1711. Trusts held to be a sham
March 2009 – Issue 115

Ever since the decision in Land and Agricultural Bank v Parker (2005) 2 SA 77 it has been clear that the Supreme Court of Appeal is awaiting an opportune case to declare that a particular trust’s assets are, in reality, the personal property of one or more of its trustees.

In that case, Cameron JA warned that –

"The courts will themselves in appropriate cases ensure that the trust form is not abused. …It may be necessary to go further and extend well-established principles to trusts by holding in a suitable case that the trustees’ conduct invites the inference that the trust form was a mere cover for the conduct of business ‘as before’, and that the assets allegedly vesting in trustees in fact belong to one or more of the trustees [and] that the trust form is a veneer that in justice should be pierced in the interests of creditors."

A test case now in the pipeline

Just such an "appropriate case" may now be in the pipeline, set in train by the decision of the Durban High Court in Nedbank Ltd v Thorpe (case 7392/2007; judgment delivered on 26 September 2008; not yet reported).

In this case, the bank had applied for the provisional sequestration of the estate of one Thorpe, arising out of a failure to recover a loan of some R6 million from a trust of which Thorpe was a trustee and a beneficiary, for which Thorpe had bound himself as surety.

Over an extended period preceding the litigation, Thorpe had done what attorneys, estate planners and investment advisers have for many years counselled their moneyed clients to do, namely to move all or the bulk of their growth assets out of their personal estate and into a trust, substantially controlled by themselves as trustees.

Conventional wisdom is that this ensures, not only that the growth in value of such assets is not subject to estate duty and capital gains tax on the individual’s death, but also that funds and assets held in the trust are not available to their personal creditors in the event of their insolvency.

In this case the respondent, Thorpe, admitted that he had no assets and was insolvent. He said that he was one of the trustees and one of the beneficiaries of a discretionary family trust that he had formed many years ago. He said that the Trust had been set up to care for his family –

"so as to ensure an independent source of income outside my estate to guard against the possibility that a financial disaster may befall me, as is common cause happened. That was a perfectly lawful and prudent thing to do …"

That may have been true as far as it goes, but it was the manner in which he thereafter used the trust that provoked his creditors’ wrath.

The use of a trust to quarantine assets from the claims of creditors

Nedbank contended that Thorpe had over the years been conducting his business via corporate entities or trusts; that he had established various family trusts which he used to insulate his wealth from creditors and thereby frustrate the efforts of his creditors to recover the debts owed to them; that, despite a prohibitory interdict, he had continued to carry on business as a short-term insurance broker; that Thorpe was a trustee and beneficiary of a discretionary family trust established by himself, namely the Banavie Trust (previously called the Robin Thorpe Family Trust); that this trust had made an expensive car available for his personal use; and that whenever he received funds or assets, he would transfer them to the trust.

Proving that sequestration would be to the advantage of creditors

The first hurdle that Nedbank, as the applicant creditor, had to overcome was to show that, as required by section 10 of the Insolvency Act –

"there is reason to believe that it will be to the advantage of creditors of the debtor if his estate is sequestrated"

In this regard, the Durban High Court, per Levinsohn DJP ruled that this requirement would be fulfilled if, on the facts placed before the court, it was satisfied that –

"there is a reasonable prospect – not necessarily a likelihood, but a prospect that is not too remote – that some pecuniary benefit will result to creditors. It is not necessary to prove that the insolvent has any assets. Even if there are none, but there are reasons for thinking that as a result of the inquiry under the [Insolvency] Act, some may be revealed or recovered, that is sufficient."

Nedbank’s argument in this regard was that –

"there is reason to believe that the respondent [Thorpe] is possessed of considerable financial assets which a trustee [of his insolvent estate] will uncover and this will be to the advantage of creditors"

and, in particular, that –

"the use of the Banavie Trust as a vehicle for [Thorpe’s] business activities constitutes an abuse of the institution of a trust and is simply a mechanism to shield his personal assets from creditors".

On the evidence of the affidavits placed before it, the Court accepted Nedbank’s argument in this regard, holding that –

"In my opinion, there is a prima facie case that there is a reasonable prospect that investigation and interrogation under the Insolvency Act will yield a not negligible pecuniary benefit to creditors."

This inference flowed from the conclusion that, on the evidence placed before the Court, there was –

"the strong suspicion that [Thorpe] is simply conducting his personal business through the trust and that the trust is simply the vehicle to do so. The impression is created that the remaining trustees, while notionally independent persons, may simply be doing [Thorpe’s] bidding. … In my view, there is a real prospect of [a forensic examination] showing that the trust is a mirage used by [Thorpe] for his own commercial ends."

