“Illusory Trusts” – a new doctrine to invalidate Trusts: Part 2

In my last article I wrote about a judgment that Rodney Hansen J delivered in Clayton & Others v Clayton [2013] NZHC 301.

He said “it is clear that Mr Clayton intended to create a trust and intended to do so for legitimate business purposes”. He also held that the Trust was not a sham. But despite these findings, he said the Trust was “illusory” and could be ignored because Mr Clayton had “unfettered power to distribute the income and the capital of the trust to himself as he wishes and to bring the trust to an end at any time he pleases.”

Professor Donovan Waters read my article (they circulate independently from NZ Lawyer) and has helpfully referred me to the latest edition of his work Waters’ Law of Trusts in Canada. (Before I wrote the article I checked the index of my copy of the third edition and noted that there was no reference to “illusory” Trusts there. I wasn’t aware that a fourth edition of his work had been published last year.)

Professor Waters suggests that a Trust will be “illusory” in the following circumstances:

“Suppose the settlor as trustee, or operating through a compliant relative or friend as trustee, acted from the first as if he remained the absolute owner of the assets held in trust. Evidence shows, for instance, that, regardless of the trust terms, the trust property was used without hesitation for the settlor’s personal purposes, and the named beneficiaries of the trust had never received any benefits from the trust, or any accounting from the trustees. They may have been told nothing of the trust, and lied to if they had asked.”

Where this occurs:

“… courts in Canada, as in England and in offshore jurisdictions, have seen the situation as the settlor resisting the legitimate creditors and family claimants with false trust assertions. The settlor in question, … has ignored the trust where it suited him to do so; the true object of the creation of the trust was to deceive creditors and claimants into believing a transfer to others had taken place. The courts have regarded this as going beyond trustee breach. Such trusts have been judicially ruled to be void as shams, and the trust property to have remained the personal property of the settlor.

“This form of sham has therefore nothing to do with a requirement of certainty of intent in the creation of trusts. It is more concerned with an intention on the part of the settlor to employ the trust concept to perpetrate an illegality … This type of sham has been described as a ‘partial sham’ and the would-be trust as an ‘illusory trust’. But all are agreed that the same results flow – namely, the trust is void, as if it were a ‘total sham’ ”.

Professor Waters accepts that “extrinsic evidence is likely to be vital” to show the insincerity of a declaration of trust.

In the Clayton case this was problematic as there was no evidence of any actual insincerity. The evidence was to the contrary effect: Mr Clayton had always relied upon the advice of a retired accountant and another adviser, and the decisions had been made “on a purely commercial basis”: [77]

In this way, Professor Waters’ assessment of the circumstances in which a Trust may be held to be “illusory” would not be so applicable to Mr Clayton’s Trust.

Mr Clayton’s Trust was not like a typical New Zealand family Trust. Consider his positions and powers: he was the settlor; the sole trustee; he could appoint and remove trustees; he could appoint and remove beneficiaries; he could act without considering the interests of all beneficiaries; he could act despite having an interest that might otherwise disqualify him; he could pay the income and capital to himself. In the words of the Judge, he had an “unfettered discretion … to distribute the property without considering the interests of any beneficiary, including future beneficiaries.” The fact that he had not done so was - according to the Judge - “neither here nor there”: [90]

The topic of “illusory” Trusts is too big to be dealt with in two short articles and I will continue it in Part 3 in the next issue of NZ Lawyer. I will refer there to a 2010 case from the Supreme Court of Bermuda where Ground J held that a Trust was “illusory” during the settlor’s lifetime. The facts were not too dissimilar to the Clayton case.

What is important for local Trusts practitioners to know is that the notion of “illusory” Trusts is not likely to strip typical New Zealand family Trusts of their validity. To the extent that the concept may find favour here, I think it likely that Courts will be inclined to apply it to those rare cases where either a settlor makes himself the sole trustee and gives himself powers to do virtually anything with the Trust assets, or alternatively, to cases where – in Professor Waters’ words, “the trust concept” is being used “to perpetrate an illegality.”

I will explain more about this in Part 3.

For information about Anthony Grant, see www.anthonygrant.com