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Sham Trusts and Sham Transactions | ||
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Introduction.
Many trusts are in my opinion shams or a series of invalid transactions. Many trusts are in my opinion shams or a series of invalid transactions. Ross Holmes "Sham Trusts" was the second book in the world written on this topic. In the course of writing that book Ross reviewed many cases from a number of jurisdictions in which trusts had been set aside as shams. The function of this article is to look at why this has occurred, and how such situations can be avoided. Trusts have not only been extensively used, they have frequently been abused by advisers. In many instances the desire to sell an "additional product" without a detailed knowledge of basic trust law concepts could prove disastrous (with that factor not being known by most advisers or their clients as the trust has not been challenged). Recent overseas cases show that many trustees and their advisors are skating on very thin ice. Trust litigation is a growth industry in Australia and England. Liability
The liability of advisors to the trust
Solicitors owe a duty to their clients to exercise the care and skill to be expected of a qualified competent and careful solicitor in the practice of his or her profession: Oliver J in Midland Bank v. Hett, Stubbs and Kemp (1979) 1 Ch 384 at pp 402-403, Deane J in Hawkins v. Clayton (1988) 164 CLR 539 at p 578, Mullighan J in Austrust Pty Ltd V. Astley and Ors (1993) 60 SASR 354. There is no reason to expect a lesser duty of others who hold themselves out as having estate planning expertise. In considering whether the nature and extent of the duty of care owed by an estate planner, and whether he or she is in breach of it, it is necessary to consider the experience and expertise of the client and the action the client took independently of the estate planner: Ormindale Holdings Ltd. v. Ray and Ors. (1980) 116 DLR(3d) 346 at p 357, Carradine Properties Ltd. v. D.J. Freeman and Co. (1982) 1 PN 41 and Mullighan J in Austrust Pty Ltd V. Astley and Ors (1993) 60 SASR 354 Depending upon the length and nature of the relationship between the estate planner and his or her client, the scope of the duty owed by the estate planner may include the duty to give the advice which the client appeared to need regardless of whether or not it had been specifically requested: Carradine Properties Ltd. v. D.J. Freeman and Co. (supra) per Donaldson LJ at p 41, and Mullighan J in Austrust Pty Ltd V. Astley and Ors (1993) 60 SASR 354: "Having regard to all of these matters, the only sensible conclusion is that the scope of the duty which Mr. Astley owed to the plaintiff included the duty to give the advice which it appeared to need regardless of whether or not it had been specifically requested: Carradine Properties Ltd. v. D.J. Freeman and Co. (supra) per Donaldson LJ at p 41. The liability of estate planning advisors to beneficiaries
The question of the liability of solicitors to beneficiaries of Will Solutions is one which has troubled the courts in many jurisdictions. As a result of developments in the modern law of negligence over the last 20 years it is no longer possible to argue that a solicitor's duty of care arises simply in contract and is owed only to his or her client. Recent court decisions show that all estate planning advisors (whether solicitors or not) who profess to have the expertise in this area are likely to be held liable not only to their clients, but also to the beneficiaries of Will Solutions and trusts if they are negligent in performing their services. The observation of Richardson J in Gartside v Sheffield Young & Ellis 1983 NZLR 37 at page 49 must be borne in mind, about the temptation to generalise: "I venture to repeat one point that was emphasised in Allied Finance and Investment Solutions Ltd v Haddow & Co 1983 NZLR 22. It is that under a general principle of negligence liability cut down by policy considerations in particular cases the ambit of the duty of care is determined on a case by case basis. So, what is decided in this case cannot be applied automatically to other situations in which a duty of professional care to third parties is alleged." That aside, the observations of Richardson J in Gartside v Sheffield Young & Ellis 1983 NZLR 37 at page 49 make it clear that there are important policy considerations which will result in liability if estate planners do not exercise professional competence: "There are, too, three further policy considerations which in my opinion reinforce the prima facie duty of care. First, the recognition of a duty in this class of case serves two important social objectives: to compensate deserving plaintiffs and to promote professional competence. Beneficiaries designated under a proposed will are not ordinarily able to protect their own interests and in the absence of a right of action have to absorb the costs to them of the negligence of the solicitor. In so far as an action in negligence may be viewed in social terms as a loss allocation mechanism there is much force in the argument that the costs of carelessness on the part of the solicitor causing foreseeable loss to innocent third parties should in such a case be borne by the professionals concerned for whom it is a business risk against which they can protect themselves by professional negligence Insurance