The “2 million Dollar” question: If a Trust is a sham, is it a sham for all purposes?
Recently the interesting concept of sham trust has been decided in a UK High Court Family Law case (see ND v SD & Ors [2017] EWHC 1507 (Fam) Robert’s J. (21 June 2017).
What is the definition of “sham”?
The leading case and well known definition is coming from Diplock LJ in Snook v London and West Riding Investments Ltd [1967] 1 All ER 518 at 528, [1967] 2 QB 786 at 802 in which his Lordship says :
‘… it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means 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 legal rights and obligations (if any) which the parties intend to create. One thing I think, however, is clear, in legal principle, morality and the authorities … that for acts or documents to be a “sham”, with whatever legal consequences follows from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating.”
A Twitter definition
A short definition would be: “A sham exists where all the parties say one thing intending another”.
Risky litigation
Sham Trust cases are very risky litigation and should be avoided at all costs. This was pointed out by Munby J in A v A (No 2) [2008] 1 FLR 1428 in which he described Wife’s case as a “hopeless” case.
In the latest case in ND v SD & Ors [2017] EWHC 1507 (Fam) High Court Judge Roberts made it clear how important this preliminary issue for the Wife in that case was. She found at [2] and [3]:“…
- In terms of a practical outcome for this couple, the stakes are very high. If the husband’s case is made out and the Trust is genuine and left undisturbed by the wife’s alternative application to set it aside by engaging the court’s powers under section 37 of the Matrimonial Causes Act 1973, some £50 million will be removed from the overall computation of this couple’s accumulated family wealth. The wife’s claim to an equal share in what they built up together through their marriage will be confined to a share in the value of the wealth which was not diverted into the Trust. This would reduce her potential entitlement to c. £5 million in round figures. If she succeeds in her attack upon the Trust, the scope of her claims will increase exponentially. A separate issue which I shall need to determine is whether the husband has successfully alienated his wealth into the Trust or whether, as the wife contends, she had a 50% beneficial interest in one of the companies which now falls outside the terms of the Trust.
- The issue may be simple to define but the litigation it has generated has been far from straightforward. Enormous costs (in excess of £2.2 million) have been run up on both sides of the case and we are still only in the foothills of proceedings in terms of a final resolution of the wife’s financial claims. … “ [Emphasis added]
The Court of Appeal and Lady Arden’s 5 fundamental principles
The above passage from Snook was cited with approval by the Court of Appeal the following year in Stone v Hitch [2011] EWCA Civ 63 per Arden LJ and also used in the latest ND v SD & Ors case. In the Stone case, her Ladyship set out five fundamental principles in relation to the law on sham acts or documents.
(1) “65. First, in the case of a document, the court is not restricted to examining the four corners of the document. It may examine external evidence. This will include the parties’ explanations and circumstantial evidence, such as evidence of the subsequent conduct of the parties.”
(2) “66. Second, as the passage from Snook makes clear, the test of intention is subjective. The parties must have intended to create different rights and obligations from those appearing from (say) the relevant document, and in addition they must have intended to give a false impression of those rights and obligations to third parties.”
(3) “67. Third, the fact that the act or document is uncommercial, or even artificial, does not mean that it is a sham. A distinction is to be drawn between the situation where the parties make an agreement which is unfavourable to one of them, or artificial, and a situation where they intend some other arrangement to bind them. In the former situation, they intend the agreement to take effect according to its tenor. In the latter situation, the agreement is not to bind their relationship.”
(4.) “68. Fourth, the fact that parties subsequently depart from an agreement does not necessarily mean that they never intended the agreement to be effective and binding. The proper conclusion to draw may be that they agreed to vary their agreement and that they have become bound by the agreement as varied: see for example Garnac Grain Co Inc v H.M.F. Faure and Fairclough Ltd [1966] 1 QB 650, 683-4 per Diplock LJ….”