In this dictum, the Court accepts the premise, articulated by the Supreme Court of Appeal in Land and Agricultural Bank v Parker that, as a matter of law, it is conceivable that, in appropriate circumstances –

"the assets allegedly vesting in trustees in fact belong to one or more of the trustees [and] that the trust form is a veneer that in justice should be pierced in the interests of creditors."

This proposition encompasses two distinct possibilities, one narrow and containable, the other broad and radical.

The narrow possibility – no divestment of particular funds or assets to the trust

The first possibility is that a court may find that, when the founder or a trustee remitted particular funds or transferred particular tangible assets to the trust, neither he nor the trust had the intention that they should, in reality, pass out of his de facto ownership or control.

In this regard, our courts have recognised the concept of a "disguised transaction", entered into in fraudem legis, as contemplated in Erf 3183/1 Ladysmith (Pty) Ltd v Commissioner for Inland Revenue (1996) (58 SATC 229), where the court quoted with approval from Zandberg v Van Zyl (1910) AD 302 at 309, where Innes J said that –

"Not frequently, however (either to secure some advantage which otherwise the law would not give, or to escape some disability which otherwise the law would impose), the parties to a transaction endeavour to conceal its real character. They call it by a name, or give it a shape, intended not to express but to disguise its true nature. And when a Court is asked to decide any rights under such an agreement, it can only do so by giving effect to what the transaction really is; not what in form it purports to be"

Thus, if a court were to find in a particular case that the founder of a trust or a trustee, when donating money to the trust, did not genuinely intend to divest himself of those funds, ownership in the money would have passed to the trust by virtue of the legal rule that property in money passes by commixtio (in other words, the ownership passes as soon as the recipient mingles the received money with his own funds) but that donor or his trustee in insolvency would have a right, in personam, to reclaim such moneys from the trust.

The broad and radical possibility – the trust itself was a sham that never came into existence

The more radical possibility, arguably implicit in Cameron JA’s dictum, is that, in certain circumstances, a trust may be a sham (what he called a "veneer" and what Levinsohn DJP in the Thorpe case called a "mirage") in other words that, at its inception, there was no intention to create a genuine trust.

This would arise where the founder and the first trustees, in giving their assent to the terms of the deed of trust, had no genuine intention to create the legal relationships inherent in a trust, but intended instead to create a mere façade – a pretence to conceal the reality that the founder or a trustee would remain, in every substantial respect, the owner or controller of the trust assets.

In such a situation, it is arguable that the trust – even though ostensibly duly formed, and registered in an office of the Master of the High Court – never came into existence at all.

In this regard, it should be borne in mind that a trust is not, save where a statute provides otherwise, a legal person in its own right. An inter vivos trust comes into existence as a contract entered into between the founder and the first trustees, in which the latter agree to administer the trust assets in accordance with the terms of the trust deed.

What is at stake is therefore not the creation of a legal persona, but merely pretence at the creation of a contractual arrangement.

The, the Companies Act provides that –

"A certificate of incorporation given by the Registrar in respect of any company shall, upon its mere production, in the absence of fraud, be conclusive evidence that …. The company is a company duly incorporated under the Act"

No similar statutory rule applies to a trust that is registered in the office of the Master of the High Court.

Nevertheless, for a court to declare a trust, duly registered in the office of the Master of the High Court, to have no existence in the eyes of the law, would give rise to a juridical nightmare, with potentially catastrophic consequences for innocent third parties.

Such parties may have done all that they could by way of a due diligence investigation into the authenticity of the trust deed, the trustees’ letters of authority, and the registration of the trust at the Master’s office, only to find later that they have contracted with a phantom that has no legal substance. It would, in short, be ruinous for legal certainty if a court were to hold that a duly registered trust was a sham with no legal existence.

There is, however, some precedent for an ostensibly duly-formed legal entity to be non-existent in the eyes of the law.

Thus, in terms of section 65 of the Close Corporations Act, where there has been a "gross abuse of the juristic personality of the corporation", a court may declare that the close corporation "is deemed not to be a juristic person".

In Airport Cold Storage (Pty) Ltd v Ebrahim (2008) 2 SA 303 (C) the Cape High Court applied this provision, and held that the sole member and the manager of the close corporation were jointly and severally liable for the debt owing to the plaintiff. On appeal, the Supreme Court of Appeal held that these individuals were personally liable in terms of the reckless trading provisions of the Close Corporations Act, but found it unnecessary to determine whether they were liable in terms of section 65 of the Act.


Close Corporations Act No. 69 of 1984: s 65