and so spread the risk, rather than be borne by the hapless individual third party. The other side to the coin is the promotion of professional competence. Drafting a will is perhaps the classic instance of the performance of tasks for clients that lawyers know will directly affect third parties. The sanction of a negligence suit provides an incentive for lawyers to confirm their conduct to a standard of reasonable care. However, the client and his personal representatives have limited redress except perhaps where the estate is depleted by claims of the Revenue and by the administrative costs of dealing with testamentary promises and family protection claims and the like which would not have been faced if the lawyer concerned had fulfilled his responsibilities to his client. A more generally effective sanction and one which because of the proximity of the relationship the solicitor should have in the forefront of his mind is the possibility of a negligence claim by disappointed designated beneficiaries. Second, the recognition of a duty of care in this class of case should serve to enhance rather than erode the solicitor client relationship. Because of the nature of the services provided by lawyers their professional conduct directly and foreseeably affects third parties. The drawing and execution of a will is intended to result in the benefit of third parties. If the solicitor is carelessly dilatory and fails to present the will in time the client's expectations are disappointed and the anticipated benefit to the third party fails. In these circumstances the solicitor's duty of care to third parties parallels and complements the responsibilities he owes to his client. Third, the framework of the duty of care in this class of case is defined and limited. There is no risk that solicitors will be exposed, in the words of Cardozo CJ in Ultramares Corporation v Touche, Niven & Co 174 NE 441 (1931), at p 444, ". .to a liability in an indeterminate amount for an indeterminate time to an indeterminate class". The duty is owed only to persons identified in terms of the testamentary instructions accepted by the solicitors. Any breach must occur between the acceptance of the instructions and the death of the client. And the liability is limited by the size of the estate." It is clear in England and New Zealand that where a will fails because of the negligence of the testator's solicitors, the disappointed beneficiary under the ineffective will can recover damages from the solicitors in negligence. It is not necessary to explore fundamental questions as to the relationship between contract and tort. The contract of retainer between solicitor and client does not include any provision for the benefit of a third party. The benefit to the third party from the bounty of the client arises only when the contract is properly carried out. It is not conferred under the contract of retainer itself: Richardson J in Gartside v Sheffield Young & Ellis 1983 NZLR 37 at page 49. Since its decision in Scott Group Ltd v McFarlane 1978 1 NZLR 553 the Court of Appeal, in Mount Albert Borough Council v Johnson 1979 2 NZLR 234, and subsequently, has applied the principles set out in Anns v London Borough of Merton 1977 2 All ER 492; 1978 AC 728, and a number of judgments in the Court of Appeal have proceeded on the basis that these principles prove the best guide to a Court faced with determining the existence or otherwise of a duty of care in negligence in a situation where such a duty has not previously been recognised. One significant reservation to complete acceptance of those principles are the statements by Cooke J, repeated in the joint judgment of himself and Somers J in the Mount Albert Borough Council case, concerning the desirability of "an essentially pragmatic approach" to this problem, and the necessity to avoid rules of a fixed or arbitrary nature. The consequences of the failure of advisors to observe basic trust law concepts and to provide trustees with practical guidance
The failure of advisors to observe basic trust law concepts and to provide trustees with practical guidance could (and has in many cases) contributed to findings that trust transactions, or the trust itself was invalid and a "sham"due to:
Accordingly not only must the Settlor intend to create a trust, and in fact create a trust, but the trustees in administering the trust must comply with the legal rights and obligations imposed by the trust deed or the law of trusts. The trustees must not act as agents or nominees of the Settlor. If a the trust was not, or was never intended to be, established, or the trustees in administering the trust must comply with the legal rights and obligations imposed by the trust deed or the law of trusts, legal rights and obligations will be created, but they will not be those of an express trust. In most cases when the trust is set aside there is a resulting trust back in favour of the Settlor i.e. the trustees have at all time held the assets upon trust for the Settlor. I f trust transaction is set aside there is a resulting trust back in favour of the trust by the beneficiaries who have received assets from the trust. In every case a trust is set up as part of an estate plan in case dangers which could occur do occur. If the estate plan does not provide any protection in the event of such worst case scenarios occurring, it has not fulfilled its function What is a sham?
