structures under which they and/or their families are beneficiaries. In the context of fraud litigation, claimants often find that assets which they want to enforce their judgment against are in fact held by third party trustees. As such, it has become common for claimants to argue that such trusts are 'shams'. The hurdle for showing a trust is a sham is actually a high one, and these claims rarely succeed.

What is a sham trust?

A trust is considered a sham when the terms of the trust do not accurately reflect the common intention of the settlor and the trustee. An essential part of a sham trust is that there is a deceit: the trust is set up to appear to third parties as one type of structure, but in fact operates differently. If there is no intention to deceive, the trust will not be a sham.

This intention must be shared by the settlor and the trustee. Where the settlor is himself the trustee, this should of course not be hard to prove. However, in many cases the trustee of a trust will be an independent third party, for example an offshore trust company. In these cases, in order to prove that a trust is a sham, a claimant would needs to show that the trustee shared the intention to deceive third parties with the settlor. For obvious reasons, where the trustee is a reputable offshore trust company, this hurdle should usually be insurmountable for a claimant.

If the trust is a sham

A sham trust is void and unenforceable. The assets remain the assets of the settlor and available for enforcement by creditors of the settlor.

From the trustee's perspective, one key risk is that indemnities against trust assets which most trust instruments contain can be held to be void, and in any event the trustee will enjoy no priority over the creditor in seeking to recover its expenses.

Practical points

The increase in 'sham trust' allegations in litigation is a reminder of the importance to document the management of trusts properly.  Significant litigation costs can be saved if trustees and settlors accused of setting up a sham trust are able to produce contemporaneous evidence to show that a trust was in fact set up and managed appropriately.  The absence of such documentation does not prove that the trust is a sham: the burden in proving this still lies with the claimant. However, if such documentation exists and can be disclosed, it is likely to save significant litigation costs, as it may allow the sham trust allegations to be struck out at an early stage in proceedings.



Ros Prince

Ros Prince

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