(5) “69. Fifth, the intention must be a common intention: see Snook’s case above.”
Farming and receiver in bankruptcy case
In a farming case involving bankruptcy claims, Lord Neuberger (as he then was) in National Westminster Bank plc v Jones and Others [2001] 1 BCLC had to decide over the issues of a grant of an agricultural tenancy of a farm and the sale of its farming assets by the partners in a farming business where the issue was the genuineness or otherwise of those transactions in the face of claims by a receiver in bankruptcy appointed by the bank. At paras 36 to 39 of his judgment, his Lordship said this:
“36. The bank contends that the tenancy and the sale agreement are, on proper analysis, shams. As I have mentioned, it is conceded that the formation and acquisition of the company, the grant of the tenancy, and the sale agreement were artificial, in that they occurred solely because the defendants wished to do their best to protect their farming business, and their home, from being taken from them and sold over their heads by the bank…..”
“37. It is equally clear, to my mind, that the mere fact that a tenancy, or any other contractual transaction, is entered into for such an artificial purpose, namely to avoid the contractual or statutory rights which a third party would otherwise enjoy, does not by any means of itself render the transaction a sham…..”
“39. Accordingly, while the palpable, and freely admitted, artificiality of the agreements in the present case cannot be doubted, it certainly does not follow that, as a result, the agreements must be shams. However, in my judgment, the fact that a particular transaction is palpably artificial is a factor which can properly be taken into account when deciding whether it is a sham. Indeed, it would seem to me to require very unusual circumstances before the court held that a transaction which was not artificial was in fact a sham. I add this. If the court were to conclude that a transaction was artificial, in circumstances where the party relying on it was contending that it was not artificial, then that might be a further reason (although certainly not a conclusive reason) for deciding that the transaction was a sham, given that a sham transaction involves a degree of dishonesty on the part of the parties involved.”
Sham Trust cases in the UK Family Division
How is the recent development in the Family Division? Above authorities were considered more recently by Munby J (as he then was) in A v A [2007] EWHC 99 (Fam), [2007] 2 FLR 467.
In that case, the allegation of sham was levelled by a wife against two discretionary trusts which held shares in a family business which she and the husband had run throughout a twenty-year marriage. The settlors were the husband’s father (who had originally established the business) and his brother. The trustees had changed through the life of the trusts but were based offshore in Jersey at the time of the litigation which concerned the wife’s entitlement to ancillary (financial) relief arising on divorce. The wife alleged that the trusts were shams and that the husband should be treated as holding a significantly enlarged share of the business. In the alternative, she argued that the shares held within the trusts should be treated as available to the husband in accordance with the principle enunciated in Thomas v Thomas [1995] 2FLR 668, CA.
Munby J held that the wife had not even begun to make out a case against the original trustees as having been parties to a sham transaction. Further, the two cases presented by the wife as alternatives in respect of the shares held within the trusts were wholly inconsistent with each other and involved diametrically different assertions. The first proceeded on the basis that the trusts were shams and the second on the basis that the trusts were genuine.
Roberts J in ND v SD & Ors [2017] EWHC 1507 (Fam) [187] to [190] agreed with this observation and referred to the very helpful guidance set out by Munby J in A v A [2007] EWHC 99 (Fam).
A v A guidance
In Munby J’s judgment in A v A traces the authorities and provides the following extremely helpful guidance:
“[49] … Whatever the settlor or anyone else may have intended, and whatever may have happened since it was first created, a trust will not be a sham – in my judgment cannot as a matter of law be a sham – if either:
(i) The original trustee(s), or
(ii) The current trustee(s),
were not, because they lacked the relevant knowledge and intention, party to the sham at the time of their appointment. In the first case, the trust will never have been a sham. In the second case [which is not relevant here – my addition], the trust, even it was previously a sham, will have become a genuine – a valid and enforceable – trust as from the date of appointment of the current trustee(s).