A common intention must exist between parties (to the sham) that the acts done or documents executed do not create the legal rights or obligations which they appear to create. Diplock L.J. in Snook v London and West Riding Investment Solutions Ltd 1967 1 All ER 518 (a decision of the English Court of Appeal) at page 802 described the "popular and pejorative word" sham as follows: "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. But one thing, I think, is clear in legal principle, morality and the authorities ... that 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." This definition of "sham" has been adopted in many subsequent cases. Put more shortly, a sham exists where the parties say one thing intending another: Donald v Baldwyn 1953 NZLR 313 at 321 per F B Adams J, and Antoniades v Villiers and another 1988 2 All ER 309 at 316.A sham is an act done or document executed that is intended to mislead. It is where the parties resort to a form of action or document which does not fit the real facts in order to deceive a third person: Bateman Television v Coleridge Finance Co Ltd 1969 NZLR 794. In Scott v. Federal Commissioner of Taxation Solutions (No. 2) (1966) 40 ALJR 265, at p 279 Windeyer J. identified the relevant matters to be considered as follows:> ".... if the scheme, including the deed, was intended to be a mere facade behind which activities might be carried on which were not to be really directed to the stated purposes but to other ends, the words of the deed should be disregarded ... A disguise is a real thing: it may be an elaborate and carefully prepared thing; but it is nevertheless a disguise. The difficult and debatable philosophic questions of the meaning and relationship of reality, substance and form are for the purposes of our law generally resolved by asking did the parties who entered into the ostensible transaction mean it to be, and in fact use it as, merely a disguise, a facade, a sham, a false front - all these words have been metaphorically used - concealing their real transaction ..." Lockhart J, with Foster J agreeing, in Sharrment v Official Trustee (1988) 82 ALR 530 concluded at p 537 that: "A "sham" is therefore, for the purposes of Australian law, something that is intended to be mistaken for something else or that is not really what it purports to be. It is a spurious imitation, a counterfeit, a disguise or a false front. It is not genuine or true, but something made in imitation of something else or made to appear to be something which it is not. It is something which is false or deceptive." This statement in Sharrment has been applied in Re State Public Services Federation; Ex parte Attorney-General (W.A) (1993) 67 ALJR 577 per Toohey J at 593; Dalco v Federal Commissioner of Taxation Solutions (1988) 82 ALR 669 at 670-1, subsequently reversed by the High Court (168 CLR 614) but not in this respect and Re La Rosa; Ex parte Norgard v Rocom Pty. Ltd. (1990) 21 FCR 270 at 277-80. Accordingly a common intention must exist between parties (to the sham) that the acts done or documents executed do not create the legal rights or obligations which they appear to create. All the parties involved must have a common intention to that effect, since the law will not allow the insincere act of a deceiver to prejudice a party who sincerely entered into the transaction in question): Re State Public Services Federation; Ex parte Attorney-General for the State of Western Australia (1993) 178 CLR 249 at 290 per Toohey ; and Baker and others v. Official Trustee in Bankruptcy (1995) No. Qg102 of 1994 Fed No. 565/95, Burchett, Ryan and Carr JJ at para 22. In New Zealand the topic of "sham transactions" has been the subject of a binding ruling of the New Zealand Inland Revenue Department which provides a useful summary of some of the requirements for the existence of a sham in Tax Information Bulletin Vol 9 No 11 pp 7-8. If there is no intention to create a trust, there is no trust regardless of the form of words used. It is not simply a case of using the right words. If there is no intention to create a trust, there is no trust whatever form of words are used: Sharrment Pty Ltd v Official Trustee in Bankruptcy (1988) 18 FCR 449 at 454-455 and Official Trustee in Bankruptcy V. James Andrew Baker, Art Holdings Pty. Ltd., Goodglint Pty. Ltd., Vestos Pty. Ltd. And Service and Property Pty. Ltd. (1994) No. NB72 of 1990 FED No. 530/94 at para 84. The Supreme Court of the United States has consistently stated that the substance rather than the form of a transaction is controlling for tax purposes.
The steps required to ascertain the true nature of the transaction
Step 1: What was the genuine intention of the parties ? It is the intention of the parties to the transaction which determines the question whether the act or document was intended to be operative according to its tenor or whether it was simply a facade or a disguise: Clarke J. in Northumberland Insurance Ltd. (in liq.) v. Alexander (1984) 8 ACLR 882, stated at pp 888-9: "...it is the intention of the parties to the transaction which determines the question whether the act or document was intended to be operative according to its tenor or whether it was simply a facade or a disguise. It is not essential, in my view, that the facade disguise another and different transaction. It is enough if it creates an appearance that the contractual relationship between parties is different from the actual relationship." < P> To determine whether there is a sham, it is necessary to ascertain what the genuine intentions of the parties to the transactions were: Boydell v. James (1936) 36 SR (NSW) 620 per Jordan C.J. at 627, Dennis Willcox Pty. Ltd. v. Federal Commissioner of Taxation Solutions 88 ATC 4,292 at p 4,295, Miles v. Bull (1969) 1 QB 258 per Megarry J. at 264. Mullens v. Federal