Guiding You Through Sham Trusts

When is a sham not a sham?

At a time when trusts are coming increasingly under attack, it is quite common for the validity of a trust to be questioned on the basis that the instrument creating it is a sham document or fails to fulfil the requirements for the creation of a valid trust.

The validity of a trust may be challenged in many circumstances, for example, during a divorce, if you suspect a creditor is hiding assets or if you are a judgment debtor.

It is important to understand when a trust can be considered to be a sham and consequently be void. This guide sets out the defining characteristics of sham trusts and provides an overview of some of the issues. It does not provide definitive advice on the law. You are recommended to seek legal advice on your specific circumstances.

Sham?

The term 'sham trust' is really a misnomer. In the sham cases it is not the trust that is a sham, but rather the document which purports to evidence the terms of the trust which may be found to have been a sham.

The 'Sham' test

The test for establishing if a transaction is actually a sham was set out in Snook v. London and West Riding Investment Ltd (1967) 2 QB 786, where Lord Diplock identified the elements in a sham transaction as:

"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 rights and obligations (if any) which the parties intend to create...for acts or documents to be a sham, with whatever legal consequences follow 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. No unexpressed intentions of a 'shammer' affect the rights of a party whom he deceived".

This definition was subsequently held to apply to ascertaining whether a trust was a sham, by the Court in Midland Bank plc v Wyatt [1995] 1 FLR 696.

Intention

It is clear that the key prerequisite for finding that a transaction is a sham is the parties' common intention (ie the settlor and the trustee/s), that the transaction does not create the rights and obligations that it appears to create.

Although Diplock LJ's statement of a sham in Snook requires a common intention of pretence by all parties to the allegedly sham transaction, there was some doubt as to its application in the trust...