[50] There has been some debate in the authorities as to what is required to establish the requisite common intention. In Midland Bank plc v Wyatt [1995] 1 FLR 696, [1996] BPIR 288, the deputy judge, Mr David Young QC, said at 699 that:
‘a sham transaction will still remain a sham transaction even if one of the parties to it merely went along with the “shammer” not either knowing or caring about what he or she was signing. Such a person would still be a party to the sham and could not rely on any principle of estoppel; such as was the case in Snook.’
Singer J said much the same thing in Minwalla v Minwalla and DM Investments SA, Midfield Management SA and CI Law Trustees Ltd [2004] EWHC 2823 (Fam), [2005] 1 FLR 71 (Minwalla), adopting at paras [54]-[55] the following statement of principle by a commentator:
‘In order for a trust to be found to be a sham, both of the parties to the establishment of the trust (that is to say the settlor and the trustees in the usual case) must intend not to act on the terms of the trust deed. Alternatively in the case where one party intends not to act on the terms of the trust deed, the other party must at least be prepared to go along with the intentions of the shammer neither knowing or caring about what they are signing or the transactions they are carrying out.’
[51] Singer J’s judgment in Minwalla gave rise to further proceedings in the Royal Court of Jersey, where the relevant trusts were located. In CI Law Trustees Limited and Another v Minwalla and Others [2005] JRC 099, the bailiff pointed out at para [15] that Singer J appears not to have been referred to
Shalson v Russo where, as the bailiff correctly observed, the judgment of the deputy bailiff in Re Esteem had been cited and been regarded, as a matter of English law, as correct in principle. The bailiff continued:
‘In Re Esteem Settlement, this Court held that, in order for a trust deed to be a sham, both the settlor and the trustee must subjectively have a common intention that the trust deed is not to create the legal rights and obligations which it gives the appearance of creating: it is not sufficient that the settlor alone has such an intention. Re Esteem Settlement has been followed in MacKinnon v Regent Trust Company Limited 2004 JLR 477, a decision which was upheld by the Jersey Court of Appeal at [2005] JCA 066, [2005] WTLR 1367.’
[52] In Re Esteem the Royal Court had in fact been referred to Midland Bank plc v Wyatt [1995] 1 FLR 696, [1996] BPIR 288. The deputy bailiff in Re Esteem explained matters as follows:
‘[58] … In our judgment, the court in Wyatt was simply confirming that a party who goes along with a sham neither knowing or caring what he is signing (ie, who is reckless) is to be taken as having the necessary intention.
[59] It follows that in our judgment, in order to succeed, the plaintiffs will need to establish that as well as [the settlor], [the trust company] intended that the assets would be held upon terms otherwise than as set out in the trust deed or, alternatively, went along with [the settlor’s] intention to that effect without knowing or caring what it had signed, and that both parties intended to give a false impression of the position to third parties or to the court.’
High Court Judge Roberts in ND v SD & Ors case followed this guidance and, after hearing evidence at the hearing, consequently removed £50 million from the overall computation of this couple’s accumulated family wealth.
This potentially has reduced Wife’s Financial Remedy entitlement to c. £5 million in round figures but also with a potential cost bill of £2million.
But as T. S. Eliot says: “Only those who will risk going too far can possibly find out how far one can go” or would it be better for the Wife in the latest case to keep her portfolio and her risk at her own individual comfortable sleeping point?
Conclusion
- Sham is not a concept of tax law or trust law. It is a concept of general law.
- What matters is the intention of all parties at time of execution of documentation, ulterior purposes, dishonesty, artificiality, sloppiness of execution or general disapproval of the Court is not proof of sham.
- A transaction is no sham merely because it is carried out with a particular purpose or object. If what is done is genuinely done, it does not remain undone merely because there was an ulterior purpose in doing it. (see Miles v Bull [1969] 1 QB 258 at P. 264)
- It must be shown that the settlor/original trustee/current trustees (if different) intended the trust to be a sham.
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