Commissioner of Taxation Solutions (1976) 10 ALR 513, Coppleson v. Federal Commissioner of Taxation Solutions (1981) 34 ALR 377 per Hunt J. at pp 380-381, Oakey Abattoir Pty. Ltd. v. Federal Commissioner of Taxation Solutions (1984) 55 ALR 291 at 297, Trimbole v. Donnelly, Full Court of the Federal Court of Australia, unreported, 5 November 1986 per Evatt, Lockhart and Wilcox JJ. at pp 9-10, Re Caruana; Ex parte Deputy Commissioner of Taxation Solutions, 23 December 1987, unreported, per Davies J. at pp 9-10, Sherdley v. Sherdley (1987) 2 WLR 1071 per Lord Brandon at p 1079, Beaumont J. in Sharrment v Official Trustee (1988) 82 ALR 530 at p 550, (1988) 18 FCR 449 at 467, Yeung v. Federal Commissioner of Taxation Solutions (1988) 19 ATR 1006, per Davies J. at p 1013. < P> The intentions of the parties are to be ascertained by reference to their actual intentions whether by direct evidence or by inference from the circumstances of the transactions: Sharrment v Official Trustee (1988) 82 ALR 530 at p 539 per Lockhart J. In the judgement of Lockhart J in Sharrment v Official Trustee (1988) 82 ALR 530, he said on the question of whether it is the subjective intention of the parties that is determinative:"....logically this seems to be the correct result. In Coppleson's Case Coppleson v. Federal Commissioner of Taxation Solutions (1981) 34 ALR 377 ....Hunt J. at 381 took the view that the authorities established that it is the intention of the parties to the transaction which determines the question whether the act or document was never intended to be operative according to its tenor at all but rather was meant to cloak another and different transaction." Step II In ascertaining the true nature of the transaction one must consider the legal character of the agreement which embodies the transaction. It is only where the genuineness of the agreement evidenced by the documents is challenged that it is then necessary to consider whether the substance of the transaction as represented by the documents is not the true substance of the transaction and the documents themselves are a cloak to conceal its true nature: Re Securitibank Ltd (No 2) 1978 2 NZLR 136 (Court of Appeal). < P> The modern trend is for the courts to try to give business efficacy to commercial transactions. If a court is satisfied that the real intention of the parties was to enter into a binding agreement, then the court will do its best to give effect to that intention: Attorney-General v Barker Bros Ltd 1976 2 NZLR 495; unreported decision of Thorp J. in A.G.C. v Broadlands Ltd and General Motors Acceptance Corporation (NZ) Ltd v A.G.C. and Broadlands Finance Ltd (unreported, High Court Auckland A256/80). This modern trend may be contrasted with an earlier judicial approach, when a finding of sham inevitably enabled a Court to infer the true nature of the arrangement in an "in substance" manner. For example, in Polsky v S A Services 1951 1 ALL ER 185, Lord Goddard had no difficulty inferring from the fact that there had not been payment of a deposit, as set out in a hire purchase agreement used in a refinancing situation, that he was dealing with a clear case of sham. As Thorp J. said in the A.G.C. case, supra: "That precedent can no longer safely be followed". Step III In arriving at that determination all the circumstances and incidents of the ostensible transaction may be taken into account < P> Before any issue of sham arises, it is important that a systematic and objective approach is undertaken to ascertain the true nature of the transaction. The following points, as set out by Richardson J.(with Woodhouse J concurring) in Re Securitibank Ltd (No 2) 1978 2 NZLR 136 (Court of Appeal) at pages 167 - 168 provide useful guidance in this context: "..the first step in determining whether the transactions under review were loans is to ascertain their true nature or substance. ....It is well settled that, where documents have been drawn to define the relationship of persons involved in a business operation, the true nature of the transaction can only be ascertained by careful consideration of the legal arrangements actually entered into and carried out (Helby v Matthews 1895 AC 471; Inland Revenue Commissioners v Duke of Westminster 1936 AC 1; Commissioners of Inland Revenue v Wesleyan & General Assurance Society (1946) 30 TC 11). As Lord Tomlin said in the Duke of Westminster case: ". . . the substance is that which results from the legal rights and obligations of the parties ascertained upon ordinary legal principles . . ." (1936 AC 1, 20-21). It is the legal character of the transaction which is decisive, not the overall economic consequences to the parties (Commissioner of Inland Revenue v Europa Oil (NZ) Ltd 1971 NZLR 641, 648-649; 1971 AC 760, 771-772; Europa Oil (NZ) Ltd v Commissioner of Inland Revenue 1976 1 NZLR 546, 553; 1976 1 WLR 464, 472). That character is not determined conclusively by the nomenclature used by the parties. Consideration must be given to the whole of the contract in order to determine the true nature of the relationship. If the transaction is embodied in a number of interrelated agreements, all the agreements must be considered together and one may be read to explain the others. The first question then in this class of case is: what is the substance of the bargain as disclosed by the documents before the Court (Re George Inglefield 1933 Ch 1, 24). In arriving at the answer to that question, the circumstances surrounding the entering into the transactions may be taken into account. This does not mean that evidence is admissible to vary or contradict the written agreement; only that before you construe the agreement you are entitled to understand the setting in which it was made and that you construe it against that background. While then it is legitimate to take into