“Illusory Trusts” – a new doctrine to invalidate Trusts? Part 3
If the notion of “illusory” Trusts was well known in the law and able to invalidate large numbers of Trusts you’d expect to find it wrapped in lights in all the leading text books on Trusts - but it isn’t. For example, it isn’t referred to in the current editions of: Lewin on Trusts; Waters’ Law of Trusts in Canada; Thomas & Hudson’s Law of Trusts; Ong’s Trusts Law in Australia; Virgo’s Principles of Equity and Trusts, and Thomas on Powers.
However, the absence of a reference to the term in the indexes of these works is misleading. For example, although it isn’t referred to in the indexes of Waters and Lewin, the topic is, in fact, referred to in both those texts.
The term does appear in the indexes of the current editions of Underhill and Hayton; Jacobs’ Law of Trusts in Australia; and Garrow & Kelly’s Law of Trusts and Trustees.
What do these texts say? Garrow & Kelly say that the term “is misleading” and what is meant is an arrangement that “leads to the conclusion that no trust was intended.”
They say that “the other common instances of ‘illusory’ trusts arise in connection with directions by testators to executors or trustees to employ named persons; and interests created or granted subject to conditions.”
Jacobs agrees that the term is ‘misleading’, saying that “illusory Trusts” are “arrangements … which upon examination have been found not to be express trusts at all … such arrangements fail to become trusts if a settlor has not manifested an intention of transferring the beneficial interest in the property concerned to the apparent beneficiaries. The most important classes of such arrangements are revocable mandates, directions for management, governmental ‘trusts’, and certain commercial transactions.”
Lewin says “the reservation by the settlor of large beneficial powers and interests may leave the lifetime trusts declared in favour of others so squeletic as to be considered illusory. If a power of revocation is also reserved, this can turn a settlement into a Will …”.
Lewin’s analysis was recently applied by Ground CJ of the Supreme Court of Bermuda in Re the AQ Revocable Trusts [2010] SC(B)(da) 40 CIV.
A settlor established two Trusts of which he appointed himself their sole trustee. He could revoke the Trusts during his life; he was to receive the entire net income of the Trusts and as much of the capital as he wanted; he had an unfettered right to amend the Trust in any way and at any time; and he could exonerate the trustee from “any liability or responsibility … to any person”, a provision which tipped the Trusts into the “illusory” category since it meant that the Courts had no ability to monitor and safeguard the interests of any beneficiary.
Waters’ assessment of the circumstances when a Trust would be held to be “illusory” was approved by Ground CJ. (I wrote about the Waters’ assessment in Part 2 of this series of articles.)
The settlor was informed by his counsel – or more accurately, misinformed – that the Trusts would be effective “notwithstanding the fact that he would be the sole trustee and the sole beneficiary”; that he would have “unlimited power to revoke or amend the trust during his lifetime”; and that “all of the income of the trust and so much of the principal as you may wish to have must be paid to you.”
The Judge said there was no documentation “to indicate that the Settlor thought he was acting as trustee, or held his shares in that capacity. Nor is there any other trust documentation such as accounts or minutes or memoranda of meetings with professional advisers.”
He held that “the concatenation of rights and powers of the Settlor, when coupled with the fact that he was the sole trustee at the time of the constitution of the Trusts, rendered this Trust illusory during his lifetime.” He said the Settlor “could not effectively be called to account during his lifetime.”
“I find that when the Settlor executed the Trust Agreements he believed and understood that he would retain effective sole dominion over the settled assets during his life-time, and that is borne out by the advice that he was receiving.”
He held that the Trusts were not only “illusory” but also “ … invalid as the Settlor did not have the necessary intention to create a Trust during his life-time.”
By any standard, the powers that were given to the Settlor in the AQ Revocable Trusts case were at the far end of the spectrum and were way beyond the range of powers that are given in a typical New Zealand Trust.
Even so, it is interesting to record Ground CJ’s observation that Trusts of this nature would be valid in the USA. Referring to Scott & Fratcher (4th ed) he said:
“The trend of modern authorities [in the USA] is to uphold an inter vivos trust no matter how extensive may be the powers over the administration of the trust reserved by the settlor.”
What does all this mean for Trust practitioners in New Zealand? And for the thousands of people who want to know if the Trusts they have established are valid or will be ignored by the Courts because they are “illusory”?
In the next and final article in this series I will attempt to summarise the different circumstances when a Trust may be categorised as “illusory” and express an opinion on the High Court’s assessment that Mr Clayton’s Trust fell into this category.