Sham Trusts and Constructive Trusts over assets of a Trust

Like a rubber duck, the topic of sham Trusts will keep bobbing out of the water until the Courts find a more acceptable solution to the problems that are created by “dubious” Trusts.

The most recent case is F v W, Wellington CIV-2009-485-000531 3.8.09 where Gendall J has held that the Family Courts have no jurisdiction to declare a Trust a sham.

Section 4 of the PRA was intended to give the Family Courts exclusive jurisdiction over all disputes that were likely to arise between spouses and partners but that intention is steadily being undone.  In Jew [2003] 1 NZLR 708 the High Court held the Family Court has no jurisdiction to make declarations concerning the ownership of assets in family Trusts.  Equitable claims between spouses – such as proprietary estoppel are not prevented by s 4 and must be litigated in the High Court if the sum at stake exceeds $200,000.  In Kerridge [2009] NZFLR 705 the CA held that allegations between spouses of deceit, negligent misstatement and breach of duty of care can be litigated in the High Court.  And now, the High Court says that the Family Courts have no jurisdiction to investigate claims that Trusts are shams.

What is the effect of this?  One outcome is forum shopping.  Litigants who think they’ll get a better hearing in the High Court will sprinkle their pleadings with claims that are justiciable only in the High Court and apply for the whole case to be heard there.  I have had experience of this.

A second outcome is that High Court Judges will get more relationship property work – and they will not have the depth of knowledge and expertise of the PRA and all its associated case law that the Family Court Judges have been building up over the years.  This development will undermine the Parliamentary resolve to create specialist Courts for relationship property disputes.

The Trust that was in dispute in F v W was typical of many of the cases that have come before the Courts in recent years.  Gendall J said it was the alter ego of Mr F who “obviously controlled” it but that this was “not necessarily determinative of whether the Trust is a sham.  It has to be shown that it is intended by the settlor and trustees that the Trust has an effect different from its objectively determined legal effect.”

This appears to be a reference to the “common intention” test that the CA applied in OA v Wilson [2008] 3 NZLR 45, ie a Trust will only be a sham if the Courts can establish that the trustees have a common intention that the Trust will not be a genuine entity.  Justice David Hayton’s criticism of this test - to which I referred in a recent article - has considerable merit.  If the Courts have to prove the secret dishonest intentions of a trustee there will be few cases where the sham doctrine will ever be proven.  He favoured a more objective test and there is much to be said for this stance.

In the major sham case of Rahman v Chase Bank [1991] JLR 103 it was held that a Trust was a sham for two reasons.

First, the settlor had such a degree of control over it – an objective observation - that he never intended to relinquish ownership of the property which was settled on the Trust.

Second, the way in which he was able to manipulate the Trust – a test that was also established objectively – showed that it was a sham.

None of this depended upon the subjective intentions of the trustee – who appeared to be genuine in his attempts to administer the Trust properly.

It can be expected that in future, there will be attempts to persuade the Courts that the “common intention” test is too narrow and that the Courts should apply a test which is more objective.

There is a second reason why the case of F v W is of interest.  Ms W contended that the assets of the Trust were to be held on a constructive Trust for her.  Gendall J gave her leave to plead more widely than that.  She is to plead that all of the assets that were created during her relationship with Mr F were the subject of a constructive Trust(s).

There has only been a handful of cases in which the Courts have upheld a claim that the assets of a Trust are subject to a constructive Trust.

Such claims usually arise where the settlor (who may not be a trustee) leads his or her spouse to believe that the assets of the Trust are ‘their’s” and speaks in that way.  The innocent partner is encouraged to stay on in the relationship, or add value to Trust assets, in the belief that he or she will receive the fruits of the investment in due course.

In Q v Q FAM 2002-004-0002523, 24.2.05, Judge Fitzgerald upheld such a claim in circumstances where three of the four trustees appear to have been ignorant of the representations on which the innocent spouse relied.  It seems wrong in principle for the Courts to be able to strip assets from their owners as a consequence of representations that were not made on their behalf, and of which they knew nothing.

The imposition of a constructive trust over Trust assets in such circumstances may not be good law.