account surrounding circumstances and to look at the documents as a whole, the documents themselves may be brushed aside only if and to the extent that the parties had a common intention that they were not to create the legal rights and obligations which they gave the appearance of creating and in that sense were shams. Finally, the concern is with the legal arrangements actually carried out. It is what the parties eventually did that counts, not what they may initially have agreed to do. In some cases the parties may have departed from the initial agreement, in which event questions of a new agreement or variation of the original agreement, or estoppel, or sham in operation may arise. But that is not in question here and requires no further consideration. It is also unnecessary on the facts of this case to consider further the two qualifications to the principle that the rights and obligations of the parties to an agreement are determined according to the terms of the agreement which have been adverted to: first, where the essential genuineness of the documentation of the arrangements is challenged and sham is alleged; and second, where there is a statutory provision directing a broader or different approach designed to prevent the erosion of the policy of the legislation by refusing recognition to attempts to structure arrangements so as to take them outside or bring them within the statutory provision as the case may be, or by directing attention to the end result or economic purpose of the transaction." < P> The decision of the Court of Appeal in Buckley & Young Ltd v Commissioner of Inland Revenue 1978 2 NZLR 485 (Woodhouse, Richardson and Somers JJ) also gives a detailed outline of the evidence which can be taken into account when determining whether there is a sham. Richardson J at pp 489 - 491 in delivering the judgment of the Court stated: "page 489 But it is well established that the true nature of a transaction must be ascertained by reference to the legal arrangements actually entered into and carried out (Commissioners of Inland Revenue v Duke of Westminster 1936 AC 1; Commissioners of Inland Revenue v Wesleyan and General Assurance Society (1946) 30 TC 11). And in both the Europa Oil cases (1971 NZLR 641, 648-649; 1971 AC 760, 771-772 and 1976 1 NZLR 546, 553; 1976 1 WLR 464, 472) the Judicial Committee stressed that it is the legal character of the transaction actually entered into determined by the contractual arrangements which is decisive, not the overall economic consequences to the parties. Referring to the doctrine of substance, Lord Russell of Killowen said in the Duke of Westminster's case: >"If all that is meant by the doctrine is that having once ascertained the legal rights of the parties you may disregard mere nomenclature and decide the question of taxability or non-taxability in accordance with the legal rights, well and good . . . If, on the other hand, the doctrine means that you may brush aside deeds, disregard the legal rights and liabilities ! Page 490 arising under a contract between parties, and decide the question of taxability or non-taxability upon the footing of the rights and liabilities of the parties being different from what in law they are, then I entirely dissent from such a doctrine" (1936 AC 1, 25). < P> While the nomenclature used by the parties is not decisive, it is the legal rights and duties created by the transaction into which the parties entered and as ascertained by ordinary legal principles, taking into account surrounding circumstances, that must be determined. Thus, while it is legitimate to take into account surrounding circumstances and to refuse to be blinded by terms employed in documents, the documents themselves may be brushed aside only if and to the extent that they are shams, in the sense of not being bona fide in inception or of not having been acted upon, and are only used in whole or in part as a cloak to conceal a different transaction or if required by a provision such as s 99 of the Income Tax Act 1976. < P> The starting point is to consider the documentation embodying the transaction. "The decision in any particular case can only be arrived at by considering what is the substance of the transaction in question, and what is the substance of that transaction can only be ascertained by a careful consideration of the contract which embodies the transaction. That being so, in our judgment what has to be done here is to examine the particular clauses of . . . the agreement in question, and to see what is the appropriate conclusion . . . to be arrived at on the consideration of that agreement" (Commissioners of Inland Revenue v Ramsay (1935) 20 TC 79, 94, per Lord Wright MR; see, too, Nicholls v Commissioner of Inland Revenue 1965 NZLR 836, 845). A deed or other instrument must to construed as a whole and, if the transaction is embodied in a number or complex of interrelated agreements, then all the agreements must be considered together and one may be read to explain the others......And, as already noted, oral evidence is admissible for the purpose of ascertaining the surrounding circumstances. However, that does not mean that oral evidence may be given for the purpose of varying the written agreement or for the purpose of ascertaining the actual intention of the parties. It means that, before you construe the agreement, you are entitled to understand the setting in which it was made (Hose v Warwick (1946) 27 TC 459, 468). The inquiry is not concerned with what was in the minds of some or all of the parties at an earlier negotiating stage in relation to an inchoate transaction, or with the surrounding circumstances at that earlier time. The motives of the negotiators and the relative significance attached by them, or some of them, to various factors at the outset of negotiations are not necessarily reflected in the agreement that is eventually reached. Moreover, transactions evolve in the course of negotiations and their character may change. There are sound reasons for refusing to admit evidence of negotiations or of the views and intentions of the parties which do not appear from the concluded agreements. As it was put by Lord Wilberforce in Prenn v Simmonds 1971 1 WLR 1381, 1385; 1971 3 All ER 237, 241: ". . . evidence should be restricted to evidence of the factual background known to the parties at or before the date of the contract, including evidence of the 'genesis' and objectively the 'aim' of the transaction." Page 491 < P> And the surrounding circumstances that may be relevant are those that obtain at the time the transaction under scrutiny in entered into, not those that existed at an earlier point of time. Analysis of the documentation may not determine the true character of payments made. Indeed, the contract may be silent or equivocal as to the quality which ought to be attributed to the payment in question. In that situation evidence of surrounding circumstances may be of particular significance in determining what the contractual expenditure is calculated to effect from a practical and business point of view - to use the language of Hallstroms case Hallstroms Pty Ltd v Federal Commissioner of Taxation Solutions (1946) 72 CLR 634. In other cases the essential genuineness of the documentation of the arrangements may be challenged. The Court must then determine whether the substance of the transaction as reflected in the documentation is the true legal arrangement between the parties, or whether the documentation is used as a cloak intended by them to conceal, in whole or in part, the true arrangement emphasis added. In that situation the Court may take into account all evidence which bears on that question and is not limited to consideration of evidence admissible in the ordinary course of construction of documents. Finally, in some cases the parties may have departed from the documents, in which event questions of a new agreement or estoppel or sham in operation may arise." Nothing said in Sharrment v Official Trustee (1988) 82 ALR 530 or the cases there reviewed, prevents consideration of ulterior purpose, artificiality, complexity and the exchange of cheques if they are relevant. The way in which the court looks at all the circumstances and incidents of the ostensible transaction is illustrated by the decision of the Federal Court of Appeal in Baker and others v. Official Trustee in Bankruptcy (1995) No. Qg102 of 1994 Fed No. 565/95 in which Burchett, Ryan and Carr JJ stated: "22. But the judge did go on to consider the question of sham. He referred to Sharrment; Snook v London and West Riding Investment Solutions Ltd (1967) 2 QB 786 at 802 ......but pointed out that all the parties involved must have a common intention to that effect, since the law will not allow the insincere act of a deceiver to prejudice a party who sincerely entered into the transaction in question); Re State Public Services Federation; Ex parte Attorney-General for the State of Western Australia (1993) 178 CLR 249 at 290 (where Toohey J said that "the term (sham) has come to be applied where persons have entered into an ostensible transaction as a disguise to conceal their real transaction"); Dalco v Federal Commissioner of Taxation Solutions (1988) 82 ALR 669 at 670-671 (where it was said in the joint judgment of Sheppard and Gummow JJ that neither artificiality nor complexity will establish a sham, and that "a vital question is whether transactions were not to take effect according to their terms"), a decision reversed on appeal, but not so as to affect the proposition cited: The Commissioner of Taxation Solutions for the Commonwealth of Australia v Dalco (1990) 168 CLR 614; Re La Rosa; Ex parte Norgard v Rocom Pty Ltd (1990) 21 FCR 270, a decision which was affirmed on appeal: Norgard as Trustee in Bankruptcy of the Estate of La Rosa v Rocom Pty Limited (Northrop, Davies and Lee JJ, unreported, 16 August 1990); Hancock v Federal Commissioner of Taxation Solutions (1961) 108 CLR 258 at 301-302 (where Windeyer J pointed out that "going through a form" does not make "a pretended transaction real"); and Northumberland Insurance Ltd (in liquidation) v Alexander (1984) 8 ACLR 882 at 888-889. After referring to several passages, particularly in Sharrment, the judge emphasized that the actual intentions of the parties must be ascertained to decide whether a transaction is a sham, and that a heavy onus lay upon the Official Trustee to displace the natural effect of the documents. He said that "the Court will not lightly infer that documents do not reflect the true intention of the parties". 23. Nevertheless, he concluded that Sharrment, where the architect of the scheme was unavailable to give evidence, being deceased, so that the whole of the case had to be decided upon inferences from the documents and the circumstances, was distinguishable upon its facts, and that in the present case the transactions by which the art collection was apparently made the property of Art Holdings Pty Ltd as trustee of the Contemporary Art Trust were shams. His Honour held that "Baker's true intention was that Art Holdings would acquire legal title to the collection not as trustee for the Contemporary Art Trust but rather for Baker personally. The same holds true for the transfer of 31 January, 1990 of the collection from Art Holdings to Goodglint." 24. The judge clearly recognized that the authorities contain B warnings against too ready an acceptance of an argument that artificiality or complexity suggests a sham. Transactions may be both complex and artificial, yet intended to have precisely the legal effect apparent on their face. It is not an intention to achieve an artificial result that makes a transaction a sham, but an intention to achieve a different result from that represented by the legal forms employed. In the evocative phrase adopted by the joint judgment of Neaves, Ryan and Lee JJ in Donnelly v Edelsten (supra, at 390), the question is whether the legal forms were "merely scenery moved around by (the true owner of the property involved) to reflect whatever landscape he sought to construct". If that be so, as Cotton LJ said in In re Watson. Ex parte Official Receiver in Bankruptcy (1890) 25 QBD 27 at 38, the Court is not "bound by the form of the agreement", and "when documents are mere shams or cloaks to hide the real nature of the transaction, the Court will not allow them to prevent it from going into the real transaction". There was a wealth of evidence to support the conclusion to which his Honour came. Some of it has already been referred to. Very much of it came out of the mouth of Mr Baker himself. As was the case in respect of the closely related question whether there was an intention to subject to the terms of a trust particular pictures acquired after its setting up in point of legal form, the question whether the trust itself and all the relevant transactions in relation to it were shams is a question of fact into the determination of which the credibility of Mr Baker's oral evidence, and the impression he made as a man, must have entered very largely. 25. In his reasons, the judge commented on the actions of Mr Baker in connection with a number of matters concerning his property and affairs. In June 1987 he had, as his Honour said, "solemnly declared he held all his personal effects, including his wrist watch, on trust although he continued to enjoy the full use of them". He claimed he had done this so thoroughly that he "would not have been able to pay for a pie" to eat, except by borrowing from one of his companies. Yet he said that he had "good legal advice" that he was going to win the tax case, and his purpose was "just following the pattern that had been established for years that all the family assets were held by family trusts, regardless". The judge did not believe this. His reasons state of Mr Baker:"He is a person who has been prepared to fabricate documents and company records on a substantial scale for his own pecuniary advantage in carrying on his tax avoidance activities. He has disposed of company records to impede official investigations into his unlawful activities. He lied persistently to those investigators and sought in other ways to mislead them." 26. The judge pointed out that Mr Baker, over a substantial period, utilized "loans" to a total of well over $500,000 from two of his companies, Vestos Pty Ltd and Service and Property Pty Ltd, to pay his living expenses. These companies carried on business solely as trustees of trusts. Yet Mr Baker, who controlled them, saw no problem in recording as actual legal transactions what purported to be his own extensive borrowings from them, not only without providing security, but without any intention of ever making any repayment. Ultimately, his indebtedness to Vestos Pty Ltd appears to have become an embarrassment, because it was borrowing money from Westpac Bank. Accordingly, it was desirable to remove such a large indebtedness from the company's books, which was achieved by transferring the debt to another company, Telminco Pty Ltd. It was put to him in cross-examination: < P> "Now, one of the interesting things about it is that if you had companies in a group, what you say might be right. But these were not companies in a group, were they? These are trusts that we are talking about here. They are individual trusts, constituted by separate trust deeds. Is not that so?" < P> 27. He answered "Yes." He was then asked: "And you thought it was all right to amalgamate, as it were, the inter-trust situation too; consolidate the inter-trust accounts?" This also he answered: "Yes." < P> 28. On all of the evidence, the trial judge concluded that Mr Baker's intention was so to "arrange things that they would give to outsiders the appearance that the art collection was held in trust by Dacine, and then by Art Holdings, on certain trusts, when the reality was that the collection remained in the full beneficial ownership of Baker personally." He did not intend the books of the companies to record the true position in respect of his use of funds emanating from their bank accounts or with respect to the art collection. "They were instead merely camouflage to conceal the true position, at least so far as they recorded dealings with respect to the art collection and his personal expenses: Baker was taking funds available to his companies as he needed them for own purposes without ever intending to repay them. He was simply misappropriating them, not borrowing them. Writing them up as loans to himself in the companies' books does not alter this." 29. This aspect of the appeal should be resolved on the basis that his Honour's conclusion was amply supported by the evidence. In any case, being largely based on credibility, it could only be disturbed if its acceptability had been destroyed by the clear revelation of some serious and demonstrable error. Far from that, it is the correct conclusion on the evidence........" Step IV The Court may receive oral testimony as to the intentions of the parties: Perpetual Trustee Co. Ltd v Bligh (1940) 41 SR(NSW) 33 at 39; Hawke v Edwards (1947) SR(NSW) 21 at p 23; Buckley & Young Ltd v Commissioner of Inland Revenue 1978 2 NZLR 485 (Woodhouse, Richardson and Somers JJ) as detailed in paragraph 5.1 Step III, by Richardson J in Mills v Dowdall 1983 NZLR 154 at p 159, by Casey J in National Westminster Finance New Zealand Ltd v South Pacific Rent-a-Car Ltd 1985 1 NZLR 646 at p 647(a decision affirmed on appeal by the Court of Appeal, Richardson, Somers and Eichelbaum JJ), Marac Life Assurance Ltd v Commissioner of Inland Revenue 1986 1 NZLR 694 per Richardson J at p 706 and McMullin J at page 711, Sharrment v Official Trustee (1988) 82 ALR 530 at p 550 per Beaumont J, Commerce Commission v Fletcher Challenge Ltd 1989 2 NZLR 554 (High Court) per McGechan J at p 626. In Hawke v. Edwards (1947) 48 SR (NSW) 21, at p 23 Jordan C.J. said: "...oral evidence is admissible in such proceedings that the parties intended themselves to be bound only by a contemporaneous oral agreement and that the document was brought into existence as a mere piece of machinery for serving some other purpose than that of constituting the real agreement between them. Oral evidence may also be given that the document is a sham - that it was never intended by the parties to be operative according to its tenor at all, but was meant to cloak another and different transaction...". Step V The court may have regard not only to the inferences to be drawn from its acceptance of such evidence but also those which flow from its disbelief: Baker and others v. Official Trustee in Bankruptcy (1995) No. Qg102 of 1994 Fed No. 565/95. Step VI To draw that inference of a sham in the absence of direct evidence, is to reach a finding and one which cannot be made if another inference is at least equally open < P> This warning must be borne in mind in deciding whether the transactions were shams: Sharrment v Official Trustee (1988) 82 ALR 530 at p 544. A trust is not a sham if it is bona fide
In Marac Finance Ltd v Virtue 1981 1?NZLR?586 (Court of Appeal) it was established that where the essential genuineness of the documentation is challenged a trust may be treated as a sham only: where the document does not reflect the true agreement between the parties in which case the cloak is removed and recognition given to their common intentions; and where the document was bona fide in inception but the parties have departed from their initial agreement and yet have allowed its shadow to mask their new arrangement. Once it is established that a transaction is not a sham its legal effect will be respected: Marac Finance Ltd v Virtue 1981 1 NZLR 586, Court of Appeal. On the other hand if there is no intention to create a trust, there is no trust regardless of the form of words used, and regardless of whether there are independent trustees. No one has ever suggested, as alleged by Mr Hart, that, as a matter of fact, so called "independent" trustees in New Zealand are always mere puppets of the settlors. If trustees exercise their functions in a proper manner, and there is an intention to create a trust, no problems are created by the presence or absence of "independent" trustees. The cases establish that far more trusts with "independent" trustees have been set aside as "shams", than trusts without independent trustees. There is no prohibition on a person settling property upon a trust of which he or she is a trustee and also one of a number of discretionary beneficiaries It is a fundamental requirement for the existence of a trust that the trustee is under an equitable duty to someone else. Accordingly a trust will not be legally effective where a sole trustee claims to hold property on trust for himself or herself as sole beneficiary: Morice v Bishop of Durham (1805) 10 Ves 522, Farwell J in Re Selous, Thomson v Selous 1901 1 Ch 922, Re Cook (deceased), Beck v Grant 1948 1 All ER 231, 1948 Ch 212, Re Annett, Annett v Taylor 1956 NZLR 929 and Re Cook 1948 Ch 212, Re Heberley (deceased) 1971 NZLR 325; and H.A.J. Ford and W.A.Lee, Principles of The Law of Trusts, 3rd edition, 1996 at para 5010. Each new settlement on a trust is a new trust on the terms of that trust Each new settlement upon a trust creates a new settlement upon the terms of the existing trust. In Baldwin v Commissioner of Inland Revenue 1965 NZLR 1, MaCarthur J. considered the meaning of the words "a trust has been created", and stated at p 6: "The dictionary meaning of the word 'create' is 'to make, form, constitute, or bring into legal existence': see Shorter Oxford Dictionary. In my opinion the phrase 'a trust has been created' in s. 84A simply means 'a trust has been brought into legal existence.' No particular method of creation of a trust is indicated by the section. I think therefore that if it is shown that trust obligations have been imposed or constituted in respect of certain property by one or more of the specified persons then a trust has been created by that person or those persons within the meaning of the section". He then went on to consider the facts of the case and said at pp 6 - 7: "I think it is clear that the appellant and his wife have thus imposed or constituted fresh trust obligations in respect of the property under consideration. There was a suggestion during the argument that in order to constitute a trust there must be some element of gift by the Settlor, but clearly this is not so. It is sufficient for the establishment of a trust if property is impressed with a trust obligation: see the general definition of a trust in Underhill's Law of Trusts and Trustees, 11th ed. 3. In all the circumstances of the present case I think that by virtue of the deed of assignment dated 24 August 1961 a new trust has been created in respect of the trust property hitherto held in terms of the Surrey trust. That property is now held by the appellant and his wife upon the trusts set forth in the Ritz trust deed." The Baldwin decision was applied in Tucker v Commissioner of Inland Revenue 1965 NZLR 1027 when Woodhouse J adopted the above passages in the following terms at pp 1030 - 1031: "With respect I agree with both these passages, and in my opinion they provide a useful basis for any exami |
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